ch.13 equity financing - · pdf file11.statement of changes in stockholders’ equity...
TRANSCRIPT
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13-1
1. Stock Rights (common and preferred stock)
2. Stock Issuance for cash, noncash assets or for services
3. Treasury stock
4. Stock rights and warrants
5. Compensation expense with stock options
6. Equity-related items reported as liabilities
7. Stock conversions
8. Factors affecting retained earnings
9. Cash dividends, property dividends, stock dividends, and
stock splits
10.Unrealized gains and losses recorded as OCI and major
types of equity reserves
11.Statement of changes in stockholders’ equity
Ch.13 Equity Financing
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13-2
Nature and Classifications of Paid-In Capital
• A corporation is a legal artificial entity separate
from its owners.
• Individuals contribute capital for which the
corporation issues stock certificates
evidencing ownership interests.
• Stockholders elect a board of directors
whose members oversee the strategic and
long-run planning of the corporation.
1. Rights associated with ownership of common
and preferred stock
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13-3
Common and Preferred Stock
• When a corporation is formed, a single class of
stock, known as common stock, is usually
issued.
• Corporations may later find that there are
advantages to issuing one or more additional
classes of stock with varying rights and priorities.
Stock with certain preferences (rights) over
common stock is called preferred stock.
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13-4
Common Stock
Unless restricted by terms of the articles of
incorporation, certain basic rights are held by
each common stockholder:
1. To vote in the election of directors and in the
determination of certain corporate policies.
2. To maintain one’s proportional interest in
the corporation through purchase of
additional common stock if and when it is
issued. This right is known as the
preemptive right.
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13-5
Par or Stated Value of Stocks
The journal entry to record the issuance of
common stock in exchange for cash frequently
looks something like this:
Cash XXX
Common Stock (at par value) XXX
Additional Paid-In Capital XXX
(continued)
• Historically, par value was equal to the market
value of the shares at issuance.
• Today, most stocks have a nominal par value or no
par value at all.
• No-par stock sometimes has a stated value that for
financial reporting purposes acts like a par value.
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13-6
Preferred Stock
• The term preferred stock is somewhat
misleading because it gives the impression
that preferred stock is better than common
stock.
• Preferred stock isn’t better—it’s different.
• Preferred stockholders give up many of the
rights of ownership in exchange for some of
the protection enjoyed by creditors.
(continued)
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13-7
Preferred Stock
Rights of ownership given up by preferred
stockholders:
(continued)
• 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. Therefore, if the company
does exceptionally well, preferred stockholders
do not get to share in the success.
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13-8
Preferred Stock
• Cash dividend preference. Preferred
stockholders are entitled to receive the full
cash dividend before any cash dividends are
paid to common stockholders.
• Liquidation preferences. If the company goes
bankrupt, preferred stockholders are entitled to
have their investment repaid, in full, before
common stockholders receive anything.
The protections enjoyed by preferred stockholders,
relative to common stockholders, are:
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13-9
Cumulative and Noncumulative Preferred Stock
• When a corporation fails to declare dividends
on cumulative preferred stock, such
dividends accumulate and require payment in
the future before any dividends may be paid to
common stockholders.
• Dividends on cumulative preferred stock that
are passed are referred to as dividends in
arrears.
• With noncumulative preferred stock, it is not
necessary to provide for passed dividends.
(continued)
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13-10
Good Time Corporation has outstanding
100,000 shares of 9% cumulative preferred
stock, $10 par. Dividends were last paid in 2010.
Total dividends of $300,000 are declared in
2013 by the board of directors.
Cumulative and Noncumulative Preferred Stock
(continued)
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13-11
Dividends may be declared on common stock as
long as the preferred stock receives its preferred
rate for the current period. If the preferred stock
were noncumulative, the 2013 dividends would
be distributed as follows:
Cumulative and Noncumulative Preferred Stock
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13-12
Participating Preferred Stock
• Participating preferred stock issues provide
for additional dividends to be paid to preferred
stockholders after dividends of a specified
amount are paid to the common stockholders.
• A participating provision makes preferred stock
more like common stock.
• Participating preferred stocks are now
relatively rare.
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13-13
Convertible Preferred Stock
• Preferred stock is convertible when it can be
exchanged by its owner for some other
security of the issuing corporation.
• Conversion rights generally provide for the
exchange of preferred stock into common
stock.
• In some instances, preferred stock may be
converted into bonds.
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13-14
Callable Preferred Stock
• Many preferred issues are callable, meaning they
may be called and canceled at the option of the
corporation.
• The call price is usually specified in the original
agreement and provides for payment of dividends in
arrears as part of the repurchase price.
Redeemable Preferred Stock
• Redeemable preferred stock is preferred stock that
is redeemable at the option of the stockholder or upon
other conditions not within the control of the issuer.
• Redeemable preferred stock is somewhat like a loan
in that the issuing corporation may be forced to repay
the stock proceeds.
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13-15
Current Development in The Accounting for
Preferred Stock
• In the Preliminary Views document, the
FASB recommends the “basic ownership
approach” to identifying equity.
• This approach hinges on the idea that equity
claims are those that remain when all other
claims have been satisfied.
• The basic ownership approach would be very
restrictive. In fact, all preferred stock, whether
redeemable or not, would be reported as a
liability under this approach.
(continued)
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13-16
Current Development in The Accounting for
Preferred Stock
• Users prefer a “perpetual approach,” which
describes an equity instrument as one for
which there is no requirement to repay the
invested funds, and the holder of the
instrument is entitled to some assets if the
company is liquidated.
• Both the FASB and IASB are leaning toward
the “perpetual approach.”
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13-17
Capital Stock Issued for Cash
• The issuance of stock for cash is recorded by a
debit to Cash and a credit to Capital Stock for
the par value.
• When the amount of cash received for the stock
is more than the par value, the excess is
recorded as a credit to an additional paid-in
capital account.
(continued)
2. Issuance of stock for cash, on a subscription
basis, and in exchange for noncash assets or
for services
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13-18
Goode Corporation issued 4,000 shares of $1
par common stock on April 1, 2011, for $45,000
cash.
Apr. 1 Cash 45,000
Common Stock 4,000
Paid-In Capital in Excess
of Par 41,000
2011
Par Value Stock Par Value Stock
Capital Stock Issued for Cash
(continued)
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13-19
On April 1, 2011, Goode Corporation issued
4,000 shares of no-par common stock with a $1
stated value.
Apr. 1 Cash 45,000
Common Stock 4,000
Paid-In Capital in Excess
of Stated Value 41,000
2011
Stated Value Stock Stated Value Stock
Capital Stock Issued for Cash
(continued)
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13-20
On April 1, 2011, Goode Corporation issued
4,000 shares of no-par common stock for
$45,000 cash.
Apr. 1 Cash 45,000
Common Stock 45,000
2011
No-Par Stock No-Par Stock
Capital Stock Issued for Cash
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13-21
Capital Stock Sold on Subscription
• A subscription is a legally binding contract
between the subscriber (purchaser of stock)
and the corporation (issuer of stock).
• The contract states the number of shares
subscribed, the subscription price, the terms of
payment, and other conditions of the
transaction.
• Ordinarily, stock certificates are not issued
until the full subscription price has been
received by the corporation.
(continued)
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13-22
November 1-30: Received subscriptions on
November 1 for 5,000 shares of $1 par common
stock at $12.50 per share with 50% down,
balance due in 60 days. The entries for
November 1 are as follows:
Common Stock Subscriptions Receivable 62,500
Common Stock Subscribed 5,000
Paid-In Capital in Excess of Par 57,500
Cash 31,250
Common Stock Subscriptions
Receivable 31,250
Capital Stock Sold on Subscription
(continued)
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13-23
December 1-31: Received balance due on one-
half of subscriptions and issued stock to the fully
paid subscribers, 2,500 shares.
Cash 15,625
Common Stock Subscriptions
Receivable 15,625
Common Stock Subscribed 2,500
Common Stock 2,500
Capital Stock Sold on Subscription
(continued)
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13-24
Capital Stock Sold on Subscription
Contributed capital would be reported in the
Stockholders’ Equity section of the December 31
balance sheet as follows:
Common Stock Subscriptions Receivable should
normally be shown as an offset to equity.
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13-25
Subscription Defaults
If a subscriber defaults on a subscription, a
corporation may:
1) return to the subscriber the amount paid,
2) return to the subscriber the amount paid less
any reduction in price or expense incurred on
the resale of the stock,
3) declare the amount paid by the subscriber as
forfeited, or
4) issue to the subscriber shares equal to the
number paid for in full.
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13-26
Capital Stock 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.
Land 10,000
Common Stock 100
Paid-In Capital in Excess of Par 9,900
When other than cash is received, the fair
market value of the stock or the fair market
value of the property or service, whichever
is more determinable is used.
When other than cash is received, the fair
market value of the stock or the fair market
value of the property or service, whichever
is more determinable is used.
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13-27
The land has a readily determinable market price
of $12,000, but AC Company’s common stock
has no established fair market value.
Land 12,000
Common Stock 100
Paid-In Capital in Excess of Par 11,900
Capital Stock Issued for Consideration Other
Than Cash
If no readily determinable value is available for
either, the accepted procedure is to have the
value of the property or services appraised.
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13-28
Reasons Companies Repurchase Stock
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.
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.
3. Use both the cost and par value methods to
account for stock repurchases
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13-29
Treasury Stock
• Treasury stock is stock issued by a corporation
and subsequently reacquired by the corporation
and held for possible future reissuance or
retirement.
• Treasury stock should not be viewed as an
asset; report as a reduction in owner’s equity.
• There is no income or loss on the reacquisition,
reissuance, or retirement of treasury stock.
• Retained Earnings can be decreased by
treasury stock transactions but never increased
by such transactions.
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13-30
2012—Newly organized corporation issued
10,000 shares of common stock, $1 par, at
$15: Cash 150,000
Common Stock 10,000
Paid-In Capital in Excess of Par 140,000
2013—Reacquired 1,000 shares of common
stock at $40 per share:
Treasury Stock 40,000
Cash 40,000
Cost Method of Accounting for Treasury Stock
(continued)
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13-31
2013—Sold 200 shares of treasury stock at $50
per share:
Cash 10,000
Treasury Stock (200 × $40) 8,000
Paid-In Capital from Treasury
Stock 2,000
Note: No gain is recorded on the
sale. The excess is credited
to Paid-in Capital from
Treasury Stock.
Note: No gain is recorded on the
sale. The excess is credited
to Paid-in Capital from
Treasury Stock.
Cost Method of Accounting for Treasury Stock
(continued)
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13-32
2013—Sold 500 shares of treasury stock at $34
per share:
Cash 17,000
Paid-In Capital from Treasury Stock 2,000
Retained Earnings 1,000
Treasury Stock (500 × $40) 20,000
Cost Method of Accounting for Treasury Stock
(continued)
Note: No loss is recorded on the
sale. The difference is debited
to Retained Earnings.
Note: No loss is recorded on the
sale. The difference is debited
to Retained Earnings.
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13-33
Common Stock 300
Paid-In Capital in Excess of Par 4,200
Retained Earnings [300 × ($40 – $15)] 7,500
Treasury Stock (300 × $40) 12,000
2013—Retired remaining 300 shares of
treasury (3% of original issue of 10,000
shares):
Cost Method of Accounting for Treasury Stock
Alternatively, the entire $11,700 difference between
Common Stock and the cost to acquire the treasury
stock may be debited to Retained Earnings.
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13-34
Par (or Stated) Value Method of Accounting for
Treasury Stock
Treasury Stock 1,000
Paid-In Capital in Excess of Par 14,000
Retained Earnings [1,000 x ($40 – $15)] 25,000
Cash 40,000
Same entry as the cost method (Slide 13-30). Same entry as the cost method (Slide 13-30).
2013—Reacquired 1,000 shares of common
stock at $40 per share:
2012—Newly organized corporation issued
10,000 shares of common stock, $1 par,
at $15:
(continued)
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13-35
Par (or Stated) Value Method of Accounting for
Treasury Stock
2013—Sold 200 shares of treasury stock at $50
per share:
Cash 10,000
Treasury Stock 200
Paid-In Capital in Excess of Par 9,800
2013—Sold 500 shares of treasury stock at $34
per share:
Cash 17,000
Treasury Stock 500
Paid-In Capital in Excess of Par 16,500
(continued)
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13-36
Par (or Stated) Value Method of Accounting for
Treasury Stock
2013—Retired remaining 300 shares of
treasury stock:
Common Stock 300
Treasury Stock 300
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13-37
Evaluating the Cost and Par Value Methods
Less than 10% of large US. Companies
use the par value method
Less than 10% of large US. Companies
use the par value method
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13-38
Stock 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.
4. Account for the issuance of stock rights and
stock warrants
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13-39
Stock Rights
• When announcing rights to purchase additional
shares of stock, the directors of a corporation
specify a date on which the rights will be issued.
• All stockholders of record on the issue date are
entitled to the rights. Thus, between the
announcement date and the issue date, the stock is
said to sell rights-on.
• After the rights are issued, the stock sells ex-rights,
and the rights may be sold separately by those
receiving them from the corporation.
• An expiration date is also designated when the
rights are announced, and rights not exercised by
this date are worthless.
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13-40
Stock Warrants
The value assigned to the warrants is determined by
the relative fair value method which is illustrated in the
following equation:
Value
assigned to
warrants
Total issue
price
Market value of warrants
Market value
of security
without
warrants
Market
value of
warrants +
x =
(continued)
• Detachable warrants are similar to stock rights
because they can be traded separately from the
security with which they were originally issued.
• Nondetachable warrants cannot be separated from
the security with which they were issued.
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13-41
• 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.
Stock Warrants
(continued)
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13-42
Value
assigned to
warrants =
Total
issue
price
x Market 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
Stock Warrants
(continued)
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13-43
The entry on Stewart’s books to record the sale
of the preferred stock with detachable warrants
is as follows:
Cash 58,000
Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of Par—
Preferred Stock 5,100
Common Stock Warrants 2,900
Stock Warrants
(continued)
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13-44
If the warrants are exercised: Common Stock Warrants 2,900
Cash 25,000
Common Stock, $2 par 2,000
Paid-In Capital in Excess of Par—
Common Stock 25,900
If the warrants expire:
Common Stock Warrants 2,900
Paid-In Capital from Expired
Warrants 2,900
Stock Warrants
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13-45
Stock Option Compensation Expense
• Whether or not to expense stock options is a “hot
potato” issue in accounting.
• The FASB kept bringing up the issue of stock
option accounting only to find that there were
strong feelings against expensing the cost of stock
options.
• Recognition of a stock option compensation
expense would reduce reported earnings. (continued)
5. Compute the compensation expense
associated with the granting of employee stock
options
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13-46
Stock Option Compensation Expense
• In December 2004, the FASB adopted pre-
Codification Statement No. 123 which
requires the expensing of the fair value of
stock options granted as compensation.
• This standard is now found in FASB ASC
Topic 718.
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13-47
• Neff 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
(10,000 x $10) as of the grant date.
Compensation expense is allocated over three
years from January 1, 2011 (the grant date) to
January 1, 2014 (the vesting date). The year-end
entry is shown in Slide 13-48.
Basic Stock Option Compensation Plan
(continued)
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13-48
$100,000/3
Dec. 31 Compensation Expense 33,333
Paid-In Capital from Stock
Options 33,333
2011
Basic Stock Option Compensation Plan
Note that this paid-in capital is not from the
investment of cash in the business but instead
represents an investment of work by the
employees covered under the stock option
plan.
(continued)
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13-49
On December 31, 2014, all 10,000 of the options are
exercised to purchase Neff’s no-par common stock:
Basic Stock Option Compensation Plan
Dec. 31 Cash (10,000 x $50) 500,000
Paid-In Capital from Stock
Options 100,000
Common Stock (no
par) 600,000
2014
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13-50
Basic Stock Option Compensation Plan
The following note disclosure is required each year:
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13-51
Accounting for Performance-Based Plans
In a performance-based stock option plan,
the plan terms are dependent on how well the
individual performs after the date the options
are granted or how well the company
performs during the vesting period.
(continued)
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13-52
• On January 1, 2011, the board of directors of
Neff Company authorized the granting of stock
options to supplement the salaries of certain
employees.
• Each stock option permits the purchase of one
share of Neff common stock at a price of $50
per share; the market price on January 1,
2011, is also $50 per share.
Accounting for Performance-Based Plans
(continued)
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13-53
• The options vest, or become exercisable,
beginning on January 1, 2012, and only if the
employee stays with the company for the entire
3-year period. The options expire on December
31, 2014.
• The number of options granted is contingent on
Neff’s level of sales for 2013. If Neff sales are
less than $50 million, only 10,000 options will
vest. If Neff’s sales are between $50 million and
$80 million, an additional 2,000 options will vest.
If sales exceed $80 million, 15,000 vest.
Accounting for Performance-Based Plans
(continued)
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13-54
• As of December 31, Neff forecasts that 2013
sales will be around $60 million, indicating
that 12,000 options will vest.
• Recognition of compensation expense for
2013 involves recognizing one-third of the
$120,000 (12,000 x $10) total estimated
expense for the 3-year service period.
• The change in Neff’s stock price during the
year (from $50 to $60) does not affect the
calculation. (continued)
Accounting for Performance-Based Plans
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13-55
Recognition of compensation of $40,000 for each
of the three years [(12,000 options × $10)/3]:
Dec. 31 Compensation Expense 40,000
Paid-In Capital from
Stock Options 40,000
2011
Accounting for Performance-Based Plans
(continued)
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13-56
Events in 2012 lead Neff to lower its forecast of
2013 sales. Sales are expected to be only $40
million, so only 10,000 options will vest on
January 1, 2014. Because two-thirds of the
service period has elapsed, aggregate
compensation expense should be $66,667
($100,000 x 2/3).
Dec. 31 Compensation Expense–
($66,667 – $40,000) 26,667
Paid-In Capital from
Stock Options 26,667
2012
(continued)
Accounting for Performance-Based Plans
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13-57
Actual sales for 2013 are $85 million, so 15,000
options will vest on January 1, 2014. Because
compensation expense of $66,667 ($40,000 +
$26,667) has already been recognized in 2011
and 2012, the necessary journal entry in 2013 is
as follows:
Dec. 31 Compensation Expense
($150,000 – $66,667) 83,333
Paid-In Capital from Stock
Options 83,333
2013
Accounting for Performance-Based Plans
(continued)
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13-58
On December 31, 2014, all 15,000 options are
exercised to purchase Neff’s no-par common
stock.
Dec. 31 Cash ($15,000 × $50) 750,000
Paid-In Capital from Stock
Options 150,000
Common Stock (no par) 900,000
2014
Accounting for Performance-Based Plans
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13-59
Accounting for Awards That Call for Cash
Settlement
• Assume that Neff Company has decided
instead of granting its employees 10,000
stock options, it will grant an equal number of
cash stock appreciation rights (SARs).
• A cash SAR awards an employee a cash
amount equal to the market value of the
issuing firm’s shares above a specified
threshold price.
(continued)
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13-60
• Fair value of one SAR:
– January 1, 2011 $10
– December 31, 2011 6
– December 31, 2012 7
– December 31, 2013 9
• As of December 31, 2011, the estimated fair
value of each SAR is $6. The best estimate of
the amount of cash that will be transferred when
the cash SARs are exercised is $60,000
(10,000 x $6).
Accounting for Awards That Call for Cash
Settlement
(continued)
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13-61
Dec. 31 Compensation Expense
($60,000/3 years) 20,000
Share-Based
Compensation Liability 20,000
2011
As of December 31, 2012 the estimated fair value
of each SAR is $7. The new estimation for
compensation expense is $70,000 (10,000 × $7).
(continued)
Dec. 31 Compensation Expense
($46,667 – $20,000) 26,667
Share-Based
Compensation Liability 26,667
2012
Accounting for Awards That Call for Cash
Settlement
$70,000 x 2/3
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13-62
The estimated fair value of each SAR is $9 on
December 31, 2013. Aggregate compensation
expense for the 3-year service period is $90,000
($10,000 x $9). Because the compensation
expense of $46,667 has been recognized in 2011
and 2012, the necessary journal entry in 2013 is
as follows:
Dec. 31 Compensation Expense
(90,000 –$46,667) 43,333
Share-Based
Compensation Liability 43,333
2013
(continued)
Accounting for Awards That Call for Cash
Settlement
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13-63
The share price on December 31, 2014 is $61,
meaning that Neff will pay $11 ($61 – threshold
price of $50) for each SAR.
Dec. 31 Compensation Expense 20,000
Share-Based
Compensation Liability 20,000
2014
Accounting for Awards That Call for Cash
Settlement
Cash payments are made to the holders of the
10,000 SARs on December 31, 2014.
Dec. 31 Share-Based
Compensation Liability 110,000
Cash [10,000 × ($61 – $50)] 110,000
2014
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13-64
Mandatorily Redeemable Preferred Shares
• Historically, the SEC required that firms not
include mandatorily redeemable preferred stock
under the Stockholders’ Equity heading.
• Given a “mezzanine” treatment.
• The FASB now requires mandatorily redeemable
preferred shares to be reported as liabilities in the
balance sheet.
(continued)
6. Determine which equity-related items should
be reported in the balance sheet as liabilities
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13-65
Mandatorily Redeemable Preferred Shares
On January 1, 2011, Tarazi Company issued mandatorily
redeemable preferred shares in exchange for $100 cash.
The shares must be redeemed on January 1, 2012, for
$110. The interest rate implicit in this agreement is 10%.
Jan. 1 Cash 100
Mandatorily Redeemable
Preferred Shares (liability) 100
2011
Dec. 31 Interest Expense ($100 x 0.10) 10
Mandatorily Redeemable
Preferred Shares (liability) 10
Jan. 1 Mandatorily Redeemable
Preferred Shares (liability) 110
Cash 110
2012
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13-66
Written Put Options
• A put option is an agreement that allows
investors to sell the issuing corporation shares
they hold at set prices on specific dates.
• If the stock price stays above a set level per
share, the issuing corporation pays nothing.
• Historically, companies have recorded these put
options as part of equity. The FASB now
instructs companies to record the fair value of
the obligation as a liability.
(continued)
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13-67
Written Put Options
On January 1, 2011, Kamili Company wrote a
put option agreeing to purchase one share of its
own stock for $100 on December 31, 2012 at
the option of the purchaser. The market price of
Kamili’s shares on January 1, 2011, was $100.
On January 1, 2011, this put option has a fair
value of $20.
Jan. 1 Cash 20
Put Option (liability) 20
2011
(continued)
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13-68
Written Put Options
An option-pricing formula suggests that the fair
value of the put option on December 31, 2011, is
$30, up from $20 at the beginning of the year.
Dec. 31 Loss on Put Option 10
Put Option (liability)($30 – $20
already recognized) 10
2011
On December 31, 2012, the put option
expiration date, the market price of Kamili stock
is $82 per share. The put option holder decides
to exercise the option and sell one share of
Kamili stock to Kamili for $100.
(continued)
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13-69
Written Put Options
Kamili would record the purchase of one share
of its stock in conjunction with the exercise of
the put option.
Dec. 31 Treasury Stock (the fair value
of the share repurchased) 82
Put Option (liability) 30
Gain on Put Option 12
Cash 100
2012
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13-70
Obligation to Issue Shares of a
Certain Dollar Value
• Companies occasionally agree to satisfy their
obligations by delivering shares of their own
stock rather than by paying cash.
• This is especially true for startup companies
trying to conserve their limited cash supply.
• Depending on how the contract is written, this
promise to deliver shares of one’s stock to
satisfy the obligation can be recorded as equity
or as a liability.
(continued)
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13-71
Obligation to Issue Shares of a
Certain Dollar Value
Example 1: On October 1, 2011, Lily Company
experienced trouble with its office air conditioning
system. The repair bill is $5,000. Lily agrees to
deliver 200 shares of no-par common stock to
the repairperson on February 1, 2012. On
October 1, 2011, Lily’s shares have a market
value of $25.
Oct. 1 Maintenance Expense (200 x
$25) 5,000
Common Stock Issuance
Obligation (equity) 5,000
2011
(continued) Similar to Common Stock Subscribed
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13-72
Obligation to Issue Shares of a
Certain Dollar Value
Example 2: On October 1, 2011, Lily Company
received air conditioning repair services costing
$5,000. Lily agrees to deliver shares of Lily’s no-
par common stock with a market value of $5,000
to the repairperson on February 1, 2012. On
October 1, 2011, Lily’s shares have a market
value of $25, and on February 1, 2012, the
shares have a market value of $20.
Feb. 1 Common Stock Issuance
Obligation (equity) 5,000
Common Stock 5,000
2012
(continued)
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13-73
Obligation to Issue Shares of a
Certain Dollar Value
Feb. 1 Common Stock Issuance
Obligation (liability) 5,000
Common Stock (250 x $20) 5,000
2012
Oct. 1 Maintenance Expense 5,000
Common Stock Issuance
Obligation (liability) 5,000
2011
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13-74
Noncontrolling Interest
• Financing provided by minority stockholders is
called minority interest.
• Minority interest is the amount of equity
investment made by outside shareholders to
consolidated subsidiaries that are not 100%
owned by the parent.
• The FASB uses the term noncontrolling
interest to replace “minority interest” in the
consolidated balance sheet.
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13-75
The capital section of Sorensen Corporation on
December 31, 2013, is as follows:
Preferred stock, $50 par, 10,000 $ 500,000
Paid-in capital in excess of par—
preferred 100,000
Common stock, $1 par, 100,000
shares 100,000
Paid-in capital in excess of par—
common 2,900,000
Retained earnings 1,000,000
Stock Conversions
7. Distinguish between stock conversions that
require a reduction in retained earnings and
those that do not
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Stock Conversions
On December 31, 2013, 1,000 shares of
preferred stock (par $50) are exchanged for
4,000 shares of common stock (par $1).
Case 1: One Preferred for Four Common ($1) Case 1: One Preferred for Four Common ($1)
Dec. 31 Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of Par—
Preferred 10,000
Common Stock, $1 par 4,000
Paid-In Capital in Excess of
Par—Common 56,000
2013
(continued)
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On December 31, 2011, 1,000 shares of
preferred stock (par $50) are exchanged for
4,000 shares of common stock (par $20).
Dec. 31 Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of Par—
Preferred 10,000
Retained Earnings 20,000
Common Stock, $20 par 80,000
2011
Stock Conversions
Case 2: One Preferred for Four Common ($20) Case 2: One Preferred for Four Common ($20)
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Factors Affecting Retained Earnings
A number of factors can affect retained earnings
in addition to net income, losses, and dividends.
These transactions and events that affect
retained earnings are summarized as follows:
8. List the factors that impact the Retained
Earnings balance
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Net Income and Dividends
• The primary source of retained earnings is the
net income generated by a business.
• When operating losses or other debits to
retained earnings produce a debit balance in
the account, the debit balance is referred to as a
deficit.
• Use of the term dividends without qualification
normally implies the distribution of cash.
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13-80
Prior-Period Adjustments
In some situations, errors made in past years
are discovered and corrected in the current year
by an adjustment to Retained Earnings, referred
to as a prior-period adjustment:
• Mathematical mistakes
• Failure to apply appropriate accounting procedures
• Misstatement or omission of certain information
• Change from a non-GAAP principle to a GAAP
principle
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Appropriated Retained Earnings
• Retained Earnings may be restricted at the
discretion of the board of directors.
Example: Expansion of plant facilities
• The restricted portion may be designed as
appropriated retained earnings and the
unrestricted portion as unappropriated (or free)
retained earnings.
• The main idea behind this restriction is to
notify stockholders that some of the assets
may not be available for dividends.
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Accounting for Dividends
In setting dividend policy, the board of directors
must answer two questions:
1. Do we have the legal right to declare a dividend?
2. Is a dividend distribution financially advisable?
The board of directors must observe the state
incorporation laws governing the payment of
dividends.
9. Properly record cash dividends, property
dividends, small and large stock dividends,
and stock splits
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Recognition and Payment of Dividends
• Declaration date—date the corporation’s board
of directors formally declares a dividend will be
paid
• Date of record—date on which stockholders of
record are identified as those who will receive a
dividend
• Date of payment—date when the dividend is
actually distributed to stockholders
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Cash Dividends
Entries to record the declaration and payment of a
$100,000 cash dividend by a corporation follows:
Declaration of Dividend:
Dividends (or Retained Earnings) 100,000
Dividends Payable 100,000
Payment of Dividend:
Dividends Payable 100,000
Cash 100,000
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13-85
Property Dividends
• A dividend to stockholders that is payable in some
asset other than cash is generally referred to as a
property dividend.
• Frequently, the assets to be distributed are securities
of other companies owned by the corporation. The
corporation thus transfers to stockholders the
ownership interest in such securities.
• This type of transfer is sometimes referred to as a
nonreciprocal transfer to owner inasmuch as
nothing is received by the company in return for its
distribution to stockholders.
(continued)
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Property Dividends
Bigler 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 Bigler stock
outstanding. A dividend of 1/10 of a share of
Tri-State Oil Co. is declared for each share of
Bigler stock outstanding.
The entries for Bigler for the dividend declaration
and payment are on Slide 13-87.
(continued)
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13-87
Property Dividends
Declaration of Dividend:
Dividends (or Retained Earnings) 3,000,000
Property Dividends Payable 2,700,000
Gain on Distribution of Property
Dividends 300,000
Payment of Dividend:
Property Dividends Payable 2,700,000
Investment in Tri-State Oil
Co. Stock 2,700,000
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13-88
Stock Dividends
• A corporation may distribute to stockholders
shares of the company’s own stock as a stock
dividend.
• A stock dividend involves no transfer of cash or
any other asset to stockholders.
• From a shareholder’s standpoint, receipt of a
stock dividend is an economic nonevent.
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Small versus Large 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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13-90
Small Dividend Example
The stockholders’ equity section for the Fuji
Company on July 1 is as follows:
Common Stock, $1 par, 100,000
shares outstanding $ 100,000
Paid-In Capital in Excess of Par 1,100,000
Retained Earnings 750,000
The company declares a 10% stock dividend.
Before the stock dividend, the stock is selling for
$22 per share. After the stock dividend, each
share will have a value of $20 ($22/1.1).
(continued)
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13-91
Declaration of Dividend:
Retained Earnings 200,000
Stock Dividends Distributable 10,000
Paid-In Capital in Excess of Par 190,000
Payment of Dividend:
Stock Dividends Distributable 10,000
Common Stock, $1 par 10,000
Small Dividend Example
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13-92
Large Dividend Example
The stockholders’ equity section for the Fuji
Company on July 1 is as follows:
Common Stock, $1 par, 100,000
shares outstanding $ 100,000
Paid-In Capital in Excess of Par 1,100,000
Retained Earnings 750,000
The company declares a 50% stock dividend.
Before the stock dividend, the stock is selling for
$22 per share. Entries for declaring of the
dividend and issuance of the 50,000 new shares
(100,000 x 0.50) are on Slide 13-93.
(continued)
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13-93
Declaration of Dividend:
Retained Earnings 50,000
Stock Dividends Distributable 50,000
OR
Paid-In Capital in Excess of Par 50,000
Stock Dividends Distributable 50,000
Issuance of Dividend:
Stock Dividends Distributable 50,000
Common Stock, $1 par 50,000
Large Dividend Example
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13-94
Stock Dividends versus Stock Splits
• A corporation may effect a stock split by
reducing the par or stated value of each share
of capital stock and proportionately increasing
the number of shares outstanding.
• A stock dividend results in an increase in the
number of shares outstanding. The par or
stated value remains unchanged.
• A stock split divides the existing Capital Stock
balance into more parts, with a reduction in
par or stated value of each share.
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13-95
Reverse Stock Split
• A reverse stock split is the consolidation of
shares outstanding into a smaller number of
shares.
• Share of stock trading for less than $10 are
viewed with some skepticism, and a reverse
split can make the stock look more
respectable.
• A reverse split is almost always viewed as bad
news by investors.
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13-96 13-96
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13-97
Liquidating Dividends
• A liquidating dividend is a distribution representing a return to stockholders of a portion of contribution capital.
• Example: Stubbs Corporation declared and paid a cash dividend ($10 cash dividend on 10,000 shares of common stock) totaling $100,000 and a partial liquidating dividend of $50,000. The liquidating dividend is a $5-per-share dividend. The declaration and payment entries are on Slide 13-98.
(continued)
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13-98
Liquidating Dividends
Declaration of Dividend:
Dividends 100,000
Paid-In Capital in Excess of Par 50,000
Dividends Payable 150,000
Payment of Dividend:
Dividends Payable 150,000
Cash 150,000
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13-99
Statement of Comprehensive Income
• FASB ASC Topic 220 requires that all
companies provide a statement of
comprehensive income.
• An example of Microsoft’s 2009 statement of
comprehensive income is included on Slide
13-100.
10. Explain the background of unrealized gains
and losses recorded as part of accumulated
other comprehensive income, and list the
major types of equity reserves found in foreign
balance sheets
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13-100 13-100
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13-101
Equity Items That Bypass the Income
Statement and are Reported as Part of
Accumulated Other Comprehensive Earnings
Since 1980, the Equity sections of the U.S.
balance sheets have begun to fill up with a
strange collection of times, each the result of an
accounting controversy. These items are
summarized in the following slides.
(continued)
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Foreign Currency Translation Adjustment
• The foreign currency translation
adjustment arises from the change in the
equity of foreign subsidiaries (as measured in
terms of U.S. dollars) that occurs as a result of
changes in foreign currency exchange rates.
• These changes are recorded as direct
adjustments to equity, insulating the income
statement from the aspect of foreign currency
fluctuations.
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Unrealized Gains and Losses
on Available-for-Sale Securities
• Available-for-sale securities are those that
were not purchased with immediate intention to
resell, but that a company also doesn’t
necessarily plan to hold forever.
• The unrealized gains and losses from market
value fluctuations in trading securities are
included in the income statement.
• The unrealized gains and losses from market
value fluctuations in available-for-sale
securities are shown as a direct adjustment to
equity. (continued)
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13-104
Unrealized Gains and Losses
on Derivatives
• A derivative is a financial instrument, such as
an option or a future, that derives its value from
the movement of a price, an exchange rate, or
an interest rate associated with some other
item.
• Derivatives are used to manage risk
associated with sales or purchases that will not
occur until a future period.
(continued)
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13-105
Unrealized Gains and Losses on Derivatives
The last few lines of Kendall Company’s income
statement were as follows:
(continued)
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13-106
Unrealized Gains and Losses on Derivatives
Kendall had the following items impacting
comprehensive income:
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13-107
Unrealized Gains and Losses on Derivatives
Assume that the income tax rate for all items is
40%. Kendall Company would report its
comprehensive income for the year as follows:
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13-108
Balance Sheet Reporting
The accumulated amount of comprehensive
income is reflected in the Equity section of the
balance sheet in two ways:
• Net income (less dividends) is cumulated in
retained earnings.
• Other comprehensive income is cumulated in
accumulated other comprehensive income.
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13-109
International Accounting: Equity Reserves
• In foreign countries, the payment of cash
dividends is linked to the amount of
distributable equity.
• Equity is divided among various equity
reserve accounts, each with legal restrictions
dictating whether it can be distributed to
stockholders.
(continued)
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13-110
13-110
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Disclosures 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
In accounting for capital stock, it should be
recognized that stock may be:
11. Prepare a statement of changes in
stockholders’ equity
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13-112 13-112
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