Additional

Stockholders’ Equity
Transactions and
Income Disclosures
© Copyright Doug Hillman 1999
 Retained Earnings
 Cumulative net income of past years minus
net losses and dividends declared during
those years
 Primary factors affecting retained earnings

› Net income or loss

› Restrictions of retained earnings
› Prior period adjustments
› Dividends

© Copyright Doug Hillman 1999

 Restrictions on Retained
Earnings
 Tells the financial statement reader that company
may not pay out this part of retained earnings as
dividends
 Required restrictions

› To comply with legal or contractual limits on

dividend distribution
 Voluntary

› To show reasons why management wishes to

restrict dividends

© Copyright Doug Hillman 1999

 Prior Period Adjustment
 An error in preparing financial statements in
one accounting period not discovered until a
later period
 Treat correction of error, if material, as
adjustment of beginning retained earnings
› Adjusts affected balance sheet account
› Adjusts beginning retained earnings

© Copyright Doug Hillman 1999

 Dividends
 Distribution of cash, stock, or other
corporate assets to stockholders
 Declaration decreases retained earnings
 When board of directors takes formal
action, declaration, dividend immediately
becomes liability

© Copyright Doug Hillman 1999

 Cash Dividend
 Date of declaration
› Increase Dividends - a nominal account
closed to Retained Earnings
› Increase Dividends Payable
 Date of record

› No entry
› Determines persons who will receive dividend
› Stock sold after is sold ex-dividend

© Copyright Doug Hillman 1999

 Cash Dividend
 Date of payment
› Decreases Cash
› Decreases Dividends Payable
 Cumulative preferred in arrears

› First must pay arrearages

› Then pay current period preferred
› Then common is entitled to dividends

© Copyright Doug Hillman 1999

 Stock Dividends
 Issuance of additional shares of
authorized stock
 Reasons

› Need to conserve cash

› Give measure of company’s success
› Increase permanent capitalization
› Decrease market price

© Copyright Doug Hillman 1999

 Small Stock Dividend
 Involves less than 20-25% of previously
outstanding shares
 Transfer from retained earnings to paid-in
capital an amount equal to market value
of shares
 Reasoning is that small stock dividends
do not decrease market value
significantly

© Copyright Doug Hillman 1999

 Small Stock Dividend
 Date of declaration
› Increase Stock Dividends , a nominal
account closed to Retained Earnings, for
market value
› Increase Stock Dividends to be Issued
for par value
› Increase Paid-in Capital-Excess Over
Par for difference

© Copyright Doug Hillman 1999 1

 Small Stock Dividend
 Stock Dividends to be Issued appears in
paid-in capital
 Date of payment

› Decrease Stock Dividends to be

Issued
› Increase Stock

© Copyright Doug Hillman 1999 1

 Large Stock Dividend
 Involves more than 20-25% of
previously outstanding shares
 Transfer from retained earnings to paid-
in capital an amount equal to par value
of shares
 Reasoning is that large stock dividend
should decrease market value

© Copyright Doug Hillman 1999 1

 Large Stock Dividend
 Date of declaration
› Increase Stock Dividends , a nominal
account closed to Retained Earnings, for
par value
› Increase Stock Dividends to be Issued
for par value
 Stock Dividends to be Issued appears in
paid-in capital

© Copyright Doug Hillman 1999 1

 Large Stock Dividend
 Date of payment
› Decrease Stock Dividends to be
Issued
› Increase Stock

© Copyright Doug Hillman 1999 1

 Effect of Stock Dividend
 Small stock dividend
› Increase paid-in capital by market
value of shares issued in dividend
› Decreases retained earnings by
market value of shares issued in
dividend

© Copyright Doug Hillman 1999 1

 Effect of Stock Dividend
 Large stock dividend
› Increases paid-in capital by par value
of shares issued in dividend
› Decreases retained earnings by par
value of shares issued in dividend
 Capitalizes (makes permanent) some of
retained earnings

© Copyright Doug Hillman 1999 1

 Stock Split
 Decreases the par or stated value per
share and increases number of shares
issued proportionally
 Total paid-in capital remains the same
 Total retained earnings remains the same
 Market value of shares decreases
proportionally

© Copyright Doug Hillman 1999 1

 Treasury Stock
 Shares of own stock reacquired by
corporation
 Acquisition reduces assets and
stockholders’ equity
 Shown as deduction from stockholders’
equity

© Copyright Doug Hillman 1999 1

 Treasury Stock
 Acquisition
› Increases contra owners’ equity
account Treasury Stock by cost
› Decreases Cash

© Copyright Doug Hillman 1999 1

 Treasury Stock
 Reissuance above cost
› Increases cash by proceeds
› Decreases Treasury Stock by cost
› Increases Paid-in Capital from
Treasury Stock Transactions by
difference

© Copyright Doug Hillman 1999 2

 Treasury Stock
 Reissuance below cost
› Increases cash by proceeds
› Decreases Treasury Stock by cost
› Decreases Paid-in Capital from
Treasury Stock Transactions by
difference

© Copyright Doug Hillman 1999 2

 Treasury Stock
 Reissuance below cost
› If Paid-in Capital from Treasury Stock
Transactions does not exist
–decrease any paid-in capital from
same class of stock
–retained earnings

© Copyright Doug Hillman 1999 2

 Book Value of Common Stock
 Divide stockholders’ equity available to
common stockholders by number of shares
outstanding
 When more than one class of stock is
outstanding
› subtract liquidation claims of noncommon
from total stockholders’ equity to
determine equity available to common

© Copyright Doug Hillman 1999 2

 Presentation of Stockholders’
Equity
Paid-in capital
Stock
Common stock, $1 par,
10,000 sh authorized,
8,000 sh issued $ 8,000
Additional paid-in capital
Paid-in capital-excess over
par, common 24,000
Total paid-in capital $32,000

© Copyright Doug Hillman 1999 2

 Presentation of Stockholders’
Equity
Retained earnings
Restricted for plant
expansion $10,000
Unrestricted 50,000
Total retained earnings 60,000
Total paid-in capital and R.E. $92,000
Deduct: Treasury stock 1,000
Total stockholders’ equity $91,000

© Copyright Doug Hillman 1999 2

 Quality of Income Information
 Accounting methods and estimates used
to prepare financial statements
 Number and size of nonrecurring
revenue and expense items on income
statement

© Copyright Doug Hillman 1999 2

 Intraperiod Tax Allocation
 Assigning the tax consequences of
nonrecurring items to the item
 Assume a nonrecurring loss of $40,000
with a tax rate of 30%
Loss $40,000
Tax savings due to loss 12,000
Loss net of tax $28,000

© Copyright Doug Hillman 1999 2

 Continuing Operations
 Financial statement users want to know
income from continuing operations
 It is important number for predicting
future earnings

© Copyright Doug Hillman 1999 2

 Nonrecurring Income Statement
Items
 Discontinued operations
 Extraordinary items
 Cumulative effect of change in
accounting principle

© Copyright Doug Hillman 1999 2

 Discontinued Operations
 A line of business or class of customer
may qualify as discontinued segment
 When management decides to dispose
of a segment, results for segment must
be reported separately

© Copyright Doug Hillman 1999 3

 Discontinued Operations
 Two elements reported for discontinued
segment
› Operating income or loss for period
› Gain or loss on disposal of the
segment
 Each element reported net of tax

© Copyright Doug Hillman 1999 3

 Extraordinary Items
 Gains and losses that are both unusual
and infrequent
 Must consider the environment in which
firm operates
 Reported net of tax

© Copyright Doug Hillman 1999 3

 Examples of Extraordinary Items
 Uninsured losses from earthquakes and
fires
 Gains or losses from early retirement of
debt
 Gains and losses from passing a new law
 Gains and losses from foreign
governments taking business property

© Copyright Doug Hillman 1999 3

 Changes in Accounting Principle
 Consistency principle states should use
same accounting principles from period
to period
 Change permitted when it improves
reporting
 Reported net of tax

© Copyright Doug Hillman 1999 3

 Changes in Accounting Principle
 Changes in principle often would have
changed prior periods’ expenses
 Total change in net income for prior
periods is cumulative effect of a change
in accounting principle

© Copyright Doug Hillman 1999 3

 Reporting Earnings Per Share
 Income from continuing operations
 Discontinued operations
 Extraordinary items
 Cumulative effect of change in
accounting principle
 Net income

© Copyright Doug Hillman 1999 3

 Earnings Per Share
 Expresses net income on a per-common-
share basis
 Under FASB Statement No. 128
presentation depends on whether simple or
complex capital structure
 Simple capital structure - no debt or equity
that could dilute EPS
 Complex capital structure - dilutive securities

© Copyright Doug Hillman 1999 3

 EPS - Weighted Average
Common Shares
 For total year, sum of
› Number of shares outstanding times
fraction of year outstanding
 Used as denominator in EPS
calculations

© Copyright Doug Hillman 1999 3

 EPS - Simple Capital Structure
 Net income minus dividends on
preferred stock
 divided by
 Weighted average number of common
shares outstanding

© Copyright Doug Hillman 1999 3

 Complex Capital Structure
 Convertible debt or equity securities that
have potential to dilute (decrease) EPS
 Present two earnings per share figures
 Basic earnings per share

› EPS based on weighted average common

shares
 Diluted earnings per share

› Assumes all dilutive securities converted

© Copyright Doug Hillman 1999 4

 EPS Example
 Net income $48,000
 Stock
› 10% Convertible Preferred, $100 par, 1,000 shares
issued and outstanding, convertible into 7,000
common
› Common, $1 par,
– Issued and outstanding 1/1 to 4/1, 16,000 shares
– Issued and outstanding 4/1 to 12/31, 20,000
shares

© Copyright Doug Hillman 1999 4

 EPS Example
 Weighted average common shares
outstanding computation
› 16,000 x 1/4 = 4,000
› 20,000 x 3/4 = 15,000
 Weighted average common shares
outstanding
› 19,000 shares

© Copyright Doug Hillman 1999 4

 Basic EPS Computation
 Preferred dividends
› 1,000 x ($100 x 0.10) = $10,000
 Net income available to common

› $48,000 - $10,000 = $38,000

 Basic EPS

› $38,000 / 19,000 = $2.00 per share

© Copyright Doug Hillman 1999 4

 Diluted Earnings Per Share
 Assume convertible preferred converted into
common at beginning of year
 Weighted average common shares

› 19,000 + 7,000 = 26,000

 Net income available to common

› $48,000 - $0 = $48,000
 Diluted EPS

› $48,000 / 26,000 = $1.85 per share

© Copyright Doug Hillman 1999 4

 Analyzing Information
 Major differences in capital structure between
companies
 Number of shares issued and outstanding
 Treasury stock
 Market value
 Dividend yield
 ROA
 EPS and P/E ratio

© Copyright Doug Hillman 1999 4