Ch11 ACCT1101 DE S1 2223 MOODLE

ACCT1101
Dr. Olivia Leung

chapter 11 Reporting and Interpreting
Stockholders’ Equity
Financial Accounting
11e
Libby • Libby • Hodge
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Learning Objectives
After studying this chapter, you should be able to:
11-1 Explain the role of stock in the capital structure of a corporation.
(E11-1)
11-3 Describe the characteristics of common stock and report common

stock transactions. (E11-2, E11-15, P11-5)
11-4 Discuss and report dividends. (M11-7)
11-8 Describe the characteristics of preferred stock and report preferred

stock transactions. (AP11-3)
Ratios
11-2 Compute and analyze the earnings per share ratio. (E11-10)
11-5 Compute and analyze the dividend yield ratio.
Ch 13 ROE (pg 697 in textbook), PE ratio (Pg 709 in textbook)
SELF TEST : AP11-1

Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
11-2
Learning Objective 11-1
11-3
Ownership of a Corporation
Corporations enjoy a continuous existence separate and apart from
its owners. A corporation can . . .
Own assets Incur liabilities
Sue others and be sued Expand and contract in size
Enter into contracts

independently of its
owners
Corporations are created by application to a state government (not the

federal government). Corporations are governed by a board of directors
elected by the stockholders.
11-4
Advantages of a Corporation
The corporate form of business has the primary advantage of ease

of participation in ownership, as compared to a sole proprietorship
or a partnership. Ease of ownership exists in three forms.
+ Shares of stock may be purchased in small amounts.

+ Ownership interests can be transferred easily through the
sale of shares on established markets.
+ Stock ownership provides investors with limited liability.
Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11-5
Stockholders’ Equity Section of the Balance Sheet
The stockholders’ equity section of the balance sheet lists

two primary sources of equity:
1. Contributed capital from the sale of stock.
2. Earned capital generated by the company’s profit-making
activities (Retained Earnings or Accumulated Deficit, if
negative)
11-6
11-7
Benefits of Stock Ownership
Owners of common stock (known as stockholders or

shareholders) receive a number of benefits:
A voice in management.
Dividends: Proportional share of

the distribution of profits.
Residual claim: Proportional share

of the distribution of remaining assets
upon the liquidation of the company.
11-8
Authorized, Issued, and Outstanding Shares (1 of 3)
The authorized number of shares is the maximum number of shares

of stock a corporation can issue as specified in its charter.
Issued Unissued
shares are shares are the
the total shares that
number of have never
shares sold been sold.
to the public.
11-9
Outstanding
Shares (owned by
stockholders)
Issued Unissued
Shares Shares
Treasury Shares
(reacquired by the
corporation)
Authorized number of shares is the

maximum number of shares of stock
a corporation can issue.
11-10
11-12
11-13
11-14
11-15
11-3 Describe the characteristics of common stock and report
common stock transactions.
11-16
Common Stock Transactions (1 of 2)
Common stock is held by investors who are the owners of a corporation.
Stockholders have the right to:
• Vote
• Share in profits of the business through dividends
• Elect the board of directors who hire and monitor the executives who
manage a company’s activities on a day-to-day basis
11-17
Common Stock Transactions (2 of 2)
Par value is the nominal value per share, established in the

corporate charter.*
Par Value ¹ Market Value
Legal capital is the amount of capital, required by the state,

that must remain invested in the business.
*Some states do not require a par value to be

stated in the charter.
11-18
Initial Sale of Stock
An initial public offering, or IPO, involves the very first sale of a company’s
stock to the public (i.e., when the company first “goes public”).
Additional sales of new stock to the public are called seasoned offerings.
Assume Microsoft sold 1 million shares of its $0.00000625 par value

common stock for $220 per share.
The company would record the following journal entry:
11-19
Sale of Stock in Secondary Markets
• When a company sells stock to the public, the transaction is
between the issuing corporation and the investor.
• Subsequent to the initial sale, investors can sell shares to other
investors without directly affecting the corporation. Stockholders
expect to earn money on their investments through possible
dividends and increases in a company’s stock price.
Ø The corporation is not a part of the transaction and therefore
does not receive or pay anything.
*Secondary market is the market where
investors buy & sell shares they already
own and is often called the “stock
Market” by investors.
11-20
Stock Issued for Employee Compensation
• Managers may not act in the owners’ best interest. Compensation

packages can be developed to reward employees for meeting goals
important to stockholders.
• Another strategy is to offer employees stock, either directly through

stock awards or indirectly through stock options.
• Stock awards grant shares of stock to employees that vest on
future dates.
• Stock options give employees the right to buy stock in the
future at a fixed price.
• Both stock awards and stock options provide incentives for

employees to take actions that increase a company’s stock price
(thereby aligning their interest with the interest of stockholders).
11-21
Repurchase of Stock
• A corporation repurchase its stock from existing stockholders for a number

of reasons.
• One common reason is the existence of an employee bonus plan that
provides workers with shares of the company’s stock as part of their
compensation.
• Due to SEC regulations, it is less costly to give employees
repurchased shares than to issue new ones.
• Reissuing treasury stock avoids diluting existing shareholders’
investments.
• Stock that has been repurchased and is held by the issuing corporation is
called treasury stock.
• Treasury stock is not an asset, rather it is a contra-equity account.
• Treasury stock is shown as a negative number on the balance sheet.
• Treasury shares have no voting, dividend, or other stockholder rights while
they are held as treasury stock.
11-22
Repurchase and Reissuance of Stock (1 of 2)
IBM reacquired 100,000 shares of its

common stock when it was selling for $140 per share.
Treasury Stock is a contra-equity account, not an asset!
IBM reissued 10,000 shares

of treasury stock at $150 per share.
When Treasury Stock is reissued, no accounting profit or loss is recorded.

11-23
Repurchase and Reissuance of Stock (2 of 2)
IBM reissued 10,000 shares

of treasury stock at $130 per share.
11-24
E11-2
11-25
11-26
11-27
11-28
11-29
11-4 Discuss and report dividends.
11-30
Dividends on Common Stock
• The return from investing in a company’s common stock can come from
two sources: stock price appreciation and dividends.
• Some investors prefer to buy stocks that pay little or no dividends.
• Companies that reinvest the majority of their earnings back into
their operations tend to increase their future earnings potential
and their stock price.
• Wealthy investors in high tax brackets prefer to receive their return
in the form of higher stock prices because capital gains may be
taxed at a lower rate than dividend income.
• Other investors, such as retired people who need a steady income,
prefer to receive their return in the form of dividends.
• Retirees seek stocks that will pay relatively high dividends, such as
utility stocks.
• Analysts compute the dividend yield ratio to evaluate a company’s
dividend policy.
11-31
Key Dividend Dates (1 of 2)
The declaration and payment of a dividend involve several key dates.
1. Declaration date. The date on which the board of directors officially
approves the dividend. As soon as the board declares a dividend, a
liability is created and must be recorded.
2. Date of record. The date on which the corporation prepares the list of
current stockholders who will receive the dividend payment. The
dividend is payable only to those names listed on the record date. No
journal entry is made on this date.
3. Date of payment. The date on which cash is disbursed to pay the
dividend liability.
11-32
Key Dividend Dates (2 of 2)
Date of Declaration: Assume Microsoft declared a $3,886 million dividend

on 9/18/2019:
Date of Record: 11/21/2019, stockholders who own shares on this date

will receive the dividend. (No journal entry)
Date of Payment: 12/12/2019 the liability is paid.
Note: The corporation must have sufficient retained earnings and

cash to cover the amount of the dividend.
11-33
M11-7
11-34
11-8 Describe the characteristics of preferred stock and report
preferred stock transactions.
11-35
Preferred Stock Transactions
Less risky because of

priority payments of
dividends and assets
before common stock
Typically does not have Typically has a fixed

voting rights dividend rate
11-36
What’s in a Name?
International
Perspective
U.S. GAAP and IFRS use different

words to describe the same
stockholders’ equity accounts.
IBM (U.S.) GAAP ASOS (UK) IFRS
Common stock = Share capital

Additional paid-in capital = Share premium
Dividends on Preferred Stock (1 of 2)
Preferred stock offers a dividend preference over common stock.
Current dividend preference: Requires a company to pay current
dividends to preferred stockholders before paying dividends to common
stockholders. After this is met then dividends can be paid to common
stockholders.
Cumulative dividend preference: Requires any unpaid dividends on

preferred stock to accumulate. This amount, called dividends in arrears,
must be paid before common dividends are paid.
If preferred stock is noncumulative, any dividends not declared in previous
years are permanently lost and will never be paid.
Note: Dividends in arrears are disclosed in the notes to the financial
statements. They are not a liability until the board of directors declares
them.
11-38
Dividends on Preferred Stock (2 of 2)
Wally Company has the following stock outstanding:
Assume a current dividend preference only:
Assume the preferred stock is cumulative and that dividends have been in
arrears for two years:
11-39
11-40
11-41
Learning Objective 11-2; 11-5
11-2 Compute and analyze the earnings per share ratio.
11-5 Compute and analyze the dividend yield ratio.
Ch13 ROE & P/E Ratios
11-42
Earnings per Share (EPS)
How well is a company performing?
Companies are required to report EPS on their income statements.
11-43
11-44
Dividend Yield
How much does a company pay out in dividends each year relative to its
share price?
11-45
Return on Equity (ROE)
Return on Equity relates income earned to the investment made by the
owners. Investors expect to earn a return on the money they invest.
The ROE ratio for The Home Depot for fiscal 2020 is computed as follows:
*We normally use average stockholders’ equity for the denominator; however, because The Home
Depot reported negative stockholders’ equity in fiscal 2019, we are using the ending balance for
fiscal year 2020. For comparability reasons, we are also using the ending balance for Lowe’s.
On average, for every $1.00 equity investors contributed to

The Home Depot, the company earned $3.90 in fiscal 2020.
Comparison with Lowes: ROE for Lowe’s was 406.05 percent, indicating that
Lowe’s produced a better return on its owners’ investment than did The Home
Depot in fiscal 2020.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 11-46
Price/Earnings (P/E) Ratio
This ratio measures the relationship between the current market price of a
company’s stock and its earnings per share.
* At the end of fiscal 2020, The Home

Depot’s stock was trading at $269.13
per share.
The P/E ratio reflects the stock market’s assessment of a company’s

future performance. A high ratio indicates that earnings are expected to
grow rapidly. The P/E ratio for The Home Depot indicates that the
market expects them to perform well in the future. This P/E ratio
indicates that The Home Depot’s stock was selling at a price that was just
over 22 times its earnings per share.
Comparison with Lowes: Lowe’s P/E ratio was 21.33.
Exhibit 13.1 (1 of 3)
The Home Depot Financial Statements
Net sales will be
set to 100 percent, 2020 Cost of Sales ÷ 2020 Net Sales
and all other $87,257 ÷ $132,110 = 0.6605 or 66.05%
components will be
expressed as a
percentage of net 2020 Gross Profit ÷ 2020 Net Sales
sales. $44,853 ÷ $132,110 = 0.3395 or 33.95%
2020 Selling, G&A ÷ 2020 Net Sales

$24,447 ÷ $132,110 = 0.1851 or 18.51%
Exhibit 13.1 The Home Depot Financial Statements (1 of 2)
(2 of 3)
Exhibit 13.1 The Home Depot Financial Statements (2 of 2)
(3 of 3)
SELF-TEST
11-51
11-52
11-53

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ACCT1101

Dr. Olivia Leung

11-3 Describe the characteristics of common stock and report common

11-4 Discuss and report dividends. (M11-7)

11-8 Describe the characteristics of preferred stock and report preferred

SELF TEST : AP11-1

Own assets Incur liabilities

Sue others and be sued Expand and contract in size

Enter into contracts

Corporations are created by application to a state government (not the

The corporate form of business has the primary advantage of ease

+ Shares of stock may be purchased in small amounts.

The stockholders’ equity section of the balance sheet lists

Owners of common stock (known as stockholders or

 Dividends: Proportional share of

 Residual claim: Proportional share

The authorized number of shares is the maximum number of shares

Authorized number of shares is the

Common stock is held by investors who are the owners of a corporation.

Stockholders have the right to:

Par value is the nominal value per share, established in the

Par Value ¹ Market Value

Legal capital is the amount of capital, required by the state,

*Some states do not require a par value to be

Assume Microsoft sold 1 million shares of its $0.00000625 par value

• Managers may not act in the owners’ best interest. Compensation

• Another strategy is to offer employees stock, either directly through

• Both stock awards and stock options provide incentives for

• A corporation repurchase its stock from existing stockholders for a number

IBM reacquired 100,000 shares of its

Treasury Stock is a contra-equity account, not an asset!

IBM reissued 10,000 shares

When Treasury Stock is reissued, no accounting profit or loss is recorded.

IBM reissued 10,000 shares

Date of Declaration: Assume Microsoft declared a $3,886 million dividend

Date of Record: 11/21/2019, stockholders who own shares on this date

Date of Payment: 12/12/2019 the liability is paid.

Note: The corporation must have sufficient retained earnings and

Less risky because of

Typically does not have Typically has a fixed

U.S. GAAP and IFRS use different

IBM (U.S.) GAAP ASOS (UK) IFRS

Common stock = Share capital

Cumulative dividend preference: Requires any unpaid dividends on

Assume a current dividend preference only:

How well is a company performing?

Companies are required to report EPS on their income statements.

On average, for every $1.00 equity investors contributed to

* At the end of fiscal 2020, The Home

The P/E ratio reflects the stock market’s assessment of a company’s

Comparison with Lowes: Lowe’s P/E ratio was 21.33.

2020 Selling, G&A ÷ 2020 Net Sales

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