Reporting Stockholders Equity

ckChapter 11 – Reporting and Analyzing Stockholders’ Equity I. Characteristics of a Corporation (Publicly held (closely held)) * Separate legal existence; * Limited liability of stockholders; limited to investment * Transferable ownership rights; * Ability to acquire capital; * Continuous life; * Corporation management: Shareholders Shareholders * Voting rights * Profit sharing * Preemptive right * Residual claim Board of Directors Board of Directors CEO(PRESIDENT) CEO(PRESIDENT) . other vps . other vps CIO CIO CFO CFO COO COO Treasurer Treasurer ControllerController * Government regulations; file application with state government-> corportate charter by-law * Additional taxes. Double taxation II. Stock Issue 1. Basics of Stock Issue: (1) Authorized Stock: The maximum amount of stock that a corporation is authorized to sell by corporate charter. (2) Outstanding Stock: Capital stock that has been issued and is being held by stockholders. Legal capital= # of issued shares x par value per share (3) Par Value Stock: Capital stock that has been assigned an arbitrary value per share in the corporate charter. 4) No-par value Stock: Capital stock that has not been assigned a value in the corporate charter. (5) Stated Value of No-par value Stock: Value per share assigned by the board of directors to no-par value stock. Authorized Issued Outstanding (6) Paid-in Capital: Amount paid to corporation by stockholders for shares of ownership. (7) Retained Earnings: Earned capital held for future use in the business. 2. Accounting for Common Stock Issues: (1) Issuing Stock at Par Example 1: On March 1, 2002, XYZ Company issued 10,000 shares of $10 par value common stock at par. (2) Issuing Stock above ParExample 2: On June 10, XYZ Company issued 5,000 shares of $10 par value common stock at $12 per share. Cash 60,000(=5,000Ãâ€"12) Common Stock50,000 Additional paid in capital14,000 (Paid in capital in excess of par) What if the common stock issued on June 10 is n o par stock with a stated value of $10? Cash60,000 Common Stock50,000 Additional Paid in capital10,000 3. Treasury Stock: * A corporation’s own stock that has been issued, fully paid for, and reacquired by the corporation but not retired. * Issued but not outstanding (1) Corporations acquire treasury stock to †¦ reissue shares to employees under bonus and stock compensation plans; * increase trading of company’s stock in securities market to enhance market value; * reduce number of shares outstanding , and therefore increase earnings per share (EPS); * prevent a hostile takeover. (2) Purchasing Treasury Stock: * Cost method: Treasury stock is increased by the amount paid to reacquire the shares, and is decreased by the same amount when the shares are later sold. Example 3: On October 15, 2002, XYZ Company acquired 2,000 shares of the stock issued on June 10 in Example 2 at $9 per share.On the balance sheet: Stockholders equity Paid in capital Common stock (par) Ad ditional paid in capital Retained earnings Less: Treasury stock (a contra equity account) * Effect of purchasing treasury stock on common stock: * Effect of purchasing treasury stock on stockholders’ equity: III. Preferred Stock * Preferred stock has contractual provisions that give it preferences over common stock in dividends and assets in the event of liquidation. * Preferred stockholders do not have voting rights. Example 4: On November 5, 2002, XYZ Company issued 5,000 shares of $10 par value preferred stock for $13 per share.Cash65,000 Preferred Stock50,000 Additional Paid in capital15,000 1. Dividend Preference * Preferred stockholders have the right to share in the distribution of corporate income before common stockholders; * The first claim to dividends does not guarantee dividends; * Cumulative Dividends: Preferred stockholders receive current and unpaid prior-year dividends before common stockholders receive any dividends. When dividends are cumulative, preferred dividends that were not declared in a given period are called dividends in arrears. Example 5:XYZ Company issued 10,000 shares of 10%, $5 par value cumulative preferred stock On January 1, 1999. XYZ had not declared any dividends until December 31, 2002. 1999: 10,000x 5 x 10% = 5,000 2000: 5,000 2001: 5,000 2002:5,000 Dec 31, 02: $20,000 in cash * Dividends in arrears are not liability. They should be disclosed in the notes to financial statements. 2. Liquidation Preference- Creditors Prefered stock holders common stock holders IV. Dividends * A distribution by the corporation to the stockholders on a pro rata basis. 1.Cash Dividends: (1) To pay a cash dividend, a company must have: * retained earnings * adequate cash * declared dividends (2) Some Important Dates: * Declaration date: the date the board of directors formally authorizes the cash dividends and announces it to stockholders. Retained earnings Dividends payable * Record date: The date ownership of outstanding shares is de termined for dividend purposes. * Payment date: The date dividends are paid. Dividends payable Cash * Cumulative effect of declaration and payment of cash dividends on accounting equation: 2. Stock Dividends: Companies pay stock dividends to †¦ * Satisfy stockholders’ dividend expectations without paying cash; * Increase the marketability of its stock; * Emphasize that a portion of stockholders’ equity has been permanently reinvested in the business. * Small Stock Dividend: If the stock dividend is less than 20%-25% of the corporation’s issued stock, it is recorded at the fair market value per share. * Large Stock Dividend: If the stock dividend is greater than 20%-25% of the corporation’s issued stock, it is recorded at par or stated value per share. Example 6:On February 1, 2003, the balance of XYZ Company’s retained earnings was $2,500,000. XYZ Company declared a 15% stock dividend on its 100,000 shares of $10 par value common stock. The cu rrent fair market value of XYZ Company’s stock is $13 per share. Retained earnings195,000 Stock dividend Distributable150,000 Additional paid in capital45,000 On March 1, 2003, XYZ Company issued the dividend shares. Stock dividend distributable 150,000 Common Stock150,000 – Effect of stock dividends on stockholders’ equity and its components: S/E Retained earnings195,000 (Decrease)Common Stock150,000 (Increase) Additonal paid in capital45,000 (Increase) NET EFFECT: No change V. Stock Splits: * The issuance of additional shares of stock to stockholders accompanied by: * A reduction in the par or stated value; * An increase in number of shares. No entry * Effect of stock splits on stockholders’ equity and its components: S/E Common Stock (Par value per share x total # of issued shares) Add. Paid in capital Retained Earnings VI. Retained Earnings: * Net income that is retained in the business. Revenues (Credit, transfer to credit of income)Income Summary(Tr ansfer N. I to retained earnings credit) Retained Earnings Expenses (Transfer debit to debid of income summary) * Deficit: a debit balance in retained earnings. Deficit is reported as a deduction in stockholders’ equity on the balance sheet. * Retained earnings restrictions- Debt covenants VII. Financial Statement Presentation: 1. Balance Sheet S/E Paid-in-capital Common stock (par value) Preferred stock (par value) Additional paid in capital Retained earnings Less: Treasury Stock 2. Statement of Cash Flows Cash Flows from Financing ActivitiesIssuance of stock (cash inflows) Repurchase of stock (cash outflows) Dividend payment (cash outflows) VIII. Ratio Analysis: 1. Dividend Record * Payout Ratio: Cash dividends declared on common stock/ Net income 2. Earnings Performance * Return on common stockholders’ equity ratio: (NI-Prefered stockholders dividends)/Average common stockholders equity 3. Debt versus Equity Decision | Bond| Common Stock| Owners’ Control| Not affected| Diluted| Tax Benefit| Bond interests are tax deductible| Dividends are not deductible| Financial Ratio(EPS)| Not affected| Lower| Fixed payment| Yes | No|