Chapter 11

Reporting and Analyzing Equity

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

Conceptual Learning Objectives
C1: Identify characteristics of corporations and their organization C2: Describe the components of stockholders’ equity C3: Explain characteristics of common and preferred stock C4: Explain the items reported in retained earnings
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

Analytical Learning Objectives
A1: Compute earnings per share and describe its use A2: Compute price-earnings ratio and describe its use in analysis A3: Compute dividend yield and explain its use in analysis A4: Compute book value and explain its use in analysis
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

Procedural Learning Objectives
P1: Record the issuance of corporate stock P2: Record transactions involving cash dividends P3: Account for stock dividends and stock splits P4: Distribute dividends between common stock and preferred stock P5: Record purchases and sales of treasury stock and the retirement of stock
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

C1

Corporate Form of Organization
An entity created by law Existence is separate from owners Has rights and privileges Privately Held

Ownership can be

Publicly Held
© The McGraw-Hill Companies, Inc., 2008

McGraw-Hill/Irwin

C1

Characteristics of Corporations
Advantages
     

Separate legal entity Limited liability of stockholders Transferable ownership rights Continuous life Lack of mutual agency for stockholders Ease of capital accumulation Disadvantages Governmental regulation Corporate taxation

 

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C1

Organizing and Managing a Corporation
Stockholders

Board of Directors

President, Vice-President, and Other Officers

Employees of the Corporation
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

C1

Organizing and Managing a Corporation

C o r p o r a t e O r g a n iz a t io n C h a r t
Ultimate control. Selected by a vote of the stockholders.

S to c k h o ld e r s B o a r d o f D ir e c to r s P r e s id e n t

Stockholders usually meet once a year. Overall responsibility for managing the company.

S e c re ta ry

V ic e P r e s id e n t F in a n c e

V ic e P r e s id e n t P r o d u c tio n

V ic e P r e s id e n t M a r k e tin g

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C1

Rights of Stockholders
     Vote at stockholders’ meetings Sell stock Purchase additional shares of stock Receive dividends, if any Share equally in any assets remaining after creditors are paid in a liquidation

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C1

Stock Certificates and Transfer

Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

C1

Basics of Capital Stock
Total amount of stock that a corporation’s charter authorizes it to sell.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C1

Basics of Capital Stock
Total amount of stock that has been issued or sold to stockholders.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C1

Selling (Issuing) Stock

Par value is an arbitrary amount assigned to each share of stock when it is authorized.
McGraw-Hill/Irwin

Market price is the amount that each share of stock will sell for in the market.
© The McGraw-Hill Companies, Inc., 2008

P1

Classes of Stock

Par Value No-Par Value Stated Value

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P1

Issuing Par Value Stock
Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record:
• The cash received. • The number of shares issued × the par value per share in the Common Stock account. • The remainder is assigned to Paid-In Capital in Excess of Par Value, Common Stock.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P1

Issuing Par Value Stock
Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction.
Sept. 1 Cash Common stock, $2 par value Paid-In Capital in Excess of Par Value, Common Stock
Sold and issued 100,000 shares of common stock

Dr 2,500,000

Cr 200,000 2,300,000

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P1

Issuing Par Value Stock

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P1

Issuing Stock for Noncash Assets
Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Record:
• The asset received at its market value. • The number of shares issued × the par value per share in the Common Stock account. • The remainder is assigned to Paid-In Capital in Excess of Par, Common Stock.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P1

Issuing Stock for Noncash Assets
Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction.
Sept. 1 Land Common stock, $2 par value Paid-In Capital in Excess of Par Value Common Stock
Exchanged 100,000 common shares for land

2,500,000 200,000 2,300,000

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P2

Cash Dividends
To pay a cash dividend the corporation must have:

Cash Dividend Types and Frequency 100% 80% 60% 40% 20% 0% Common Preferred 22% 75%

2.

3.

A sufficient balance in retained earnings and The cash necessary to pay the dividend.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C3

Preferred Stock
A separate class of stock, typically having priority over common shares in . . .
 

Dividend distributions Distribution of assets in case of liquidation

Usually has a stated dividend rate

Normally has no voting rights

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P4

Cumulative or Noncumulative Dividend
Cumulative Vs. Noncumulative
Undeclared dividends from current and prior years do not have to be paid in future years.

Dividends in arrears must be paid before dividends may be paid on common stock. Most preferred stock is cumulative.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P4

Cumulative or Noncumulative Dividend
Example: Consider the following Stockholders’ Equity Section of the Balance Sheet

The Board of Directors did not declare or pay dividends in 2007. In 2008, the Board of Directors declare and pay cash dividends of $42,000.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P4

Cumulative or Noncumulative Dividend
Preferred Common $ $ $ 9,000 $ 33,000

If Preferred Stock is Noncumulative: Year 2007: No dividends paid. Year 2008: 1. Pay 2008 preferred dividend. 2. Remainder goes to common. If Preferred Stock is Cumulative: Year 2007: No dividends paid. Year 2008: 1. Pay 2007 preferred dividend in arrears. 2. Pay 2008 preferred dividend. 3. Remainder goes to common. Totals
McGraw-Hill/Irwin

Preferred Common $ $ $ 9,000 9,000 24,000 24,000

$ $ 18,000 $

© The McGraw-Hill Companies, Inc., 2008

P4

Participating or Nonparticipating Dividend
Participating Vs. Nonparticipating
Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate.

Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate.

Most preferred stock is nonparticipating.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P4

Reasons for Issuing Preferred Stock
To raise capital without sacrificing control To boost the return earned by common stockholders through financial leverage To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low

 

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P2

Cash Dividends
Regular cash dividends provide a return to investors and almost always affect the stock’s market value.

June 30 Corporation Dividends

Stockholders

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P2

Entries for Cash Dividends

Three important dates
D s end ivid

Date of Declaration

Date of Record

Date of Payment

Record liability for dividend.
McGraw-Hill/Irwin

No entry required.

Record payment of cash to stockholders.
© The McGraw-Hill Companies, Inc., 2008

P2

Entries for Cash Dividends
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.

D

s end ivid

Jan. 19 Retained earnings Common dividend payable
Date of Declaration

Dr 10,000

Cr 10,000

Declared $1 per share cash dividend

Record liability for dividend.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P2

Entries for Cash Dividends
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.

Date of Record

No entry required on February 19.
© The McGraw-Hill Companies, Inc., 2008

No entry required.
McGraw-Hill/Irwin

C1

Entries for Cash Dividends
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.
Mar. 19 Common dividend payable Cash Dr 10,000 Cr 10,000

Date of Payment

Paid $1 per share cash dividend

Record payment of cash to stockholders.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P2

Deficits and Cash Dividends
Created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P3

Stock Dividends
The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return.

Why a stock dividend?
100 shares

HotAir, Inc. Common Stock
$1 par

•Can be used to keep the market price on the stock affordable. •Can provide evidence of management’s confidence that the company is doing well.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P3

Stock Dividends
Small Stock Dividend
 

Distribution is ≤ 25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed.

Large Stock Dividend  Distribution is > 25% of the previously outstanding shares.  Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P3

Recording a Small Stock Dividend
Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P3

Recording a Small Stock Dividend
On December 31, 2008, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2009. Let’s make the December 31 entry.

Dec. 31 Retained earnings 20,000 Common Stock Dividend Distributable Paid-In capital in excess of par value
Declared a 2,000 share (2%) stock dividend

2,000 18,000

100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P3

Before the stock dividend.

After the stock dividend.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P3

Recording a Large Stock Dividend
Router, Inc. shows the following stockholders’ equity section just prior to issuing a large stock dividend.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P3

Recording a Large Stock Dividend
On December 31, 2008, Router declared a 40% stock dividend, when the stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share.
Dr 20,000 Cr 20,000

Dec. 31 Retained earnings

Common stock dividend distributable

Declared a 20,000 share (40%) stock dividend

50,000 × 40% = 20,000 shares × $1 par value = $20,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P3

Stock Splits
A distribution of additional shares of stock to stockholders according to their percent ownership.
$10 par value

Common Stock
100 shares

Old Shares

$5 par value

New Shares
McGraw-Hill/Irwin

Common Stock
200 shares
© The McGraw-Hill Companies, Inc., 2008

P3

Stock Splits
After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this .
No accounting entry is made.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P5

Treasury Stock

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P5

Purchasing Treasury Stock
On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000.
May 8 Treasury stock, common Cash at $4 per share Cr 8,000 Dr 8,000

Purchase 2,000 treasury shares

Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

P5

Selling Treasury Stock at Cost
On June 30, Whitt sold 100 shares of its treasury stock for $4 per share.

June 30

Cash Treasury stock, common
Sold 100 shares of treasury

Dr 400

Cr 400

$8,000 ÷ 2,000 shares $4$4 cost per treasury share for = per share
© The McGraw-Hill Companies, Inc., 2008

McGraw-Hill/Irwin

P5

Selling Treasury Stock Above Cost
On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share.
Cr 4,000 Dr 2,000 2,000

July 19

Cash Treasury Stock, common Paid-In Capital, Treasury Stock

Sold 500 treasury shares for $8 per share

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

P5

Selling Treasury Stock Below Cost
On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share.

Aug. 27

Cash Paid-in Captial, treasury stock Treasury stock, common

Cr 600 1,000

Dr

1,600

Sold 500 treasury shares for $1.50 per share

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

A1

Stock Options
The right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases.

Option purchase price $30 per share.
McGraw-Hill/Irwin

Market price of stock $75 per share.

© The McGraw-Hill Companies, Inc., 2008

P5

Stock Options
Options are given to key employees to motivate them to:  focus on company performance,  take a long-run perspective, and  remain with the company.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C4

Statement of Retained Earnings
Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C4

Restricted Retained Earnings

Legal
Most states restrict the amount of treasury stock purchases to the amount of retained earnings.

Contractual
Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C4

Appropriated Retained Earnings
A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C4

Prior Period Adjustments
Correction of material errors in past years’ financial statements. If an amount is incorrectly expensed, add amount to Retained Earnings.

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

C4

Statement of Stockholders’ Equity
Matrix, Inc. Statement of Stockholders' Equity For the Year Ended December 31, 2008 Common stock and (In millions) capital in excess of par Shares Amount Balance at January 1, 2008 821 $ 2,500 Stock sales 17 500 Stock repurchases and retirement (17) (260) Cash dividends declared Other, net Net income Balance at December 31, 2008 821 $ 2,740 Retained Earnings $ 9,500 (925) (150) 70 5,100 $ 13,595

Total $ 12,000 500 (1,185) (150) 70 5,100 $ 16,335

This is a more inclusive statement than the statement of retained earnings.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

A1

Earnings Per Share
Earnings per share is one of the most widely cited items of accounting information.
Basic Net income - Preferred dividends earnings = Weighted-average common shares outstanding per share

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

A2

Price Earnings
This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities.

PriceMarket value per share = Earnings Earnings per share
If earnings go up, will the market price of my stock follow?

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

A3

Dividend Yield
Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price.

Dividend = Yield

Annual cash dividends per share Market value per share

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

A4

Book Value per Share—Common
Records amount of stockholders’ equity applicable to common shares on a per share basis. Stockholders’ equity applicable Book value per to common shares = common share Number of common shares outstanding

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

A4

Book Value per Share—Preferred
Records amount of stockholders’ equity applicable to preferred shares on a per share basis. Stockholders’ equity applicable Book value per to preferred shares = preferred share Number of preferred shares outstanding

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

End of Chapter 11

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2008

Sign up to vote on this title
UsefulNot useful

Master Your Semester with Scribd & The New York Times

Special offer for students: Only $4.99/month.

Master Your Semester with a Special Offer from Scribd & The New York Times

Cancel anytime.