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CHAPTER 18CHAPTER 18

Shareholders EquityShareholders EquityOverview

We turn our attention in this chapter from liabilities, which represent the creditors interests in theassets of a corporation, to the shareholders residual interest in those assets. The discussionsdistinguish between the two basic sources of shareholders equity (1) invested capital and ()earnedcapital. These two sources are the sub!ects of "arts # and $ of this chapter paid%in capitaand retained earnings. We e&plore the e&pansion of corporate capital through the issuance of sharesas well as the contraction caused by the retirement of shares or the purchase of treasury shares.Within the conte&t of our discussions of retained earnings, we e&amine cash di'idends, propertydi'idends, stoc di'idends, and stoc splits.

LEARNINO!"ECTI#ESfter studying this chapter, you should be able to*

fter studying this chapter, you should be able to*LO18-1 +escribe the components of shareholders equity and e&plain how they are reported in

a statement of shareholders equity.

LO18-2 +escribe comprehensi'e income and its components.

LO18-3 -nderstand the corporate form of organiation and the nature of stoc.

LO18-4 /ecord the issuance of shares when sold for cash and noncash consideration.

LO18-5 +istinguish between accounting for retired shares and treasury shares.

LO18-6 +escribe retained earnings and distinguish it from paid%in capital.

LO18-7 0&plain the basis of corporate di'idends, including the similarities and differencesbetween cash and property di'idends.

LO18-8 0&plain stoc di'idends and stoc splits and we account for them.LO18-9 +iscuss the primary differences between -.. 2" and 34/ with respect to

accounting for shareholders equity.

Le$ture Outli%eLe$ture Outli%e

Part A& The Nature o' Shareholders Equity

I( Sour$es o' Shareholders Equity. company can raise money e&ternally to fund operations in either of two ways*

1. +ebt financing.a. Taes the form of notes, bonds, leases, and other liabilities.b. $reates creditors interest in the assets of the business.

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. 0quity financing.a. $reates ownership interests in the assets of the business.b. 5wners of a corporation are its shareholders.

c. Shareholders equity is a residual amount, the amount that remains

after creditor claims have been subtracted from assets. (T18-1)

#. hareholders equity is created mainly by*1. mounts in'ested by shareholders paid%in capital.. mounts earned by the firm on behalf of its shareholders retained earnings.

II( Shareholders Equity i% )i%a%$ial State*e%ts. The balance sheet reports balances of shareholders equity accounts. (T16%)#. $omprehensi'e income, a more e&pansi'e 'iew of the change in shareholders equity than

traditional net income, is the total nonowner change in equity for a reporting period.Transactions between the corporation and its shareholders primarily include di'idends andthe sale or purchase of shares of the companys stoc. 7onowner changes other than thosethat are part of traditional net income are the ones reported as 8other comprehensi'e

income.9 5ther comprehensi'e income is reported in two places.1. $omponents of comprehensi'e income created during the reporting period % can be

reported either (a) as an additional section of the income statement, (b) as part of thestatement of shareholders equity, or (c) as a separate statement, often included in thefinancial statements in a disclosure note. 0ach component is reported net of its relatedincome ta& e&pense or income ta& benefit. (T16%:)

. The comprehensi'e income accumulated o'er the current and prior periods isreported as a separate component of shareholders equity.

$. The statement of shareholders equity discloses transactions that cause changes inshareholders equity account balances. (T16%;)

Part !& Paid+I% Ca,italI( )u%da*e%tal Share Ri-hts

. -sually ownership rights held by common shareholders include the right to*1.

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II( The Co%$e,t o' Par #alue. "ar 'alue has little significance other than historical.#. "ar 'alue originally indicated the actual 'alue of shares, but this is no longer the case.$. $ompanies usually assign shares a nominal par 'alue to elude elaborate statutory rules

pertaining to par 'alue shares.

+. When shares are issued, we record the par amount in common stoc and the remainder ofthe proceeds in additional paid%in capital.

III( A$$ou%ti%- 'or the Issua%$e o' Shares. When shares are sold for cash, shareholders in'estment is allocated between stated capita

and additional paid%in capital. (T16%=)#. t times, shares are sold for noncash consideration lie a ser'ice or a noncash asset

(T16%>)1. The transaction should be recorded at the fair 'alue of either the shares or the

noncash consideration, whiche'er seems more clearly e'ident.. This is consistent with the general rule for accounting for any noncash transaction.

$. ?ore than one security might be sold for a single price.

1. The cash recei'ed usually is the sum of the separate maret 'alues of the twosecurities. 0ach is then recorded at its maret 'alue.

. 3f only one securitys 'alue is nown, the second securitys maret 'alue is in'erredfrom the total selling price. (T16%@)

:. 3f the total selling price is not equal to the sum of the two maret prices, the totalselling price is allocated between the two securities in proportion to their relati'emaret 'alues.

0. hare issue costs are the costs of the legal, promotional, and accounting ser'icesnecessary to effect the sale of shares.1. The costs reduce the net cash proceeds from selling the shares and thus paid%in

capital e&cess of par.. hare issue costs are not recorded separately.

4. -.. 2" and 34/ are generally compatible with respect to accounting forshareholders equity. ome differences e&ist in presentation format and terminology and inchoices regarding reporting comprehensi'e income. (T16%6)

I#( Rea$quired Shares. $ompanies sometimes reacquire shares pre'iously sold.

1. The most common moti'ation is to support the maret price of the shares.. ll share repurchases are functionally the same.:. ccounting treatment depends on whether the company states that it is formally

retiring the shares or purchasing treasury shares. (T16%A) (T16%1B) (T16%11)#. When a corporation formally retires pre'iously issued shares, those shares assume the

same status as authoried but unissued shares !ust the same as if they ne'er had beenissued.1. "ayments to retire shares are 'iewed as a distribution of corporate assets to

shareholders.. We decrease precisely the same accounts that pre'iously were increased when the

shares were sold namely, common (or preferred) stoc and paid%in capital e&cessof par.


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:. The difference between the cash paid to buy the shares and the amount the sharesoriginally sold for are treated differently depending on whether that difference ispositi'e (credit) or negati'e (debit)*a. 3f a creditdifference is created, we credit paid in capital share repurchase.b. 3f a de(itdifference is created, we debit retained earnings unless a credit balance

already e&ists in paid in capital share repurchase, in which case we debit thataccount.

$. $orporations often 'iew a share buybac as a purchase of treasury stoc.1. The cost of acquiring the shares is 8temporarily9 debited to the treasury stoc

account.. We delay recording the effects on specific shareholders equity accounts until later

when the shares are reissued.:. 0ssentially, we 'iew the purchase of treasury stoc as a temporary reduction of

shareholders equity, re'ersed later when the treasury stoc is resold.;. When the treasury shares are resold, we treat the difference between the cash

recei'ed and the amount the shares originally cost differently depending on whetherthat difference is positi'e (credit) or negati'e (debit)*

a. 3f a creditdifference is created, we credit paid%in capital share repurchase.b. 3f a de(itdifference is created, we debit retained earnings unless a credit balance

already e&ists in paid%in capital share repurchase, in which case we debit thataccount.

Part C& Retai%ed Ear%i%-s

I( The Nature o' Retai%ed Ear%i%-s. 3n "art #, we studied invested capital. 3n "art $, we consider earnedcapital, usually

referred to as retained earnings. (T16%1)#. 3n general, retained earnings represents a corporations accumulated, undistributed or

rein'ested net income (or net loss).$. +istributions of earned assets are di'idends.+. We refer to a de(itbalance in retained earnings as a deficit.

II( .ivide%ds. ?ost corporate di'idends are paid in cash. t the declaration date, retained earnings is

reduced and a liability is recorded. /egistered owners of shares on the date of record areentitled to recei'e the di'idend. (T16%1:)

#. 5ccasionally, a noncash asset is distributed. 3n that case it is referred to as a propertydi'idend. The fair maret 'alue of the assets to be distributed is the amount recorded for aproperty di'idend. #efore recording the property di'idend, the asset may need to bewritten up or down to fair maret 'alue. This would create a gain or loss. (T16%1;)

III( Sto$/ .istri0utio%s

. 3n a stoc di'idend, additional shares of stoc are distributed to e&isting shareholders.1. stoc di'idend affects neither the assets nor the liabilities of the firm.. #ecause each shareholder recei'es the same percenta%e increase in shares, each

shareholders percentage ownership of the firm remains the same.:. 4or a CsmallC stoc di'idend (=D or less), the fair 'alue of the additional shares

distributed is transferred from retained earnings to paid%in capital. (T16%1=)

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#. stoc distribution of =D or higher is a stoc split. (T16%1>)1. 3f referred to merely as a stoc split, no !ournal entry is recorded.. 3f referred to as a Cstoc split effected in the form of a stoc di'idend,C the par 'alue

of the additional shares is reclassified within shareholders equity.

.e$isio%+a/ers Pers,e$tive

. "rofitability is 'ital to a companys long run sur'i'al.#. The return on shareholders equity is a popular summary measure of profitability.

1. The return on shareholders equity is calculated by di'iding net income by a'erageshareholders equity

. The return on shareholders equity measures the ability of company management togenerate net income from the resources that owners pro'ide.

$. nalysts often supplement the return on shareholders equity ratio with the earnings%priceratio.1. This ratio relates earnings to the maret 'alue of equity rather than the boo 'alue of

equity.. 3t is calculated as the earnings per share di'ided by the maret price per share.

:. common 'ariation is the in'erse the price%earnings ratio.+. hareholders equity transactions can affect the return to shareholders.

1. When a company buys bac some of its shares, the return on shareholders equitygoes up.

. 5n the other hand, the buybac of shares uses assets, which decreases the resourcesa'ailable to earn net income in the future.

0. nalysts should e'aluate di'idend decisions with consideration for pre'ailingcircumstances. ?anagement must decide whether shareholders are better off recei'ingcash di'idends or ha'ing funds rein'ested in the firm.

A,,e%di2 18& 3uasi+Reor-a%i4atio%s

. quasi%reorganiation aids a company that e&periences financial difficulties, and yet hasfa'orable future prospects.1. 3nflated asset 'alues are written down.. The accumulated deficit (debit balance in retained earnings) is eliminated.

#. ssets (and liabilities if necessary) are written up or down to reflect fair 'alues.1. $orresponding credits or debits are made to retained earnings.. The deficit usually is temporarily increased by this step.

$. The deficit in retained earnings (debit balance) is eliminated.1. /etained earnings is creditedE additional paid%in capital is debited.. 3f additional paid%in capital is not sufficient to absorb the entire deficit, common

stoc is debited also.+. /etained earnings is 8dated9 to indicate the date the deficit was eliminated and when the

new accumulation of earnings began.

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PowerPoi%t SlidesPowerPoi%t Slides

"ower"oint presentation of the chapter is a'ailable at the te&tboo website.

n alternate 'ersion of the "ower"oint presentation also is a'ailable.

Tea$hi%- Tra%s,are%$y astersTea$hi%- Tra%s,are%$y astersThe following can be reproduced on transparency film as they appear here, or

you can use the dis 'ersion of this manual and first modify them to suit yourparticular needs or preferences.


1#-+ Intermediate $ccontin%, &e

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SHAREHOL.ERS E35IT6

hareholders equity accounts represent the ownershipinterests of shareholders. hareholders equity is a residalamount whats left o'er after creditor claims ha'e beensubtracted from assets (in other words, net assets).

Assets 7 Lia0ilities Shareholders equity

Net Assets

5wnership interests of shareholders arise primarily fromtwo sources (1) amounts investedby shareholders in thecorporation and () amounts earnedby the corporation onbehalf of its shareholders. These two sources are reportedas (1) ,aid+i% $a,italand () retai%ed ear%i%-s.

third source is ccumulated 5ther $omprehensi'e3ncome

T16%1

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T16%


1#-# Intermediate $ccontin%, &e

0&position $orporation!ala%$e Sheet 9: i% *illio%s;

+ecember :1, B1:Assets

FG:,BBBHLia0ilitiesFG1,BBBH

Shareholders equityPAI.+INCAPITAL&Capital stock (par):

"referred stoc, 1BD, G1B par,cumulati'e, nonparticipating G1BB

$ommon stoc, G1 par ==$ommon stoc di'idends distributable =

Additional Paid-in Capital:"aid%in capital e&cess of par, common >B"aid%in capital e&cess of par, preferred =B"aid%in capital share repurchase 6"aid%in capital con'ersion of bonds @"aid%in capital stoc options A"aid%in capital stoc award plan ="aid%in capital lapse of stoc options 1Total paid-in capital G =BB

RETAINE.

EARNINS

1,>@BACC55LATE.COPONENTSO)COPREHENSI#EINCOE&-nrealied gains (losses) on in'estment securities (6=)-nrealied net loss on pensions (@=)+eferred gains (losses) on deri'ati'es (;)4oreign currency translation ad!ustments %B % (1>;)

TREAS5R6STOC )Total shareholders equity G,BBB

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COPREHENSI#E INCOE

0ncompasses all changes in equity other than from transactions withowners.

7onowner changes other than those that are part of traditional netincome are the ones reported as 8other comprehensi'e income.9

$omprehensi'e income accmlated o'er the current and prior

periods is reported in the shareholders equity section of the balancesheet.

$omponents of comprehensi'e income created drin% the reportin%

period can be reported either (a) as an additional section of theincome statement, (b) as part of the statement of shareholders equityor (c) as a separate statement in a disclosure note*

(G in millions)

7et income G&&&5ther comprehensi'e income*7et unrealied holding gains (losses) on in'estments (net of ta&)I G &2ains (losses) from and amendments to postretirement plans (net of ta&)J (&)+eferred gains (losses) from deri'ati'es (net of ta&)K (&)2ains (losses) from foreign currency translation (net of ta&)L & &&

$omprehensi'e income G&&&

I $hanges in the fair 'alue of some securities.J 2ains and losses due to re'ising assumptions or maret returns differing from e&pectations and

prior ser'ice cost from amending the plan (described in $hapter 1@).K When a deri'ati'e designated as a cash flow hedge is ad!usted to fair 'alue, the gain or loss is

deferred as a component of comprehensi'e income and included in earnings later, at the sametime as earnings are affected by the hedged transaction (described in the +eri'ati'es ppendi&to the te&t).

L 2ains or losses from changes in foreign currency e&change rates. The amount could be anaddition to or reduction in shareholders equity. (This item is discussed elsewhere in youraccounting curriculum.)

T16%:

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T16%;


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SHARES SOL. )OR CASH When shares are sold for cash, the capital stoc account

(usually common or preferred) is credited for the amountrepresenting stated capital. When shares ha'e a designatedpar 'alue, that amount denotes stated capital and is credited tothe stoc account. "roceeds in e&cess of this amount arecredited to paid%in capital e&cess of par.

+ow 3ndustrial sells 1BB,BBB of its common shares, G1 par per

share, for G1B per share* (G in BBBs)$ash (1BB,BBB shares at G1B price per share)....................... 1,BBB

$ommon stoc (1BB,BBB shares at G1 par )................... 1BB"aid%in capital e&cess of par (remainder).............. ABB

The entire proceeds from the sale of nopar stoc are deemed

stated capital and recorded in the stoc account.

3f the shares are nopar, the entry is as follows*

$ash (1BB,BBB shares at G1B price per share)....................... 1,BBB$ommon stoc .................................................... 1,BBB

T16%=


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SHARES SOL. )OR NONCASH CONSI.ERATION

5ccasionally, a company might issue its shares for

consideration other than cash. 3t is not uncommon for a newcompany, yet to establish a reliable cash flow, to pay forpromotional and legal serviceswith shares rather than withcash. imilarly, shares might be gi'en in payment for land, orfor equipment, or for some other noncash asset.

hares should be issued at whiche'er e'idence of fair maret'alue seems more clearly e'ident.

+u?ont $hemicals issues 1 million of its common shares, G1par per share, in e&change for a custom%built factory for whichno cash price is a'ailable. Todays issue of the all treet/ornallists +u?onts stoc at G1B per share*

(G in millions)

"roperty, plant, and equipment (1 million shares at G1B).... 1B

$ommon stoc (1 million shares at G1 par )..................... 1"aid%in capital e&cess of par (remainder)................. A

T16%>


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ORE THAN ONE SEC5RIT6SOL. )OR A SINLE PRICE

?ore than one security might be sold for a single price. The

cash recei'ed usually is the sum of the separate maret 'aluesof the two securities. 0ach is then recorded at its maret'alue.

3f only one securitys 'alue is nown, the second securitysmaret 'alue is in'erredfrom the total selling price.

"M" issues ; million of its common shares, G1 par per share,

and ; million of its preferred shares, G1B par, for G1BB million.Todays issue of the all treet /ornallists "M"s common atG1B per share. There is no established maret for the preferredshares*

(G in millions)

$ash........................................................................... 1BB$ommon stoc (; million shares & G1 par)...................... ;"aid%in capital e&cess of par, common................. :>

"referred stoc (; million shares & G1B par)..................... ;B"aid%in capital e&cess of par, preferred................ B

3f the total selling price is not equal to the sum of the twomaret prices, the total selling price is allocated between thetwo securities in proportion to their relati'e maret 'alues.

T16%@


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INTERNATIONAL )INANCIAL REPORTIN STAN.AR.S

5se o' the ter* @reserves a%d other ter*i%olo-y di''ere%$es( hareholders equity

is classified under 34/ into two categories* hare capital and 8reser'es.9 The termreser'es is considered misleading and thus is discouraged under -.. 2". Nere aresome other differences in equity terminology*

U.S. GAAP IFRSCapital stock: Share capital: Common stock Ordinary shares Preferred stock Preference shares Paid-in capitalexcess of par, common Share premium, ordinary

shares

Paid-in capitalexcess of par, preferred Share premium, preferencesharesAccumulated other comprehensive income: Reserves: et !ains "losses# on investmentsAOC$ $nvestment revaluation

reserve et !ains "losses# currency translation AOC$ %ranslationreserve {N/A: adjusting P,P, & E to fair value not permitted} Revaluation

reserve Retained earnin!s Retained earnin!s

Total shareholers! e"#$t% Total e"#$t%

Presented after &ia'ilities Often presented 'efore&ia'ilities

T16%6

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COPARISON O) SHARE RETIREENT AN.TREAS5R6 STOC< ACCO5NTIN

7 SHARE !56!AC

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COPARISON O) SHARE RETIREENT AN.TREAS5R6 STOC< ACCO5NTIN7 S5!SE35ENT SALE O) SHARES

merican emiconductor sold 1 million shares after reacquiring shares at G1: per share($ase in 3llustration 16%1B)

Retire*e%t Treasury Sto$/

Case A& Shares sold at :1,er share$ash................................... 1; $ash............................................ 1;

$ommon stoc (par)........ 1 Treasury stoc (cost).............. 1:"3$ e&cess of par........ 1: "3$ share repurchase.......... 1

OR

Case !& Shares sold at :1F,er share$ash................................... 1B $ash............................................ 1B

$ommon stoc (par)........ 1 /etained earnings (to balance)....... 1"3$ e&cess of par ......... A "3$ share repurchase .............. L

Treasury stoc (cost).............. 1:

L#ecause there is a G million credit balance.

T16%1B

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REPORTIN SHARE !56!AC

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RETAINE. EARNINS

3n general, retained earnings represents a corporations

accumulated, undistributed, or rein'ested net income (or netloss). 3t also is called 8rein'ested capital9 or 8earned capital.9

+istributions of earned assets are di'idends.

debit balance in retained earnings is referred to as a deficit.

restriction of retained earnings communicatesmanagements intention to withhold assets represented by aspecified portion of the retained earnings balance (normallyindicated by a disclosure note).

T16%1


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CASH .I#I.EN.S

5n Pune 1, the board of directors of $raft 3ndustries declares a

cash di'idend of G per share on its 1BB million shares, payableto shareholders of record Pune 1=, to be paid Puly 1*

(G in millions)

"u%e 1 7 de$laratio% date/etained earnings............................................... BB

$ash di'idends payable (1BB million shares at GQshare)............................ BB

"u%e 1D 7 e2+divide%d dateno entry

"u%e 1G 7 date o' re$ordno entry

"uly 1 7 ,ay*e%t date

$ash di'idends payable .................................... BB$ash ............................................................. BB

T16%1:



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PROPERT6 .I#I.EN.S

#efore recording a property di'idend, the asset first must be

written up to fair maret 'alue.5n 5ctober 1, the board of directors of $raft 3ndustriesdeclares a property di'idend of million shares of #eaman$orporations preferred stoc that $raft had purchased in?arch as an in'estment (boo 'alue* GA million).

The in'estment shares ha'e a fair maret 'alue of G= pershare and are payable to shareholders of record 5ctober 1=,

to be distributed 7o'ember 1*

O$to0er 1 7 de$laratio% date (G in millions)

3n'estment in #eaman $orporationpreferred stoc .......................................... 1

2ain on appreciation of in'estment (G1B GA) 1

/etained earnings( million shares at G= per share) 1B

"roperty di'idends payable ................... 1BO$to0er 1G 7 date o' re$ord

no entry

Nove*0er 1 7 ,ay*e%t date

"roperty di'idends payable .......................... 1B3n'estment in #eaman $orporation preferred stoc .................................... 1B

T16%1;


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STOC< .I#I.EN.S

stoc di'idend is the distribution of additional shares o'

stocto crrentshareholders of the corporation. #ecause each shareholder recei'es the same percenta%e

increase in shares, shareholders proportional interest in(percentage ownership of) the firm remains unchanged.

4or a CsmallC stoc di'idend (less than =D), the 'air maretvaleof the additional shares distributed is transferred from

retained earnings to paid%in capital.

$raft declares and distributes a 1BD common stoc di'idend(1B million shares) when the maret 'alue of the G1 par commonstoc is :1per share*

(G in millions)

/etained earnings (1B million shares at G1 per share)..... 1B

$ommon stoc (1B million shares at G1 par per share). . 1B"aid%in capital e&cess of par(remainder)............ 11B

T16%1=



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STOC< SPLITS

stoc distribution of =D or higher is referred to as a stoc

split. frequent reason for issuing a stoc split is to reduce the

maret price per share (by half in a for 1 split, for e&ample).

The proper accounting treatment of stoc split is to mae no!ournal entry, unless the stoc distribution is referred to as aCstoc split effected in the form of a stoc di'idend.C

$raft declares and distributes a for 1 stoc split effectedin the form of a 1BBD stoc di'idend (1BB million shares)when the maret 'alue of the G1 par common stoc is G1per share*

(G in millions)

"aid%in capital e&cess of par.......................... 1BB$ommon stoc (1BB million shares at G1 par) ........ 1BB

ome companies choose to debit retained earnings instead*

/etained earnings.............................................. 1BB$ommon stoc(1BB million shares at G1 par)........ 1BB

T18+1


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Su--estio%s 'or Class A$tivitiesSu--estio%s 'or Class A$tivities

1( Resear$h A$tivity

s students to loo up three companies in the ?oney M 3n'esting section of the all treet /ornal,

the financial pages of another newspaper, or on the 3nternet. Na'e them find the price%earnings ratioof each company. -sing those data, ha'e them determine the rate of return on the maret 'alue ofshareholders equity.

Su--estio%s&"ose these questions*1. What information does the rate of return pro'ideR. Now is the information different from that pro'ided by the rate of return of shareholders equity

as commonly calculated from financial statementsR

Poi%ts to %ote&

The rate of return on the maret 'alue of shareholders equity is the in'erse of the price%earningsratio, i.e., the earnings%price ratio. The rate of return on the maret 'alue of shareholders equity is asummary measure of profitability. 3t measures the ability of management to generate earnings fromthe resources that owners pro'ide. Oie other ratios, analysts must be careful not to 'iew it inisolation Thats why its useful to supplement the return on shareholders equity ratio as commonlycalculated from financial statements (net income di'ided by a'erage shareholders equity) with thismaret%based ratio. This ratio is simply the earnings per share di'ided by the maret price per share.

( Real >orld S$e%ario

Hor*el )oods Cor,., which maes pam and other prepared foods, distributed a two%for%one stocsplit in ?arch B11. t the time the split was announced, the companys stoc price was G;A.

Su--estio%s&

s students to*1. peculate as to why Normel declared the stoc split.. $onsider what the share price would be at the time of the distribution, other things being equal.

Poi%ts to %ote&

7ormally, as in this case, a split is made to reduce the per share price and thus enhance the

maretability of the stoc by maing it affordable to a larger number of potential in'estors. 3t alsomight signal fa'orable performance. 5ther things equal, the new share price would be G;.=B afterthe split. 5f course, quite a few circumstances and e'ents can cause the price to 'ary.


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D( Real >orld S$e%ario

4ollowing is a news release from 2eneral 0lectric*

43/430O+, $onn.%%(#-370 W3/0)%%+ec. 1B, BB;%%The #oard of +irectors of 20 todayraised the $ompanys quarterly di'idend 1BD to GB. per outstanding share of its common stoc andauthoried the repurchase of up to G1= billion of its common stoc o'er the ne&t three years. C20 has tremendous prospects for growth in earnings and cash flow,C said 20 $hairman and $05Peff 3mmelt. CWe ha'e been e&ecuting a clear strategy to build a capital%efficient portfolio of faster%growthindustrial businesses and higher%returning financial ser'ices businesses,C 3mmelt said. CThat wor isnow largely behind us, and we ha'e the best set of 20 businesses we'e had in many years. Wereconfident that in BB= we will return to solid double%digit earnings growth with e&pandingincremental returns on capital and increasing cash flow from operating acti'ities. s a result we fullye&pect to ha'e the fle&ibility to in'est in technology and inno'ation while returning 'alue toshareowners through a substantial di'idend and a share repurchase program.C

The di'idend increase, from GB.B per share, mars the Ath consecuti'e year in which 20 hasraised its di'idend. 20 has paid a di'idend e'ery year since 16AA. The di'idend is payable Panuary =,BB=, to shareowners of record on +ecember @, BB;. The e&%di'idend date is +ecember . The new share repurchase program replaces a program first authoried in 1AA;. ince 1AA;, 20has returned more than G@= billion to shareowners through di'idends and the repurchase of more than1.1 billion shares.

Su--estio%s&s students to consider the statement that 20 has the 8fle&ibility to in'est in technology andinno'ation while returning 'alue to shareowners through a substantial di'idend and a sharerepurchase program.9 This implies a choice. What are the choicesR Now do the choices return 'alue

to shareholdersR

Poi%ts to %ote&$ompanies ha'e choices regarding the disposition of earnings. 5ne choice is to rein'est in profit%maing acti'ities, hopefully benefiting shareholders through higher future earnings and thereforefuture capital gains and di'idends. nother choice is to distribute the earnings currently as di'idendsnother is to buy bac shares. This supports the maret price of stoc and reduces dilution thatoccurs when new shares are issued.

The McGraw-Hill Companies, Inc., 2013Instrctors! "esorce Manal 1#-2*

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( Real >orld S$e%ario

4ollowing is a news release from7ortheast $ommunity #ancorp*

Northeast Co**u%ity !a%$or, I%$( 9NAS.A3& NEC!) today announced that its #oard of+irectors declared an initial quarterly cash di'idend of GB.B: per common share. The di'idendwill be paid on or about 7o'ember 1= to stocholders of record as of the close of business on5ctober 1.

Su--estio%s&

s students to*1. $onsider the effect on the share price on the e&%date, other things being equal.. $onsider the ongoing effect of the decision on company assets, other things being equal.:. peculate as to why7ortheast $ommunity #ancorpdeclared the di'idend after not

pre'iously paying di'idends.

Poi%ts to %ote&

7ormally, the stoc price declines by the amount of a cash di'idend, G.B: in this case, the firstday the stoc trades after the recipients of the di'idend are determined. +i'idends use cash thatotherwise would be a'ailable for rein'estment in company growth or other acti'ities.$ompanies typically pay cash di'idends when they feel that is a better return to shareholdersthan would be rein'esting with the e&pectation of higher future stoc prices. +i'idend decisionsreflect managerial strategy concerning the mi& of internal 'ersus e&ternal financing, alternati'ein'estment opportunities, and industry conditions. Nigh di'idends often are found in matureindustries and low di'idends in growth industries. ?icrosoft, for instance, lie 4ed0&pre'iously, for years paid no di'idends, focusing instead on plowing a'ailable cash into growth

opportunities.


1#-2+ Intermediate $ccontin%, &e

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G( Professional Skills Development Activities

The following are suggested assignments from the end%of%chapter material that will help yourstudents de'elop their communication, research, analysis, and !udgment sills.

Co**u%i$atio% S/ills( nalysis $ase 16%, 0&ercise 16%:, and "roblem 16%> are suitable forstudent presentation(s). 3n addition to $ommunication $ases 16%: and 16%>, /esearch $ase 16%; can be adapted to as students to prepare a memo to the $ontroller outlining the findings ofthe research. $ommunication $ases 16%: and 16%1B requires group interaction. "roblem 16%1and nalysis $ase 16%@ do well as group assignments. Suestions 16%11, 16%1, 0&ercise 16%1;and /esearch $ase 16%1B create good class discussions.

Resear$h S/ills( 3n their professional li'es, our graduates will be required to locate and e&tractrele'ant information from a'ailable resource material to determine the correct accountingpractice, perhaps identifying the appropriate authoritati'e literature to support a decision. 3naddition to /esearch $ase 16%;, $ommunication $ases 16%: and 16%1B pro'ide an e&cellent

opportunity to help students de'elop this sill. 3n addition, Pudgment $ase 16%= can be adaptedto require students to research the authoritati'e literature on accounting for stoc splits.

A%alysis S/ills( The 8#roaden our "erspecti'e9 section includes nalysis $ases that directstudents to gather, assemble, organie, process, or interpret date to pro'ide options for maingbusiness and in'estment decisions. 3n addition to nalysis $ases 16% and 16%@, 0&ercise 16%1,"roblem 16%@, and /eal World 16%11 also pro'ide opportunities to de'elop analysis sills.

"ud-*e%t S/ills(The 8#roaden our "erspecti'e9 section includes Pudgment $ases that requirestudents to critically analye issues to apply concepts learned to business situations in order toe'aluate options for decision%maing and pro'ide an appropriate conclusion. 3n addition to

Pudgment $ase 16%=, $ommunication $ase 16%: also requires students to e&ercise !udgment.

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( Ethi$al .ile**a

The chapter includes the following ethical dilemma.

ETHICAL.ILEA

3nterworld +istributors has paid quarterly cash di'idends since 1A6=. The di'idends ha'esteadily increased from G.= per share to the latest di'idend declaration of G.BB per share. Theboard of directors is eager to continue this trend despite the fact that re'enues fell significantlyduring recent months as a result of worsening economic conditions and increased competition. Thecompany founder and member of the board proposes a solution. Ne suggests a =D stoc di'idendin lieu of a cash di'idend to be accompanied by the following press announcement*

C3n lieu of our regular G.BB per share cash di'idend, 3nterworld will distribute a =D stocdi'idend on its common shares, currently trading at G;B per share. $hanging the form of the

di'idend will permit the $ompany to direct a'ailable cash resources to the moderniation ofphysical facilities in preparation for competing in the 1st century.C

What do you thinR

ou may wish to discuss this in class. 3f so, discussion should include these elements*

Ste, 1 + The )a$ts&

The founder of 3nterworld +istributors suggests distributing a =D stoc di'idend in lieu of itsregular G.BB per share cash di'idend. The board of directors wants to continue pro'iding di'idendsto shareholders despite the fact that re'enues ha'e recently declined. The stoc di'idend will permit3nterworld to conser'e cash and rein'est cash resources in moderniation of physical facilities.hareholder percentage of ownership in the company does not change as a result of a small stocdi'idend. +istribution of a small stoc di'idend results in a reclassification of retained earnings topaid%in capital. /etained earnings are reduced !ust as if a cash di'idend had been paid. "er sharestoc prices usually decline after a company issues a small stoc di'idend in order to maintain thesame o'erall 'alue of in'estment in the company. The company founder is attempting to produce theillusion that current shareholders will be recei'ing a real di'idend and camouflage the fact thatre'enues ha'e declined.

Ste, + The Ethi$al Issue a%d the Sta/eholders&The ethical issue or dilemma is whether the boards obligation to protect the company s image

(and perhaps their !obs) is greater than its obligation to protect in'estors and creditors interests bypro'iding full disclosure of rele'ant information.

taeholders include the founder of 3nterworld, other members of the board of directors,company management, employees, current and future creditors, and current and future in'estors.

Ste, D + #alues&

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Ste, + Alter%atives&1. +istribute and record a =D stoc di'idend to current holders of common stoc.. +o not declare a stoc di'idend.

Ste, G + Evaluatio% o' Alter%atives i% Ter*s o' #alues&1. lternati'e 1 illustrates loyalty to protecting the company image to current shareholders., lternati'e reflects 'alues of honesty, integrity, ob!ecti'ity, and responsibility for fair

reporting to current shareholders and to other users of the financial statements.

Ste, + Co%seque%$es&$lternative 1"ositi'e consequences* The company and its management may loo better in the eyes of some

shareholders. The company reser'es cash to in'est in the future moderniation of plant facilities.7egati'e consequences* ome shareholders may falsely belie'e they are recei'ing a distribution of

'alue from the company. -sers of the financial statements would be misinformed. The founder andthe board may lose the respect of some shareholders and the financial community.

$lternative 2"ositi'e consequences* The founder and board members maintain self%respect and gain the

respect of the financial community. -sers of the financial statements are better informed regardingthe true financial position of the company.

7egati'e consequences* hareholders become displeased about the lac of di'idend distributionand rein'est elsewhere. The stoc price per share may decline due to the lac of a di'idenddistribution. ome managers !obs may be in !eopardy.

Ste, B + .e$isio%&tudent(s) must decide their course of action.


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Assi-%*e%t ChartAssi-%*e%t Chart

Lear%i%- Est( ti*e

3uestio%s O0Je$tive9s; To,i$ 9*i%(;

16%1 1 ources of shareholders equity =16% 1 ources of shareholders equity =16%: 1 ources of shareholders equity =16%; 1 ources of shareholders equity =16%= 1 ources of shareholders equity =16%> 1 ources of shareholders equity =16%@ 1 ources of shareholders equity =16%6 1 ources of shareholders equity =16%A 1 ources of shareholders equity =16%1B 1 ources of shareholders equity =16%11 1 ources of shareholders equity =16%1 $omprehensi'e income =16%1: $omprehensi'e income =16%1; : tatement of shareholders equity =16%1= ; hares sold for consideration other than cash =16%1> ; ?ore than one security sold for a single price =16%1@ ; hare issue costs =16%16 = When shares are retired =16%1A = Treasury shares =16%B 6 toc di'idends =16%1 6 toc splits =16% 6 /e'erse stoc split =16%: 6 toc di'idends =

16%; Suasi%reorganiation =



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!rie' Lear%i%- Est( ti*eE2er$ises O0Je$tive9s; To,i$ 9*i%(;

16%1 $omprehensi'e income =

16% ; toc issued =16%: ; toc issued =16%; ; toc issued =16%= ; 0ffect of preferred stoc on di'idends =16%> = /etirement of shares =16%@ = /etirement of shares =16%6 = Treasury stoc =16%A = Treasury stoc =16%1B = Treasury stoc =16%11 @ $ash di'idend =16%1 @ "roperty di'idend =16%1: 6 toc di'idend =16%1; 6 toc split =16%1= 6 toc split =16%1> A 34/E reporting shareholders equity =


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Lear%i%- Est( ti*e

E2er$ises O0Je$tive9s; To,i$ 9*i%(;

16%1 $omprehensi'e income =16% FASB codification research;reporting other

comprehensi'e income in shareholders equity 1=16%: Earnings or OCI? 1=

16%; ; toc issued for cashE >ri-ht edi$al rou, 1=16%= ; 3ssuance of sharesE noncash consideration B16%> ; /edeemable shares 1=16%@ ; hare issue costsE issuance 1=16%6 ; /eporting preferred shares 1=16%A ; 7ew equity issuesE offerings announcements 1=

16%1B ; 0ffect of cumulati'e, nonparticipating preferredstoc on di'idends : years 1=

16%11 = /etirement of shares 1=16%1 = /etirement of shares B16%1: = Treasury stoc 1=16%1; = Treasury stoc weighted a'erage and 4345 cost B16%1= = /eporting shareholders equity B16%1> = $hange from treasury stoc to retired stoc B16%1@ = toc buybacE press releaseE .uPo%t 1=16%16 >, @ Transactions affecting retained earnings =16%1A 6 toc di'idend 1B16%B 6 toc splitE Ha*%i )i%a%$ial 1=16%1 6 $ash in lieu of fractional share rights 1=16% 1, =, 6 4# codification research 1=

16%: >, @, 6 Transactions affecting retained earnings :=16%; 1 "rofitability ratio 1=16%= A 34/E equity terminology 1=

CPA?CA Lear%i%- Est( ti*eE2a* 3uestio%s O0Je$tive9s; To,i$ 9*i%(;

$"%1 = /etirement of shares :$"% = Treasury stoc :$"%: @ "roperty di'idend :

$"%; @ toc di'idend :$"%= 6 toc di'idend :$"%> 6 toc split :$"%@ A 34/ :$"%6 A 34/ :$?%1 1 $ommon stoc :$?% 1 $ommon stoc :$?%: 6 toc di'idend :



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Lear%i%- Est( ti*e

Pro0le*s O0Je$tive9s; To,i$ 9*i%(;

16%1 ;

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Lear%i%- Est( ti*e

Cases O0Je$tive9s; To,i$ 9*i%(;

/eal World $ase 16%1 ; 3"5E .ol0y La0s 1Bnalysis $ase 16% 1, :, >, @ tatement of shareholders equity :=

$ommunication $ase16%: 1 3s preferred stoc debt or equityR groupinteraction :B

/esearch $ase 16%; $odification researchE comprehensi'e incomeEresearchE integrati'eE Cis$o

B

Pudgment $ase 16%= =%6 Treasury stocE stoc splitE di'idendsE Al$oa 1=$ommunication $ase 16%> ; 3ssuance of sharesE share issue costsE prepare a

report ;=

nalysis $ase 16%@ 1 nalying financial statementsE price%earningsratioE di'idend payout ratio :B

0thics $ase 16%6 ; The wiss label maerE 'alue of shares issued

for equipment =/esearch $ase 16%A 1, > /esearching the way shareholders equity

transactions are reportedE retrie'ing financialstatements from the 3nternet

=B

$ommunication $ase 16%1B 1 hould the present two%category distinctionbetween liabilities and equity be retainedR groupinteraction :B

Air )ra%$e?

18irm_7e.doc

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