CHAPTER 11

Equity Financing
 Learning Objective 1
Distinguish between
debt and equity
financing and
describe the
advantages and
disadvantages of
organizing a
business as a
proprietorship or a
partnership.
 Time Line of
Business Issues

Choose Solicit Generate Report

 Differentiate Between
Debt and Equity
 Debt Financing Equity Financing

 Loans; repay, with No responsibility

interest to repay
Investor takes risk
 Liable for amount
Investor rewarded
of loan
by company’s future
 Relationship ends
success
with repayment
 Define Proprietorships and
Partnerships

Proprietorship
A business owned by one
person.
Partnership
An association of two or
more individuals or
organizations to carry on
an economic activity.
 What Are Some Characteristics
Shared by Proprietorships and
Partnerships?
Ease of Formation
Both types of businesses are easy to start.
Limited Life
The business can decide to dissolve at any
time.
Unlimited Liability
The proprietors or partners are personally
responsible for all of the business’s debts.
 Learning Objective 2

Describe the basic

characteristics of
a corporation and
the nature of
common and
preferred stock.
 What is a Corporation?

 A legal entity chartered by a state.

 Legally distinct from the persons responsible
for its creation.
 Accorded the same rights as individuals:
 Can conduct business.
 Can be sued.
 Can enter into contracts.
 Can own property.
 Ownership is represented by
transferable shares of stock.
List Characteristics of a
Corporation
Ability to
Limited Perpetual
Raise
Liability Existence Capital

Corporation

Taxed Government
Separately Regulation
 What are the Steps to Starting a
Corporation?
 Study state corporate laws.
 Apply for a charter with
appropriate state official.
 Sell stock to obtain financing.
 Provide prospectus.
 Outline business plan.
 Detail sources of financing.
 List significant risks.
 Offer initial public offering
(IPO).
 Common Stock
Basic rights inherent in common stock ownership:
 The right to vote in corporate matters such as the
election of the board of directors or the undertaking of
major actions such as the purchase of another
company.
 The preemptive right, which permits existing
stockholders to purchase additional shares whenever
stock is issued by the corporation.
 Right to receive dividends if they are paid.
 Rights to ownership of all corporate assets once
obligations to everyone else have been satisfied.
 Preferred Stock
Define the following terms.

Preferred Stock
A class of stock that usually
provides dividend and
liquidation preferences over
common stock.
Convertible Preferred Stock
Preferred stock that can be
converted to common stock at
a specified conversion rate.
 Learning Objective 3

Account for the

issuance and
repurchase of
common and
preferred stock.
 Issuing Stock
Par Value
Nominal value assigned to
and printed on the face of
each share of a corporation’s
stock.
Contributed Capital
The portion of owners’
equity contributed by
investors (the owners) in
exchange for shares of
stock.
 Example: Issuing Stock

The Angelfish Corporation issued 5,000

shares of $20 par common stock for $40
per share. Record the transaction.

Cash. . . . . . . . . . . . . . . . . . . . . . . . 200,000
Common Stock. . . . . . . . . . . . . . 100,000
Paid-in Capital in Excess of Par . 100,000
Issued 5,000 shares at $40 per share.
 Example: Issuing Stock

The Angelfish Corporation issued 5,000

shares of $20 no-par common stock for
$40 per share. Record the transaction.

Cash. . . . . . . . . . . . . . . . . . . . . . . . 200,000
Common Stock. . . . . . . . . . . . . . 200,000
Issued 5,000 shares at $40 per share.
 Example: Issuing Stock

The Angelfish Corporation exchanged

2,000 shares of $20 par common stock for
land. Market value of the stock is $40 per
share. Record the transaction.

Land . . . . . . . . . . . . . . . . . . . . . . . . 80,000
Common Stock. . . . . . . . . . . . . . 40,000
Paid-in Capital in Excess of Par. 40,000
Issued 2,000 shares at $40 per share for land.
 What is Treasury Stock?

Issued stock that has been subsequently

reacquired by the corporation.

Stock
Investor

Corporation
 Treasury Stock
Why purchase treasury stock?
 To fund a profit-sharing, bonus, or stock-option
plan.
 The stock is selling for a low price and is a good
buy.
 To stimulate trading of company stock.
 To remove shares from the market to avoid a
hostile takeover.
 To increase reported earnings per share.
 Example: Issuing Stock

The Goldfish Company

purchased 1,000 shares of its
own $20 par common stock for
$30 per share. Record the
transaction.

Treasury Stock, Common. . . . . . . . 30,000

Cash . . . . . . . . . . . . . . . . . . . . . . 30,000
Purchased 1,000 shares at $30 per share.
 Treasury Stock
Treasury Resold
Stock above cost

Resold Paid-In Capital, Treasury

below cost Stock

Debit Paid-In Capital,

Treasury Stock If it Exists,
Otherwise Debit
Retained Earnings
 Example: Reissuing Treasury
Stock

The Goldfish Company reissued

500 shares of treasury stock for
$35 per share. Record the
transaction.

Cash. . . . . . . . . . . . . . . . . . . . . . . .17,500
Treasury Stock, Common. . . . . . 15,000
Paid-In Capital, Treasury Stock . 2,500
Reissued 500 shares of treasury stock at $35 per
share.
 Example: Reissuing Treasury
Stock
The Goldfish Company reissued
300 shares of treasury stock
(originally issued for $30 per share)
for $25 per share. Record the
transaction.

Cash. . . . . . . . . . . . . . . . . . . . . . . . 7,500
Paid-In Capital, Treasury Stock . 1,500
Treasury Stock, Common . . . . . 9,000
Reissued 300 shares of treasury stock at $25 per
share (original cost was $30 per share).
 Example: Reissuing Treasury
Stock
The Goldfish Company reissued 150
shares of treasury stock (originally
issued for $30 per share) for $22 per
share. Record the transaction.

Cash. . . . . . . . . . . . . . . . . . . . . . . . 3,300
Paid-In Capital, Treasury Stock . . 1,000
Retained Earnings . . . . . . . . . . . . . 200
Treasury Stock, Common . . . . . 4,500
Reissued 150 shares of treasury stock at $22 per
share (original cost was $30 per share).
 Learning Objective 4

Understand the factors that impact

retained earnings, describe the
factors determining whether a
company can and should pay cash
dividends, and account for cash
dividends.
 Retained Earnings and Dividends

The portion of a corporation’s

Cash owners’ equity that has been
Dividends earned from profitable
operations and not distributed
to stockholders.
Dividends
Distributions to the owners
(stockholders) of a corporation.
Retained Cash distribution of earnings to
Earnings stockholders.
 Accounting for
Retained Earnings

Net Income

Retained
Earnings Losses
Dividends
 Match Important Dividend Dates
The date the corporation’s
board of directors formally
decides to pay a dividend
to stockholders. 1 Declara
tio n Date
The date selected by a
corporation’s board of Paymen
directors on which the t Date
stockholders of record are
identified as those who
3
Date of
will receive dividends. R ecord
The date on which a
corporation pays
dividends to its 2
stockholders.
 Example: Cash Dividend
The Dolphin Company declared a $0.50
dividend on January 1, 2003; 4,000
shares are outstanding. Record the
appropriate journal entries.

Declaration Date
Dividends. . . . . . . . . . . . . . . . . . . . . . . . 2,000
Dividends Payable. . . . . . . . . . . . 2,000

Payment Date
Dividends Payable. . . . . . . . . . . . . . . . .2,000
Cash. . . . . . . . . . . . . . . . . . . . . . . 2,000
 Dividend Preferences
Current-Dividend Preference
The right of preferred stockholders to receive
current dividends before common stockholders
receive dividends.
Cumulative-Dividend Preference
The right of preferred stockholders to receive
current dividends plus all dividends in arrears
before common stockholders receive any
dividends.
 Dividend Preferences
Dividends in Arrears
 Missed dividends for past years
that preferred stockholders
have a right to receive under the
cumulative-dividend preference
if and when dividends are
received.
 Do not represent actual
liabilities and thus are not
recorded in the accounts.
 Reported in the notes to the
financial statements.
 Example: Preferred Dividend
Lobster Company did not pay dividends
last year, but it has declared a $5,000
dividend in the current year. Outstanding
stock includes the following. Calculate
the dividend.
Preferred, 5% Cumulative, $20 par 2,000 shares
Common, $5 par 5,000 shares

Dividends in arrears $2,000

Current-dividend preference
($20 x 0.05 x 2,000 shares) 2,000
Total for preferred stockholders $4,000
Total left for common stockholders 1,000
Total $5,000
 Example: Preferred Dividend
Lobster Company did not pay dividends
last year, but it has declared a $5,000
dividend in the current year. Outstanding
stock was previously listed. Given this
calculation, provide the appropriate
journal entries.
Declaration Date
Dividends, Preferred Stock . . . . . . . . . 4,000
Dividends, Common Stock . . . . . . . . . 1,000
Dividends Payable. . . . . . . . . . . . . . 5,000

Payment Date
Dividends Payable. . . . . . . . . . . . . . . . . . 5,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . 5,000
 Learning Objective 5
Describe the
purpose of reporting
comprehensive
income in the equity
section of the
balance sheet and
prepare a statement
of stockholders’
equity.
 Define These Other Equity Terms
Accumulated Other Comprehensive Income
Market-related gains and losses that are not
reported as part of net income but are instead
reported as separate equity items.
Statement of Comprehensive Income
Statement outlining the changes in
accumulated comprehensive income that arose
during the period.
Statement of Stockholders’ Equity
A financial statement that reports all changes in
stockholders’ equity.
Comprehensive Income in the
Balance Sheet
Killer Whale Corp. has the following
comprehensive income items in the
current year:
1. Investment securities increased in
value by $600 during the current year.
2. Assets owned by Killer Whale’s British
subsidiary decreased in value by $350
due to a decline in the strength of the
British Pound.
How would this information appear in the
equity section of the balance sheet?
 Comprehensive Income in the
Balance Sheet

Killer Whale Corp.

Accumulated other comprehensive income:

Unrealized gain from investment securities. . . . $600
Foreign currency translation adjustment . . . . . . (350)
Total accumulated other comprehensive
income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250
 Expanded Material
Learning Objective 6

Account for stock

dividends and
distinguish them
from stock splits.
Match Accounting for Stock Dividends
A pro rata
distribution of Stock
Small
Dividend
additional shares
Stock
of stock to
Dividend
stockholders.
Small
Stock
Less than 25 Large
Dividend
percent. Stock
Dividend
Large
Greater than 25 Stock
percent. Stock
Dividend
 Stock Dividends
If the stock dividend is less
than 25 percent of the
25% outstanding company stock,
the journal entry requires the
use of the market value of the
stock.
Outstanding
Stock If the stock dividend is 25
percent or more of the
outstanding company stock,
75% the journal entry requires that
retained earnings be debited
only for par value.
 Example: Accounting for Stock
Dividends
Oyster Corporation declares a 20
percent stock dividend. The company
has 2,000 shares of common stock ($5
par) outstanding. What is the
necessary entry if the stock price is $15
when the dividends are declared and
issued?

Retained Earnings. . . . . . . . . . . . . . 6,000

Common Stock. . . . . . . . . . . . . . 2,000
Paid-In Capital in Excess of Par. 4,000
Declared and issued a 20% common stock dividend.
 Example: Accounting for Stock
Dividends
Oyster Corporation declares a 30
percent stock dividend. The company
has 2,000 shares of common stock ($5
par) outstanding. What is the
necessary entry if the stock price is $15
when the dividends are declared and
issued?

Retained Earnings. . . . . . . . . . . . . . 3,000

Common Stock. . . . . . . . . . . . . . 3,000
Declared and issued a 30% common stock dividend
(2,000 x 0.30 = 600 shares).
 Stock Split
A stock split is the replacement of outstanding
shares of stock with a greater number of new
shares.
Companies sometimes
enact a stock split to
encourage more
Stock investors to buy stocks
(replacing the
Stock outstanding shares
with a larger number of
Stock
new shares that sell at
a lower price per
share).
 Differentiate Between a
Stock Split vs.
a Stock Dividend
 A stock split is usually bigger.
Stock
 A stock dividend might
increase the number of shares
Stock
outstanding by 10 or 25
percent.
 A stock split is likely to
increase the number of shares
outstanding by 50 percent, 100
percent, or more.
 Expanded Material
Learning Objective 7

Explain prior-period
adjustments and
prepare a statement
of retained earnings.
 Define Prior-Period Adjustments
and the Statement of Retained
Earnings
Prior-Period Adjustments
Adjustments made directly to Retained
Earnings in order to correct errors in the
financial statements of prior periods.
Statement of Retained Earnings
A report that shows the changes in the
retained earnings account during a period of
time.
 Statement of Retained Earnings
Oyster Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2003
Retained earnings, January 1, 2003. . . . . . . . . . $300,000
Prior-period adjustment:
Deduct adjustment for 2002 inventory correction. (25,000)
Balance as restated. . . . . . . . . . . . . . . . . . . . . . . $275,000
Net income for 2003 . . . . . . . . . . . . . . . . . . . . . . 50,000
Less dividends declared in 2003:
Preferred stock . . . . . . . . . . . . . . . . . . . . . $10,000
Common stock. . . . . . . . . . . . . . . . . . . . . . 12,000

(22,000)
Retained earnings, December 31, 2003 . . . . . . . $303,000
 Expanded Material
Learning Objective 8

Understand basic
proprietorship and
partnership
accounting.
 Proprietorship and
Partnership Accounting
All owners’ equity transactions are
recorded in only two accounts.

Capital Account
An account where a proprietor’s or partner’s
interest in a firm is recorded.
Drawings Account
The account used to reflect periodic withdrawals
of earnings by the owner or owners.
 Proprietorship
Shelly Seals wants to start a business. On
January 1, 2003, she contributes $100,000 for a
sole proprietorship. On May 1, she withdraws
$2,000 for personal use. Record the
transactions.

Jan. 1 Cash. . . . . . . . . . . . . . . . . . 100,000

Shelly Seals, Capital . . . 100,000
Invested $100,000 to start a business.
May 1 Shelly Seals, Drawings. . . . . 2,000
Cash. . . . . . . . . . . . . . . . . 2,000
Withdrew cash for personal use.
Dec. 31 Shelly Seals, Capital. . . . . 2,000
Shelly Seals, Drawings . . 2,000
To close the drawings account for the year.
 Partnership
Tina and Tiny agree to start a shrimp business. On
January 1, they agree that Tina will contribute land worth
$55,000, a truck worth $15,000 and $20,000 cash. Tiny will
contribute $25,000 in equipment and $35,000 in cash. At
the conclusion of the year, Tina draws $45,000 and Tiny
draws $30,000 as salary. Make the journal entries.

Jan 1 Cash. . . . . . . . . . . . . . . . . . . 55,000

Equipment. . . . . . . . . . . . . . 25,000
Land. . . . . . . . . . . . . . . . . . . 55,000
Truck . . . . . . . . . . . . . . . . . . 15,000
Tina, Capital . . . . . . . . . . . 90,000
Tiny, Capital . . . . . . . . . . . 60,000
To record the investments of Tina and Tiny in
a partnership.
 Partnership

Dec. 31 Tina, Drawings. . . . . . . . . . . . 45,000

Tiny, Drawings. . . . . . . . . . . . 30,000
Cash . . . . . . . . . . . . . . . . . . 75,000
To record cash taken from the partnership

as salary.
Dec. 31 Tina, Capital. . . . . . . . . . . . . . 45,000
Tiny, Capital. . . . . . . . . . . . . . 30,000
Tina, Drawings. . . . . . . . . . 45,000
Tiny, Drawings. . . . . . . . . . 30,000
To close the drawings accounts for the year.
 Partnership
Statement of Partners’ Capital
A report showing the changes in the capital balances;
similar to a statement of retained earnings for a
corporation.
Tina’s & Tiny’s Shrimp
Statement of Partners’ Capital
For the Year Ended December 31, 2003
Tina Tiny Total
Investments, January 1, 2003 . . $ 90,000 $ 60,000 $150,000
Add net income for 2003 . . . . . . . 73,000 42,000 115,000
Subtotal . . . . . . . . . . . . . . . . . . . . $163,000 $102,000 $265,000
Less withdrawals during 2003 . . 45,000 30,000
75,000
Capital balances, Dec. 31, 2003 .$118,000 $ 72,000 $190,000