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Equity Equity FinancingFinancing

An electronic presentationAn electronic presentation by Douglas Cloudby Douglas Cloud

Pepperdine UniversityPepperdine University

An electronic presentationAn electronic presentation by Douglas Cloudby Douglas Cloud

Pepperdine UniversityPepperdine University

chapter 11

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Learning Objectives

1. Identify the rights associated with ownership of common and preferred stock.

2. Record the issuance of stock for cash, on a subscription basis, and in exchange for noncash assets or for services.

3. Use both the cost and par value methods to account for stock repurchases.

4. Account for the issuance of stock rights and stock warrants.

ContinuedContinuedContinuedContinued

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Learning Objectives

5. Explain the difference between the intrinsic value and fair value methods, and use both in accounting for a fixed stock option plan.

6. Distinguish between stock conversions that require a reduction in retained earnings and those that do not.

7. List the factors that impact the retained earnings balance.

ContinuedContinuedContinuedContinued

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Learning Objectives 8. Properly record cash dividends, property dividends, small and large stock

dividends, and stock splits.

9. Explain the background of unrealized gains and losses recorded as direct equity adjustments, and list the major types of equity reserves founds in foreign balance sheets.

10. Prepare a statement of changes in stockholders’ equity.

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Equity Items

XYZ Corporation

Common Stock

ISSUE preferred or

common stock

PAY cash

dividends

XYZ Corporation

Common Stock

INCREASE shares

outstanding through stock dividends and

stock splits

GRANT options to

officers and employees

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Equity Items

XYZ Corporation

Common Stock

REPURCHASE shares of stock

XYZ Corporation

Common Stock

CONVERT other securities into shares of common stock

XYZ Corporation

Common

Stock

XYZ Corporation

Common

Stock

XYZ Corporation

Common

StockXYZ Corporation

Common Stock

REPORT performance to

current and potential investors

XYZ Corporation

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Common Stock

The owners of common stock of a corporation can be thought of as the true owners of the business.

The owners of common stock of a corporation can be thought of as the true owners of the business.

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Common Stock

Unless restricted by terms of the articles of

incorporation, the common stockholder has certain

basic rights.

Unless restricted by terms of the articles of

incorporation, the common stockholder has certain

basic rights.

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The right to vote in the election of directors and in the determination of certain corporate polices such as the management compensation plan or major corporate acquisitions.

The right to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued.

Common Stock

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Rex Corporation issued 5,000 shares of common stock with a par value of $1 on

April 1, 2005, for $30,000 cash.

Rex Corporation issued 5,000 shares of common stock with a par value of $1 on

April 1, 2005, for $30,000 cash.

Apr. 1 Cash 30,000Common Stock 5,000Additional Paid-In Capital 25,000

Common Stock

at Par Valueat Par Value

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Preferred StockPreferred Stock

The title “preferred” stock is

somewhat misleading.

The title “preferred” stock is

somewhat misleading.

Preferred isn’t better; it’s different.

Preferred isn’t better; it’s different.

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Preferred StockPreferred Stock

The rights of ownership given up by preferred stockholders:

The rights of ownership given up by preferred stockholders:

• Voting: In most cases, preferred stockholders are not allowed to vote for the board of directors.

• Sharing in success: The cash dividends received by preferred stockholders are usually fixed in amount. If the company does exceptionally well, preferred stockholders do not get to share in the success.

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• Cash dividend preference: Preferred stockholders are entitled to receive their full cash dividend before any cash dividend can be issued to common stockholders.

• Liquidation preference: If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid in full, before common stockholders receive anything.

The protection enjoyed by preferred stockholders is:

The protection enjoyed by preferred stockholders is:

Preferred StockPreferred Stock

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CumulativeHas the right to receive accumulated dividends before any dividends may be paid to common stockholders.

Non-Cumulative

Has no right to “passed”dividends.

ParticipatingHas claim to a portion ofcommon dividends afterreceiving preferred dividends.

Preferred StockPreferred Stock

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Callable Permits the issuing companyto redeem the preferred stock.

RedeemablePermits the holder to redeem thestock—usually with somerestrictions.

ConvertiblePermits the holder to exchangepreferred stock for common stock.

Preferred StockPreferred Stock

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Preferred StockPreferred Stock

Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.

Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.

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Preferred StockPreferred Stock

And… dividends are not a liability until declared

by the board of directors.

And… dividends are not a liability until declared

by the board of directors.

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Preferred StockPreferred Stock

Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders

after dividends of a specified amount are

paid to common stockholders.

Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders

after dividends of a specified amount are

paid to common stockholders.

Callable preferred stock is preferred

stock that is redeemable at the

option of the corporation.

Callable preferred stock is preferred

stock that is redeemable at the

option of the corporation.

Redeemable preferred stock is

preferred stock that is redeemable at the

option of the stockholder.

Redeemable preferred stock is

preferred stock that is redeemable at the

option of the stockholder.

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Capital Stock Issued for Cash

Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2005, for $45,000 cash.

Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2005, for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 4,000Paid-In Capital in Excess of Par 41,000

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On April 1, 2005, Goode Corporation issued 4,000 shares of no-par common stock without a

stated value for $45,000 cash.

On April 1, 2005, Goode Corporation issued 4,000 shares of no-par common stock without a

stated value for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 45,000

Capital Stock Issued for Cash

21Capital Stock Sold on Subscription

On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50%

down, balance due in 60 days.

On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50%

down, balance due in 60 days.

Nov. 1 Common Stock Subscription Receivable 62,500

Common Stock Subscribed 5,000Paid-In Capital in Excess of Par 57,500

22Capital Stock Sold on Subscription

On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50%

down, balance due in 60 days.

On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50%

down, balance due in 60 days.

Nov. 1 Cash 31,250Common Stock Subscription Receivable 31,250

23Capital Stock Sold on Subscription

On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares.

On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares.

Dec. 9 Cash 15,625Common Stock

Subscription Receivable 15,625

9 Common stock Subscribed 2,500Common Stock 2,500

24Stock Issued for Consideration Other Than Cash

AC Company issues 200 shares of $0.50 par value common stock in return for

land. The company’s stock is currently selling for $50 per share.

AC Company issues 200 shares of $0.50 par value common stock in return for

land. The company’s stock is currently selling for $50 per share.

Dec. 5 Land 10,000Common Stock 100

Paid-In Capital in Excess of Par 9,900

25Stock Issued for Consideration Other Than Cash

Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has

no established fair market value.

Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has

no established fair market value.

Dec. 5 Land 12,000Common Stock 100

Paid-In Capital in Excess of Par 11,900

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Stock Repurchases

1. Provide shares for incentive compensation and employee savings plans.

2. Obtain shares needed to satisfy requests by holders of convertible securities.

3. Reduce the amount of equity relative to the amount of debt.

4. Invest excess cash temporarily.

Companies Companies acquired their acquired their

own stock to…own stock to…

Companies Companies acquired their acquired their

own stock to…own stock to…

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Stock Repurchases

5. Remove some shares from the open market in order to protect against a hostile takeover.

6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.

7. Display confidence that the stock is currently undervalued by the market.

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Treasury Stock

• Stock issued by a corporation but subsequently reacquired by the corporation and held for possible future reissuance or retirement.

• Reported as a contra-equity account, not as an asset.

• Does not create a gain or loss on reacquisition, reissuance, or retirement.

• May decrease Retained Earnings, but cannot increase it.

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Issued 10,000, $1 par value shares at $15 per shareIssued 10,000, $1 par value shares at $15 per share

Cost MethodCash 150,000 Common Stock. 10,000 Paid-In Capital in Excess of Par 140,000

Treasury Stock

Cash 150,000Common Stock. 10,000

Paid-In Capital in Excess of Par 140,000

Par Value Method

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Reacquired 1,000 shares at $40 per share.Reacquired 1,000 shares at $40 per share.

Treasury Stock

Cost MethodTreasury Stock 40,000

Cash 40,000

Treasury Stock 1,000Paid-In Capital in Excess of Par 14,000Retained Earnings 25,000 Cash 40,000

Par Value Method

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Sold 200 shares of treasury stock at $50 per share.Sold 200 shares of treasury stock at $50 per share.

Treasury Stock

Cost MethodCash 10,000

Treasury Stock 8,000 Paid-In Capital from

Treasury Stock 2,000

Cash 10,000Treasury Stock 200Paid-In Capital in Excess of Par 9,800

Par Value Method

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Sold 500 shares of treasury stock at $34 per share.Sold 500 shares of treasury stock at $34 per share.

Treasury Stock

Cost MethodCash 17,000Paid-In Capital from Treasury

Stock 2,000Retained Earnings 1,000

Cash 20,000

Cash 17,000Treasury Stock 500Paid-In Capital in Excess of Par 16,500

Par Value Method

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Retired remaining 300 shares of treasury stock.Retired remaining 300 shares of treasury stock.

Treasury Stock

Cost MethodCommon Stock 300Paid-In Capital in Excess of Par 4,200Retained Earnings 7,500

Treasury Stock 12,000

Common Stock 300Treasury Stock 300

Par Value Method

34Stock Rights, Warrants, and Options

Stock rights—Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.

Stock warrants—Sold by the corporation for cash, generally in conjunction with the issuance of another security.

Stock options—Granted to officers or employees, usually as part of a compensation plan.

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Stock Warrants

Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co.

gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per

share. Immediately following the issuance of the stock, the warrants are selling for $3, and

the fair market value of a preferred share without the warrant attached is $57.

Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co.

gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per

share. Immediately following the issuance of the stock, the warrants are selling for $3, and

the fair market value of a preferred share without the warrant attached is $57.

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Stock Warrants

Value assigned to

warrants=

Total issue price

xMarket value of warrants

Market value of security

without warrants

+ Market value of warrants

$57 + $3

Value assigned to

warrants= $58,000 x $3 = $2,900

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Stock Warrants

The entry on Stewart’s book to record the sale of the preferred stock with

detachable warrants is:

The entry on Stewart’s book to record the sale of the preferred stock with

detachable warrants is:

Cash 58,000Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par--Preferred Stock5,100Common Stock Warrants2,900

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Stock Warrants

If the warrants are exercised, the entry to record the issuance of common stock is:

If the warrants are exercised, the entry to record the issuance of common stock is:

Common Stock Warrants 2,900Cash 25,000

Common Stock, $2 par 2,000 Paid-In Capital in Excess of Par—Common Stock25,900

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Stock Warrants

If these warrants were allowed to expired, what entry would be required?

If these warrants were allowed to expired, what entry would be required?

Common Stock Warrants 2,900Paid-In Capital from Expired Warrants 2,900

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All employees eligible?

Shares offered equally?

Reasonable exercise period?

Exercise Prices » Market Price?

NoYes

Yes

Non-compen-satory Plan

Record sharesissued when stock

is purchased.

No

No

No

Compensatory Plan

Determine compensationexpense; amortize

over period employeeis to provide service.

No

Grant andMeasurementdates same?

Yes

Number of sharesand Exercise Price

known?

Estimate compensationexpense; amortize

over period employeeis to provide service.

Determine actual expense;amortize over remaining

period employee is toprovide service.

Record shares issuedwhen stock is purchased.

Adjust for UnearnedCompensation, if any.

No

Yes

40Stock-Based CompensationStock-Based Compensation

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Stock-Based CompensationStock-Based Compensation

On January 1, 2003, the board of directors of Neff Company

authorize the grant of 10,000 stock options. Each option permits the

purchase of one share of Neff common stock at $50 per share.

On January 1, 2003, the board of directors of Neff Company

authorize the grant of 10,000 stock options. Each option permits the

purchase of one share of Neff common stock at $50 per share.

The company estimates a grant date value of $10 for each of the

employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from

January 1, 2003 (the grant date) to January 1, 2006 (the vesting date).

The company estimates a grant date value of $10 for each of the

employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from

January 1, 2003 (the grant date) to January 1, 2006 (the vesting date).

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Stock-Based CompensationStock-Based Compensation

Dec. 31 Compensation Expense 33,333Paid-In Capital from Stock Options 33,333

2003

$100,000 ÷ 3

SimilarSimilar entries would be made in 2004 and 2005.SimilarSimilar entries would be made in 2004 and 2005.

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Stock-Based CompensationStock-Based Compensation

Dec. 31 Cash 500,000Paid-In Capital from Stock Options 100,000

Common Stock (no par) 600,000

2006

On December 31, 2006, all 10,000 of the options are exercised to purchase Neff’s no-

par common stock.

On December 31, 2006, all 10,000 of the options are exercised to purchase Neff’s no-

par common stock.

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Stock-Based CompensationStock-Based Compensation

Dec. 31 Paid-In Capital from Stock Options 600,000

Paid-In Capital from Expired Options 600,000

2006

If the options had been allowed to expired, the following entry would have been

necessary on December 31, 2006:

If the options had been allowed to expired, the following entry would have been

necessary on December 31, 2006:

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Stock Conversions

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par—Preferred 10,000

Common Stock 4,000Paid-In Capital in Excess of Par—Common 56,000

2005

On December 31, 2005, 1,000 shares of preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $1)

On December 31, 2005, 1,000 shares of preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $1)

Case 1Case 1

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Stock Conversions

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par—Preferred 10,000Retained Earnings 20,000

Common Stock 80,000

2005

On December 31, 2005, 1,000 shares of preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $20)

On December 31, 2005, 1,000 shares of preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $20)

Case 2Case 2

47Factors AffectingRetained Earnings

Error correctionsSome changes in accounting principleNet incomeQuasi-reorganizations

RetainedEarnings IncreasesIncreasesIncreasesIncreases

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Error correctionsPrior period adjustments

Treasury stockNet loss

Some changes in accounting principlesCash and stock dividendsRetained

Earnings

Factors AffectingRetained Earnings

DecreaseDecreasess

DecreaseDecreasess

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Accounting for Dividends

• Declaration date: The date the corporation’s board of directors formally declares a dividend will be paid.

• Date of record: The date on which stockholders of record are identified as those who will receive a dividend.

• Date of payment: The date when the dividend is actually distributed to stockholders.

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Cash Dividend

ABC Corporation declares a $100,000 dividend; the following journal entries should be made:

Declaration Date

Dividends (Retained Earnings) 100,000

Dividends Payable 100,000

Payment Date

Dividends Payable 100,000

Cash100,000

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Property Dividend

What is a property dividend?

What is a property dividend?

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Property Dividend

It is a distribution to stockholders that is

payable in some asset other than cash.

It is a distribution to stockholders that is

payable in some asset other than cash.

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Property Dividend

Bigley Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value

$3,000,000, or $30 per share. There are 1,000,000 shares of Bigley stock

outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigley stock outstanding.

Bigley Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value

$3,000,000, or $30 per share. There are 1,000,000 shares of Bigley stock

outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigley stock outstanding.

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Declaration of Dividend

Dividend (or Retained Earnings) 3,000,000

Property Dividends Payable 2,700,000

Gain on Distribution of Property

Dividend 300,000

Property Dividend

Payment of Dividend

Property Dividends Payable 2,700,000

Investment in Tri-State Oil Co.2,700,000

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Stock Dividends

• Small– Less than 20-25% of the outstanding shares.– Debit Retained Earnings for the MARKET

value of the shares.• Large

– Greater than 20-25% of the shares outstanding.– Debit Retained Earnings for the PAR value of

the shares.

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• Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

• Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

Example 1: Stock Dividend

Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

Is this a large or small stock dividend?

Is this a large or small stock dividend?

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• Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

• Assume the following about Gean, Inc.:– Common stock ($2 par, 10,000

shares outstanding) $20,000– Additional paid-in capital $24,200– Retained earnings $12,500– Stock dividend declared 1,500 shares– Market price of stock $10/share

Example 1: Stock Dividend

Because 1,500 shares represent 15% of the

outstanding stock, it is a small stock dividend.

Because 1,500 shares represent 15% of the

outstanding stock, it is a small stock dividend.

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Declaration Date

Retained Earnings 15,000

Stock Dividends Distributable 3,000

Paid-In Capital in Excess of Par 12,000

Example 1: Stock Dividend

Issuance Date

Stock Dividends Distributable 3,000

Common Stock 3,000

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Example 2: Stock Dividend

• Assume the following about Gimli’s Corp.:– Common Stock ($5 par, 20,000

shares outstanding) $100,000– Additional Paid-In Capital $100,000– Retained Earnings

$52,000– Stock Dividend Declared 10,000 shares– Market Price of Stock $20/share

• Assume the following about Gimli’s Corp.:– Common Stock ($5 par, 20,000

shares outstanding) $100,000– Additional Paid-In Capital $100,000– Retained Earnings

$52,000– Stock Dividend Declared 10,000 shares– Market Price of Stock $20/share

Is this a large or small stock dividend?Is this a large or small stock dividend?50% = large dividend50% = large dividend

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Example 2: Stock Dividend

Declaration Date

Retained Earnings 50,000

Stock Dividends Distributable50,000

Issuance Date

Stock Dividends Distributable 50,000

Common Stock50,000

61Unrealized Gains and Losses on Available-For-Sale Securities

Available-for-sale securities are those that were not

purchased with the immediate intention to resell…

Available-for-sale securities are those that were not

purchased with the immediate intention to resell…

…but the company also doesn’t necessarily plan to

hold these securities forever.

…but the company also doesn’t necessarily plan to

hold these securities forever.

62Unrealized Gains and Losses on Available-For-Sale Securities

Kendell had net income of $1,350. Other items that impacted net income are:Unrealized gain (loss) on available-

for-sale securities $100(Increase) Decrease in minimum

pension liability (60 )Unrealized gain (loss) on derivative

instruments (20 )Foreign currency translation

adjustment, increase (decrease) instockholders’ equity 300

63Unrealized Gains and Losses on Available-For-Sale Securities

Net income

$1,350Other comprehensive income:

Unrealized gain on available-for- sale securities

60Increase in minimum pension liability

(36

)Unrealized loss on derivative instruments

(12

)Foreign current transaction adjustments

180Comprehensive income

$1,542

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Liquidating Dividend

A liquidating dividend is a distribution representing a return to stockholders of a

portion of contributed capital.

A liquidating dividend is a distribution representing a return to stockholders of a

portion of contributed capital.

65Disclosures Related to the Equity Section

Authorized but unissued. Subscribed for and held for issuance

pending receipt of cash for the full amount of the subscription price.

Outstanding in the hands of stockholders. Reacquired and held by the corporation for

subsequent reissuance. Canceled by appropriate corporate action.

Capital stock may be:

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The EndThe End

chapter 11

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