11 1 Chapter 11 STOCKHOLDERS EQUITY PaidIn Capital

11 -1 Chapter 11 STOCKHOLDERS’ EQUITY: Paid-In Capital Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -2 Corporations An entity created by law. Existence is separate from owners. Has rights and privileges. Mc. Graw-Hill/Irwin Ownership can be Privately, or Closely, Held Publicly Held © The Mc. Graw-Hill Companies, Inc. , 2008

11 -3 Learning Objective To discuss the advantages and disadvantages of organizing a business as a corporation. LO 1 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -4 Advantages of Incorporation Limited personal liability for stockholders Transferability of ownership Professional management Continuity of existence Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -5 Disadvantages of Incorporation Heavy taxation Greater regulation Cost of formation Separation of ownership and management Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -6 Learning Objective To distinguish between publicly owned and closely held corporations. LO 2 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

Publicly Owned Corporations Face Different Rules 11 -7 By LAW, publicly owned corporations must: v Prepare financial statements in accordance with GAAP. v Have their financial statement audited by an independent CPA. v Comply with federal securities laws. v Submit financial information for SEC review. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -8 Formation of a Corporation • Each corporation is formed according to the laws of the state where it is located. The costs associated with incorporation are usually expensed immediately, but amortized over 5 years for tax purposes. • The application for corporate status is called the Articles of Incorporation. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -9 Learning Objective To explain the rights of stockholders and the roles of corporate directors and officers. LO 3 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -10 Rights of Stockholders Voting (in person or by proxy). Rights Stockholders Mc. Graw-Hill/Irwin Proportionate distribution of dividends. Proportionate distribution of assets in a liquidation. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -11 Rights of Stockholders Ultimate control Mc. Graw-Hill/Irwin Stockholders usually meet once a year. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -12 Rights of Stockholders Stockholder Ultimate ledgers are often controlby a maintained stock transfer agent or stock registrar. Mc. Graw-Hill/Irwin Stockholders usually meet once a year. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -13 Rights of Stockholders Each unit of ownership is called a share of stock. Stock certificates serve as proof that a stockholder has purchased shares. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -14 Rights of Stockholders When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -15 Functions of the Board of Directors Selected by a vote of the stockholders Mc. Graw-Hill/Irwin Overall responsibility for managing the company. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -16 Functions of the Corporate Officers Contractual and legal representation Custodian of funds Mc. Graw-Hill/Irwin Chief Accountant © The Mc. Graw-Hill Companies, Inc. , 2008

11 -17 Learning Objective To account for paid-in capital and prepare the equity section of a corporate balance sheet. LO 4 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

Stockholders’ Equity of a Corporation Mc. Graw-Hill/Irwin 11 -18 © The Mc. Graw-Hill Companies, Inc. , 2008

Authorization and Issuance of Capital Stock Authorized Shares Mc. Graw-Hill/Irwin 11 -19 The maximum number of shares of capital stock that can be sold to the public. © The Mc. Graw-Hill Companies, Inc. , 2008

Authorization and Issuance of Capital Stock Authorized Shares Usually shares are sold through an underwriter. Mc. Graw-Hill/Irwin Issued shares are authorized shares of stock that have been sold. 11 -20 Unissued shares are authorized shares of stock that never have been sold. © The Mc. Graw-Hill Companies, Inc. , 2008

Authorization and Issuance of Capital Stock Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Issued Shares Outstanding Shares Treasury Shares Mc. Graw-Hill/Irwin 11 -21 Unissued Shares Treasury shares are issued shares that have been reacquired by the corporation. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -22 Stockholders’ Equity Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -23 Stockholders’ Equity Common stock can be issued in three forms: Par Value Common Stock No-Par Common Stock Stated Value Common Stock Let’s examine this form of stock. All proceeds credited to Common Stock Treated like par value common stock Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -24 Issuance of Par Value Stock Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Contributed Capital in Excess of Par. Matrix, Inc. issues 10, 000 shares of its $2 par value stock for $25 per share on September 1, 2007. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -25 Issuance of Par Value Stock Matrix, Inc. issues 10, 000 shares of its $2 par value stock for $25 per share on September 1, 2007. 10, 000 × $2 = $20, 000 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -26 Issuance of Par Value Stock Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -27 Learning Objective To contrast the features of common stock with those of preferred stock. LO 5 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -28 Preferred Stock A separate class of stock, typically having priority over common shares in. . . § Dividend distributions (rate is usually stated). § Distribution of assets in case of liquidation. Other Features Include: Cumulative dividend rights. Mc. Graw-Hill/Irwin Usually callable by the company. Normally has no voting rights. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -29 Cumulative Preferred Stock Cumulative Dividends in arrears must be paid before dividends may be paid on common stock. Mc. Graw-Hill/Irwin Vs. Noncumulative Undeclared dividends from current and prior years do not have to be paid in future years. © The Mc. Graw-Hill Companies, Inc. , 2008

11 -30 Stock Preferred as to Dividends Example: Consider the following partial Statement of Stockholders’ Equity. During 2007, the directors declare cash dividends of $5, 000. In 2008, the directors declare cash dividends of $42, 000. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -31 Stock Preferred as to Dividends Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -32 Other Features of Preferred Stock I just converted 100 shares of preferred stock into 1, 000 shares of common stock and ended up with a higher dividend yield! Gee, I can’t do that with MY preferred stock! Some preferred stock is convertible into shares of common stock. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -33 Preferred Stock Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -34 Learning Objective To discuss the factors affecting the market price of preferred stock and common stock. LO 6 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -35 Market Value Accounting by the issuer. Common stock is carried at original issue price. Accounting by the investor. Investments in marketable securities are carried at market value. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -36 Market Price of Preferred Stock Factors affecting market price of preferred stock: • • • Dividend rate Risk Level of interest rates The return based on the market value is called the “dividend yield. ” Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -37 Market Price of Common Stock Factors affecting market price of common stock: Changes in market value have no impact on the books of the issuer. l Investors’ expectations of future profitability. l Risk that this level of profitability will not be achieved. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -38 Learning Objective To explain the significance of par value, book value, and market value of capital stock. LO 7 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

Book Value per Share of Common Stock 11 -39 Preferred stock and preferred dividends in arrears are deducted from total stockholders’ equity. Total Stockholders’ Equity Number of Common Shares Outstanding Book Value Mc. Graw-Hill/Irwin = Market Value © The Mc. Graw-Hill Companies, Inc. , 2008

11 -40 Learning Objective To explain the purpose and effects of a stock split. LO 8 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -41 Stock Splits § Companies use stock splits to reduce market price. § Outstanding shares increase, but par value is decreased proportionately. Mc. Graw-Hill/Irwin Ice Cream Parlor Banana Splits On Sale Now © The Mc. Graw-Hill Companies, Inc. , 2008

11 -42 Stock Split Assume a corporation has 5, 000 shares of $1 par value common stock outstanding before a 2–for– 1 stock split. Increase Decrease No Change Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -43 Learning Objective To account for treasury stock transactions. LO 9 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -44 Treasury Stock No voting or dividend rights Contra equity account Treasury shares are issued shares that have been reacquired by the corporation. When stock is reacquired, the corporation records the treasury stock at cost. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -45 Treasury Stock - Example On May 1, 2007, East, Inc. reacquires 3, 000 shares of its common stock at $55 per share. Prepare the journal entry for May 1. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -46 Treasury Stock - Example On December 3, 2007, East Corp. reissued 1, 000 shares of the stock at $75 per share. Prepare the journal entry for December 3. 1, 000 shares × $75 = $75, 000 1, 000 shares × $55 cost = $55, 000 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -47 Stockholders’ Equity - Presentation Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

11 -48 End of Chapter 11 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008