Chapter 11 STOCKHOLDERS EQUITY 1 Corporations An entity

Chapter 11 STOCKHOLDERS’ EQUITY: 1

Corporations An entity created by law. Existence is separate from owners. Has rights and privileges. Ownership can be Privately, or Closely, Held Publicly Held 2

Advantages of Incorporation Limited personal liability for stockholders. Transferability of ownership. Professional management. Continuity of existence. 3

Disadvantages of Incorporation Heavy taxation. Greater regulation. Cost of formation. Separation of ownership and management. 4

Rights of Stockholders ¶ Voting (in person or by proxy). · Proportionate Rights distribution of dividends. Stockholders ¸ Proportionate distribution of assets in a liquidation. 5

Rights of Stockholders Stockholder Ultimate ledgers are often controlby a maintained stock transfer agent or stock registrar. Stockholders usually meet once a year. 6

Rights of Stockholders Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. 7

Rights of Stockholders When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate. 8

Functions of the Board of Directors Selected by a vote of the stockholders Overall responsibility for managing the company. 9

Functions of the Corporate Officers Contractual and legal representation Custodian of funds Chief Accountant 10

Paid-In Capital of a Corporation 11

Authorization and Issuance of Capital Stock Authorized Shares The maximum number of shares of capital stock that can be sold to the public. 12

Authorization and Issuance of Capital Stock Authorized Shares Usually shares are sold through an underwriter. Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. 13

Authorization and Issuance of Capital Stock Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Issued Shares Outstanding Shares Treasury Shares Unissued Shares Treasury shares are issued shares that have been reacquired by the corporation. 14

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. 15

Stockholders’ Equity Ex Let’s examine this form of stock. ’s A ny pa C m g it n is om No-Par Common Stock Co y n pa w A s ’ Par Value Common Stock Ne ct ct Common stock can be issued in two forms: All proceeds credited to Common Stock 16

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/Share Premium Prepare the journal entry to record an issuance of 10, 000 shares of $2 par value stock for $25 per share which occurred on September 1, 2003. 17

Issuance of Par Value Stock The journal entry to record an issuance of 10, 000 shares of $2 par value stock for $25 per share on September 1, 2003, should include a credit to common stock for the par value of the shares issued. 18

Issuance of Par Value Stock 19

Preferred Stock A separate class of stock, typically having priority over common shares in. . . l Dividend distributions (rate is usually stated). l Distribution of assets in case of liquidation. Other Features Include: Cumulative dividend rights. Usually callable by the company. Normally has no voting rights. 20

Cumulative Preferred Stock Cumulative Dividends in arrears must be paid before dividends may be paid on common stock. Vs. Noncumulative Undeclared dividends from current and prior years do not have to be paid in future years. 21

Stock Preferred as to Dividends Example: Consider the following partial Statement of Stockholders’ Equity. During 2002, the directors declare cash dividends of $5, 000. In year 2003, the directors declare cash dividends of $42, 000. 22

Stock Preferred as to Dividends Example: Consider the following partial Statement of Stockholders’ Equity. During 2000, the directors declare cash dividends of $5, 000. In year 2001, the directors declare cash dividends of $42, 000. 23

Convertible 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. 24

Preferred Stock 25

Stock Issued for Assets Other Than Cash Companies sometimes issue stock in exchange for noncash assets. Since no cash is received, record the transaction at the market value of the goods or services received. 26

I love this stuff! Can we do some more? 27

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. 28

Market Price of Preferred Stock Factors affecting market price of preferred stock: l Dividend rate l Risk l Level of interest rates The return based on the market value is called the “dividend yield. ” 29

Market Price of Common Stock Factors affecting market price of common stock: l Investors’ expectations of future profitability. l Risk that this level of profitability will not be achieved. Changes in market value have no impact on the books of the issuer. 30

Stock Splits l Companies use stock splits to reduce market price. l Outstanding shares increase, but par value is decreased proportionately. Ice Cream Parlor Banana Splits On Sale Now 31

Stock Splits - Example Assume that a corporation had 5, 000 shares of $1 par value common stock outstanding before a 2–for– 1 stock split. Increase Decrease No Change 32

Stock Dividends A company may be short of cash and be unable to pay a cash dividend. A stock dividend is a distribution by a corporation of its own stock to its shareholders. Stock dividends l Affect only stockholders equity accounts i. e. RE & Common Stock l Have no effect on total stockholders equity. Stock dividends to be distributed to stockholders are proportionate to the number of shares they already own. Example. Suppose you own 300 shares of common stock. The company distributes a 10% stock dividend. You would now receive 30 additional shares and would now have 330 shares but you would be in the same position as before in terms of percentage ownership. 33

Recording Stock Dividends Stock dividends are issued - To continue dividends but conserve on cash for investment purposes - To reduce the market price of its stock so as to make it more attractive to investors. Dr Retained Earnings (MV of shares) Cr Common Stock (Par value) Cr Paid-in Capital in Excess of Par l Note that a stock dividend merely rearranges the Stockholders equity section of the BS. 34

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. 35

Treasury Stock - Example On May 1, 2003, East Corp. reacquired 3, 000 shares of its common stock at $55 per share. Prepare the journal entry for May 1. 36

Treasury Stock - Example On December 3, 2003, 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 37

Stockholders’ Equity - Presentation 38

Statement of Changes in Equity – Presentation as per IAS 1 • Assume that the Stockholder’s Equity information on slide 38 was as at December 31. 2003 and that for 2004 the following occurred: • Net income after tax was $30, 000 • Issued 10, 000 shares of common stock with a par value of $10 for $15 • Paid cash dividends of $5, 000 for preference stock and $2000 for common stock. • Issued stock dividend of 1, 000 shares of common stock with a par value of $10. The FMV was also $10 Required: Prepare a statement of changes in equity for the year ended December 31, 2004 (Solution presented in class) 39

End of Chapter 11 This isn’t what I meant when I asked for stock for my birthday! 40