Chapter 10: Reporting & Interpreting Owners’ Equity

I. CORPORATIONS
 Separate legal entity (own assets, incur liabilities, enter into contracts,
sue and be sued)

 Governance – Stockholders (owners of voting shares) elect Board of

Directors; Board appoints President (CEO), CFO, etc.

 Stockholders have the right to vote and receive dividends (dependent

on the type of stock they own)

II. EQUITY AS A SOURCE OF FINANCING

A company can either issue stock (equity) or issue debt (liability) as a source
of financing the company's operations.

A. Advantages of issuing Equity:

1. Ease of raising capital – ready capital markets to buy/sell; great

number of potential investors

2. Dividend flexibility – dividends are NOT liabilities until declared

by the Board.

3. Return on Investment – ROI is usually higher on stocks than bonds

B. Disadvantages of issuing Equity:

1. Control – issuing additional shares of stock dilutes ownership

control

2. No tax incentive – dividends are not tax deductible, whereas

interest expense
is tax deductible

3. Effect on key ratios – EPS

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III. STOCKHOLDER'S EQUITY

Two Sources of Equity Capital

1. Contributed Capital - investments by stockholders

2. Earned Capital - earnings retained in the business (Retained Earnings)

Retained Earnings
a. Increased by Net Income (with a credit)
b. Decreased by net losses & dividends (a debit)
Beginning Retained Earnings $ XX
+ Net Income (- Net Loss) XX
- Dividends (XX)
Ending Retained Earnings $ XX

Sample Stockholders’ Equity section of Balance Sheet:

Preferred Stock (# shares issued x $ par) $ XX

Common Stock (# shares issued x $ par) XX
Additional Paid in Capital: Preferred XX
Common XX
Treasury XX
Total Contributed Capital XX
Retained Earnings XX
Treasury Stock (# shares x $ cost) (XX)
Total Stockholders’ Equity XX

IV. COMMON STOCK

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 A. RIGHTS

1. Voting rights – Vote on major issues, vote for Board of Directors

2. Dividends - right to receive share of corp. earnings as their return
on investment (ROI)
3. Liquidation - Right to a proportionate share of assets upon
liquidation (after creditors and preferred stockholders)
4. Preemptive Right – right of current stockholders to maintain their
Percentage of ownership by buying a proportional number of
shares of any future issues.

B. NUMBER OF SHARES

1. Authorized Shares - total number of shares that may be issued

2. Issued Shares - total number of shares issued to stockholders since formation

3. Outstanding Shares - number of shares held by outside stockholders

4. Treasury Stock –

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 C. ISSUANCE OF STOCK

Terms:

1. Par Value: a. A nominal value per share established in the corporate

charter.
b. Establishes the corporation’s "legal capital"
(minimum that must be maintained in SHE)
c. Protects creditors by limiting the amount of assets that can be
distributed to shareholders before liquidation
d. Par is usually below the market price (selling price) of the stock

2. Initial Public Offering: first sale of a company’s stock to the public

3. Seasoned New Issues: additional sales of new stock to the public

Examples:

1. Sold stock for > Par

Sold 1,000 shares, $1 par for $15/share:

2. Stock issued for non-cash asset:

Record at FMV of stock traded or FMV of asset received,

whichever is a better indicator of market value.

Purchased land for 10,000 shares of common stock, $1 par value.

The FMV of the land is $300,000; however, the stock is traded
daily at a selling price of $35 per share.

D. TREASURY STOCK
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 • The corporation re-acquires shares of its own stock from stockholders.
• Treated as a separate component of Shareholder Equity (reduces
Shareholder Equity on the Balance Sheet)

1. Reasons why a co. would buy back shares as treasury:

a.

b.

c.

d.

2. Cost Method:
a. Purchase of Treasury Stock
Treasury Stock is debited for full cost of shares purchased.

Example: Corporation purchases 300 of its

shares on Jan. 15 at $20/share.
($1 par; 10,000 shares issued & outstanding)

Required: Record purchase of Treasury Shares

b. Sale of Treasury Stock

Rules:
A. If the selling price of the Treasury shares is greater
than the cost, the difference is credited to
Additional Paid in Capital-Treasury Stock.
B. If the selling price of the Treasury shares is less
than the cost, the difference is debited to Additional
Paid in Capital–Treasury Stock or debited to
Retained Earnings if the Additional Paid in Capital -
Treasury Stock account is eliminated or non-
existent.

Example: The stockholders' equity section of the ABC Corporation appeared as follows
on January 1:
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 Common Stock, $15 par, 20,000 shares
Issued and outstanding $300,000
Additional Paid in Capital – Common Stock
Total Contributed Capital $375,000
Retained Earnings
Total Stockholder's Equity $455,000

Additional Information:

Feb. 1 Purchased 800 of its outstanding shares at $25 per share.

June 15 Sold 500 of these shares at $29 per share.

Required: Prepare the necessary journal entries to record the above transactions and prepare
the stockholders' equity section of the balance sheet as of June 30.

3. Retirement of Treasury Stock:

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 When a corporation permanently retires its stock so that it will not be reissued at a later
date:

The par value of the stock is reduced from Common Stock. Any amount paid above par
value reduced the APIC – CS account.

Example: Corporation X purchases 300 of its shares on Jan. 15 at $20/share.

Corporation X purchased this stock for retirement. ($1 par; 10,000 shares issued &
outstanding)

Record purchase of Treasury Shares for retirement:

E. DIVIDENDS
• Distribution of earnings to shareholders
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 • Usually in the form of cash. Can be other assets
or additional shares of stock.
• Once board declares a dividend, it becomes a liability

1. Cash Dividends - 3 Important Dates

Ex: On Nov. 1 the Board declares a $1 per share dividend to
shareholders of record on Nov. 30. The dividend is payable
Dec. 15. The company has 100,000 shares of common stock
issued and 20,000 in the treasury.

1. Date of declaration - record the liability

2. Date of record - stockholders as of the date

of record are entitled to receive the
dividends.

3. Date of payment - record distribution of cash

Effect of Cash Dividends

• Payment of dividends reduces cash
AND
• Retained Earnings are reduced at closing:

2. Stock Dividends

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 Purpose: To issue additional shares of common stock.
Each stockholder's % share of ownership remains the
same.

Why issue a stock dividend?

1.
2.

3.

Effect of Stock Dividend:

1. No effect on Total Stockholder Equity

2. Increases Contributed Capital (increases # shares issued)
3. Decreases Retained Earnings

Two types:

1. Large: additional shares = 20-25% of outstanding shares

Use par value to record dividend
2. Small: additional shares = less than 20-25% of outstanding shares
Use market value to record dividend

STOCK DIVIDEND EXAMPLE:

The stockholders' equity of Union, Inc. appears as follows on its December 31 balance sheet.
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 Common stock ($9 par, 25,000 issued & outstanding) $225,000
Additional Paid in Capital 125,000
Total Contributed Capital $350,000
Retained Earnings 195,000
Total Stockholders Equity $545,000

Required: Record the following independent transactions:

A. Union, Inc. declares and distributes a 5% stock dividend on July 1 when the market
price of the stock is $15 per share.

B. Union, Inc. declares and distributes a 30% stock dividend on July 1 when the market
price of the stock is $15 per share.

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 F. STOCK SPLITS

A. Purpose:

1. Decrease market price of stock

2. Increase # of shares outstanding
3. Decrease (split) the par value

Example: Corporation has 20,000 shares, $10 par, market price = $200.
Announce 2-for-l split.

Result: Each shareholder now owns 2 shares of

$5 par for each one share owned prior to split.
Market price now = $100.

B. Effect of Stock Splits

1. No change in value of corporation

2. No change in total Shareholder Equity
3. No change in Retained Earnings

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 V. Preferred Stock

A. Rights

1. Dividend Preference - right to receive a dividend before common

stockholders
2. Liquidation Preference – after creditors
3. No voting rights

B. Dividends – payable before dividends paid on common stock

1. Dividends are payable of preferred stock before dividends are paid

on common stock.

Example:
ABC Corp. declares $60,000 cash dividend. Currently ABC has:
Stockholder's Equity:
Preferred Stock (40,000 shares issued, $20 par, 7%)
Common Stock (60,000 shares issued, $1 par)

To Distribute Dividend:

2. If Preferred Stock is Cumulative Preferred:

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 any unpaid preferred dividends + current year's dividend, must be
paid in full before common receive any.

Example:

Aggie Corporation was organized on January 1, 2017. On that date, the

corporation issued 1,000 shares of $100 Par value, 6 percent preferred
stock and 20,000 shares of $10 par value common stock. During the first
five years of its life, the corporation paid the following total dividends to
its stockholders.

2017................................................$0
2018...........................................8,000
2019.........................................20,000
2020.........................................15,000
2021.........................................18,000

Determine the total dividends paid to each class of stockholders assuming

that the preferred stock is cumulative.

A junior accountant for the XYZ Company is unsure as to how to complete the
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 following stockholder's equity section of the balance sheet.

Stockholder's Equity:

5% preferred stock (1) par value,

15,000 shares authorized, 9,000 shares
issued and outstanding $810,000
Common stock, $20 par value, 200,000 shares
Authorized, (2) shares issued & outstanding 3,000,000
Additional Paid in Capital:
Preferred Stock
Common Stock
Total Contributed Capital
Retained Earnings
TOTAL STOCKHOLDER'S EQUITY $4,099,000

Additional Information:
Earnings for the corporation over its three-year life were
$18,000 a year. No dividends have ever been paid.

Required: Complete the stockholders' equity section by filling

in the missing numbers.

Required: Find the average selling price of the Preferred Stock:

By using the following code, indicate each transaction's effect on the respective columns.
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 + = increases 0 = no effect
- = decreases ? = cannot be determined

The market value of the company's common stock exceeds par value.

Common Retained Stockholder's

Transaction Stock Earnings Equity
1. A company declared a cash
dividend payable in the next
fiscal year to persons holding
shares of preferred stock
2. Company purchased shares of its
own common stock through a
broker at the New York Stock
Exchange.
3. Company declared and issued a
small stock dividend on the
common stock.
4. A cash dividend was declared and
paid.

5. Treasury shares of common stock

were sold at an amount in excess
of the purchase price.

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Earnings per share:

EPS = Net income – Preferred Dividends

Weighted average # of Common Shares Outstanding

Example:

The following information is available for Williams Company as of December 31, 2021.

Preferred Stock (9%, cumulative; $90 par; 1,000 issued) $ 90,000

Common Stock ($10 par) 500,000
Additional Paid In Capital 70,000
Net Income 100,000

Additional Information:

On April 1, 2021, Williams Company issued 5,000 new shares of common stock for cash.
On July 1, 2021 an additional 10,000 new shares were issued for cash.

Required:
Determine Earnings per share as of December 31, 2021 (round to the nearest whole cent).

EPS = $ ______

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