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CHAPTER15

StockholdersEquity
ASSIGNMENTCLASSIFICATIONTABLE(BY TOPIC)
Topics 1. Corporate form: capital stock system. 2. Stockholders equity components. 3. Issuance of stock. Questions 1, 2 Brief Exercises Exercises Problems Conceptsfor Analysis 1, 3

3, 4, 5, 6, 16, 18 7, 10

7, 10, 11, 16, 17, 18 1, 2, 4, 6, 9, 18 3, 4, 5, 6, 18

1, 2, 3, 9, 12 1, 3, 4, 9 12 1, 4, 9, 12

1, 3

1, 2, 6

4. Lump sum sales; noncash stock transactions; stock issue costs. 5. Treasury stock transactions. 6. Preferred stock. 7. Dividend policy. 8. Cash, property, and liquidating dividends. 9. Restrictions of retained earnings. 10. Stock dividends and stock splits. 11. Analysis of stockholders equity. 12. Presentation of stockholders equity.

8, 9, 10

4, 5, 6

11, 12, 16, 17 3, 13, 14, 15 19, 20, 21 16, 22, 25 27, 28

7, 8

6, 7, 9, 10, 18 8 12, 16 8, 12, 15, 16, 18

1, 2, 3, 5, 6, 7, 9, 12 1, 3, 12 7, 10 3, 6, 7, 8, 10, 11

6, 7

9 10, 11, 12 10, 11, 12

5, 7 5, 6

22, 23, 24

13, 14

13, 14

8, 9, 11

4, 5

10, 19, 20

15, 18

7, 8, 10, 11, 16, 17, 18 21, 22, 23, 24

1, 2, 3, 5, 6, 9, 11, 12

3, 6

*13. Dividend preferences and book value.

29

15

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*This material is covered in an Appendix to the chapter.

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ASSIGNMENTCLASSIFICATIONTABLE(BY LEARNINGOBJECTIVE)
Brief Exercises

LearningObjectives 1. Discuss the characteristics of the corporate form of organization. Identify the key components of stockholders equity. Explain the accounting procedures for issuing shares of stock. Describe the accounting for treasury stock.

Exercises

Problems

2.

3.

1, 2, 4, 5, 6

1, 2, 3, 4, 5, 6, 8, 9, 10 6, 7, 9, 10, 18

1, 3, 4, 9, 12

4.

3, 7, 8

1, 2, 3, 5, 6, 7, 9, 12 4

5.

Explain the accounting for and reporting of preferred stock. Describe the policies used in distributing dividends. Identify the various forms of dividend distributions. Explain the accounting for small and large stock dividends, and for stock splits. Indicate how to present and analyze stockholders equity. Explain the different types of preferred stock dividends and their effect on book value per share. Compare the procedures for accounting for stockholders equity under GAAP and IFRS.

6.

10, 11, 12

16

7.

11, 12

11, 12, 15, 16, 18 11, 13, 14, 15, 16, 18 17, 19, 20

3, 6, 7, 8, 9, 11, 12 3, 8, 10, 11, 12 1, 2, 6, 9, 11, 12

8.

13, 14

9.

*10.

15

21, 22, 23, 24

*11.

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ASSIGNMENTCHARACTERISTICSTABLE
Item E15-1 E15-2 E15-3 E15-4 E15-5 E15-6 E15-7 E15-8 E15-9 E15-10 E15-11 E15-12 E15-13 E15-14 E15-15 E15-16 E15-17 E15-18 E15-19 E15-20 *E15-21 *E15-22 *E15-23 *E15-24 P15-1 P15-2 P15-3 P15-4 P15-5 P15-6 P15-7 P15-8 P15-9 P15-10 P15-11 P15-12 CA15-1 CA15-2 CA15-3 CA15-4 CA15-5 CA15-6
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Description Recording the issuances of common stock. Recording the issuance of common and preferred stock. Stock issued for land. Lump-sum sale of stock with bonds. Lump-sum sales of stock with preferred stock. Stock issuances and repurchase. Effect of treasury stock transactions on financials. Preferred stock entries and dividends. Correcting entries for equity transactions. Analysis of equity data and equity section preparation. Equity items on the balance sheet. Cash dividend and liquidating dividend. Stock split and stock dividend. Entries for stock dividends and stock splits. Dividend entries. Computation of retained earnings. Stockholders equity section. Dividends and stockholders equity section. Comparison of alternative forms of financing. Trading on the equity analysis. Preferred dividends. Preferred dividends. Preferred stock dividends. Computation of book value per share. Equity transactions and statement preparation. Treasury stock transactions and presentation. Equity transactions and statement preparation. Stock transactionslump sum. Treasury stockcost method. Treasury stockcost methodequity section preparation. Cash dividend entries. Dividends and splits. Stockholders equity section of balance sheet. Stock dividends and stock split. Stock and cash dividends. Analysis and classification of equity transactions. Preemptive rights and dilution of ownership. Issuance of stock for land. Conceptual issuesequity. Stock dividends and splits. Stock dividends. Stock dividend, cash dividend, and treasury stock.

Level of Difficulty Simple Simple Simple Moderate Simple Moderate Moderate Moderate Moderate Moderate Simple Simple Simple Simple Simple Simple Moderate Moderate Moderate Moderate Simple Moderate Complex Moderate Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Simple Moderate Simple Complex Moderate Moderate Moderate Simple Simple Moderate

Time (minutes) 1520 1520 1015 2025 1015 2530 1520 1520 1520 2025 1520 1015 1015 1012 1015 0510 2025 3035 2025 1520 1015 1520 1520 1015 5060 2535 2530 2030 3040 3040 1520 2025 2025 3545 2535 3545 1020 1520 2530 2530 1520 2025

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CA15-7

Treasury stock, ethics.

Moderate

1015

*This material is presented in an appendix to the chapter.

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LEARNINGOBJECTIVES
1. 2. 3. 4. 5. 6. 7. 8. 9. *10. Discuss the characteristics of the corporate form of organization. Identify the key components of stockholders equity. Explain the accounting procedures for issuing shares of stock. Describe the accounting for treasury stock. Explain the accounting for and reporting of preferred stock. Describe the policies used in distributing dividends. Identify the various forms of dividend distributions. Explain the accounting for small and large stock dividends, and for stock splits. Indicate how to present and analyze stockholders equity. Explain the different types of preferred stock dividends and their effect on book value per share. *11. Compare the procedures for accounting for stockholders equity under GAAP and IFRS.

*This material is covered in an Appendix to the chapter.

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CHAPTERREVIEW
1. Chapter 15 focuses on the stockholders equity section of the corporate form of business organization. Stockholders equity represents the amount that was contributed by the shareholders and the portion that was earned and retained by the enterprise. There is a definite distinction between liabilities and stockholders equity that must be understood if one is to effectively grasp the accounting treatment for equity issues. This chapter addresses the accounting issues related to capital contributed by owners of a business organization, and the means by which profits are distributed through dividends. The CorporateFormof Organization 2. (L.O. 1)The corporate form of business organization begins with the submitting of articles of incorporation to the state in which incorporation is desired. Assuming the requirements are properly fulfilled, the corporation charter is issued and the corporation is recognized as a legal entity subject to state law. The laws of the state of incorporation that govern owners equity transactions are normally set out in the states business corporation act. 3. Within a given class of stock, each share is exactly equal to every other share. A persons percent of ownership in a corporation is determined by the number of shares he or she possesses in relation to the total number of shares owned by all stockholders. 4. In the absence of restrictive provisions, each share carries the right to share proportionately in: (a) profits, (b) management,(c) corporateassets uponliquidation, and (d) any new issuesof stock of the sameclass(preemptiveright). ShareSystem 5. The transfer of ownership between individuals in the corporate form of organization is accomplished by one individual selling or transferring his or her shares to another individual. The only requirement in terms of the corporation involved is that it be made aware of the name of the individual owning the stock. A subsidiary ledger of stockholders is maintained by the corporation for the purpose of dividend payments, issuance of stock rights, and voting proxies. Many corporations employ independent registrars and transfer agentswho specialize in providing services for recording and transferring stock. 6. The basic ownership interest in a corporation is represented by common stock. Common stock is guaranteed neither dividends nor assets upon dissolution of the corporation. Common stockholders are considered to hold a residual interest in the corporation. However, common stockholders generally control the management of the corporation and tend to profit most if the company is successful. In the event that a corporation has only one authorized issue of capital stock, that issue is by definition common stock, whether or not it is so designated in the charter.

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CorporateCapital 7. (L.O. 2)Owners equity in a corporation is defined as stockholders equity, share holders equity, or corporate capital. The following categories normally appear as part of stockholders equity. a. Capital stock. b. Additional paid-in capital. c. Retained earnings. StockholdersEquity:ContributedCapital 8. Capital stock and additional paid-in capital constitute contributed (paid-in) capital; retained earnings represents the earned capital of the company not distributed as dividends. Contributed capital (paid-in capital) is the total amount paid in on capital stock. Earned capital is the capital that develops from profitable operations. 9. Stockholders equity is the difference between the assets and the liabilities of the companyalso known as the residual interest. Stockholders equity is not a claim to specific assets, but a claim against a portion of the total assets. Accountingfor the Issuanceof Stock 10. (L.O. 3)The par value of a stock has no relationship to its fair value. Par value associated with most capital stock issues is generally very low. Low par values help companies avoid the contingent liability associated with stock that is issued below par. 11. When par valuestockis issued, the capital stock (common or preferred) account is credited for an amount equal to par value times the number of shares issued. Any amount received in excess of par value is credited to additional paid-in capital. For example, if 200 shares of common stock with a par value of $2 per share are sold for $500, the following journal entry would be made: Cash................................................................................. Common Stock (200 $2).......................................... Paid-in Capital in Excess of Par................................. 500 400 100

Par value stock is always credited at its issue date for its par value times the number of shares issued. 12. When no-par stock is issued, the capital stock account is credited for an amount equal to the value of the consideration received. If no-par stock has a stated value, it may be accounted for in the same way as true no-par stock with the entire proceeds from issuance credited to the capital stock account, or the stated value may be treated similar to par value with any excess above stated value being accounted for as additional paid-in capital.
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LumpSumSales 13. More than one class of stock is sometimes issued for a single payment or lump sum amount. Such a transaction requires allocation of the proceeds between the classes of securities involved. 14. The two methods of allocation used are (a) the proportional methodand (b) the incremental method. The proportional method is used when the fair value for each class of security is readily determinable, and the incremental method is used when only one class fair value is known. StockIssuedin NoncashTransactions 15. Stock issued for services or property other than cash should be recorded by using the fair value of the property or services or the fair value of the stock issued, whichever is more clearly determinable. In cases where the fair value of both items is not clearly determinable, the board of directors has the authority to establish a value for the transaction. Costsof IssuingStock 16. Direct costs incurred to sell stock such as underwriting costs, accounting and legal fees, and printing costs should be debited to Paid-in Capital in Excess of Par. Management salaries and other indirect costs related to the stock issue should be expensed as incurred. TreasuryStock 17. (L.O. 4)Treasury stock is a corporations own stock that (a) was outstanding, (b) has been reacquired by the corporation, and (c) is not retired. Treasury stock is not an asset and is reported in the balance sheet as a reduction of stockholders equity. 18. The reasons corporations purchase their outstanding stock include: (a) to provide tax efficient distributions of excess cash to shareholders; (b) to increase earnings per share and return on equity; (c) to provide stock for employee stock compensation contracts; (d) to thwart takeover attempts or to reduce the number of stockholders; and (e) to make a market in the stock. 19. Two methods are used in accounting for treasury stock, the cost methodand the par value method. Under the cost method, treasury stock is recorded in the accounts at acquisition cost. When the treasury stock is reissued, the Treasury Stock account is credited for the acquisition cost. If treasury stock is reissued for more than its acquisition cost, the excess amount is credited to Paid-in Capital fromTreasuryStock. If treasury stock is reissued for less than its acquisition cost, the difference is debited to any paid-in capital account from previous treasury stock transactions. If the balance in this account is insufficient, the remaining difference is charged to retained earnings. 20. The following example shows the accounting for treasury stock under the cost method. No previous acquisitions or sales of treasury stock have occurred.
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10,000 shares of common stock with a par value of $5 per share were originally issued at $12 per share. A. Entry for Purchase: 2,000 shares of common stock are reacquired for $20,000. Treasury Stock........................................................... Cash..................................................................... 20,000 20,000

B. Entry for Resale: 1,000 shares of treasury stock are resold for $8,000. Cash........................................................................... Retained Earnings..................................................... Treasury Stock..................................................... 8,000 2,000 10,000

21. Retirement of Treasury Stock. The retirement of treasury stock is similar to the sale of treasury stock except that the corporation debits the paid-in capital accounts applicable to the retired shares instead of cash. 22. The cost of treasury stock is shown in the balance sheet as a deduction from the total of all stockholders equity accounts. PreferredStock 23. (L.O. 5)Preferred stock is the term used to describe a class of stock that possesses certain preferences or features not possessed by the common stock. The dividend preference of preferred stock is normally stated as a percentage of the preferred stocks par value. However, a preference as to dividends does not assure the payment of dividends; it merely assures that corporations must pay the applicable amount to the preferred stock prior to paying any dividends on common stock. 24. The following features are those most often associated with preferred stock issues: a. Preference as to dividends. b. Preference as to assets in the event of liquidation. c. Convertible into common stock. d. Callable at the option of the corporation. e. Nonvoting. Some features used to distinguish preferred stock from common stock tend to be restrictive. For example, preferred stock may be nonvoting, noncumulative, and nonparticipating. A corporation may attach whatever preferences or restrictions in whatever combination it desires to a preferred stock issue, so long as it does not specifically violate its state incorporation law.

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25. Certain terms are used to describe various features of preferred stock. These terms are the following: a. Cumulative.Dividends not paid in any year must be paid first in a later year before paying any dividends to common stockholders. Unpaid annual dividends on cumulative preferred stock are referred to as dividendsin arrears and are disclosed in a note to the financial statements. b. Participating.Holders of participating preferred stock share with the common stockholders in any profit distribution beyond the prescribed preference rate. This participation involves a pro rata distribution based on the total par value of the outstanding preferred and common stock. c. Convertible.Preferred stockholders may, at their option, exchange their preferred shares for common stock on the basis of a predetermined ratio. d. Callable.At the option of the issuing corporation, preferred shares can be redeemed at specified future dates and at stipulated prices. e. Redeemable. Redeemable stock has a mandatory redemption period or a redemption feature that the issuer cannot control. Debt-like securities, such as redeemable preferred stock, are classified as liabilities and measured and accounted for similar to liabilities. Accountingand Reportingof PreferredStock 26. Preferred stock is accounted for similar to common stock at issuance. The proceeds are allocated between the par value and additional paid-in capital. 27. Preferred stock generally has no maturity date and therefore no legal obligation exists to pay preferred stock dividends. As a result, preferred stock is classified as part of stockholders equity. Mandatory redeemable preferred stock is reported as a liability. DividendPolicy 28. (L.O. 6)Very few companies pay dividends in amounts equal to their legally available retained earnings. The major reasons are: (a) to maintain agreements with creditors, (b) to meet state corporation laws, (c) to finance growth or expansion, (d) to provide for continuous dividends whether in good or bad years, and (e) to build a cushion against possible future losses. 29. Before a dividend is declared, management must consider availability of funds to pay the dividend. Directors must also consider economic conditions, most importantly, liquidity. 30. The SEC encourages companies to disclose their dividend policy in their annual report. For example, companies that (a) have earnings but fail to pay dividends or (b) do not expect to pay dividends in the foreseeable future are encouraged to report this information. In addition, companies that have had a consistent pattern of paying dividends are encouraged to indicate whether they intend to continue this practice in the future.

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Typesof Dividends 31. (L.O. 7)Dividendsmay be paid in cash (most common means), stock, or some other asset. Dividends other than a stock dividend reduce the stockholders equity in a corporation through an immediate or promised distribution of assets. When a stock dividend is declared, the corporation does not pay out assets or incur a liability. It issues additional shares of stock to each shareholder and nothing more. CashDividends 32. The accounting for a cash dividendrequires information concerning three dates: (a) date of declaration,(b) date of record, and (c) date of payment.A liability is established by a charge to retained earnings on the declaration date for the amount of the dividend declared. No accounting entry is required on the date of record. The stockholders who have earned the right to the dividend are determined by who owns the shares on the date of record. The liability is liquidated on the payment date through a distribution of cash. The following journal entries would be made by a corporation that declared a $50,000 cash dividend on March 10, payable on April 6 to shareholders of record on March 25. DeclarationDate(March10) Retained Earnings (Cash Dividends Declared).......... Dividends Payable................................................. RecordDate(March25) No entry PaymentDate(April 6) Dividends Payable...................................................... Cash...................................................................... PropertyDividends 33. Property dividends represent distributions of corporate assets other than cash. A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners. Suchtransfersshouldbe recordedat the fair value of the assetstransferred. Fair value is measured by the amount that would be realized in an outright sale near the time of distribution. Just before a property dividend is declared, the value of the property is adjusted to fair value and a gain or loss is recognized. The fair value then serves as the basis used in accounting for the property dividend. 34. For example, if a corporation held stock of another company that it intended to distribute to its own stockholders as a property dividend, it would first adjust the carrying amount to reflect current fair value. If on the date the dividend was declared, the difference between the cost and fair value of the stock to be distributed was $75,000, the following additional entry would be made. Equity Investments...................................................... Unrealized Holding Gain or LossIncome...........
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50,000 50,000

50,000 50,000

75,000 75,000

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LiquidatingDividends 35. Liquidating dividends represent a return of the stockholders investment rather than a distribution of profits. In a more general sense, any dividend not based on profits must be a reduction of corporate capital, and to that extent, it is a liquidating dividend. StockDividends 36. (L.O. 8)A stock dividendcan be defined as a capitalizationof retainedearningsthat results in a reduction in retained earnings and a corresponding increase in certain contributed capital accounts. Total stockholders equity remains unchanged when a stock dividend is distributed. All stockholders retain their same proportionate share of ownership in the corporation. 37. When the stock dividend is less than 2025% of the common shares outstanding at the time of the dividend declaration, generally accepted accounting principles (GAAP) require that the accounting for stock dividends be based on the fair value of the stock issued. When declared, Retained Earnings is debited at the fair value of the stock to be distributed. The entry includes a credit to CommonStockDividendDistributableat par value times the number of shares, with any excess credited to Paid-in Capital in Excess of Par. Common Stock Dividend Distributable is reported in the stockholders equity section of the balance sheet once declared and prior to issuance. 38. Consider the following set of facts. Vonesh Corporation, which has 50,000 shares of $10 par value common stock outstanding, declares a 10% stock dividend on December 3. On the date of declaration the stock has a fair value of $25 per share. The following entry is made when the stock dividend is declared: Retained Earnings (5,000 $25)................................ Common Stock Dividend Distributable.................. Paid-in Capital in Excess of Par............................ When the stock is issued, the entry is: Common Stock Dividend Distributable....................... Common Stock...................................................... LargeStockDividend 39. If the number of shares issued in a stock dividend exceeds 20 or 25% of the shares outstanding, calling it a stock split is warranted, and only the par value of the shares issued is transferred from retained earnings. 50,000 50,000 125,000 50,000 75,000

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StockSplit 40. A stocksplit results in an increase or decrease in the number of shares outstanding with a corresponding decrease or increase in the par or stated value per share. In general, no accounting entry is required for a stock split as the total dollar amount of all stockholders equity accounts remains unchanged. A stock split is usually intended to improve the marketability of the shares by reducing the market price of the stock being split. In general, the difference between a stock split and a stock dividend is based upon the size of the distribution. Restrictionson RetainedEarnings 41. In many corporations restrictions on retained earnings or dividends exist, but no formal journal entries are made. Such restrictions are best disclosed by note. Presentationof StockholdersEquity 42. (L.O. 9)An example of a comprehensive stockholders equity section of a balance sheet is provided in the textbook. A company should disclose the pertinent rights and privileges of the various securities outstanding. Examples of information that should be disclosed are dividend and liquidation preferences, participation rights, call prices, and dates. 43. Statements of stockholders equity are frequently presented in the following basic format: a. Balance at the beginning of the period. b. Additions. c. Deductions. d. Balance at the end of the period. Analysisof StockholdersEquity 44. Several ratios use stockholders equity related amounts to evaluate a companys profitability and long-term solvency. The following three ratios are discussed and illustrated in the chapter: (1) rate of return on common stock equity, (2) payout ratio, (3) book value per share. Net income Preferred dividends Rate of Return = On Common Stock Equity Average common stockholders' equity Payout Ratio= Cash dividends Net income Preferred dividends Common stockholders' equity Outstanding shares

Book Value Per Share =

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DividendPreferences *45. (L.O. 10)Preferred stock generally has a preference in the receipt of dividends. Preferred stock can also carry features that require consideration at the time a dividend is declared and at the time of payment. These features are (a) the cumulative feature, and (b) the participating feature. BookValuePer Share *46. Book value per share is computed as net assets divided by outstanding common shares at the end of the year. There are complications that impact book value such as the number of authorized and unissued shares, the number of treasury shares on hand, commitments with respect to the issuance of unissued shares, and the relative rights of various types of authorized stock.

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LECTUREOUTLINE
The material in this chapter is straightforward and can be covered in two class sessions. Treasury stock transactions under the cost method should be emphasized. Consider emphasizing the difference between stock splits and stock dividends and the accounting difference between small and large stock dividends. A. (L.O. 1)The Corporate Form of Organization. 1. The primary forms of business organization are the proprietorship, the partnership, and the corporation. 2. Influence of state corporate law. Each state has its own business corporation act. These acts are complex and vary in their provisions and definitions.

3. Capital stock system. Each share represents an ownership right with the following privileges: a. b. c. d. To share proportionately in profits and losses. To share proportionately in management (vote for directors). To share proportionately in corporate assets upon liquidation. To share proportionately in any new issues of stock of the same class (preemptive right).

4. The share system provides easy transferability of ownership interests. 5. Variety of ownership interests. a. Commonstock. The residual corporate interest that bears the ultimate risks of loss and receives the benefits of success. Preferred stock. In return for certain preferences to earnings, preferred stockholders may sacrifice their rights to a voice in management or the right to share in profits above a stated rate. Different classes of common stock may have differences in voting rights.

b.

c.

B. (L.O. 2)Corporate Capital. 1. The stockholders interest in a company is a residual interest. It can be derived from the basic accounting equation: assets less liabilities equals stockholders equity.

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2. The two primary sources of equity are:


TEACHING TIP

Illustration 15-1 can be used to provide an overview of the major components of stockholders equity that are described in the chapter. a. Stockholders investments (contributed capital, consisting of capital stock and additional paid-in capital). Retained earnings (earned capital).
TEACHING TIP

b.

Illustration 15-2 can be used to demonstrate the variety and scope of transactions and events that cause changes in Stockholders Equity. C. (L.O. 3)Accounting for the Issuance of Stock.
TEACHING TIP

Illustration 15-3 provides a numerical example of the journal entries made to issue par value and no-par value stock. 1. Par value stock. a. b. The par value is credited to the respective capital stock account. The excess of proceeds over par value is credited to paid-in capital in excess of par (excess over par).

2. No-par stock.The issuance of no-par stock avoids any contingent liability and also prevents par value from being misused as a basis for fair value. In some cases, no-par stock is given a stated or minimum value. 3. Lump-sum sales.Either the proportional method or the incremental method can be used to allocate proceeds among the different securities. 4. Noncash stock transactions.When stock is issued for services or property other than cash, the property or services should be recorded at either its fair value or the fair valueof the stock issued, whichever is more clearly determinable. 5. Costs of issuing stock.These costs are treated as a reductionof the amountspaid in and debited to Paid-in Capital in Excess of Par.

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D. (L.O. 4)Reacquisition of Shares. 1. Corporations may buy their own stock for a variety of reasons. a. b. c. To provide tax-efficient distributions of excess cash to shareholders. To increase earnings per share and return on equity. To provide stock for employee stock compensation contracts or to meet potential merger needs. To thwart takeover attempts or to reduce the number of shareholders. To make a market for the stock.

d. e.

2. Treasury stock is a contra-stockholders equity account, not an asset. Treasury stock does not vote, receive dividends, or have other rights afforded stockholders. A corporation cannot own a part of itself. 3. Treasury stock is most often accounted for using the cost method.
TEACHING TIP

Illustration 15-4 provides a numerical example of the journal entries made under the cost method of accounting for treasury stock. a. The cost method results in debiting the Treasury Stock account for the reacquisition cost and reporting this amount as a deduction from total paid-in capital and retained earnings on the balance sheet. (1) Sale of Treasury Stock above cost.The difference between the cost and the selling price is credited to Paid-in Capital from Treasury Stock. The company identifies which shares are sold using a FIFO, average cost, or specific identification basis. (2) Sale of TreasuryStockbelowcost. The difference is debited to: (a) Paid-in Capital from Treasury Stock until that account is depleted. (b) Any balance is debited to Retained Earnings. (3) Retiring Treasury Stock.Retired treasury shares have the status of authorized and unissued shares. The accounting is similar to the sale of treasury stock except the debits are to the Paid-in Capital accounts applicable to the retired shares.

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E. (L.O. 5)Preferred Stock. Preferred stock is usually issued with a par value. Sometimes, preferred stock has more debt characteristics than equity characteristics. Preferred stock is a special class of stock which may carry a variety of features or preferences. 1. Preference as to dividends.Preferred stockholders receive dividends before common stockholders are paid dividends. The dividend preference is expressed as a percentage of par value or as a specific dollar amount. a. Cumulativepreferredstock . Dividends in arrears must be paid before payment of the current years dividend to either preferred or common stockholders. Dividends in arrears are not a liability until declared by the Board of Directors. They are disclosed in the footnotes. Participating preferred stock . Preferred stockholders share ratably with common stockholders in any dividends beyond the prescribed preference rate.

b.

2. Preference as to assets in the event of liquidation. 3. Convertible into common stock. 4. Callable at the option of the corporationat set prices. 5. Nonvoting. 6. Redeemable preferred stock. This preference has a mandatory redemption period or redemption feature that the issuer cannot control. a. Because it has characteristics of debt, the FASB requires that it be classified as liabilities and be measured and accounted for similar to liabilities.

F. Accounting and Reporting of Preferred Stock. 1. The accounting for preferred stock at issuance is similar to common stock. The proceeds are allocated between the par value of the preferred stock and additional paid-in capital. 2. Convertible preferred stock is reported as part of stockholders equity. G. (L.O. 6)Dividend Policy. 1. Very few companies pay dividends in amounts equal to their legally available retained earnings. Among the reasons: reinvestment of earnings in assets, the desire to build up a cushion, and the smoothingout of dividendpayments. Legality of dividends.The legality of a dividend is determined by applicable state laws. Financial condition of the company:Before dividends are declared, the availability of funds to pay the dividend should be considered. The SEC encourages companies to disclose their dividend policy in the annual report.

2. 3. 4.

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H. (L.O. 7)Types of Dividends.


TEACHING TIP

Use Illustration15-5 to emphasize the importance of various dates in distributing dividends and to summarize the various types of dividend distributions. 1. Cash dividends.Once declared, a dividend (except a stock dividend) is a liability (usually current). Dividends are not declared and paid on treasury stock. Property dividends.These are dividends payable in assets of the corporation other than cash. Just prior to declaration, the fair value principle is used in valuing the assets distributed as dividends. Liquidating dividends.Dividends that are not based on earnings are liquidating dividends. They reduce paid-in capital when declared.

2.

3.

I. (L.O. 8)Stock dividends and stock splits.No assets are distributed and each stockholder retains the sameproportionateinterest in the corporation. 1. Small (ordinary) stock dividends.The fair value of the stock issued is used to record the stock dividend by debiting Retained Earnings and crediting Common Stock and Paid-in Capital in Excess of Par. Large stock dividends.If the dividend is more than 20-25% of the outstanding shares, then the par value of the stock issued is used to record the stock dividend by debiting Retained Earnings and crediting Common Stock.

2.

3. Stock splits.No entry is made to recognize a stock split. A memorandum note is made to indicate that the number of shares outstanding and the par value of the shares have changed.
TEACHING TIP

Illustration15-6 summarizes the differences between stock splits and stock dividends. J. Disclosure of Restrictions on Retained Earnings. 1. Restrictions are best disclosed by note, and should include the source of the restriction, pertinent provisions, and the amount of retained earnings subject to restriction, or the amount not restricted.

K. (L.O. 9)Presentation and Analysis of Stockholders Equity. 1. Presentation. a.


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On the balance sheet, three categories normally appear.

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(1) Capital stock. (2) Additional paid-in-capital. (3) Retained earnings or deficit. b. On the statement of stockholders equity, the basic format is usually: Beginning balance + Additions Deductions = Ending balance c. Disclosures related to stockholders equity include dividend and liquidation preferences, participation rights, and call and conversion information.

2.

Analysis.Several ratios use stockholders equity amounts to evaluate a companys profitability and long-term solvency. Net income Preferred dividends Rate of Return = On Common Stock Equity Average common stockholders' equity Payout Ratio= Cash dividends Net income Preferred dividends Common stockholders' equity Outstanding shares

Book Value Per Share = a.

Trading on the equity at a gain occurs when the return on total assets is lower than the rate of return on the common stockholders investment.
TEACHING TIP

Illustration 15-7 presents the ratios using stockholders equity amounts used to measure profitability and long-term solvency. *L. (L.O. 10)Dividend Preferences and Book Value per Share. 1. Dividend preferences. a. b. c. d. Preferred stock is noncumulative and nonparticipating. Preferred stock is cumulative and nonparticipating. Preferred stock is noncumulative and fully participating. Preferred stock is cumulative and fully participating.

2. Book value per share.

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a. b.

In simplest form:

Net assets Outstanding shares at end of year

Complications may occur if preferred stock exists. For example: (1) Preferred dividends are in arrears. (2) Preferred stock is participating. (3) The redemption or liquidation value of the preferred stock is higher than its carrying amount.

c.

These complications require that the retained earnings be allocated between the preferred and common stockholders when computing the book value per share.

*M. IFRS Insights 1. The primary IFRS related to stockholders equity are IAS 1 (Presentation of Financial Statements), IAS 32 (Financial Instruments: Presentation), and IAS 39 (Financial Instruments: Recognition and Measurement). 2. Similarities a. The accounting for the issuance of shares and purchase of treasury stock are similar under both IFRS and GAAP. b. The accounting for declaration and payment of dividends and the accounting for stock splits are similar under both IFRS and GAAP. 3. Differences a. Major differences relate to terminology used, introduction of concepts such as revaluation surplus, and presentation of stockholders equity information. Many countries have different investor groups than the United States. For example, in Germany, financial institutions like banks are not only the major creditors but often are the largest shareholders as well. In the United States and the United Kingdom, many companies rely on substantial investment from private investors. The accounting for treasury share retirements differs between IFRS and GAAP. Under GAAP, a company has three options: (1) charge the excess of the cost of treasury shares over par value to retained earnings, (2) allocate the difference between paid-in capital and retained earnings, or (3) charge the entire amount to paid-in capital. Under IFRS, the excess may have to be charged to paid-in capital, depending on the original transaction related to the issuance of the shares. The statement of changes in equity is usually referred to as the statement of stockholders equity (or shareholders equity) under GAAP.

b.

c.

d.

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e.

Both IFRS and GAAP use the term retained earnings. However, IFRS relies on the term reserve as a dumping ground for other types of equity transactions, such as other comprehensive income items as well as various types of unusual transactions related to convertible debt and share option contracts. GAAP relies on the account Accumulated Other Comprehensive Income (Loss). We also use this account in the discussion below, as it appears this account is gaining prominence within the IFRS literature. Under IFRS, it is common to report revaluation surplus related to increases or decreases in items such as property, plant, and equipment; mineral resources; and intangible assets. The term surplus is generally not used in GAAP. In addition, unrealized gains on the above items are not reported in the financial statements under GAAP.

f.

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ILLUSTRATION15-1 COMPONENTSOF CAPITAL

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ILLUSTRATION15-2 SOURCESOF CHANGESIN STOCKHOLDERSEQUITY

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ILLUSTRATION15-3 ACCOUNTINGFORTHEISSUANCEOF STOCK

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ILLUSTRATION15-4 TREASURYSTOCKTRANSACTIONSCOSTMETHOD

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ILLUSTRATION15-4 (continued)

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ILLUSTRATION15-5 JOURNALENTRIESFORVARIOUSTYPESOF DIVIDENDDISTRIBUTIONS

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ILLUSTRATION15-6 EFFECTS OF COMMON STOCK DIVIDENDS AND STOCK SPLITS ON STOCKHOLDERSEQUITY

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ILLUSTRATION15-7 STOCKHOLDERSEQUITYANALYSIS

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