Stockholders Equity

By

Dr. Francis Gitagia, PhD, CPA (K)

Learning objectives
1. Be able to describe the characteristics, advantages, and disadvantages
of the corporate
form of business organization.
2. Know the different types of investments shareholders make in firms and
the rights of
each.
3. Be able to describe and demonstrate accounting and reporting practices
for the
issuance of the various forms of capital stock.
4. Understand the accounting and reporting practices for treasury stock,
including both
the cost method and the par value method.
The Corporate Form
A corporation is generally defined as a body of
persons granted a charter legally recognizing them as
a separate entity having its own rights, privileges, and
liabilitiesdistinct from those of its owners.
Organization Costs
The costs of forming a corporation are called organizational costs. Such
costs, which are incurred before the incorporation begins operation,
include incorporation fees, drawing up articles and memorandum of
association, and other expenditures incidental to incorporation.
Theoretically, organization costs benefit the entire life of the corporation.
For that reason, a case can be made for recording them as intangible
assets and amortizing them over the
life of the corporation.
However, the life of a corporation normally is not known, so
accountants amortize organizational costs over the early years of the
corporation life.
Illustration
The concept of owners equity
Common Stock
A Corporation can issue two basic types of stock: common stock and
preferred stock. If the Corporation issues only one kind, it is called
common stock.
Common stock is the company’s residual equity.
This means all other creditors and preferred stockholders claims to
the company’s assets rank ahead of those of the common
stockholders in the
case of liquidation.
Treasury stock are shares of the company repurchased by the
company itself.
These shares can be resold to the general public. When such shares
are sold for a higher amount than the purchase price, the extra
amount raised will be capitalized as Contributed capital from treasury
stock.
Accounting For Stock Issues

Issuing par value common stock for cash. Par value does not indicate
a stocks’ market value. Therefore, the cash proceeds from issuing par
value stock may be equal to, greater than, or less than par value.
When the issuance of common stock for cash is recorded, the par
value of shares is credited to common stock.
The portion of proceeds that is above or below par value is recorded
in a separate paid-in capital account.
Illustration
cont.’
Issuing No-Par Common Stock For Cash
When no par common stock has a stated value, the entries are similar
to those illustrated for par value stock. The stated value represents
legal capital. Therefore it is credited to common stock.
Issue of shares at premium
when the selling price of no-par stock exceeds stated value, the excess
is credited to paid-in capital in excess of stated value.
For example, assume that instead of Sh1 par value stock, Kerio Flowers
has Sh5 stated value no-par stock and the company issues 5,000 shares
at Sh8 per share for cash. The entry is:
Issue at a discount

 For example, assume that instead of Sh1 par value stock, Kerio Flowers has Sh5 stated

value no-par stock and the company issues 5,000 shares at Sh4 per share for cash. The

entry is:

Dr. Cash

Dr. Discount

Cr. Share capital

Cont.’
Issuing Common Stock For Services Or Non-Cash Assets Stock may
also be issued for services or for non-cash assets.
In such cases, what cost should be recognized in the exchange
transaction?
To comply with the cost principle, in a non-cash transaction, cost is
the cash equivalent price.
Thus, cost is either the fair market value of the consideration given
up, or the fair market value of the consideration received, whichever
is more clearly determinable.
Illustration
Assume that Mutwola and Co. advocates have helped Maisha company
incorporate. They have billed the company Sh5,00 for their services.
They agree to accept 4,000 shares of SH1 par value common stock in
full settlement of their bill. At the time of the exchange, there is no
established market price of for the stock. In this case, the
market value of the consideration received, Sh5,000, is more evident.
Accordingly the entry will be:
Cont.’
Note that organizational costs are expenses as incurred. If in contrast,
Maisha company is an existing publicly owned company and its Sh5 par
value stock is publicly traded at Sh8 per share. The company issues 10,000
shares of stock to acquire recently advertised land at Sh90,000. The most
evident value in this non-cash transaction is the market price of the
consideration given, Sh80,000. The transaction will be recorded as follows:
Illustration
Issuing preferred stock

The accounting treatment for preferred stock is the same as that of

common stock. The only difference is that preferred stock account and
paid-in capital in excess of par value, preferred stock are credited
instead of common stock and paid-in capital in excess of par
value, common stock respectively.
Treasury Stock
Treasury stock is capital stock, either common or preferred, that has
been issued and reacquired by issuing company and has not
subsequently been resold or retired. The company normally gets the
stock back by purchasing the shares on the market.
A company may purchase its own stock for
several reasons:
1. It may want stock to distribute to employees through stock option
plans.
2. It may be trying to maintain a favorable market for its stock.
3. It may want to increase its earnings per share.
4. It may want to have additional shares of stock available for such
activities as
purchasing other companies.
5. It may want to prevent a hostile takeover.
Purchase Of Treasury Stock
When a treasury stock is purchased, it is normally recorded at cost.
The transaction reduces both the assets and the stockholders’ equity
of the firm.
For example, assume that on September 15 Stage Buses Ltd.
purchases 1,000 shares of its common stock on the market at a price
of Sh50 per share. The purchase would be recorded as follows:
Sale Of Treasury Stock
Cont.’
When Treasury stock is sold below par (although it is rarely to sell at a
discount), the paid-in capital in excess of par value- treasury account
is used to write off the discount.
 However, if the amount is not enough or the account is non existent,
retained earnings is used to write of the discount
Retirement Of Treasury Stock
If a company determines that it will not reissue stock it has
purchased, with the approval of its stockholders it can retire the
stock.
When shares of stock are retired, all items related those shares are
removed from the related capital accounts. When stock that cost less
than its original contributed capital is retired, the difference is
recognized in paid-in capital retirement of stock.
On the other hand, if the stock had cost more than its par
value, the difference is debited to retained earnings.
Example
EXAMPLE 3
Comprehensive example
Comprehensive illustration cont.’
Cont.’
Cont.’