FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGAN INTRODUCTION TO CONCEPTS,AN INTRODUCTION TO CONCEPTS,

METHODS, AND USESMETHODS, AND USES12th Edition12th Edition

Chapter 12 – Shareholders’ Equity: Capital Contributions, Distributions,

and Earnings

Clyde P. Stickney and Roman L. Weil

Learning ObjectivesLearning Objectives1.1. Understand the different priority claims Understand the different priority claims

of common and preferred shareholders of common and preferred shareholders on the assets of a firm and the disclosure on the assets of a firm and the disclosure of those claims in the shareholders’ of those claims in the shareholders’ equity section of the balance sheet.equity section of the balance sheet.

2.2. Understand the concepts underlying and Understand the concepts underlying and apply the accounting procedures for, the apply the accounting procedures for, the issuance of capital stock, particularly issuance of capital stock, particularly with respect to capital stock issued with respect to capital stock issued under various option arrangements.under various option arrangements.

3.3. Understand the concepts underlying, Understand the concepts underlying, and apply the accounting procedures for, and apply the accounting procedures for, cash, property, and stock dividends.cash, property, and stock dividends.

Learning ObjectivesLearning Objectives4.4. Understand the concepts underlying, and Understand the concepts underlying, and

apply the accounting procedures for, the apply the accounting procedures for, the acquisition and reissue of treasury stock.acquisition and reissue of treasury stock.

5.5. Understand why the format for reporting Understand why the format for reporting income matters and master the concept income matters and master the concept that different kinds of income require that different kinds of income require different formats.different formats.

6.6. Understand the distinction between Understand the distinction between earnings and comprehensive income.earnings and comprehensive income.

7.7. Develop the skills to interpret disclosures Develop the skills to interpret disclosures about changes in shareholders’ equity about changes in shareholders’ equity accounts.accounts.

Chapter OutlineChapter Outline1.1. Capital ContributionsCapital Contributions2.2. Issuing Capital StockIssuing Capital Stock3.3. Corporate DistributionsCorporate Distributions4.4. Reporting Earnings TransactionsReporting Earnings Transactions5.5. Earnings and Book Value per ShareEarnings and Book Value per Share6.6. An International PerspectiveAn International Perspective7.7. Disclosure of Changes in Shareholders’ EquityDisclosure of Changes in Shareholders’ EquityChapter SummaryChapter Summary8.8. Appendix 12.1: Effects on the Statement of Cash Appendix 12.1: Effects on the Statement of Cash

Flows of Transactions Involving Shareholders’ Flows of Transactions Involving Shareholders’ EquityEquity

Define These TermsDefine These Terms

Capital ContributionsCapital Contributions:: Firms issue common or preferred stock to obtain Firms issue common or preferred stock to obtain funds to finance various operating and investing funds to finance various operating and investing activitiesactivities..

Earnings TransactionsEarnings Transactions: : Firms use assets financed by creditors and Firms use assets financed by creditors and owners to generate earnings.owners to generate earnings.

DistributionsDistributions:: Firms distribute assets to shareholders either in Firms distribute assets to shareholders either in the form of a dividend or the repurchase of the form of a dividend or the repurchase of common or preferred stock.common or preferred stock.

Review of Important ConceptsReview of Important Concepts

1.1. Shareholders’ equity is a Shareholders’ equity is a residual residual interestinterest, representing the shareholders’ , representing the shareholders’ claims on the assets of a firm in excess claims on the assets of a firm in excess of the claims of creditors.of the claims of creditors.

2.2. All firms issue common stock. Firms All firms issue common stock. Firms may also issue preferred stock which may also issue preferred stock which has a senior but limited claim on assets.has a senior but limited claim on assets.

3.3. Common and preferred stock usually Common and preferred stock usually have a par or a stated value. have a par or a stated value.

4.4. Firms accumulate information about Firms accumulate information about revenues and expenses to support the revenues and expenses to support the income statement. Revenues and income statement. Revenues and expenses are closed to retained expenses are closed to retained earnings at the end of the accounting earnings at the end of the accounting period.period.

5.5. Firms may distribute assets to Firms may distribute assets to shareholders as a dividend which shareholders as a dividend which reduces retained earnings and assets.reduces retained earnings and assets.

6.6. Retained earningsRetained earnings is the accumulation is the accumulation of earnings reduced by dividends.of earnings reduced by dividends.

Review of Important ConceptsReview of Important Concepts

Capital ContributionsCapital Contributions The Corporate form:The Corporate form:

1. Limits the liability of owner1. Limits the liability of owner2. Allows for raising funds by issuing 2. Allows for raising funds by issuing

sharesshares3. Makes transfer of ownership easy in 3. Makes transfer of ownership easy in

secondary marketssecondary markets Financing a corporation:Financing a corporation:

a. Preferred stocka. Preferred stockb. Common stockb. Common stock

Preferred Shareholders’ EquityPreferred Shareholders’ Equity Preferred shareholders generally have a Preferred shareholders generally have a

claim on assets that is superior or claim on assets that is superior or senior to any claim by common senior to any claim by common shareholders.shareholders.

Their claims are often limited so that Their claims are often limited so that preferred shareholders look more like preferred shareholders look more like creditors than owners.creditors than owners.

Some preferred is convertible into Some preferred is convertible into common shares.common shares.

Firms do not have to issue preferred Firms do not have to issue preferred stock and many firms have not.stock and many firms have not.

Common Shareholders’ EquityCommon Shareholders’ Equity All corporations have common stock; All corporations have common stock;

they need not have preferred stock.they need not have preferred stock. Common shareholders are the Common shareholders are the residual residual

interestinterest owners; that is, they own owners; that is, they own everything that is left after all other everything that is left after all other obligations have been fulfilled.obligations have been fulfilled.

Balance sheet disclosure includes:Balance sheet disclosure includes:1.1. Capital contributionsCapital contributions2.2. Earnings and dividendsEarnings and dividends3.3. Accumulated other comprehensive incomeAccumulated other comprehensive income4.4. Treasury share transactionsTreasury share transactions

Issuing Capital StockIssuing Capital Stock

1.1. Issue for Cash.Issue for Cash.2.2. Issue for non-cash Assets.Issue for non-cash Assets.3.3. Issue under Option Arrangements.Issue under Option Arrangements.4.4. Employee Stock Option Plans.Employee Stock Option Plans.5.5. Stock Rights.Stock Rights.6.6. Stock Warrants.Stock Warrants.7.7. Convertible Bonds or Preferred Convertible Bonds or Preferred

Stock.Stock.

Capital Contributions -- Issue for CashCapital Contributions -- Issue for Cash A firm needing financing may issue new shares A firm needing financing may issue new shares

of stock. In return for the shares, the firm gets of stock. In return for the shares, the firm gets cash.cash.

This is not disadvantageous to previous owners This is not disadvantageous to previous owners of shares because even though ownership goes of shares because even though ownership goes up, the total assets go up.up, the total assets go up.

For historical and legal reasons, the increase in For historical and legal reasons, the increase in equity is separated into an increase in common equity is separated into an increase in common stock at par and the remainder, an increase in stock at par and the remainder, an increase in additional paid-in capital.additional paid-in capital.

Cash 100,000 Common stock ($10 par) 10,000 Additional P.I.C. 90,000

Capital Contributions Capital Contributions -- Issue for Non-Cash Assets-- Issue for Non-Cash Assets

A firm may find it desirable to trade stock A firm may find it desirable to trade stock for an asset other than cash.for an asset other than cash.

In this case, the question is what is the In this case, the question is what is the value of the transactions?value of the transactions?

We look first to a reliable market based We look first to a reliable market based value of the asset and record that stock value of the asset and record that stock and the asset at this price. If the value of and the asset at this price. If the value of the asset is hard to measure, we may take the asset is hard to measure, we may take the market value of the stock instead.the market value of the stock instead.

Capital Contributions -- Issued Under Capital Contributions -- Issued Under Options ArrangementsOptions Arrangements

Firms sometimes give stock at Firms sometimes give stock at reduced prices or free in exchange for reduced prices or free in exchange for goods or services or as compensation.goods or services or as compensation.

Top management is often Top management is often compensated in stock or stock options compensated in stock or stock options so that they will have strong so that they will have strong incentives to make decisions which incentives to make decisions which will increase the price of shares.will increase the price of shares.

Employee Stock Option PlansEmployee Stock Option Plans A A stock optionstock option is a contract that allows the holder is a contract that allows the holder

to buy a stated number of shares of stock for a to buy a stated number of shares of stock for a fixed price, called the fixed price, called the exercise priceexercise price. If the . If the market price is above the exercise price, then the market price is above the exercise price, then the option have value. Otherwise, the holder will just option have value. Otherwise, the holder will just ignore the option and it has no value.ignore the option and it has no value.

On the On the grant dategrant date, the firm transfers options to , the firm transfers options to an employee, for free or a reduced price.an employee, for free or a reduced price.

The employee typically cannot sell the stock The employee typically cannot sell the stock immediately but must wait until the immediately but must wait until the vesting datevesting date..

When the employee does buy shares of stock When the employee does buy shares of stock using the option (to get the lower price), this is using the option (to get the lower price), this is called called exercisingexercising the option. the option.

Employee Stock Option Plans (cont.)Employee Stock Option Plans (cont.) How do you value an option? If the price of the How do you value an option? If the price of the

stock falls, it is valueless. If the price goes up, then stock falls, it is valueless. If the price goes up, then the amount of increase is the value.the amount of increase is the value.

One cannot know the ultimate value until the One cannot know the ultimate value until the exercise date.exercise date.

Two GAAP methods:Two GAAP methods:– Market Value Method.Market Value Method.– APB Opinion 25 Method.APB Opinion 25 Method.

Firms have argued (under APB 25) that if the Firms have argued (under APB 25) that if the exercise price is above the current stock price, then exercise price is above the current stock price, then the option has no value and requires no recording.the option has no value and requires no recording.

Define Stock Rights.Define Stock Rights. Like stock options, Like stock options, stock rightsstock rights give the give the

holder the right to acquire shares at a holder the right to acquire shares at a specified price.specified price.– Stock Options are generally granted to Stock Options are generally granted to

employees and cannot be transfer until vested.employees and cannot be transfer until vested.– Stock Rights are generally granted to current Stock Rights are generally granted to current

shareholders who can trade them in secondary shareholders who can trade them in secondary public markets.public markets.

GAAP ignore any value inherent in the stock GAAP ignore any value inherent in the stock right on the date of the grant and make no right on the date of the grant and make no entry when granted. Of course, the exercise entry when granted. Of course, the exercise of a stock right is recorded like the sale of of a stock right is recorded like the sale of shares.shares.

Why issue stock warrants?Why issue stock warrants?

Firms issue stock warrants to the Firms issue stock warrants to the investing public for cash. investing public for cash.

When sold, the warrants are recorded When sold, the warrants are recorded in a manner similar to a liability.in a manner similar to a liability.

When warrant holders exercise their When warrant holders exercise their rights, the firm records the rights, the firm records the transaction like the sale of stock transaction like the sale of stock except that the warrant account except that the warrant account created when granted is reduced.created when granted is reduced.

Convertible SecurityConvertible Security

A A convertible securityconvertible security may be exchanged at may be exchanged at the holders option for another security. the holders option for another security.

For example, a convertible bond may be For example, a convertible bond may be exchangeable for a share of common stock.exchangeable for a share of common stock.

This feature allows the holder to choose the This feature allows the holder to choose the option that has the greater benefit and is a option that has the greater benefit and is a desirable feature.desirable feature.

Convertible securities are recorded as Convertible securities are recorded as regular securities until they are converted.regular securities until they are converted.

Corporate DistributionsCorporate Distributions

A A dividenddividend is the distribution of assets is the distribution of assets to the owners. to the owners.

The amount of any dividend may be The amount of any dividend may be limited by statue or by contract.limited by statue or by contract.

Three forms of dividends:Three forms of dividends:– Cash dividends.Cash dividends.– Stock dividends.Stock dividends.– Stock splits.Stock splits.

A company may repurchase its own A company may repurchase its own stock as stock as treasury stocktreasury stock..

Restrictions on DividendsRestrictions on Dividends1. Legal limits on dividends -- statutory1. Legal limits on dividends -- statutory

some states limit the payment of dividends: some states limit the payment of dividends: they are not allowed if retained earnings they are not allowed if retained earnings were to be forced to below zero.were to be forced to below zero.

2. Legal limits on dividends -- contractual2. Legal limits on dividends -- contractualcontracts with debtors or others may further contracts with debtors or others may further restrict the payment of dividends.restrict the payment of dividends.

3. Dividends and corporate financial policy3. Dividends and corporate financial policy4. Accounting for dividends4. Accounting for dividends

a. cash dividends a. cash dividends c. stock c. stock dividendsdividendsb. property dividends b. property dividends d. stock splitsd. stock splits

How to Record Cash DividendsHow to Record Cash Dividendsa. a. Cash dividendsCash dividends -- dividends paid in cash-- dividends paid in cash

– When dividends are declared, they give rise to a When dividends are declared, they give rise to a liability and a reduction in retained earningsliability and a reduction in retained earnings Dividends of $150,00 are declared. Please Record.Dividends of $150,00 are declared. Please Record.

Retained earnings 150,000 Dividends payable 150,000

Dividends payable 150,000 Cash 150,000

– When the cash is sent out, the liability is fulfilledWhen the cash is sent out, the liability is fulfilled

How to Record Non-Cash DividendsHow to Record Non-Cash Dividends

b. b. Property dividendsProperty dividends -- dividends paid in assets -- dividends paid in assets other than cash.other than cash. A non-cash dividend of A non-cash dividend of $150,00 is declared. Please record.$150,00 is declared. Please record.

– The accounting is similar to cash dividends except The accounting is similar to cash dividends except when the dividend is paid, the credit is to the asset when the dividend is paid, the credit is to the asset rather than to cash.rather than to cash.

Dividends payable 150,000 Asset 150,000

Dividends in StockDividends in Stockc. c. Stock dividendsStock dividends Technically this is a dividend paid in new Technically this is a dividend paid in new

shares of stock and not general dividends. shares of stock and not general dividends. However the term is often used to refer to all However the term is often used to refer to all

kinds of dividends including cash dividends in kinds of dividends including cash dividends in the sense of “dividends on stock” rather than the sense of “dividends on stock” rather than “dividends paid in stock.”“dividends paid in stock.”

Retained earnings are reduced (debited) and Retained earnings are reduced (debited) and common stock and a.p.i.c. are increased common stock and a.p.i.c. are increased (credited).(credited).

The effect of this is to move equity from The effect of this is to move equity from retained earnings to common stock and a.p.i.c.retained earnings to common stock and a.p.i.c.

Stock SplitsStock Splitsd. d. Stock splits or split-upsStock splits or split-ups Theoretically this is just a large stock dividend.Theoretically this is just a large stock dividend. It has long been debated whether there is any It has long been debated whether there is any

difference between a stock dividend and a difference between a stock dividend and a stock split other than the size.stock split other than the size.

GAAP does consider the two different and GAAP does consider the two different and requires a different accounting treatment for requires a different accounting treatment for stock splits.stock splits.

Specifically, no journal entry is required for a Specifically, no journal entry is required for a stock split.stock split.

Many believe that a stock split will result in an Many believe that a stock split will result in an increase in the market price of the shares. increase in the market price of the shares. Empirical evidence seems to support this, but a Empirical evidence seems to support this, but a causal relationship has not been established.causal relationship has not been established.

Stock RepurchaseStock Repurchase Treasury sharesTreasury shares are common shares that are common shares that

have been repurchased by the firm.have been repurchased by the firm. Treasury shares are not assets or Treasury shares are not assets or

investments.investments. Instead, they are a reversal of the Instead, they are a reversal of the

issuance of common shares.issuance of common shares. Recall that when stock was issued, the Recall that when stock was issued, the

firm received cash and issued stock:firm received cash and issued stock:

Cash 100,000 Common stock ($10 par) 10,000 Additional P.I.C. 90,000

Treasury SharesTreasury Shares The purchase of treasury shares is the reverse of the The purchase of treasury shares is the reverse of the

issuance; the firm gives up cash and gets back the shares:issuance; the firm gives up cash and gets back the shares:

Treasury shares (cost) 110,000 Cash 110,000

Treasury shares are recorded at cost and kept in a Treasury shares are recorded at cost and kept in a separate account so that the firm can more easily separate account so that the firm can more easily resell them, if they desire.resell them, if they desire.

Treasury shares are a contra account to the Treasury shares are a contra account to the shareholders’ equity section.shareholders’ equity section.

Treasury shares do not receive cash dividends or Treasury shares do not receive cash dividends or vote. They may split or receive dividends in stock.vote. They may split or receive dividends in stock.

Treasury Shares (Cont.)Treasury Shares (Cont.) If treasury shares are later resold, there If treasury shares are later resold, there

is no gain or loss on the sale.is no gain or loss on the sale. Rather any difference increases or Rather any difference increases or

decreases the additional paid in capital decreases the additional paid in capital account.account.

Cash 14,000 Treasury shares (cost) 11,000 Additional p.i.c. from sale of treasury shares 3,000

Reporting Earnings TransactionsReporting Earnings Transactions

The term The term EarningsEarnings has no precise has no precise definition. It is used to refer to profits in a definition. It is used to refer to profits in a general sense but not a technical sense. general sense but not a technical sense. It is often used as a broader view of profit It is often used as a broader view of profit which might include changes in economic which might include changes in economic wealth not captured by net income.wealth not captured by net income.

Net IncomeNet Income is a measure of earnings is a measure of earnings using accrual accounting methods as using accrual accounting methods as defined by GAAP.defined by GAAP.

Earnings and net income are gauges Earnings and net income are gauges of the operating activities of the firm.of the operating activities of the firm.

We assume that investors desire We assume that investors desire earnings information so that they can earnings information so that they can forecast future cash flows as input to forecast future cash flows as input to their investment decision.their investment decision.

Reporting Earnings TransactionsReporting Earnings Transactions

Reporting Earnings TransactionsReporting Earnings Transactions

Reporting earnings transactionsReporting earnings transactions– Recurring/nonrecurring and Recurring/nonrecurring and

central/peripheralcentral/peripheral– Measurement of earnings effectMeasurement of earnings effect– Classification in the income statementClassification in the income statement– Unrealized gains and losses from changes Unrealized gains and losses from changes

in market values…in market values…– An international perspective An international perspective

Comprehensive income Comprehensive income

Recurring/NonrecurringRecurring/Nonrecurring and Central/Peripheral and Central/Peripheral

Recurring/nonrecurringRecurring/nonrecurring refers whether refers whether earnings can be expected to repeat in earnings can be expected to repeat in the future.the future.

Central/peripheralCentral/peripheral refers to how closely refers to how closely earnings are related to the core activities earnings are related to the core activities of the firm. The firm may be more of the firm. The firm may be more efficient in core activities than in efficient in core activities than in peripheral activities. Sometimes the term peripheral activities. Sometimes the term core competencies is used.core competencies is used.

Measurement of Earnings EffectMeasurement of Earnings Effect Revenues and expenses result from recurring Revenues and expenses result from recurring

primary activities of the firm.primary activities of the firm. Gains and losses result from either peripheral or Gains and losses result from either peripheral or

nonrecurring activities.nonrecurring activities. Revenue and gains result in increases in Revenue and gains result in increases in

shareholders’ equity. shareholders’ equity. Expenses and losses result in decreases in Expenses and losses result in decreases in

shareholders’ equity.shareholders’ equity. Revenues and expenses are gross concepts in that Revenues and expenses are gross concepts in that

nothing is subtracted. nothing is subtracted. Gains and losses are net concepts in that a cost Gains and losses are net concepts in that a cost

basis is subtracted from an inflow in defining the basis is subtracted from an inflow in defining the gain or loss.gain or loss.

Discuss ClassificationDiscuss Classification Earnings from continuing operationsEarnings from continuing operations are revenues, are revenues,

gains, expenses and losses from activities of the gains, expenses and losses from activities of the firm that can be expected to continue in the near firm that can be expected to continue in the near future.future.

Earnings, gains and losses from discontinued Earnings, gains and losses from discontinued operationsoperations are separate reports of activities that are separate reports of activities that will be discontinued in the near future.will be discontinued in the near future.

Extraordinary gains and losses Extraordinary gains and losses areare gains and gains and losses from events which are bothlosses from events which are both

– Unusual in nature, andUnusual in nature, and– Infrequent in occurrence.Infrequent in occurrence.

Adjustments for changes in Accounting PrinciplesAdjustments for changes in Accounting Principles are disclosures of the effects of a change in the are disclosures of the effects of a change in the use of accounting rules.use of accounting rules.

Unrealized Gains and Losses from Unrealized Gains and Losses from Changes in Market ValuesChanges in Market Values

The FASB has increasingly required The FASB has increasingly required firms to report certain assets and firms to report certain assets and liabilities at their current market values:liabilities at their current market values:

– Inventories at lower of cost or marketInventories at lower of cost or market– Plant assets and intangibles at current Plant assets and intangibles at current

market value when asset impairment has market value when asset impairment has occurredoccurred

– Financial instruments including Financial instruments including derivatives at market valuederivatives at market value

– Marketable equity securities at market Marketable equity securities at market valuevalue

Unrealized Gains and Losses from Unrealized Gains and Losses from Changes in Market Values (Cont.)Changes in Market Values (Cont.)

When an asset (or liability) account is changed to When an asset (or liability) account is changed to market value, double entry accounting systems market value, double entry accounting systems require an offset. require an offset.

The offset is generally to an unrealized gain or loss.The offset is generally to an unrealized gain or loss. Unrealized means that the gain or loss was not the Unrealized means that the gain or loss was not the

result of an economic transaction, but rather a result of an economic transaction, but rather a market adjustment.market adjustment.

Marketable securities nnn Unrealized gain (or loss) nnn

What is the nature of the unrealized gain or What is the nature of the unrealized gain or loss account?loss account?

Unrealized Gains and Losses from Unrealized Gains and Losses from Changes in Market Values (Cont.)Changes in Market Values (Cont.)

The unrealized gain or loss account is part The unrealized gain or loss account is part of earnings because it changes the wealth of earnings because it changes the wealth of the firm.of the firm.

It may or may not be part of net income It may or may not be part of net income depending of the accounting rules.depending of the accounting rules.

Unrealized gains or losses may be closed Unrealized gains or losses may be closed at the end of the accounting period and at the end of the accounting period and appear on the income statement.appear on the income statement.

Or they may bypass the income statement Or they may bypass the income statement and appear on the balance sheet.and appear on the balance sheet.

Earnings Per ShareEarnings Per Share

Publicly traded firms must show earnings-Publicly traded firms must show earnings-per-share data in the body of the income per-share data in the body of the income statement.statement.

Earnings per common share is net Earnings per common share is net earnings divided by the average number earnings divided by the average number of outstanding common shares.of outstanding common shares.

Firms that report more than one of the Firms that report more than one of the four categories of earnings must disclose four categories of earnings must disclose earnings per common share for each earnings per common share for each category.category.

Securities (such as preferred shares) Securities (such as preferred shares) that are convertible into common that are convertible into common shares complicate the meaning of shares complicate the meaning of this number. This is an advanced this number. This is an advanced accounting topic.accounting topic.

Earnings Per ShareEarnings Per Share

Disclosure of Changes in Shareholders’ Disclosure of Changes in Shareholders’ EquityEquity

Annual reports must explain the changes in Annual reports must explain the changes in all shareholders’ equity accounts.all shareholders’ equity accounts.

For retained earnings, this means that a For retained earnings, this means that a reconciliation must be presented. This reconciliation must be presented. This reconciliation may be in the income reconciliation may be in the income statement, the balance sheet or as a statement, the balance sheet or as a separate statement.separate statement.

Also, this means that otherAlso, this means that other comprehensive comprehensive income accounts must also be reconciled.income accounts must also be reconciled.

An International Perspective – Capital An International Perspective – Capital ContributionsContributions

Accounting for shareholders’ equity is Accounting for shareholders’ equity is similar the world over. similar the world over.

Foreign financial statements often use Foreign financial statements often use the term the term reservereserve in the equity section in the equity section to show a restriction on equity.to show a restriction on equity.

U.S. GAAP discourages the use the the U.S. GAAP discourages the use the the word word reservereserve because it may seem to because it may seem to some that there is a cash or asset fund some that there is a cash or asset fund available -- there is not.available -- there is not.

An International Perspective -- An International Perspective -- EarningsEarnings

Almost all industrial countries require income Almost all industrial countries require income statements.statements.

The format and classification of earnings items The format and classification of earnings items on those income statements vary.on those income statements vary.

Revenue and expense recognition rules may vary Revenue and expense recognition rules may vary in detail but most countries require a form of in detail but most countries require a form of accrual accounting rather than cash basis.accrual accounting rather than cash basis.

The nature of what can by-pass the income The nature of what can by-pass the income statements may vary.statements may vary.

A few countries require inflation adjustments to A few countries require inflation adjustments to items on the income statement.items on the income statement.

Chapter SummaryChapter Summary This chapter has presented issues in This chapter has presented issues in

accounting for earnings and its effect on accounting for earnings and its effect on shareholders equity.shareholders equity.

Careful distinctions were made between Careful distinctions were made between results of operations and other changes results of operations and other changes in the firms’ wealth.in the firms’ wealth.

These distinctions are presented as These distinctions are presented as separate parts of the income statement.separate parts of the income statement.

The shareholders’ equity section is The shareholders’ equity section is likewise divided into different sections likewise divided into different sections reflections distinctions among sources of reflections distinctions among sources of capital.capital.

Appendix 12.1: Effects on Cash Flows Appendix 12.1: Effects on Cash Flows of Transactions Involving Shareholders’ of Transactions Involving Shareholders’

EquityEquity Capital contributions (including cash received Capital contributions (including cash received

from the issuance of stock options or from the issuance of stock options or warrants and treasury stock transactions) are warrants and treasury stock transactions) are a source of cash in the financing section.a source of cash in the financing section.

The conversion of convertible securities into The conversion of convertible securities into common stock is a financing activity but is common stock is a financing activity but is not reported unless it does not involves cash.not reported unless it does not involves cash.

Dividends are use of cash in the financing Dividends are use of cash in the financing section.section.

Rapid Review – Yes NoRapid Review – Yes No

1. Claims against assets after settling all 1. Claims against assets after settling all liabilities can be called residual interest.liabilities can be called residual interest.

2. A stock option allows the holder to 2. A stock option allows the holder to buy a stated number of shares of stock buy a stated number of shares of stock for the market price.for the market price.

3. Treasury shares are common shares 3. Treasury shares are common shares that have been repurchased by the firm.that have been repurchased by the firm.