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Chapter 11`

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Chapter 11 Reporting and Analyzing

Stockholders’ EquityAfter studying Chapter 11, you should be able to:

Identify and discuss the major characteristics of a corporation.

Record the issuance of common stock.Explain the accounting for purchase of

treasury stock.Differentiate preferred stock from

common stock.

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Chapter 11 Reporting and Analyzing

Stockholders’ EquityAfter studying Chapter 11, you should be able to:

Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Identify the items that affect retained earnings.

Prepare a comprehensive stockholders' equity section.

Evaluate a corporation's dividend and earnings performance from a stockholder's perspective.

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CorporationPossess legal entity Created by law Has most of the rights and privileges of a

personClassified by purpose and ownership

Purpose - profit or nonprofit Ownership - publicly or privately held

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Separate legal existenceLimited liability of stockholdersTransferable ownership rightsAbility to acquire capitalContinuous lifeCorporation managementGovernment regulationsAdditional taxes

Characteristics of a Corporation

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Stock Certificate Shows... name of the corporation stockholder's name class and special features of the stock the number of shares owned the signatures of duly

authorized corporate officials.

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Authorized Stock...Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter.

Outstanding Stock...Number of shares of issued stock

that are being held by stockholders.

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Corporations Can Issue Stock...Directly to investors (typical in

privately held corporations). Indirectly through an investment

banking firm (customary with publicly held corporations).

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Par Value Stock... Is capital stock that has been

assigned an arbitrary value per share in the corporate charter.

Is usually low because some states levy a tax on the corporation based on par value.

The legal capital per share that must be retained in the business.

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No-Par Value Stock...Capital stock that has not been assigned

a value per share in the corporate charter.Stated Value of No-Par Stock

Amount per share assigned by the board of directors to no-par stock.

Par Value and Stated Value have NO relationship to market value.

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Stockholders’ Equity Section of a Corporation’s Balance Sheet...

Two Parts: Paid-in (contributed) capital Retained earnings (earned

capital).

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Paid-in Capital...Amount paid to corporation by stockholders for shares of ownership.

Retained Earnings...Earned capital held for future use in the business.

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Accounting for Common Stock Issues

The issue of common stock affects only paid-in capital accounts.

When the issuance of common stock for cash is recorded, the par value of the shares is credited to common stock.

The portion of the proceeds above or below par value is recorded in an additional paid-in capital account.

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If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is:

Cash 5,000Common Stock 1,000Paid-in Capital in 4,000Excess of Par Value

Issuing Stock Above Par

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Stockholders' equity Paid-in capital Common stock, par value $ 2,000 Additional paid-in capital 4,000 Total paid-in capital $ 6,000 Retained earnings 27,000Total stockholders' equity $33,000

Hydro-Slide, Inc.Balance Sheet (partial)

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Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and

outstanding $ 500,000

Retained Earnings 200,000

Total stockholders’ equity $ 700,000

Mead, Inc.Balance Sheet (partial)

BEFORE TREASURY STOCK TRANSACTION

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Treasury Stock... Is a corporation's own stock

that has been issued fully paid for reacquired by the corporation held in its treasury for future use.

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Corporations Acquire Treasury Stock to...

Reissue shares to officers and employees under bonus and stock compensation plans.

Increase trading of company's stock in securities market in hopes of enhancing market value.

Have additional shares available for use in acquisition of other companies.

Reduce number of shares outstanding thereby increasing earnings per share.

Prevent a hostile takeover.

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Purchase of Treasury Stock On February 1, 2004, Mead acquires

4,000 shares of its stock at $8 per share. Treasury Stock 32,000

Cash 32,000

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Treasury StockThe Treasury Stock account would increase by

the cost of the shares purchased - $32,000.The original paid-in capital account, Common

Stock, would not be affected because the number of issued shares does not change.

Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet.

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Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and 96,000 outstanding $

500,000 Retained Earnings

200,000 Total stockholders’ equity 700,000 Less: Treasury Stock 32,000Total stockholders’ equity $

668,000

Mead, Inc.Balance Sheet (partial)

AFTER TREASURY STOCK TRANSACTION

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Preferred Stock...Capital stock that has contractual preferences over common stock in certain areas.DividendsAssets in the event of liquidation

Preferred stockholders do not have voting rights.

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Preferred Stock Assume Corporation issues 10,000 shares of $10

par value preferred stock for $12 cash per share.

Cash 120,000Preferred Stock 100,000Paid-in Capital in Excess 20,000

of Par Value--Preferred Stock

(Preferred stock may have either a par value or no-par value.)

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Dividend PreferencesPreferred stockholders have the right to

share in the distribution of corporate income before common stockholders.

The first claim to dividends does not guarantee dividends.

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Cumulative Dividend...

Is a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

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Dividends in Arrears... Are preferred dividends that were

scheduled but were not declared during a given period.

Are not a liability. No liability exists until a dividend is declared by board of directors.

Must be disclosed in the notes to the financial statements.

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Dividends in Arrears

Dividends in arrears ($35,000 x 2 years) $ 70,000

Current-year dividends 35,000 Total preferred dividends $105,000

Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. The annual dividend is $35,000 (5,000 x $7 per share). Dividends are 2 years in arrears

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Liquidation PreferenceIs a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.

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Dividend...Is a distribution by a corporation to its

stockholders on a pro rata basis. Pro rata means that if you own 10% of

the common shares, you will receive 10% of the dividend. Dividend forms: cash stock

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Cash DividendIs a pro rata distribution of cash to

stockholders.A corporation must have 2 things to

pay cash dividends:Retained earnings Adequate cash

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Cash DividendIn many states, payment of dividends

from legal capital is illegal. Payment of dividends from paid-in capital

in excess of par is legal in some states.Payment of dividends from retained

earnings is legal in all states.Companies are frequently constrained by

agreements with lenders to pay dividends only from retained earnings.

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Entries for Cash DividendsThree dates are important in connection with dividends:

the declaration date the record date the payment date

Month and yearMonday

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The Declaration Date...Is the date the board of directors declares the

cash dividend. Commits the corporation to a binding legal

obligation that cannot be rescinded.On December 1, 2004, the directors of Media General declare a $.50 per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000 x $.50). 12/1 Retained Earnings 50,000 Dividends Payable 50,000

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The Record Date... The date ownership of the outstanding shares is

determined for dividend purposes. Dec 20 No Entry Necessary.

The date dividend checks are mailed.January 20 is the payment date for Media General.

Jan 20 Dividends Payable 50,000Cash 50,000

The Payment Date...

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A Stock Dividend...Is a pro rata distribution of the corporation's

own stock to stockholders.Is paid in stock.Results in a decrease in retained earnings and

an increase in paid-in capital.Does not decrease total stockholders' equity

or total assets.Is often issued by companies that do not have

adequate cash to issue a cash dividend.

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Stock DividendsYou have a 2% ownership interest in Cetus

Inc., owning 20 of its 1,000 shares of common stock.

In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22 /1,100).

You now own more shares of stock, but your ownership interest has not changed.

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Reasons for Stock DividendsTo satisfy stockholders' dividend

expectations without spending cash.To increase marketability of its stock by

increasing number of shares outstanding and decreasing market price per share.

To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends.

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Stock DividendsA small stock dividend (less than 20%-

25% of the corporation's issued stock) is recorded at the fair market value per share.

A large stock dividend (greater than 20%-25% of the corporation's issued stock) is recorded at par or stated value per share.

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Stock DividendsMedland Corporation has $300,000 in retained

earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock.

The current fair market value of the stock is $15 per share. Retained Earnings 75,000 Common Stock Dividends 50,000

DistributablePaid-in Capital in Excess 25,000 of Par Value

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Stock Split...Is 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.

A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders' equity.

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Stock SplitBecause a stock split does not affect

the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.

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Retained Earnings...Is net income that is retained in the

business.The balance in retained earnings is

part of the stockholders' claim on the total assets of the corporation.

Retained earnings does not represent a claim on any specific asset.

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Deficit... Is a debit balance in retained

earnings and is reported as a deduction in the stockholders' equity section of the balance sheet.

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Retained Earnings Restrictions...

Are legal, contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends.

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Stockholders' equity Paid-in capital

Common Stock $ 3,571

Paid-in capital in excess of par value 1,322,479Total paid-in capital

1,326,050 Accumulated Deficit 2,293,301 Total stockholders’ equity (deficit) $ (967,251)

AMAZON.COM Balance Sheet (Partial)December 31, 2000

(in thousands)

Stockholders Equity With Deficit

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Stockholders' equity Common stock, $.01 par value;

1,500,000,000 shares authorized -- 250,000,000; 503,294,515shares issued $ 503 Capital in excess of par value 1,695

Retained earnings 1,261Total stockholders' equity $ 3,459

Kmart, Inc. Balance Sheet (Partial)

(in millions)

Stockholders Equity Section

SARA LEE CORPORATIONStatement of Cash Flows (partial)For the Year Ended June 30,2001

(in millions)Cash flow from Financing Activities Issuance of common stock $ 104 Purchase of common stock (643) Payment of dividends (486) Borrowing of long-term debt 1,023 Repayment of long-term debt (390) Short-term (repayments)borrowing (1,914)Net cash used in financing activities (2,306)

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The Payout Ratio =

CASH DIVIDENDS DECLARED ON COMMON STOCKNET INCOME

… measures the percentage of earnings distributed in the form of cash

dividends to common stockholders.

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Return on Equity Ratio =

NET INCOME - PREFERRED STOCK DIVIDENDSAVERAGE COMMON STOCKHOLDERS’ EQUITY

...measures the profitability from the stockholders’ point of view.

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Advantages of Bond Financing Over Common Stock

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The Dividend Yield =DIVIDENDS DECLARED PER SHARE OF COMMON STOCK

STOCK PRICE AT END OF YEAR

…reports the rate of return an investor earned from dividends.

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Earnings Per Share =

NET INCOME - PREFERRED STOCK DIVIDENDSAVERAGE COMMON SHARES OUTSTANDING

...measures the net income earned on each share of common stock.

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Price-Earnings Ratio = MARKET PRICE PER SHARE OF STOCK

EARNINGS PER SHARE

In order to make a meaningful comparison of earnings across firms, use the price-earnings ratio.

The price-earnings ratio reflects the market’s assessment of a company's future earnings.