BUS210 Stockholders Equity - Emory University 2014/11.Handout SHE.pdfChapter 12: Shareholders’ Equity. Debt versus Equity ... Company was incorporated on 4.1.15 and was authorized

BUS210 Stockholders Equity

How to Finance the Corporation?

• Borrow – Notes, Bonds, Leases

– The debt holders are legally entitled to repayment of their principal and interest claims

• Issue Equity – Common and Preferred Stock

– The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets

• Retained Earnings

Chapter 12: Shareholders’ Equity

Debt versus Equity

Debt Equity

Formal legal contract No legal contract Fixed maturity date No fixed maturity date Fixed periodic payments Discretionary dividends Security in case of default Residual asset interest No voice in management Voting rights - common Interest expense deductible Dividends not deductible Double taxation

Interested Party Debt Equity

Investors / Creditors

Lower investment risk Higher investment risk

Management

Fixed cash receipts Variable cash receipts

Contractual future cash payments

Dividends are discretionary

Effects on credit rating

Effects of dilution/ takeover

Interest is tax deductible

Dividends are not tax deductible

Accountants/ Auditors

Liabilities section of the balance sheet

Shareholders’ equity of the balance sheet

Income statement effects from debt

No income statement effects from equity

Distinctions between Debt and Equity

Preferred Stock vs Common Stock

Preferred Stock Common Stock

Advantages Preference over common in

liquidation

Voting Rights

Stated dividend Rights to residual profits

(after preferred)

Preference over common in

dividend payout

Disadvantages Subordinate to debt in liquidation Last in liquidation

Stated dividend can be skipped No guaranteed return

No voting rights (versus common)

Debt or Equity? Components of both

Usually classified as equity

E12-3 Authorizing and Issuing Stock Prepare entries for each event:

1. Authorized to issue: (a) 100,000 shares of $100 par value , 8% preferred stock (b) 150,000 shares of no-par, $5 preferred stock; and (c) 250,000 shares of $5 par value common stock.

2. Issued 10,000 shares of $5 par value common stock for $30 per share.

E12-3 Authorizing and Issuing Stock Prepare entries for each event:

3. Issued 25,000 shares of the $100 par value preferred stock for $150 per share.

4. Issued 50,000 shares of no-par preferred stock for $50 each.

Treasury Stock

• Created when a company buys back shares of its own common stock.

• Reasons for buyback?

• The debit balance account called “Treasury Stock” is reported in shareholders’ equity as a contra account to SE.

– Note: Treasury Stock is not an asset.

• The stock remains issued, but is no longer outstanding.

– does not have voting rights

– cannot receive cash dividends

• May be reissued (to the market or to employees) or retired.

• No gains or losses are ever recognized from these equity transactions.

E12-5 Treasury Stock Company was incorporated on 4.1.15

and was authorized to issue 100,000 shares of $5 par value common stock and 10,000 shares of $8, no-par preferred stock.

a. T accounts: 1. Issued 25,000 shares of common

stock in exchange for $500,000 cash.

2. Issued 5,000 shares of preferred stock in exchange for $60,000 cash.

3. Purchased 3,000 common shares for $15 per share and held them in the treasury.

4. Sold 1,000 treasury shares for $18 per share.

5. Issued 1,000 treasury shares to executives who exercised stock options for a reduced price of $5 per share.

b. Assume company generated $500,000 in net income in 2015 and did not declare any dividends. Prepare the stockholders’ equity section of the balance sheet as of 12.31.2015.

E12-6 Treasury Stock

12.31.2014 Shareholders’ section

Common stock $80,000

Additional paid-in capital 10,000

Retained earnings 60,000

Total shareholders’ equity $150,000

During 2015, the company entered into the following transactions:

1. Purchased 1,000 shares of treasury stock for $60 per share.

2. As part of a compensation package, reissued half of the treasury shares to

executives who exercised stock options for $20 per share.

3. Reissued the remainder of the

treasury stock on the open market for $66 per share.

a. Prepare the shareholders’ equity section of the balance sheet as of 12.31.2015. Company generated $20,000 in net income and did not declare dividends during 2015.

E12-6 Treasury Stock

12.31.2014 Shareholders’ section

Common stock $80,000

Additional paid-in capital 10,000

Retained earnings 60,000

Total shareholders’ equity $150,000

b. What portion of the additional paid-in capital account is attributed to treasury stock transactions?

E12-9 Inferring Transactions from SHE

Provide the journal entries for the following:

a. Issuance of preferred stock during 2015.

b. Issuance of common stock during 2015. c. Sale of treasury stock during 2015.

2015 2014

Preferred stock (no par) $ 700 $ 400

Common stock ($1 par value) 1,000 900

Additional paid-in capital:

Common stock Treasury stock

40 10

20 ---

Less Treasury stock 130 150

Cash Dividends and Stock Dividends: 3 Dates

BE12-2 Stock Splits and Market Value When Tandy (Radio Shack) Corporation announced a 2:1 stock split, it had 97 million shares outstanding, trading at $100 per share.

a. Estimate the number of shares outstanding and market price per share immediately after the split.

b. Estimate the company’s overall market value, and explain whether you expect the company’s overall market value to change due to the split.

E12-1 SHE Transactions For each transaction indicate which SHE accounts are affected, whether these accounts increase or decrease, and the transaction’s effect on total SHE. 1. Issue common stock above par for

cash.

2. Declare a 3-for-1 stock split.

3. Repurchase 10,000 shares of own stock for cash.

4. Declare and issue a stock dividend. Market>Par

5. Reissue 1,000 treasury shares for $75. Treasury stock had been previously acquired for $60.

6. Pay cash dividend that had been previously declared.

7. Generate net income of $250,000.

E12-13 Dividends in Arrears The company paid the following total cash dividends since 2011: 2011:$0; 2012:$30,000; 2013:$80,000; 2014:$15,000; and 2015:$40,000. • Preferred stock-10,000 shares

authorized, 5,000 issued, cumulative, nonparticipating, $5, $10 par.

• Common stock-500,000 shares authorized, 200,000 shares issued, 50,000 held in treasury, no par.

a. Compute the dividends paid to the preferred and common shareholders for each year since 2011. b. Compute the balance of dividends in arrears at yearend. c. Should dividends in arrears be considered a liability?

E12-14 Stock Dividends and Stock Splits

Prepare journal entries for the following independent transactions:

a. Declare and distribute a 2% stock dividend when the market price of the stock was $70.

b. Declare a 3:2 stock split.

c. Declare a 10% stock dividend when the market price of the stock was $80.

d. Declare a 2:1 stock split.

SHE as of 12.31.2015:

Common stock (10,000 shares issued @$6 par) $ 60,000

Additional paid in capital-common stock 100,000

Retained earnings 60,000

Less: Treasury stock (2,000 @ $12) (24,000)

Total shareholders’ equity $196,000

P12-10 Inferring Transactions from BS

a. How many shares of preferred stock were issued during 2015? What was the average issue price?

b. How many shares of common stock were issued during 2015? What was the average issue price?

c. Prepare the entry to record the repurchase of the company’s own stock during 2015? What was the average repurchase price?

2015 2014

Preferred stock (9%, $100 par value) $200,000 $110,000

Common stock ($10 par value, 750,000 authorized, 90,000 issued, and 5,000 held in treasury

900,000 750,000

Additional paid in capital-preferred 150,000 35,000

Additional paid in capital-common 465,000 298,000

Retained earnings 575,000 495,000

Less: Treasury stock (110,000)

Total shareholders’ equity $2,180,000 $1,688,000

Sample Co. Shareholders’ Equity Common stock, $1 par value, 500,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding $ 80,000 Common stock dividends distributable 2,000 Preferred stock, $100 par value, 1,000 shares authorized, 100 shares issued and outstanding 10,000 Paid in capital on common $ 20,000 Paid in capital on preferred 3,000 Paid in capital on treasury stock 2,000 25,000 Retained earnings: Unappropriated $18,000 Appropriated 4,000 22,000 Less: Treasury stock, 5,000 shares (at cost) (6,000) Less: Other comprehensive income items (unrealized loss on AFS securities) (2,000) Total Shareholders’ Equity $131,000

Retained Earnings We will be expanding the basic retained earnings formula

in this chapter. Now the Statement of Retained Earnings will include the following:

RE, beginning (unadjusted) xx Add/Subtract: Prior period adjustment xx RE, beginning (restated) xx Add: net income xx Less dividends: Cash dividends-common xx Cash dividends - preferred xx Stock dividends xx Property dividends xx Less: Adjustment for TS transactions xx Appropriation of RE xx RE, ending xx

Other Comprehensive Income

• “Other Comprehensive Income” includes certain direct equity adjustments that are not part of the current income statement, but which may have an eventual effect on income.

• We already discussed one of these direct equity adjustments when reviewing Available-for-sale Investments. We found that any unrealized gains/losses from revaluation to market are shown in SE (as “other comprehensive income”) rather than on the income statement.

Find the following key numbers for the most current year:

• Net income_________

• Total comprehensive net income________

• Did company grow more wealthy for reasons other than profits? Why or why not?

Stock Option Basics v. Restricted Stock • Granted to employees as part of their compensation.

• Generally not transferable and must either be exercised prior to expiration date or allowed to expire as worthless on expiration day. May have a vesting period.

• When granted, company expenses options for their fair value on grant date [may be a complicated calculation].

• Depending on the type of option granted, the employee may or may not be taxed when granted or exercised.

• Gives employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the exercise price stated in the option, the employee could exercise the option, pay the exercise price and would be issued ordinary shares in the company.