Chapter 11

Stockholders’ Equity
 Stockholders’ Equity
 Owners of a corporation and have a residual
interest in assets after liabilities are satisfied

LO 1
EXHIBIT 11.1—Advantages and Disadvantages of
Stock versus Debt Financing
 Stockholders’ Equity on the Balance
Sheet
 The basic accounting equation:

Assets = Liabilities + Stockholders’ Equity

 Two major components or subcategories:

 Contributed Capital
 Retained Earnings
 Components of the Stockholders’
Equity Section of the Balance Sheet
 Number of Shares
 Par Value
 Additional Paid-In Capital
 Retained Earnings
 Contributed Capital
 Common stock
 Carries voting rights
 The common stockholders elect the corporation’s
officers
• Establish its bylaws and governing rules
 Preferred stock
 Flexibleand tailored to a company’s needs
 Preference in dividends
 Number of Shares
 Authorized shares: the maximum number of
shares a corporation may issue as indicated in
the corporate charter
 Issued shares: the number of shares sold or
distributed to stockholders
 Outstanding shares: the number of shares
issued less the number of shares held as
treasury stock
 Par Value
 An arbitrary amount that represents the legal
capital of the firm
 Stated on the face of the stock certificate
 Also called “stated value”
 Amount presented in the stock account
 Additional Paid-In Capital & Retained
Earnings
 Additional paid-in capital: the amount received
for the issuance of stock in excess of the par
value of the stock
 Retained earnings: net income that has been
made by the corporation but not paid out as
dividends
 Not necessarily available to stockholders
 May be used for purchase of assets, the retirement of
debt, or other financial needs
 Exhibit 11.2—Retained Earnings Connects
the Income Statement and the Balance Sheet
 IFRS and Stockholders’ Equity
Convertible bond
International accounting rules
 Separated into two parts—liability and stockholders’
equity
U.S. accounting standards
 Do not require to be recorded as a separate amount
 Recorded as either liability or stockholders’ equity
 Preferred Stock
 Flexible and tailored to a company’s needs
 Preference to dividends before the common
stockholders
 Right to the company’s assets before the
common stockholders during liquidation
 The dividend rate may be stated in two ways:
 Percentage of the stock’s par value
 Per-share amount

LO 2
 Preferred stock additional terms and
features
 Convertible: allows preferred stock to be
exchanged for common stock
 Redeemable: allows stockholders to sell stock
back to the company
 Callable: Allows the firm to eliminate a class of
stock by paying the stockholders a specified
amount
 Preferred stock additional terms and
features
 Cumulative: the right to dividends in arrears
before the current-year dividend is distributed
 Participating: Allows preferred stockholders to
share on a percentage basis in the distribution
of an abnormally large dividend
 Issuance of Stock
 Issued for
cash or for noncash assets
 When issued for cash:
 Parvalue reported in the stock account
 Amount in excess of par is reported in the Paid-In
Capital account
 When exchanged for noncash items:
 Recorded at the fair market value of the stock or the
assets received, whichever is most readily
determined
LO 3
 Example 11.1—Recording Stock
Issued for Cash
 Assume that on July 1, a firm issued 1,000
shares of $10 par common stock for $15 per
share
 Example 11.2—Recording Stock for
Noncash Consideration
 Assume that on July 1, a firm issued 500 shares of $10
par preferred stock to acquire a building. The stock is
not widely traded, and the current market value of the
stock is not evident. The building has recently been
appraised by an independent firm as having a market
value of $12,000
 Treasury Stock
 Issued by the firm and then repurchased but not
retired
 Repurchase is recorded as a debit to Treasury
Stock, a contra-equity account
 For an amount to be treated as treasury stock:
 It must be the corporation’s own stock
 It must have been issued to the stockholders at some
point
 It must have been repurchased from the stockholders
 It must not be retired, but must be held for some
purpose
LO 4
Example 11.3—Recording the Purchase
of Treasury Stock
 Assume that the Stockholders’ Equity section of Rezin Company’s
balance sheet on December 31, 2014, appears as follows:

 Assume that on February 1, 2015, Rezin buys 100 of its shares as

treasury stock at $25 per share
 Stockholders’ Equity Section
 TheStockholders’ Equity section of Rezin’s
balance sheet on February 1, 2015, after the
purchase of the treasury stock
 Retirement of Stock
 Repurchase of stock with no intention of reissuing
 To eliminate a particular class of stock or group of
stockholders
 The general principle for retirement of stock is the
same as for treasury stock transactions
 No income statement accounts are affected
 Effect is reflected in the Cash account and the
Stockholders’ Equity accounts
 Cash Dividends
 Declared only if acompany has sufficient cash
available and adequate retained earnings
 Not an expense on the income statement
 Date of declaration: cash dividends are declared
 Payment date: cash dividends are paid
 Date of record: dividend is paid to the
stockholders who own the stock as of this date

LO 5
 Dividend Payout Ratio

Annual Dividend
Dividend Payout Ratio =
Annual Net Income

 Ratio formany firms is 50% or 60% and seldom

exceeds 70%
 Example 11.4—Recording the
Declaration of a Dividend
 Assume that on July 1, the board of directors of
Grant Company declared a cash dividend of $7,000
to be paid on September 1. Grant reflects the
declaration as a reduction of Retained Earnings and
an increase in Cash Dividend Payable as follows:
 Example 11.5—Computing Dividend
Payments for Noncumulative Preferred Stock
 Assume that on December 31, 2014, Stricker Company has
outstanding 10,000 shares of $10 par, 8% preferred stock
and 40,000 shares of $5 par common stock. Stricker was
unable to declare a dividend in 2012 or 2013 but wants to
declare a $70,000 dividend for 2014
 Example 11.6—Computing Dividend
Payments for Cumulative Preferred Stock
 If the terms of the stock agreement in Example 11.5
indicate that the preferred stock is cumulative, the
preferred stockholders have a right to dividends in
arrears before the current year’s dividend is distributed
 Stock Dividends
 The issuance of additional shares of stock to
existing stockholders
 Firms use stock dividends for several reasons
 Do not require the use of cash
 Reduce the market price of the stock
• The lower price may make the stock more attractive
 Do not represent taxable income to recipients

LO 6
Example 11.7—Recording a Small Stock
Dividend
 Assume that Shah Company’s Stockholders’ Equity category of the balance
sheet appears as follows as of January 1, 2014:

 Assume that on January 2, 2014, Shah declares a 10% stock dividend to

common stockholders to be distributed on April 1, 2014. Small stock dividends
(usually those of 20% to 25%) normally are recorded at the market value of the
stock as of the date of declaration. Assume that Shah’s common stock is selling
at $40 per share on that date
Example 11.7—Recording a Small Stock
Dividend (continued)

Total market value = $20,000 (10% of 5,000 shares outstanding, times $40 per share

 Stockholders’ Equity section of Shah’s balance sheet on January 2, 2014

 Example 11.8—Recording the
Declaration of a Large Stock Dividend
 Assume that instead of a 10% dividend, on January 2, 2014, Shah declares a
100% stock dividend to be distributed on April 1, 2014. The stock dividend
results in 5,000 additional shares being issued and certainly meets the
definition of a large stock dividend
 Stock Splits
 Thecreation of additional shares of stock with a
reduction of the par value of the stock

LO 7
Example 11.9—Reporting a Stock Split
Before stock split

 Assume that on January 2, 2014, Shah issued a 2-for-1 stock split

instead of a stock dividend
After stock split
 Statement of Stockholders’ Equity
 Explains the reasons for thedifference between
the beginning and ending balances for all
accounts in the Stockholders’ Equity category of
the balance sheet

LO 8
Exhibit 11.3—Fun Fitness’s Statement
of Stockholders’ Equity, 2014
 Comprehensive Income
 Totalchange in net assets from all sources
except investments by or distributions to the
owners
 Important measure of a company’s profitability
 One-statement approach
 Showed at the bottom of the income statement
 Two-statement approach
 Statement of Comprehensive Income must be
presented (indicated in Exhibit 11.4—next slide)
 Exhibit 11.4—The Relationship between the Income
Statement and the Statement of Comprehensive Income
 Book Value Per Share
 Rights of each share of stock to the net assets of
the company

 If preferred stock is present, stockholders’

equity must be adjusted to reflect its liquidation
value

LO 9
Calculating Book Value When Preferred
Stock Is Present
 Exhibit 11.5—Workout Wonders’ Stockholders’ Equity Section

$13,972 − $500 = $13,472 million common stockholders’ equity

$13,472 /1,679 = $8.02 Book Value per Share
 Market Value per Share
 The selling price of the stock as indicated by the
most recent transactions
 More meaningful measure of the value of the
stock
 Example: the listing for Nike Inc. stock on the
Internet may indicate the following:
 Exhibit 11.6—The Effect of Stockholders’
Equity Items on the Statement of Cash Flows

LO 10
 Sole Proprietorships
 Business owned by one person
 The owner have an unlimited liability
 Not a separate entity for legal or tax purposes
 Assets and liabilities of the owner must be kept
separate from the business
 Owners’ equity is one account—the owner’s
capital account

LO 11
Example 11.10—Recording Investments
in a Sole Proprietorship
 Assume that on January 1, 2014, Peter Tom began a new
business by investing $10,000 cash

 Assume that on July 1, 2014, Peter Tom took an auto valued at

$6,000 from the business to use as his personal auto
Example 11.10—Recording Investments
in a Sole Proprietorship (continued)
 Assume that all revenue and expense accounts of Peter Tom
Company have been closed to the Income Summary account,
resulting in a balance of $4,000, the net income for the year

 The Owner’s Equity section of the balance sheet

 Partnerships
 More than one owner
 Separate capital account is maintained for each
partner, as well as separate drawing accounts
 Partnership agreement governs how income
(losses) will be distributed
 Unlimited liability
 Limited life
 Not taxed as a separate entity
 Income is taxed on each owner’s tax return
 Partnership Agreement
 Specifies how much the owners will invest, what
their salaries will be, and how profits will be
shared
Example 11.11—Recording Investments
in a Partnership
 Assume that on January 1, 2014, Paige Thoms and Amy Rebec
begin a partnership named AP Company. Paige contributes
$10,000 cash, and Amy contributes equipment valued at $5,000

 Assume that on April 1, 2014, each owner withdraws $2,000 of

cash from AP Company
 Distribution of Income
 Assume that AP Company has $30,000 of net income for the period
and has established an agreement that income should be allocated
evenly between the two partners, Paige and Amy

 Paige and Amy may specify that all income of AP Company should be
allocated in a 2-to-1 ratio, with Paige receiving the larger portion
End of Chapter 11