Stockholders’ Equity

1. Stockholders’ Equity Chapter 9 ©2009 Pearson Prentice Hall. All rights reserved.

2. Learning Objective 1 Explain the features of a corporation ©2009 Pearson Prentice Hall. All rights reserved.

3. Characteristics of a Corporation Separate Legal Entity Corporation distinct from owners; artificial person Continuous Life/Transfer of Ownership: Company continues to exist & operate regardless of ownership changes Separation of Ownership & Management: Stockholders elect Board of Directors who, in turn, appoint officers Limited Liability Stockholders are not personally liable for corporate debts Corporate Taxation Corporations are taxed on their earnings; dividends distributed to owners are also taxed Government Regulation Corporate activities are monitored by government regulations ©2009 Pearson Prentice Hall. All rights reserved.

4. Organizing a Corporation • Incorporators • Organize the corporation • Pay fees • Sign charter • File documents with the state • Agree to bylaws ©2009 Pearson Prentice Hall. All rights reserved.

5. Authority Structure in a Corporation Stockholders Elect the Board of Directors which elects the Chair of the Board (CEO) and the President (Chief Operating Officer) who leads Vice Presidents and other corporate officers who Manage the day-to-day operations ©2009 Pearson Prentice Hall. All rights reserved.

6. Stockholders’ Rights • Vote at stockholder meetings • Receive dividends • Receive share if corporation liquidates • Maintain proportionate ownership • Preemptive right ©2009 Pearson Prentice Hall. All rights reserved.

7. Parts of Stockholders’ Equity • Paid-in capital • Represents amounts contributed by stockholders • Include stock accounts • Retained earnings • Amounts earned and kept by the corporation ©2009 Pearson Prentice Hall. All rights reserved.

8. Common Basic form of common stock Have rights of ownership Benefit most of company succeeds Risk most if company does not succeed Preferred Have preference in receiving dividends and assets in case of liquidation Hybrid between common stock and debt Rare for corporations to issue Classes of Stock ©2009 Pearson Prentice Hall. All rights reserved.

9. Par value Arbitrary amount assigned to share of stock In most states, represents minimum price for shares Legal capital No-par Does not have a par value May have a stated value Classes of Stock ©2009 Pearson Prentice Hall. All rights reserved.

10. Learning Objective 2 Account for the issuance of stock ©2009 Pearson Prentice Hall. All rights reserved.

11. Issuing Common Stock at Par • A company issues 100,000 shares of $5 par value common stock at par • The common stock account is always credited in the amount of the shares issued multiplied by par value ©2009 Pearson Prentice Hall. All rights reserved.

12. Issuing Common Stock Above Par • A company issues $100,000 shares of $5 par value stock for $12 per share • The amount above par is credited to Paid-in Capital in Excess of Par (100,000 shs x $12 price) (100,000 shs x $5 par) What amount will make the entry balance? ©2009 Pearson Prentice Hall. All rights reserved.

13. Issuing Common Stock for Noncash Assets • Assets recorded at their fair values • Common stock and paid-in capital credited accordingly • Suppose a company purchased equipment valued at $800,000 by issuing 50,000 shares of its $5 par common stock Fair value of equipment Shares issued x par value ©2009 Pearson Prentice Hall. All rights reserved.

14. Preferred Stock • Follows the same pattern as common stock entries • Preferred stock is credited for the shares issued multiplied by the par value • A separate paid-in capital account is used if stock is issued above par ©2009 Pearson Prentice Hall. All rights reserved.

15. Authorized, Issued and Outstanding • Authorized – maximum number of shares company can issue as indicated in its charter • Issued – number of shares company has sold to shareholders • Outstanding – number of shares currently in shareholders’ possession • Any difference between issued and outstanding is due to treasury stock ©2009 Pearson Prentice Hall. All rights reserved.

16. Learning Objective 3 Describe how treasury stock affects a company 5-16 ©2009 Prentice Hall ©2009 Pearson Prentice Hall. All rights reserved.

17. Treasury Stock • Company’s own stock that it has issued and later reacquired • Reasons: • All authorized shares have been issued and shares are needed for employee stock purchase plans • Company wants to purchase its shares at a low price and the re-issue them at a higher price • Management want to avoid a takeover ©2009 Pearson Prentice Hall. All rights reserved.

18. Accounting for Treasury Stock • Recorded at cost (not par value) • Contra-equity account (debit balance) • Reduces stockholders’ equity and assets • If sold above, paid-in capital from treasurystock transactions is credited ©2009 Pearson Prentice Hall. All rights reserved.

19. Accounting for Treasury Stock • Suppose a company purchased 10,000 shares of its own $1 par common stock for $200,000 ©2009 Pearson Prentice Hall. All rights reserved.

20. Accounting for Treasury Stock • Later, the company resells the treasury shares for $250,000 Amount company paid to buy shares ©2009 Pearson Prentice Hall. All rights reserved.

21. Retained Earnings • Balance = Net incomes – net losses – dividends declared • Accumulated earnings the company keeps • Not a reservoir of cash • Normal credit balance • Debit balance = Deficit • Losses and dividends exceed earnings ©2009 Pearson Prentice Hall. All rights reserved.

22. Learning Objective 4 Account for dividends ©2009 Pearson Prentice Hall. All rights reserved.

23. Dividends • Distribution to stockholders • Three forms • Cash • Stock • Noncash assets ©2009 Pearson Prentice Hall. All rights reserved.

24. Cash Dividends • Company must have both: • Enough Retained Earnings to declare the dividend • Enough Cash to pay the dividend • Board of Directors has authority to declare the dividend ©2009 Pearson Prentice Hall. All rights reserved.

25. Dividend Dates • Date of Declaration • Board of Directors announces dividend • Corporation is now obligated to pay • Date of record • Stockholders who own shares on this date will receive dividend • Date of payment • Payment sent to shareholders on record ©2009 Pearson Prentice Hall. All rights reserved.

26. Accounting for Dividends • Date of Declaration Equity Decreases; Liabilities Increase ©2009 Pearson Prentice Hall. All rights reserved.

27. Accounting for Dividends • Date of Record – no entry • Date of Payment Liabilities Decrease; Assets Decrease ©2009 Pearson Prentice Hall. All rights reserved.

28. Retained Earnings Beginning Balance Dividends Declared Net Income Ending Balance If retained earnings increases, net income > dividends If retained earnings decreases, net income < dividends ©2009 Pearson Prentice Hall. All rights reserved.

29. Preferred Dividends • Preferred shareholders receive dividends before common shareholders • Dividend rate expressed as: • Percent of par value • Dollar amount per share • Cumulative – any unpaid dividends are carried forward until paid • Dividends in arrears ©2009 Pearson Prentice Hall. All rights reserved.

30. Preferred Dividend Example • A corporation has 10,000 shares of $100, 8% cumulative preferred stock outstanding • It also has 80,000 shares of $1 par common stock outstanding • The Board of Directors declares dividends as follows: • Year 1 = $ 20,000 • Year 2 = $150,000 ©2009 Pearson Prentice Hall. All rights reserved.

31. Preferred Dividend Example Preferred Dividend : 10,000 shares x $100 par x 8% = $80,000 ©2009 Pearson Prentice Hall. All rights reserved.

32. Stock Dividends • Proportional distribution of shares to stockholders • Reasons corporations distribute stock dividends: • Provide dividend, yet conserve cash • Reduce market price of shares • Decrease retained earnings and increase common stock • Total equity is unchanged ©2009 Pearson Prentice Hall. All rights reserved.

33. Stock Dividends • Small • Less than 25% of outstanding shares • Recorded at market value • Large • Greater than 25% of outstanding shares • Recorded at par value ©2009 Pearson Prentice Hall. All rights reserved.

34. E9-27 • 10% stock dividend – small: recorded at market value • 10% x 500,000 shares issued = 50,000 • Market value = $17 per share Shares issued x market value Shares issued x par ©2009 Pearson Prentice Hall. All rights reserved.

35. E9-27 Increase by shares in stock dividends ©2009 Pearson Prentice Hall. All rights reserved.

36. Stock Splits • Increase in shares coupled with a proportionate reduction in par value • 2-for-1 split doubles the shares outstanding and halves the par value • No entry made • Description of stock changed on balance sheet ©2009 Pearson Prentice Hall. All rights reserved.

37. Summary of Transaction Effects ©2009 Pearson Prentice Hall. All rights reserved.

38. Learning Objective 5 Use stock values in decision making ©2009 Pearson Prentice Hall. All rights reserved.

39. Stock Value Terms Price one can buy or sell one share of stock for; varies with company performance and economy Market value Set price company is required to pay to retire preferred stock Redemption value Required payment to preferred shareholders if the company liquidates Liquidation value Common equity # of common shares outstanding Book value ©2009 Pearson Prentice Hall. All rights reserved.

40. Learning Objective 6 Compute return on assets and return on equity ©2009 Pearson Prentice Hall. All rights reserved.

41. Return on Assets (ROA) • Measures company’s use of assets to earn income for financers of the business • Creditors • Stockholders Net income + Interest expense Average total assets ©2009 Pearson Prentice Hall. All rights reserved.

42. Return on Equity (ROE) • Shows relationship between net income and equity • Computed only on common stock • Should be higher than return on assets • Stockholders risk more than bondholders Net income – Preferred dividends Average common stockholders’ equity ©2009 Pearson Prentice Hall. All rights reserved.

43. Learning Objective 7 Report equity transactions on the statement of cash flows ©2009 Pearson Prentice Hall. All rights reserved.

44. Equity Transactions on the Cash Flow Statement • All equity transactions are financing activities • Financing inflow • Issuing stock • Financing outflow • Purchase of treasury stock • Payment of dividends ©2009 Pearson Prentice Hall. All rights reserved.

45. End of Chapter 9 ©2009 Pearson Prentice Hall. All rights reserved.