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Ch.11 Shareholders’ Equity

Ch.11 Shareholders’ Equity. Prof. J. Wang. Part I: Introduction. Assets = Liabilities + Owners’ Equity. Part I: Introduction. Equity v. Debt Financing Advantage of equity financing: flexibility Advantage of debt financing: tax deductible,

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Ch.11 Shareholders’ Equity

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  1. Ch.11Shareholders’ Equity Prof. J. Wang

  2. Part I: Introduction Assets = Liabilities + Owners’ Equity

  3. Part I: Introduction • Equity v. Debt Financing • Advantage of equity financing: • flexibility • Advantage of debt financing: • tax deductible, • Benefit shareholders if the borrowing rate is lower than the rate of return using the borrowed money • Shareholders’ ownership interest is not diluted

  4. Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings Ch.9&10 Ch.11

  5. Part II: Contributed Capital • Common Stock • Basic stock of corporation • Normally carries voting rights • Preferred Stock • Optional • No voting rights

  6. $100 par, 7% preferred stock Preferred Stock • In exchange for giving up voting rights, have dividend preference over common stock • Stated dividend rate • Percentage of the stock’s par value • Per-share amount • Preferred dividends usually are cumulative LO2

  7. Maximum Allowable 1,000 Number of Shares of Stock Authorized Issued: sold or distributed Outstanding: not repurchased or retired

  8. Certificate of Stock $1.00 Par Value Par Value • “Legal capital” • Arbitrary amount (usually small) stated on stock certificate • Also called “stated value”

  9. Certificate of Stock $1.00 Par Value 15 Additional Paid-in Capital • Amount received in excess of par when stock was issued

  10. Example: Common Stock $ 10,000 ( $10 par value × 1,000 shares) 1,000 shares of $10 par value stock sold for $15 per share Additional Paid-In Capital $5,000 (($15 – $10) × 1,000 shares) Stock Issued for Cash Journal entry: Cash 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000 To record the issuance of 1,000 shares of $10 common stock at $15 per share. LO3

  11. 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.

  12. Example: Common Stock $ 10,000 ( $10 par value × 1,000 shares) issued1,000 shares of $10 par value stock For land with a fair value of $15,000 Additional Paid-In Capital $5,000 Stock Issued for Non-cash Assets Journal entry: Land 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000 To record the issuance of 1,000 shares of $10 common stock for land. LO3

  13. Part III: Retained Earnings

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

  15. Retained Earnings • Increases when net income is earned • Decreases when dividends are paid

  16. Retained Earnings Connects the Income Statement and the Balance Sheet Income Statement Revenues $ xxx Less: Expenses xxx Net Income $ inc Statement of Retained Earnings Retained Earnings, Beginning Balance $ xxx Add: Net Incomeinc Deduct: Dividends xxx Retained Earnings, Ending Balance $ end Balance Sheet Total Assets $ xxx Total Liabilities xxx Stockholders’ Equity xxx Retained Earnings end Total Liabilities and Stockholders' Equity $ xxx

  17. Cash Dividend Requirements • Sufficient cash • Positive retained earnings

  18. 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 Payment date Date of declaration Cash Dividends Paid to Stockholders on date of record

  19. Dividends Journal entry required to record: (1) 12/31/06, $5,000 cash dividends declared (2) 1/15/07, $5,000 cash dividends were paid 12/31/06 1/15/07 Reduce retained earnings Pay dividends

  20. Date dividend check for Jane Doe Dept.. of Treasurer Recording Cash Dividends Retained Earnings 5,000 Cash Dividend Payable 5,000 To record the declaration of a cash dividend on 12/31/06. Cash Dividend Payable 5,000 Cash 5,000 To record the payment of a cash dividend on 1/15/07.

  21. If the company has preferred stocks outstanding then dividends must be divided between common and preferred shareholders • If preferred dividends are cumulative, preferred shareholders will receive dividends in arrears and for the current year before common shareholders receive any dividends. • If preferred dividends are non-cumulative, preferred shareholders will only receive dividends for the current year before common shareholders receive theirs.

  22. 2004 1 2 3 2005 4 5 6 7 8 9 10 11 12 13 14 15 16 17 1 2 3 2006 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 2007 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 Dividendswhen preferred stock is cumulative • Distribute dividends in arrears, if any, to preferred • Distribute current year’s dividends to preferred • Distribute remainder to common (or to both if preferred is participating) LO5

  23. Cash Dividends Example Stricker Company declares a $70,000 dividend in 2007 (no dividends were paid in 2005 or 2006). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

  24. Cash Dividends Example Noncumulative Preferred Stock To Preferred To Common Step 1: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) $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

  25. Cash Dividends Example Cumulative Preferred Stock To Preferred To Common Step 1: Distribute dividends in arrears to preferred (10,000 shares × $10 par × 8% × 2 years) $16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) 8,000 Step 3: Distribute remainder to common ($70,000 – $8,000) $46,000 Total allocated $24,000 $46,000 $0.80 per share $1.55 per share

  26. 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 LO6

  27. Small Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Dividend Assume Shah Company declares a 10% stock dividend; 500 additional shares will be issued. Assume that market value Per share at the time is $40.

  28. Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings - $20,000 +$20,000

  29. Small Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par,5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity $150,000 $150,000 + + – $20,000 ($40*500) market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) ($10*500) and Additional Paid-In Capital ($30*500).

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

  31. Large Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Dividend Assume Shah Company declares 100% stock dividend That is, additional 5,000 shares will be issued

  32. Large Stock Dividend Example BeforeAfter Stockholders’ Equity: Common stock, $10 par,10,000 shares $ 50,000 $100,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 20,000 Total stockholders’ equity $150,000 $150,000 + – Retained earnings is reduced by the total par value It’s recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected.

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

  34. 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 LO 7

  35. Disclose in notes Stock Splits • Not recorded in accounts • Reduce market price per share and make the stock more accessible to a wider range of investors

  36. 2-for-1 Stock Split Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Split Assume Shah Company declares 2-for-1 stock split

  37. 2-for-1 Stock Split Example Stockholders’ Equity: Common stock, $5 par,10,000 shares $ 50,000 $ 50,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 70,000 Total stockholders’ equity $150,000 $150,000 BeforeAfter All accounts are unchanged Only disclosures are affected

  38. Certificate of Stock Part IV: Treasury Stock • Company buys back its own stock • Contra-equity account (debit balance) • Not outstanding (no voting rights) LO4

  39. Reasons for Repurchasing Stock • Provide for employee bonuses or benefit plans • Maintain a favorable market price • Improve financial ratios • Maintain control of ownership • Prevent unwanted takeover or buyout attempts

  40. For example, the company purchased 100 shares of its own outstanding stock at $25 per share Dr. Treasury Stock 2,500 Cr. Cash 2.500 Assets = Liabilities + Stockholders’ Equity -$2,500 -$2,500

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

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