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Chapter 11

Chapter 11. `. Chapter 11 Reporting and Analyzing Stockholders’ Equity. After studying Chapter 11, you should be able to: Identify and discuss the major characteristics of a corporation. Record the issuance of common stock. Explain the accounting for purchase of treasury stock.

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Chapter 11

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  1. Chapter 11 `

  2. Chapter 11 Reporting and Analyzing Stockholders’ Equity After studying Chapter 11, you should be able to: • Identify and discuss the major characteristics of a corporation. • Record the issuance of common stock. • Explain the accounting for purchase of treasury stock. • Differentiate preferred stock from common stock.

  3. Chapter 11 Reporting and Analyzing Stockholders’ Equity After studying Chapter 11, you should be able to: • Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits. • Identify the items that affect retained earnings. • Prepare a comprehensive stockholders' equity section. • Evaluate a corporation's dividend and earnings performance from a stockholder's perspective.

  4. Corporation • Possess legal entity • Created by law • Has most of the rights and privileges of a person • Classified by purpose and ownership • Purpose - profit or nonprofit • Ownership - publicly or privately held

  5. Characteristics of a Corporation • Separate legal existence • Limited liability of stockholders • Transferable ownership rights • Ability to acquire capital • Continuous life • Corporation management • Government regulations • Additional taxes

  6. Stock Certificate Shows... • name of the corporation • stockholder's name • class and special features of the stock • the number of shares owned • the signatures of duly authorized corporate officials.

  7. Authorized Stock... Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter. OutstandingStock... Number of shares of issued stock that are being held by stockholders.

  8. Corporations Can Issue Stock... • Directly to investors (typical in privately held corporations). • Indirectly through an investment banking firm (customary with publicly held corporations).

  9. Par Value Stock... • Is capital stock that has been assigned an arbitrary value per share in the corporate charter. • Is usually low because some states levy a tax on the corporation based on par value. • The legal capital per share that must be retained in the business.

  10. No-Par Value Stock... • Capital stock that has not been assigned a value per share in the corporate charter. Stated Value of No-Par Stock • Amount per share assigned by the board of directors to no-par stock. Par Value and Stated Value have NO relationship to market value.

  11. Stockholders’ Equity Section of a Corporation’s Balance Sheet... Two Parts: • Paid-in (contributed) capital • Retained earnings (earned capital).

  12. Paid-in Capital... Amount paid to corporation by stockholders for shares of ownership. Retained Earnings... Earned capital held for future use in the business.

  13. Accounting for Common Stock Issues • The issue of common stock affects only paid-in capital accounts. • When the issuance of common stock for cash is recorded, the par value of the shares is credited to common stock. • The portion of the proceeds above or below par value is recorded in an additional paid-in capital account.

  14. Issuing Stock Above Par If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is: Cash 5,000 Common Stock 1,000 Paid-in Capital in 4,000 Excess of Par Value

  15. Hydro-Slide, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock, par value $ 2,000 Additionalpaid-in capital 4,000 Total paid-in capital $ 6,000 Retained earnings 27,000 Total stockholders' equity $33,000

  16. Mead, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and outstanding $ 500,000 Retained Earnings 200,000 Total stockholders’ equity $ 700,000 BEFORE TREASURY STOCK TRANSACTION

  17. Treasury Stock... Is a corporation's own stock • that has been issued • fully paid for • reacquired by the corporation • held in its treasury for future use.

  18. Corporations Acquire Treasury Stock to... • Reissue shares to officers and employees under bonus and stock compensation plans. • Increase trading of company's stock in securities market in hopes of enhancing market value. • Have additional shares available for use in acquisition of other companies. • Reduce number of shares outstanding thereby increasing earnings per share. • Prevent a hostile takeover.

  19. Purchase of Treasury Stock On February 1, 2004, Mead acquires 4,000 shares of its stock at $8 per share. Treasury Stock 32,000 Cash 32,000

  20. Treasury Stock • The Treasury Stock account would increase by the cost of the shares purchased - $32,000. • The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change. • Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet.

  21. Mead, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and 96,000 outstanding $ 500,000 Retained Earnings 200,000 Total stockholders’ equity 700,000 Less: Treasury Stock 32,000 Total stockholders’ equity $ 668,000 AFTER TREASURY STOCK TRANSACTION

  22. Preferred Stock... Capital stock that has contractual preferences over common stock in certain areas. • Dividends • Assets in the event of liquidation Preferred stockholders do not have voting rights.

  23. Preferred Stock • Assume Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Cash 120,000 Preferred Stock 100,000 Paid-in Capital in Excess 20,000 of Par Value--Preferred Stock (Preferred stock may have either a par value or no-par value.)

  24. Dividend Preferences • Preferred stockholders have the right to share in the distribution of corporate income before common stockholders. • The first claim to dividends does not guarantee dividends.

  25. Cumulative Dividend... Is a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

  26. Dividends in Arrears... • Are preferred dividends that were scheduled but were not declared during a given period. • Are not a liability. No liability exists until a dividend is declared by board of directors. • Must be disclosed in the notes to the financial statements.

  27. Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. The annual dividend is $35,000 (5,000 x $7 per share). Dividends are 2 years in arrears Dividends in Arrears Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000

  28. Liquidation Preference Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.

  29. Dividend... • Is a distribution by a corporation to its stockholders on a pro rata basis. • Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend. • Dividend forms: • cash • stock

  30. Cash Dividend • Is a pro rata distribution of cash to stockholders. • A corporation must have 2 things to pay cash dividends: • Retained earnings • Adequate cash

  31. Cash Dividend • In many states, payment of dividends from legal capital is illegal. • Payment of dividends from paid-in capital in excess of par is legal in some states. • Payment of dividends from retained earnings is legal in all states. • Companies are frequently constrained by agreements with lenders to pay dividends only from retained earnings.

  32. Entries for Cash Dividends Three dates are important in connection with dividends: • the declaration date • the record date • the payment date

  33. On December 1, 2004, the directors of Media General declare a $.50 per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000 x $.50). 12/1 Retained Earnings 50,000 Dividends Payable 50,000 The Declaration Date... • Is the date the board of directors declares the cash dividend. • Commits the corporation to a binding legal obligation that cannot be rescinded.

  34. The Payment Date... • The date dividend checks are mailed. • January 20 is the payment date for Media General. • Jan 20 Dividends Payable 50,000 • Cash 50,000 The Record Date... The date ownership of the outstanding shares is determined for dividend purposes. Dec 20 No Entry Necessary.

  35. A Stock Dividend... • Is a pro rata distribution of the corporation's own stock to stockholders. • Is paid in stock. • Results in a decrease in retained earnings and an increase in paid-in capital. • Does not decrease total stockholders' equity or total assets. • Is often issued by companies that do not have adequate cash to issue a cash dividend.

  36. Stock Dividends • You have a 2% ownership interest in Cetus Inc., owning 20 of its 1,000 shares of common stock. • In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22 /1,100). • You now own more shares of stock, but your ownership interest has not changed.

  37. Reasons for Stock Dividends • To satisfy stockholders' dividend expectations without spending cash. • To increase marketability of its stock by increasing number of shares outstanding and decreasing market price per share. • To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends.

  38. Stock Dividends • A small stock dividend (less than 20%-25% of the corporation's issued stock) is recorded at the fair market value per share. • A large stock dividend (greater than 20%-25% of the corporation's issued stock) is recorded at par or stated value per share.

  39. Stock Dividends • Medland Corporation has $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. • The current fair market value of the stock is $15 per share. • Retained Earnings 75,000 • Common Stock Dividends 50,000 DistributablePaid-in Capital in Excess 25,000 of Par Value

  40. Stock Split... • Is the issuance of additional shares of stock to stockholders accompanied by: • A reduction in the par or stated value. • An increase in number of shares. • A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders' equity.

  41. Stock Split • Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.

  42. Retained Earnings... • Is net income that is retained in the business. • The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation. • Retained earnings does not represent a claim on any specific asset.

  43. Deficit... Is a debit balance in retained earnings and is reported as a deduction in the stockholders' equity section of the balance sheet.

  44. Retained Earnings Restrictions... Are legal, contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends.

  45. Stockholders Equity With Deficit • AMAZON.COM • Balance Sheet (Partial) • December 31, 2000 • (in thousands) Stockholders' equity Paid-in capital Common Stock $ 3,571 Paid-in capital in excess of par value 1,322,479 Total paid-in capital 1,326,050 Accumulated Deficit 2,293,301 Total stockholders’ equity (deficit) $ (967,251)

  46. Stockholders Equity Section • Kmart, Inc. • Balance Sheet (Partial) • (in millions) Stockholders' equity Common stock, $.01 par value; 1,500,000,000 shares authorized -- 250,000,000; 503,294,515 shares issued $ 503 Capital in excess of par value 1,695 Retained earnings 1,261 Total stockholders' equity$ 3,459

  47. SARA LEE CORPORATION Statement of Cash Flows (partial) For the Year Ended June 30,2001 (in millions) Cash flow from Financing Activities Issuance of common stock $ 104 Purchase of common stock (643) Payment of dividends (486) Borrowing of long-term debt 1,023 Repayment of long-term debt (390) Short-term (repayments)borrowing (1,914) Net cash used in financing activities (2,306)

  48. The Payout Ratio = CASH DIVIDENDS DECLARED ON COMMON STOCK NET INCOME … measures the percentage of earnings distributed in the form of cash dividends to common stockholders.

  49. ...measures the profitability from the stockholders’ point of view. Return on Equity Ratio = NET INCOME - PREFERRED STOCK DIVIDENDS AVERAGE COMMON STOCKHOLDERS’ EQUITY

  50. Advantages of Bond Financing Over Common Stock

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