Section 15 & 16 – Stockholder’s Equity & Earnings Per … 15 & 16 – Stockholder’s Equity & Earnings Per Share The Nature of Shareholders’ Equity ... stockholders’ equity,

18-1

Section 15 & 16 – Stockholder’s Equity & Earnings Per Share

The Nature of Shareholders’ Equity Assets – Liabilities = Shareholders’ Equity

Shareholders’ Equity Paid-in Capital

Retained Earnings

Amounts earned by corporation

Amounts invested by shareholders

Accumulated Other Comprehensive Income

Other gains and losses not included in net income, instead, included in OCI

Sources of Shareholders’

Equity

Net Assets

18-2

Authorized Shares

Unissued Shares

Treasury Shares

Outstanding Shares Issued

Shares

Treasury shares: issued shares that have been

repurchased by the corporation, but not

retired.

Outstanding shares are issued shares that are

owned by stockholders.

Retired Shares

Retired shares:

Repurchased and retired; have the same status as authorized but

unissued shares.

Authorized, Issued, and Outstanding Shares

18-3 Capital Stock Par value stock

Dollar amount per share is stated in the corporate charter, no restriction on the assigned value. It is the minimum legal capital.

Par value (prefer & common) has no relationship to market value.

No-par stock Dollar amount per share

is not designated in corporate charter.

Corporations can assign a stated value per share (treated as if par value).

Legal capital is . . . The amount recorded as common stock or preferred stock. The least amount the stock buyers must contribute to the firm

when stock is issued, otherwise it constitutes a legal capital deficiency.

The amount of capital, required by state law, that must remain invested in the business.

Refers to par value, stated value, or full amount paid for no-par stock.

18-4

Capital Stock Common stock is the basic voting stock of the

corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined

by the board of directors.

Dividend and liquidation preference over common stock.

Generally does not have voting rights.

Usually has a par or stated value.

May be convertible ( holder’s option), or callable (by co. at a stated value; to retire).

Preferred Stock

18-5

Preferred Stock Dividends Are usually stated as a % of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating.

Unpaid dividends for cumulative preferred stock (current & prior; current for non-cumulative) must be paid in full before any distributions to common stock.

Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.

18-6

U.S. GAAP vs. IFRS

Preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is “mandatorily redeemable” preferred stock (holders have unconditional obligation to redeem).

Most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.

Distinction between Debt and Equity for Preferred Stock

18-7

Shares Issued for Cash

10,000 shares of stock are issued for $100,000 cash.

$1 Par Value

No Par Value

No Par, $1 Stated

Value

Cash ....................................................... 100,000 Common stock, par value .............. 10,000 Paid-in capital – excess of par …… 90,000 To record issue of common stock.

Cash ....................................................... 100,000 Common stock ............................. 100,000 To record issue of common stock.

Cash ................................................................... 100,000 Common stock, stated value ..................... 10,000 Paid-in capital – excess of stated value …. 90,000 To record issue of common stock.

18-8 Shares Issued for Noncash Consideration

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident.

If market values cannot be determined, use appraised values.

18-9

More Than One Security Issued for a Single Price

Allocate the lump-sum received based on the relative fair values of the two securities.

If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively. Calculate the additional paid-in capital for each class of stock.

18-10

More Than One Security Issued for a Single Price (Allocation Concept)

Cash ............................................................................ 450,000 Common stock, $10 par ..................................... 50,000 Paid-in capital – excess of par common ……….. 197,500 Preferred stock, $5 par 15,000 Paid-in capital – excess of par preferred ………. 187,500 To record issue of common and preferred stock.

Market* % Allocation** Par^ Excess^^Common Stock 275,000$ 55% 247,500$ 50,000$ 197,500$ Preferred Stock 225,000 45% 202,500 15,000 187,500 Total 500,000$ 100% 450,000$ 65,000$ 385,000$ * Market Value: ^ Par Value: Common: $55 × 5,000 shares Common: $10 × 5,000 shares Preferred: $75 × 3,000 shares Preferred: $5 × 3,000 shares

**Allocation: ^^Excess: Common: $450,000 × 55% Common: $247,500 - $50,000 par Preferred: $450,000 × 45% Preferred: $202,500 - $15,000 par

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Share Issue Costs

Share issue costs reduce net proceeds from selling shares, resulting in a lower

amount of additional paid-in capital.

Registration fees Underwriter commissions Printing and clerical costs Legal and accounting fees Promotional costs

18-12

Share Buybacks A corporation might reacquire shares of its stock to . . . support the market price. increase earnings per share. distribute in stock option plans. issue as a stock dividend. use in mergers and acquisitions. thwart takeover attempts.

Companies can account for the reacquired shares by retiring them or by holding them as treasury shares.

18-13

Accounting for Repurchase & Retired Shares - Price paid is less than issue price When shares are formally retired immediately after repurchase: reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital, and create a new “paid-in capital-share repurchase” account.

5,000 shares of $2 par value stock that were issued for $20 per share are reacquired and retired for $17 per share.

Example:

Common stock ............................................................ 10,000 Paid-in capital – excess of par common …………….... 90,000 Paid-in capital – share repurchase & retire ……… 15,000 Cash ……………………………………………….. 85,000 To record repurchase and retirement of common stock.

18-14

- Price paid is more than issue price

Accounting for Retired Shares - Example

5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.

Common stock ............................................................ 10,000 Paid-in capital – excess of par common ………………. 90,000 Paid-in capital – share repurchase …………………….. 25,000 Cash ……………………………………………….. 125,000 To record repurchase and retirement of common stock.

“Paid-in Capital- share repurchase” is initially created on the credit side. Debit the $25,000 to paid-in capital—share repurchase assuming that a credit balance of at least $25,000 already exists in this account. Otherwise, reduce (Dr.) Retained Earnings if “PIC –Share repurchase” has an insufficient credit balance.

18-15

Two acceptable methods:

Cost method (more widely used).

Par or Stated value method.

Treasury stock, reduces stockholders’ equity.

Purchase of Treasury Stock

18-16


Example: Pacific Company issued 100,000 shares of $1 par value common stock at a price of $10 per share. In addition, it has retained earnings of $300,000.

18-17

Purchase of Treasury Stock – Example (cont’d)

On January 20, 2010, Pacific acquires 10,000 shares of its stock at $11 per share. (Treasury stocks are issued but not outstanding). Cost Method: Treasury stock 110,000 Cash 110,000 Par-Value Method: Treasury stock (10,000 x 1) 10,000 PIC from treasury stock (10 x 10,000) 100,000 Cash 110,000

18-18


Illustration: Stockholders’ equity section for Pacific after purchase of the treasury stock using cost method.

18-19

Sale of Treasury Stock

Above Cost

Below Cost

Equal cost

All increases total assets and stockholders’ equity.

Sale of Treasury Stock

18-20

Sale of Treasury Stock – Example 1

3/10 Cash 15,000

Treasury stock (cost method) 11,000

Paid-in capital from treasury stock 4,000

After Pacific acquired 10,000 shares of its own common stock ($1 par value) at $11 per share, it now sells 1,000 shares at $15 per share on March 10. Pacific records the entry as follows.

18-21

Sale of Treasury Stock – Example 2 (continuation of Example 1)

3/21 Cash 8,000

Paid-in capital from treasury stock 3,000

Treasury stock (cost) 11,000

If Pacific re-sells an additional 1,000 shares of treasury stock on March 21 at $8 per share, it records the sale as follows.

18-22

Sale of Treasury Stock – Example 3 (continuation of Example 2)

4/10 Cash 8,000 Paid-in capital from treasury stock 1,000 Retained earnings 2,000 Treasury stock 11,000

Assume that Pacific sells an additional 1,000 shares of Treasury Stock at $8 per share on April 10.

18-23

On 3/26, Board decided to cancell 9,000 shares treasury stock and a reduction in the number of shares of issued stock.

(using data from example 1, slide 17, 20-21)

Retiring Treasury Stock

Entries for Cost Method: 3/26 Common Stock 9,000 Paid-in Capital in Excess of Par – com stock 81,000 PIC from treasury stock 1,000 Retained Earnings 8,000 Treasury Stock (at orig repurchase Cost, slide 17) 99,000

Note: 1,000 = 4,000 – 3,000; 99,000 = 9,000 x 11

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Retained Earnings Represents the undistributed earnings of

the company since its inception. Balance January 1, 2013 $ 106,500 Net income 25,000 Cash dividends (10,000) Balance December 31, 2013 121,500$

The statement of retained earnings may also contain the correction of a prior period accounting error, called a prior period adjustment.

Any portion of a dividend not representing a distribution of earnings (i.e., liquidating dividend) should be debited to additional paid-in capital rather than retained earnings.

Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

18-25

Accounting for Cash Dividends

Declared by board of directors.

Creates liability at declaration.

Requires sufficient Retained Earnings and

Cash.

Declaration date Board of directors declares a $10,000 cash dividend. Record a liability.

Declaration Date: Retained earnings ........................................ 10,000 Dividends payable .............................. 10,000 To record declaration of cash dividend.

Not legally required.

18-26

Date of Record Stockholders holding shares on this date will receive

the dividend. (No entry)

Dividend Dates

Date of Payment Record the dividend payment to stockholders.

Ex-dividend date A stock is said to be sold ex-dividend on the day that it

loses the right to receive the latest declared dividend, usually 2 business days before the date of record. A person who buys the stock before the ex-dividend date is entitled for the dividend. The day after the ex-dividend date, shares trade without the right to receive the declared dividend.

Date of Payment: Dividends payable ........................................ 10,000 Cash ……………….............................. 10,000 To record payment of cash dividend.

18-27 Property Dividends Distributions of non-cash assets. Record at fair value of noncash asset (via revaluating the

asset) at the date of declaration. Recognize gain or loss for difference between book value and

fair value.

Stock Dividends Corporations may issue stock dividends to • Reduce the market price per share of stock to make the shares more affordable for investors to purchase. • Signal that the management expects strong financial performance in the future. • Remind stockholders of the accounting wealth in the company, while preserving cash and reduce the existing balance in retained earnings.

18-28

Accounting for Stock Dividends Distribution of additional shares of stock to owners.

No change in total stockholders’ equity, because dr. retained

earnigns cr. stock and APIC. .

All stockholders retain same percentage ownership.

No change in par values.

Stock dividend < 25% of outstanding shares

Record at current fair value of stock.

Small Stock dividend > 25%

Record at par value of stock.

Large

18-29

Accounting for Stock Dividends - Example

CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. The required journal entry would be:

Retained earnings ..................................................... 20,000,000 Common stock …………………………………. 1,000,000 Paid-in capital – excess of par common …….. 19,000,000 To record declaration and distribution of small stock dividend.

5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000

18-30

Stock splits change the par value per share and the number of shares outstanding, but the total par value is unchanged, and no

journal entry is required.

Stock Splits

Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before

a 2–for–1 stock split.

Increase

Decrease

No Change

Before Split

After Split

Common Stock Shares 3,000 6,000

Par Value per Share 2.00$ 1.00$

Total Par Value 6,000$ 6,000$

Note: 2/1 = 200% - 100% original = 100% increase

18-31 Stock Splits in the Form of Large Stock Dividends

Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.

Paid-in capital – excess of par common (or Ret Earnings) ….... 1,000,000 Common stock ……………..……………………. 1,000,000 To record declaration and distribution of 2-for-1 stock split effected in the form of a 100% stock dividend.

A stock distribution of 25% or higher, can be accounted as (1) a large stock dividend or (2) a stock split. Thus a 100% stock dividend = 2-for-1 stock split. However, it is costly to have the par value per share changed. Thus, count it as a stock dividend rather than stock split.

Reverse Stock Split and Fractional Shares

Reverse Stock Split: 1. The motivation for declaring a reverse stock split is to increase market price. 2. It occurs particular during stock market downturn. 3. No journal entry is required. e.g., a 1-for-4 (1/4 = .25) reverse stock split, a 1MM shares, $1 par per share, would become 250K shares, $4 par per share. Fractional Shares: 1. A stock dividend or stock split results in some shareholders being entitled to fractional of whole shares. e.g., a 25% stock dividend or equivalently a 5-for-4 stock split (5/4 = 1.25, 1.25-1=.25); a shareholder owning 10 shares would be entitled to 2.5 shares, =10x.25. 2. Cash payments are made to the fractional shares. In above example, the shareholder would receive 2 shares plus $5 assuming the market value at the declaration is $10 per share.

18-33

Earnings Per Share Presentation and/or Disclosure

• One of the most widely used ratios is earnings per share (EPS), which shows the amount of income earned by a company’s each share of common stock.

• Must be disclosed on the income statement.

Basic EPS

Net income - preferred dividends

Weighted-average number of common shares outstanding for the period

Diluted EPS

Reflects the potential dilution that could occur for companies that have certain securities outstanding that are convertible into common shares or stock options that could create additional common shares if the options were exercised.

18-34

Example: In 2012, Hollis Corporation reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2012, Hollis had a weighted average of 190,000 common shares outstanding. Compute Hollis’s 2012 earnings per share.

Earnings Per Share

- $250,000 $1,000,000

190,000 = $3.95 per share

Net income - Preferred dividends

Weighted average number of shares outstanding

18-35

Complex Capital Structure exists when a business has

convertible securities,

options, warrants, or other rights

that upon conversion or exercise could dilute earnings per share.

Company is required to report both basic and diluted earnings per share.

EPS - Complex Capital Structure

18-36

Diluted EPS includes the effect of all potential dilutive common shares that were outstanding during the period.

Companies will not report diluted EPS if the securities in their capital structure are antidilutive. Ignore antidilutive securities in all calculations and in computing diluted earnings per share.

Antidilutive Securities: The effect of the conversion or exercise of potential common shares would increase rather than decrease the EPS.


18-37

Diluted EPS – Convertible Securities Measure the dilutive effects of potential conversion on EPS

using the if-converted method.

This method for a convertible bond assumes:

(1) the conversion at the beginning of the period (or at the time of issuance of the security, if issued during the period), and

(2) the elimination of related interest, net of tax.


18-38

Example - Convertible Bonds: In 2012 Buraka Enterprises issued at par (quoted at face value, no premium or discount), 75 (units), $1,000 (face value, maturity value, or par value; per unit), 8% bonds, each convertible into 100 shares of common stock.

Buraka had revenues of $17,500 and expenses, other than interest and taxes, of $8,400 for 2013. (Assume that the tax rate is 40%.) Throughout 2013, 2,000 shares of common stock were outstanding; none of the bonds was converted or redeemed.

Instructions:

(a) Compute diluted earnings per share for 2013.

(b) Assume same facts as those for Part (a), except the 75 bonds were issued on September 1, 2013 (rather than in 2012), and none have been converted or redeemed.


18-39


Calculation of Net Income

Revenues $17,500

Expenses 8,400

Bond interest expense (75 x $1,000 x 8%) 6,000

Income before taxes 3,100

Income tax expense (40%) 1,240

Net income $ 1,860


18-40


When calculating Diluted EPS, begin with Basic EPS.

Net income = $1,860

Weighted average shares = 2,000 = $.93

Basic EPS


18-41



$1,860

2,000 = $.57

Diluted EPS

+ $6,000

7,500

Basic EPS = .93

$5,460

9,500 =

Effect on EPS = .48

+


Adjustment for interest: interest is adjusted (added back as net income) at “net of tax”, i.e., if the 75 bonds are converted, there would have no interest exp. of which the net income is 60% (see PPT 39). 7,500 shares = 75x 100 shares, if converted

18-42

Revenues 17,500$ Expenses 8,400 Bond interest expense (75 x $1,000 x 8% x 4/12) 2,000 Income before taxes 7,100 Income taxes (40%) 2,840 Net income 4,260$

Calculation of Net Income

(b) Assume bonds were issued on Sept. 1, 2013 .


18-43

(b) Assume bonds were issued on Sept. 1, 2013 .


$4,260

2,000 = $1.21

Diluted EPS

$2,000

7,500 x 4/12 yr.

$5,460

4,500 =

Effect on EPS = .48 Basic EPS = 2.13

+

+


2,000 interest = 6,000 x 4/12 (PPT 39)

18-44

Variation-Convertible Preferred Stock - Example:

Prior to 2012, Barkley Company issued 40,000 shares of 6% (dividend

rate) convertible, cumulative preferred stock, $100 par value. Each

share is convertible into 5 shares of common stock.

Net income for 2012 was $1,200,000.

There were 600,000 common shares outstanding during 2012.

There were no changes during 2012 in the number of common or

preferred shares outstanding.

Instructions:



18-45



Net income $1,200,000 – Pfd. Div. $240,000*

Weighted average shares = 600,000 = $1.60

Basic EPS

* 40,000 shares x $100 par x 6% = $240,000 dividend


18-46


600,000 =

$1.50

Diluted EPS

$240,000

Basic EPS = 1.60

=

Effect on EPS = 1.20


$1,200,000 – $240,000

200,000*

$1,200,000

800,000

*(40,000 x 5)

+

+


18-47

600,000 =

$1.67

Diluted EPS

$240,000

Basic EPS = 1.60

=

Effect on EPS = 2.00

$1,200,000 – $240,000

120,000*

$1,200,000

720,000

*(40,000 x 3)

Antidilutive

Basic = Diluted EPS

(a) Compute diluted earnings per share for 2012 assuming each share of preferred is convertible into 3 shares of common stock.

+

+


Because the $1.67 DEPS is > the $1.60 BEPS, the effective is antidilutive.

18-48

Diluted EPS – Options and Warrants Measure the dilutive effects of potential conversion using the treasury-stock method.

This method assumes:

(1) company exercises the options or warrants at the beginning of the year (or date of issue if later), and

(2) that it uses those proceeds to purchase common stock for the treasury.


18-49

Example - EPS with Options:

Zambrano Company’s net income for 2012 is $40,000.

The only potentially dilutive securities outstanding were 1,000 options issued during 2011, each exercisable for 1 share at $8. None has been exercised.

10,000 shares of common were outstanding during 2012. The average market price of the stock during 2012 was $20.

Instructions

(a) Compute diluted earnings per share.

(b) Assume the 1,000 options were issued on October 1, 2012 (rather than in 2011). The average market price during the last 3 months of 2012 was $20.


18-50

Proceeds if shares issued (1,000 x $8) $8,000

Purchase price for treasury shares $20

Shares assumed purchased back 400

Shares assumed issued 1,000

Incremental share increase 600


Treasury-Stock Method

÷


18-51

(a) Compute diluted earnings per share for 2012; the options were

issued at beginning of the year.


$40,000

10,000 = $3.77

Diluted EPS

+

600

Basic EPS = 4.00

$40,000

10,600 =

Options

+


18-52

Proceeds if shares issued (1,000 x $8) 8,000$ Purchase price for treasury shares 20$ Shares assumed purchased 400 Shares assumed issued 1,000 Incremental share increase 600 Weight for 3 months assumed outstanding 3/12Weighted incremental share increase 150

Treasury-Stock Method

÷

(b) Compute diluted earnings per share assuming the 1,000 options were issued on October 1, 2012.

x


(Slide 51)

18-53

(b) Compute diluted earnings per share assuming the 1,000 options were issued on October 1, 2012.

$40,000

10,000 = $3.94

Diluted EPS

150

Basic EPS = 4.00

$40,000

10,150 =

Options

+


18-54

A company should show BEPS (if only has common stocks outstanding) and DEPS (if has both common stocks and dilutive “potential common stocks” (PCS)) for:

Income from continuing operations, (slide 56)

Income before extraordinary items, and

Net income.

Per share amounts for a discontinued operation or an extraordinary item should be presented on the face of the income statement or in the notes.

EPS Presentation - Complex Capital Structure

18-55

Complex capital structures and dual presentation of EPS require the following additional disclosures in note form:

1. Description of pertinent rights and privileges of the various securities outstanding.

2. A reconciliation of the numerators and denominators of the basic and diluted per share computations, including individual income and share amount effects of all securities that affect EPS.

3. The effect given preferred dividends in determining income available to common stockholders in computing basic EPS.

4. Securities that could potentially dilute basic EPS in the future that were excluded in the computation because they would be antidilutive.

5. Effect of conversions subsequent to year-end, but before issuing statements (subsequent event).

EPS Disclosure - Complex Capital Structure

18-56

Earnings Per Share Reporting

EPS

Divide by weighted-average shares outstanding

(given info: 100,000 shares)

Section 15 & 16 – Stockholder’s Equity & Earnings Per … 15 & 16 – Stockholder’s Equity & Earnings Per Share The Nature of Shareholders’ Equity ... stockholders’ equity,

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