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Chapter 11

Certificate of Stock. Chapter 11. Stockholders’ Equity. Financial Accounting, Alternate 4e by Porter and Norton. Disadvantages. Advantages. Equity Financing: Issue Stock. Dividend flexibility Ready markets Often provides higher ROI than debt financing Borrowing may not be feasible.

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Chapter 11

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  1. Certificate of Stock Chapter 11 Stockholders’ Equity Financial Accounting, Alternate 4e by Porter and Norton

  2. Disadvantages Advantages Equity Financing: Issue Stock • Dividend flexibility • Ready markets • Often provides higher ROI than debt financing • Borrowing may not be feasible

  3. Advantages Disadvantages Equity Financing: Issue Stock • Less control • Dividends not tax deductible • Hurts some financial ratios

  4. Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings

  5. Income Statement for 2002 Revenues $ xxx Less: expenses xxx Net income $ 54,671 Relationships among Financial Statements – Winnebago Industries, Inc. Statement of Change in Stockholders’ Equity for 2002 Beginning balance, reinvested income $ 234,139 Add: Net income 54,671 Deduct: Cash dividends (3,954) Ending balance, reinvested income $ 284,856 Balance Sheet as of August 25, 2002 Total Assets $ xxx Total Liabilities xxx Capital Stock xxx Reinvested Earnings 284,856 Total Liabilities & Stockholders' Equity $ xxx

  6. Common Stock Preferred Stock Addt’l. Paid-In Cap. Retained Earnings Deduct: Treasury Stock Other Misc. Donated Capital Stockholders’ Equity Components

  7. Delta Air Lines Inc.Partial Balance Sheet (in millions) 20022001 Shareholders' equity: Common stock, $1.50 par value, 450 million shares authorized; 2002 – 180,903,373 issued; 2001 – 180,890,356 issued 271 271 Additional paid-in capital 3,263 3,267 Retained earnings 1,639 2,930 Accumulated other comprehensive income (loss) (1,562) 25 Treasury shares at cost: 2002 – 57,544,168; 2001 – 57,644,690 (1,716) (1,865) Total shareholders' equity 8933,769

  8. Certificate of Stock Contributed Capital • Common Stock • basic stock of corporation • has voting rights • represents ownership interest • Preferred Stock • optional • tailored to meet specific needs • provides dividend returns with less risk

  9. Maximum Allowable 1,000 Number of Shares of Stock Authorized Issued - sold & distributed Outstanding - not repurchased or retired

  10. Certificate of Stock $1.00 Par Value Par Value • “Legal capital” • Arbitrary amount stated on stock certificate • Also called “stated value”

  11. Certificate of Stock $1.00 Par Value 15 Additional Paid-in Capital • Amount received in excess of par or stated value of stock

  12. Retained Earnings • Net income retained in business (not paid out as dividends) since inception • Reinvested in a variety of assets (not necessarily liquid)

  13. $100 par, 7% Preferred Stock Preferred Stock • Can tailor to specific needs of firm • Stated dividend rate • Often carries dividend preference over common stock

  14. Cumulative Participating Callable Convertible 2002 2003 1 2 3 2004 4 5 6 7 8 9 10 1 2 3 11 12 13 14 15 16 17 4 5 6 7 8 9 10 1 2 3 18 19 20 21 22 23 24 11 12 13 14 15 16 17 4 5 6 7 8 9 10 25 26 27 28 29 30 31 18 19 20 21 22 23 24 11 12 13 14 15 16 17 25 26 27 28 29 30 31 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Preferred Common Preferred Stock Features

  15. Stock Issued for Cash Example: Assets = Liab. + O/E + Rev. – Exp. Cash 15,000 Common Stk. 10,000 Addtl. Paid in Cap. - Common 5,000 Common Stock $ 10,000 ( $10 par value x 1,000 shares) 1,000 shares of $10 par value stock sold for $15 per share Addt’l Paid-In Cap. $5,000 (($15 - $10) x 1,000 shares)

  16. Certificate of Stock Stock Issued for Noncash Consideration • Record at fair market value of consideration given or received, whichever is more readily determinable Title to land, building, etc.

  17. Certificate of Stock Treasury Stock • Company buys back its own stock • Contra-equity account (debit balance) • Not outstanding (no voting rights)

  18. Reasons for Repurchasing Stock • Provide for bonus or benefit plans • Maintain favorable market value • Improve financial ratios • Maintain control of ownership • Cash in on future price increases

  19. Presentation of Treasury Stock Common stock, $10 par, 1,000 shares issued, 900 outstanding$ 10,000 Additional paid-in capital 12,000 Retained earnings 15,000 37,000 Less: Treasury stock, 100 shares at cost ($25 per share) ( 2,500) Total stockholders’ equity $34,500

  20. Date dividend check for Jane Doe Dept.. of Treasurer on 1 2 3 1 2 3 4 5 6 7 8 9 10 4 5 6 7 8 9 10 11 12 13 14 15 16 17 11 12 13 14 15 16 17 18 19 20 21 22 23 24 18 19 20 21 22 23 24 25 26 27 28 29 30 31 25 26 27 28 29 30 31 Date of declaration Payment date Cash Dividends Paid to Stockholders on date of record

  21. Dividends Record dividends when declared; not when paid 12/31/03 1/15/04 Reduce retained earnings Pay dividends

  22. Dividend Requirements • Sufficient cash • Positive retained earnings

  23. Date Dividend check for Jane Doe I.M. Treasurer Dept. of Treasurer Dividend Payout Ratio Annual dividend Net income The % of earnings paid as dividends

  24. 2001 2002 1 2 3 4 5 6 7 8 9 10 2003 11 12 13 14 15 16 17 1 2 3 4 5 6 7 8 9 10 18 19 20 21 22 23 24 11 12 13 14 15 16 17 1 2 3 25 26 27 28 29 30 31 4 5 6 7 8 9 10 18 19 20 21 22 23 24 11 12 13 14 15 16 17 25 26 27 28 29 30 31 18 19 20 21 22 23 24 25 26 27 28 29 30 31 2004 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Allocation of Cash Dividends 1) Distribute dividends in arrears, if any, to preferred 2) Distribute current dividends to preferred 3) Distribute remainder to common (or to both if preferred is participating)

  25. Cash Dividends Example Stricker Company declares a $70,000 dividend for 2004 (no dividends were paid in 2002 or 2003). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

  26. Cash Dividends Example Noncumulative Preferred Stock PreferredCommon Step 1: Distribute current-year dividend to preferred (10,000 shares x $10 par x 8% x 1 yr.) $8,000 Step 2: Distribute remaining dividend to common ($70,000 - $8,000) $62,000 Total allocated $8,000 $62,000 $0.80 per share $1.55 per share

  27. Cash Dividends Example Cumulative Preferred Stock PreferredCommon Step 1: Distribute dividends in arrears to preferred (10,000 shares x $10 par x 8% x 2 yrs.) $16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares x $10 par x 8% x 1 yr.) 8,000 Step 3: Distribute remaining dividend to common ($70,000 - $24,000) $46,000 Total allocated $24,000 $46,000 $2.40 per share $1.15 per share

  28. Certificate of Stock Certificate of Stock Certificate of Stock Certificate of Stock Certificate of Stock Certificate of Stock Stock Dividends • Issue of additional shares proportionately to existing stockholders • Reasons: • insufficient cash • market price reduction • nontaxable to recipients

  29. Small Stock Dividend Example Before Dividend Stockholders’ Equity: Common stock, $10 par, 5,000 shares $ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total $150,000 Assume Shah Company declares 10% stock dividend; 500 shares @ $40 per share market value

  30. Small Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in cap. 30,000 45,000 Retained earnings 70,000 50,000 Total $ 150,000 $150,000 + + - $40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Div. Distributable) and Addtl. Paid-In Capital.

  31. Small Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in cap. 30,000 45,000 Retained earnings 70,000 50,000 Total $ 150,000 $150,000 + + - Total S/E is unchanged

  32. Large Stock Dividend Example Before Dividend Stockholders’ Equity: Common stock, $10 par, 5,000 shares $ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total $150,000 Assume Shah Company declares 100% stock dividend

  33. Large Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,00020,000 Total $ 150,000 $150,000 + - Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected.

  34. Total S/E is unchanged Large Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,000 20,000 Total $ 150,000 $150,000 + -

  35. Certificate of Stock Certificate of Stock $3 par value Certificate of Stock Certificate of Stock $1 par value Stock Splits • Results in additional issuance of shares • Reduces par value per share • No change in Stockholders’ Equity accounts

  36. Disclose in notes Stock Splits • Not recorded in accounts • Splits reduce market value per share and make stock more affordable to a wider range of investors

  37. 2-for-1 Stock Split Example Before Split Stockholders’ Equity: Common stock, $10 par, 5,000 shares$ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total $ 150,000 Assume Shah Company declares 2-for-1 stock split.

  38. 2-for-1 Stock Split Example BeforeAfter Stockholders’ Equity: Common stock, $5.00 par, 10,000 shares$ 50,000 $ 50,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,000 70,000 Total $ 150,000 $150,000 Only disclosures are affected All accounts are unchanged

  39. Statement of Retained Earnings Beginning retained earnings Add: Net income Subtract: Dividends = Ending retained earnings Statement of Stockholders’ Equity • Shows changes in all equity accounts including • Sales and Purchases of capital stock • Includes:

  40. Statement of Comprehensive Income Income Statement For Year Ended Dec. 31, 20xx Revenues xxx Expenses xxx Other gains and losses xxx Income before tax xxx Income tax expense xxx Net income xxx Statement of Comprehensive Income For Year Ended Dec. 31, 20xx Net income xxx Foreign currency translation adjustment xxx Unrealized holding gains/losses xxx Minimum pension liability adjustment xxx Other comprehensive income xxx Comprehensive income xxx Excluded from Inc. Stmt. Comprehensive income – the total change in net assets from all sources except investments by or distributions to the owners

  41. Analyzing Owners’ Equity • Book value per share • rights of each share to net assets of corporation • Market value per share • price at which stock is currently selling

  42. Book Value per Share Total Common Stockholders’ Equity # of Common Shares Outstanding • Rights of common stockholders in event of liquidation • Generally represents “floor” price of stock

  43. Book Value vs. Market Value Southwest Airlines’ 2002: Book value per share:$ 5.69 Market value per share: $16.42 (avg.) Which value would you expect to pay for a share of Southwest Airlines’ stock? What factors account for the difference between the two values?

  44. Stockholders’ Equity Items on the Statement of Cash Flows Operating Activities Net income xxx Investing Activities Financing Activities Issuance of stock + Retirement or repurchase of stock – Payment of dividends – 44

  45. Appendix Accounting Tools: Unincorporated Businesses

  46. Sole Proprietorships • Not a separate legal entity so owner has unlimited liability • Must keep personal and business records separate • Business income is declared on the owner’s personal tax return and taxed at personal tax rate

  47. Sole Proprietorships Owner’s withdrawal of assets from business: Assets = Liab. + O/E + Rev. – Exp. Equip. (6,000) Peter Tom, Drawing (6,000) Owners’ drawing or withdrawal accounts are contra-equity accounts

  48. Sole Proprietorships • Drawing or withdrawal and income summary accounts are closed to the owner’s capital account • Owner’s Equity section of the balance sheet consists of the capital account: Beginning balance $ 0 Plus: Investments 10,000 Net Income 4,000 Less: Withdrawals (6,000) Ending balance $ 8,000

  49. Partnerships • Unlimited liability • Limited life – partnership agreements can and do end • Not taxed as a separate entity

  50. Partnerships Distribution of income: • Equal distribution • Stated ratio • Other allocation • For example, based on salaries, interest on invested capital, and a stated ratio

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