Shareholders’ Equity JOIN KHALID AZIZ COACHING CLASSES ICMAP STAGE 1,2,3,4,5 ICAP MODULE A,B,C,D PIPFA BBA & MBA B.COM & M.COM ACCOUNTING OF O/A LEVEL.

Shareholders’ EquityShareholders’ EquityJOIN KHALID AZIZJOIN KHALID AZIZ

COACHING CLASSESCOACHING CLASSESICMAP STAGE 1,2,3,4,5ICMAP STAGE 1,2,3,4,5ICAP MODULE A,B,C,DICAP MODULE A,B,C,D

PIPFAPIPFABBA & MBABBA & MBA

B.COM & M.COMB.COM & M.COMACCOUNTING OF O/A LEVELACCOUNTING OF O/A LEVEL

MA-ECONOMICSMA-ECONOMICS0322-33857520322-3385752

KARACHI, PAKISTANKARACHI, PAKISTAN

18-2

The Nature of Shareholders’ Equity

Assets – Liabilities = Shareholders’ Equity

Net Assets(Residual Interest)

18-3

Sources of Shareholders’ Equity

Shareholders’ Equity

Paid-in Capital

Retained Earnings

Amounts earnedby corporation

Amounts investedby shareholders Other

gains and losses not included in net income

Accumulated Other Comprehensive Income

18-4

The Corporate Organization

Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.

Disadvantages: Double taxation. Government regulation.

Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.

Disadvantages: Double taxation. Government regulation.

18-5

Hybrid Organizations

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but not

entirely liable for actions of other partners.

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but not

entirely liable for actions of other partners.

Doubletaxationavoided.

18-6

Formation of a Corporation

Number and classesof shares authorized.

Composition of initialboard of directors.

Nature and locationof business activities.

CorporateCharter

18-7

Formation of a Corporation

Articles of incorporationare filed with the state.

Board of directors elected by

shareholders.

Board of directors appoint officers.

Shares of stock issued.

State issues a corporate charter.

18-8

Authorized, Issued, and Outstanding Capital Stock

AuthorizedShares

The maximum number of shares of capital

stock that can be sold to the public is called

the authorized number of shares.

18-9

Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that have never been sold.

AuthorizedShares

Authorized, Issued, and Outstanding Capital Stock

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UnissuedShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that have been reacquired by the

corporation.

IssuedShares

Outstanding shares are issued shares that are

owned by stockholders.Authorized

Shares

Authorized, Issued, and Outstanding Capital Stock

18-11

UnissuedShares

RetiredShares

OutstandingShares

Retired shares assume the same status as

authorized but unissued shares.

Outstanding shares are issued shares that are

owned by stockholders.Authorized

Shares

Authorized, Issued, and Outstanding Capital Stock

18-12

Types of Capital Stock

Common Preferred

18-13

The basic voting stock of the corporation.

Ranks after preferred stock for dividend and liquidation

distribution.

Dividends determined by the board of directors.

The basic voting stock of the corporation.

Ranks after preferred stock for dividend and liquidation

distribution.

Dividends determined by the board of directors.

Common Stock

18-14

Preferred Stock

Dividend preference over common stock.

Dividend preference over common stock.

Generally does nothave voting rights.Generally does nothave voting rights.

Usually has apar or stated value.

Usually has apar or stated value.

Preference over common stock in

the event of liquidation.

Preference over common stock in

the event of liquidation.

18-15

Are usually stated as a percentage of the par or stated value.

May be cumulative or noncumulative.

May be partially participating, fully participating, or nonparticipating.

Are usually stated as a percentage of the par or stated value.

May be cumulative or noncumulative.

May be partially participating, fully participating, or nonparticipating.

Preferred Stock Dividends

18-16

Preferred Stock DividendsCumulative

Unpaid dividends must be paid before any distributions to common stock.

Dividends in arrears are not liabilities, but must be disclosed.

18-17

Comprehensive IncomeComprehensive income includes losses and

gains that traditionally havebeen excluded from net income.

Comprehensive income includes losses and gains that traditionally have

been excluded from net income.

Net holding losses (gains)

on investments.

Net holding losses (gains)

on investments.

Deferred losses (gains) from derivatives.

Deferred losses (gains) from derivatives.

Postretirement plans: Losses (gains) Prior service cost.

Postretirement plans: Losses (gains) Prior service cost.

Losses (gains) from foreign

currency translations.

Losses (gains) from foreign

currency translations.

18-18

Comprehensive IncomeComponents of comprehensive income created during the reporting period:

($ in millions)

Net income $xxxOther comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)† $ x Losses (gains) on postretirement benefit plans (net of tax)‡ (x) Prior service cost on postretirement benefit plans (net of tax) x Deferred losses (gains) from derivatives (net of tax)§ x Losses (gains) from foreign currency translation (net of tax)* x xxComprehensive income $xxx

† Changes in the market value of securities available-for-sale.‡ Increases (decreases) in the postretirement benefit obligation from changing assumptions

as well as plan assets earning less or more than expected (described in Chapter 17).Cost of recalculating postretirement benefits in prior years after amending a plan. (described

in Chapter 17). § When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or

loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).

* Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

18-19

Comprehensive income (a) is reported periodicallyas it is created and (b) also is reported as a cumulative

amount.

Comprehensive income (a) is reported periodicallyas it is created and (b) also is reported as a cumulative

amount.

Comprehensive Income

There are 3 options for reporting comprehensive income created

during the reporting period. The statement of comprehensive

income can be presented:

There are 3 options for reporting comprehensive income created

during the reporting period. The statement of comprehensive

income can be presented:

The accumulated amount of comprehensive income is

reported as a separate item of SE in the balance sheet.

The accumulated amount of comprehensive income is

reported as a separate item of SE in the balance sheet.

As an expanded version of the

income statement.

As an expanded version of the

income statement.

Within the statement of

shareholders’ equity.

Within the statement of

shareholders’ equity.

As a separate statement.

As a separate statement.

18-20

SHARES SOLD FOR CASH

Dow Industrial sells 100,000 of its common shares, $1 par per share, for $10 per share:

($ in 000s)

Cash (100,000 shares at $10 price per share) 1,000Common stock (100,000 shares at $1 par ) 100Paid-in capital – excess of par (remainder) 900

The entire proceeds from the sale of nopar stock are recorded in the stock account:

Cash (100,000 shares at $10 price per share) 1,000Common stock 1,000

18-21

Issuing Stock for Noncash Assets

Record the transaction at fair value (of stock issued or of asset or service received,

whichever is more clearly evident).

If market values cannot be determined, use appraised values.

Record the transaction at fair value (of stock issued or of asset or service received,

whichever is more clearly evident).

If market values cannot be determined, use appraised values.

18-22

Issuing Stock for Noncash AssetsDuMont Chemicals issues 1 million of its common shares, $1 par per share, in exchange for a custom-built factory for which no cash price is available. Today’s issue of the Wall Street Journal lists DuMont’s stock at $10 per share:

($ in millions)

Property, plant, & equipment (1 million sh at $10) 10Common stock (1 million shares at $1 par)1Paid-in capital – excess of par (remainder) 9

We record both the asset and the stock at the $10 million fair value.

18-23

More Than One Security Issuedfor a Single Price

Allocate the amount received based on the relative fair values of the two securities.

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

Allocate the amount received based on the relative fair values of the two securities.

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

18-24More Than One Security Issuedfor a Single Price

AP&P issues 4 million of its common shares, $1 par per share, and 4 million of its preferred shares, $10 par, for $100 million. Today’s issue of the Wall Street Journal lists AP&P’s common at $10 per share. There is no established market for the preferred shares:

($ in millions)

Cash 100Common stock (4 million shares x $1 par) 4Paid-in capital – excess of par, common 36Preferred stock (4 million shares x $10 par) 40Paid-in capital – excess of par, preferred 20

4 million shares x $10 = $40 million$100 - 40 = $60 million

18-25

Share Issue Costs

Share issue costs reduce net proceedsfrom 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

18-26

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.

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.

18-27

I can account forthe reacquired sharesby retiring them or by

holding them astreasury shares.

Share Buybacks

18-28

Accounting for Retired Shares

When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock,

and additional paid-in capital.

18-29

Acquisition of Treasury Stock Recorded at cost to acquire.

Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and

issuance price is (generally)recorded in paid-in capital –share repurchase.

Acquisition of Treasury Stock Recorded at cost to acquire.

Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and

issuance price is (generally)recorded in paid-in capital –share repurchase.

Accounting for Treasury Stock

18-30COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING

American Semiconductor’s balance sheet included the following:

Shareholders' Equity ($ in millions)

Common stock, 100 million shares at $1 par $ 100Paid-in capital – excess of par 900Paid-in capital – share repurchase

2Retained earnings 2,000

18-31COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING Reacquired 1 million of its common shares

Retirement Treasury StockCase 1: Shares repurchased at $7 per shareCommon stock ($1 par x 1 million sh) 1 Treasury stock (cost) 7PIC – excess of par ($9 per sh) 9

PIC – share repurchase (difference) 3Cash 7 Cash 7

OR

Case 2: Shares repurchased at $13 per shareCommon stock ($1 par x 1 million sh) 1 Treasury stock (cost) 13PIC – excess of par ($9 per sh) 9PIC – share repurchase 2*Retained earnings (difference) 1 Cash 13 Cash

13

We reduce common stock and PIC – excess of par the same amounts they were increased when the shares were issued:

Cash 10 Common stock 1 PIC – excess of par 9

We credit PIC – share repurchase for the amount needed to make debits equal credits in the entry.

*Because there is a $2 million credit balance.

18-32

SUBSEQUENT SALE OF SHARES

Sold 1 million shares after reacquiring shares at $13 per share (Case 2 in previous situation)

Retirement Treasury StockCase A: Shares sold at $14 per shareCash 14 Cash 14

Common stock (par) 1 Treasury stock (cost) 13PIC – excess of par 13 PIC – share repurchase 1

OR

Case B: Shares sold at $10 per shareCash 10 Cash 10 Common stock (par) 1 RE (to balance) 1 PIC – excess of par 9 PIC – share repurchase 2*

Treasury stock (cost)13

*Because there is a $2 million credit balance.

18-33REPORTING SHARE BUYBACKS IN THE BALANCE SHEET

Formally retiring shares restores the balances in both the Common stock account and Paid-in capital – excess of par to what those balances would have been if the shares never had been issued at all. Any net increase in assets resulting from the sale

and subsequent repurchase is reflected as Paid-in capital – share repurchase.

Any net decrease in assets resulting from the sale and subsequent repurchase is reflected as a reduction in retained earnings.

18-34REPORTING SHARE BUYBACKS IN THE BALANCE SHEET

Shares

Treasury Retired

StockShareholders’ Equity ($ in millions)

Paid-in capital:Common stock, 100 million shares at $1 par $ 99 $ 100Paid-in capital – excess of par 891 900Paid-in capital – share repurchase 2

Retained earnings 1,999 2,000

Less: Treasury stock, 1 million shares (at cost) (13)Total shareholders’ equity $2,989 $2,989

When a share repurchase is viewed as treasury stock, the cost of the treasury stock is simply reported as a reduction in total shareholders’ equity.

18-35

In 2009, Peridot, Inc. reacquired 3,000 shares of its common stock at $55 per share. In 2010, Peridot, Inc. reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 2010 entry?

a. Credit Cash for $165,000.b. Debit Treasury Stock for $75,000.c. Credit Treasury Stock for $55,000.d. Credit Cash for $75,000.

In 2009, Peridot, Inc. reacquired 3,000 shares of its common stock at $55 per share. In 2010, Peridot, Inc. reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 2010 entry?

a. Credit Cash for $165,000.b. Debit Treasury Stock for $75,000.c. Credit Treasury Stock for $55,000.d. Credit Cash for $75,000.

Accounting for Treasury Stock

18-36

Accounting for Treasury Stock2009Treasury stock 165,000

Cash 165,000

2010Cash 75,000

Treasury stock 55,000PIC - share repurchase 20,000

18-37

Retained Earnings

Represents the undistributed earnings of the company since its inception.

Represents the undistributed earnings of the company since its inception.

Balance January 1, 2009 $ 500,000 Net income 25,000 Cash dividends (10,000) Balance December 31, 2009 515,000$

18-38

Cash Dividends

Dividends must bedeclared by the board

of directors beforethey can be paid.

When a dividend isdeclared, a liability

is created.

A corporation is notlegally required to

pay dividends.

Cash dividendsrequire sufficient cashand retained earningsto cover the dividend.

18-39

CASH DIVIDENDSOn June 1, the board of directors of Craft Industries declares a cash dividend of $2 per share on its 100 million shares, payable to shareholders of record June 15, to be paid July 1:

($ in millions)

June 1 – declaration dateRetained earnings 200

Cash dividends payable (100 million shares at $2/share) 200

June 13 – ex-dividend date no entry

June 15 – date of record no entry

July 1 – payment dateCash dividends payable 200

Cash 200

18-40

Dividend Dates

Ex-dividend date The first day the shares trade without

the right to receive the declared dividend. (No entry)

June

X

18-41

Dividend Dates

Date of record Stockholders holding shares on this date

will receive the dividend. (No entry)

July

X

June

X

18-42

PROPERTY DIVIDENDSOn October 1, the board of directors declares a property dividend of 2 million sh. of preferred stock that Craft had purchased in March as an investment (book value: $9 million; FV: $5/sh), payable to shareholders of record October 15, to be distributed November 1:

October 1 – declaration date ($ in millions)

Investment in Beaman Corporation preferred stock 1Gain on appreciation of investment ($10 – $9) 1

Retained earnings (2 million shares at $5 per share) 10Property dividends payable 10

October 15 – date of record no entry

November 1 – payment dateProperty dividends payable 10

Investment in Beaman Corporation preferred stock 10

Before recording a property dividend, the asset first must be written up to fair market value.

Then record the property dividend the same way as a cash dividend.

18-43

STOCK DIVIDENDSA stock dividend is the distribution of additional shares of stock to current shareholders of the corporation.

Because each shareholder receives the same percentage increase in shares, shareholders' proportional interest in (percentage ownership of) the firm remains unchanged.

Craft declares and distributes a 10% common stock dividend (10 million shares) when the market value of the $1 par common stock is $12 per share: ($ in millions)

Retained earnings (10 million shares at $12 per share) 120Common stock (10 million shares at $1 par per share) 10Paid-in capital – excess of par (remainder) 110

For a "small" stock dividend (less than 25%), the fair market value of the additional shares distributed is transferred from retained earnings to paid-in capital.

18-44

STOCK SPLITSA stock distribution of 25% or higher is referred to as a stock split.A frequent reason for issuing a stock split is to reduce the market price per share (by half in a 2 for 1 split, for example).No journal entry, unless the stock distribution is referred to as a "stock split effected in the form of a stock dividend."

Craft declares and distributes a 2 for 1 stock split effected in the form of a 100% stock dividend (100 million shares) when the market value of the $1 par common stock is $12 per share:

($ in millions)

Paid-in capital – excess of par 100Common stock (100 million shares at $1 par) 100

Some companies choose to debit retained earnings instead.

18-45