Financial Accounting Textbook PDF

Prepared by Coby Harmon University of California, Santa Barbara Westmont College 11-1  Corporations: Organization, 11 Stock Transactions, and Stockholders’ Equity Learning Objectives 1 Discuss the major charac...

Prepared by Coby Harmon University of California, Santa Barbara Westmont College 11-1  Corporations: Organization, 11 Stock Transactions, and Stockholders’ Equity Learning Objectives 1 Discuss the major characteristics of a corporation. Explain how to account for the issuance of common, 2 preferred, and treasury stock. Explain how to account for cash dividends, stock 3 dividends, and stock splits. Discuss how stockholders’ equity is reported and 4 analyzed. 11-2  LEARNING Discuss the major characteristics of a 1 OBJECTIVE corporation. An entity separate and distinct from its owners. Classified by Purpose Classified by Ownership  Not-for-Profit  Publicly held  For Profit  Privately held ► Salvation Army ► McDonald’s ► Cargill Inc. ► American Cancer ► Nike Alternative Terminology Society ► PepsiCo Privately held corporations ► Google are also referred to as closely held corporations. 11-3 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights Advantages  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations Disadvantages  Additional Taxes 11-4 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. Corporation acts  Separate Legal Existence under its own name  Limited Liability of Stockholders rather than in the  Transferable Ownership Rights name of its stockholders.  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes 11-5 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence Limited to their  Limited Liability of Stockholders investment.  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes 11-6 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders Shareholders may  Transferable Ownership Rights sell their stock.  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes 11-7 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights Corporation can  Ability to Acquire Capital obtain capital through the issuance  Continuous Life of stock.  Corporate Management  Government Regulations  Additional Taxes 11-8 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights Continuance as a  Ability to Acquire Capital going concern is not affected by the  Continuous Life withdrawal, death, or  Corporate Management incapacity of a  Government Regulations stockholder, employee, or officer.  Additional Taxes 11-9 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital Separation of ownership and  Continuous Life management often  Corporate Management reduces an owner’s  Government Regulations ability to actively manage the  Additional Taxes company. 11-10 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes 11-11 LO 1  Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships.  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital Corporations pay income taxes as a  Continuous Life separate legal entity  Corporate Management and in addition,  Government Regulations stockholders pay taxes on cash  Additional Taxes dividends. 11-12 LO 1  Characteristics of a Corporation Illustration 11-1 Stockholders Corporation organization chart Chairman and Board of Directors President and Chief Executive Officer General Vice President Vice President Vice President Vice President Counsel/ Finance/Chief Human Marketing Operations Secretary Financial Officer Resources Treasurer Controller 11-13 LO 1  Forming a Corporation Initial Steps:  File application with the Secretary of State.  State grants charter.  Corporation develops by-laws. Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey). Corporations engaged in interstate commerce must obtain a license from each state in which they do business. 11-14 LO 1  Stockholder Rights 1. Vote in election of board of directors and on actions that require stockholder approval. 2. Share the corporate earnings through receipt of dividends. Illustration 11-3 Ownership rights of stockholders 11-15 LO 1  Stockholder Rights 3. Keep the same percentage ownership when new shares of stock are issued (preemptive right). * A number of companies have eliminated the preemptive right. Illustration 11-3 Ownership rights of stockholders 11-16 LO 1  Stockholder Rights 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. Illustration 11-3 Ownership rights of stockholders 11-17 LO 1  Stock Issue Considerations When a corporation decides to issue stock, it must resolve a number of basic questions: 1. How many shares should it authorize for sale? 2. How should it issue the stock? 3. What value should the corporation assign to the stock? 11-18 LO 1  Stock Issue Considerations AUTHORIZED STOCK  Charter indicates the amount of stock that a corporation is authorized to sell.  Number of authorized shares is often reported in the stockholders’ equity section.  No formal accounting entry. 11-19 LO 1  Stock Issue Considerations Prenumbered Shares Illustration 11-4 Name of corporation Stockholder’s name Signature of corporate official 11-20 LO 1  Stock Issue Considerations ISSUANCE OF STOCK  Companies issue common stock directly to investors or indirectly through an investment banking firm.  Factors in setting price for a new issue of stock: 1. Company’s anticipated future earnings. 2. Expected dividend rate per share. 3. Current financial position. 4. Current state of the economy. 5. Current state of the securities market. 11-21 LO 1  Stock Issue Considerations MARKET PRICE OF STOCK  Stock of publicly held companies is traded on organized exchanges.  Interaction between buyers and sellers determines the prices per share.  Prices tend to follow the trend of a company’s earnings and dividends.  Factors beyond a company’s control may cause day-to- day fluctuations in market prices. 11-22 LO 1  ANATOMY OF A FRAUD The president, chief operating officer, and chief financial officer of SafeNet, a software encryption company, were each awarded employee stock options by the company’s board of directors as part of their compensation package. Stock options enable an employee to buy a company’s stock sometime in the future at the price that existed when the stock option was awarded. For example, suppose that you received stock options today, when the stock price of your company was $30. Three years later, if the stock price rose to $100, you could “exercise” your options and buy the stock for $30 per share, thereby making $70 per share. After being awarded their stock options, the three employees changed the award dates in the company’s records to dates in the past, when the company’s stock was trading at historical lows. For example, using the previous example, they would choose a past date when the stock was selling for $10 per share, rather than the $30 price on the actual award date. In our example, this would increase the profit from exercising the options to $90 per share. Total take: $1.7 million THE MISSING CONTROL Independent internal verification. The company’s board of directors should have ensured that the awards were properly administered. For example, the date on the minutes from the board meeting should be compared to the dates that were recorded for the awards. The dates should again be confirmed upon exercise. 11-23 LO 1  Stock Issue Considerations PAR AND NO-PAR VALUE STOCK  Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors.  Today many states do not require a par value.  No-par value stock is fairly common today.  In many states, the board of directors assigns a stated value to no-par shares. 11-24 LO 1  Stock Issue Considerations Question Which of these statements is false? a. Ownership of common stock gives the owner a voting right. b. The stockholders’ equity section begins with paid-in capital. c. The authorization of capital stock does not result in a formal accounting entry. d. Legal capital is intended to protect stockholders. 11-25 LO 1  DO IT! 1a Corporate Organization Indicate whether each of the following statements is true or false. False 1. Similar to partners in a partnership, stockholders of a ______ corporation have unlimited liability. True 2. It is relatively easy for a corporation to obtain capital ______ through the issuance of stock. False 3. The separation of ownership and management is an ______ advantage of the corporate form of business. ______ False 4. The journal entry to record the authorization of capital stock includes a credit to the appropriate capital stock account. ______ False 5. All states require a par value per share for capital stock. 11-26 LO 1  Corporate Capital Preferred PreferredStock Stock Account Account Paid-in Paid-inCapital Capital Paid-in Paid-inCapital Capital in inExcess ExcessofofPar Par Account Account Common CommonStock Stock Account Account Two Primary Sources of Retained RetainedEarnings Earnings Account Account Equity Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock. 11-27 LO 1  Corporate Capital Preferred PreferredStock Stock Account Account Paid-in Paid-inCapital Capital Paid-in Paid-inCapital Capital in inExcess ExcessofofPar Par Account Account Common CommonStock Stock Account Account Two Primary Sources of Retained RetainedEarnings Earnings Account Account Equity Retained earnings is net income that a corporation retains for future use. 11-28 LO 1  Corporate Capital If Delta Robotics has a balance of $800,000 in common stock and $130,000 in retained earnings at the end of its first year, its stockholders’ equity section is as follows. Illustration 11-5 Stockholders’ equity section 11-29 LO 1  Corporate Capital Comparison of the owners’ equity (stockholders’ equity) accounts reported on a balance sheet for a proprietorship and a corporation. Illustration 11-6 Comparison of owners’ equity accounts 11-30 LO 1  DO IT! 1b Corporate Capital At the end of its first year of operation, Doral Corporation has $750,000 of common stock and net income of $122,000. Prepare (a) the closing entry for net income and (b) the stockholders’ equity section at year-end. Solution (a) Income Summary 122,000 Retained Earnings 122,000 (b) Stockholders’ equity Paid-in capital common Stock $750,000 Retained earnings 122,000 Total stockholders’ equity $872,000 11-31 LO 1  Explain how to account for the issuance LEARNING OBJECTIVE 2 of common, preferred, and treasury stock. Accounting for Common Stock Primary Objectives: 1) Identify the specific sources of paid-in capital. 2) Maintain the distinction between paid-in capital and retained earnings. Other than consideration received, the issuance of common stock affects only paid-in capital accounts. 11-32 LO 2  Accounting for Common Stock ISSUING PAR VALUE COMMON STOCK FOR CASH Illustration: Assume that Hydro-Slide, Inc. issues 1,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share. a. Cash 1,000 Common Stock (1,000 x $1) 1,000 b. Cash 5,000 Common Stock (1,000 x $1) 1,000 Paid-in Capital in Excess of Par Value 4,000 11-33 LO 2  Accounting for Common Stock Illustration 11-7 Stockholders’ equity—paid-in Alternative Terminology capital in excess of par Paid-in Capital in Excess of Par is also called Premium on Stock. 11-34 LO 2  Accounting for Common Stock ISSUING NO-PAR COMMON STOCK FOR CASH Illustration: Assume that instead of $1 par value stock, Hydro- Slide, Inc. has $5 stated value no-par stock and the company issues 5,000 shares at $8 per share for cash. Cash 40,000 Common Stock 25,000 Paid-in Capital in Excess of Stated Value 15,000 11-35 LO 2  Accounting for Common Stock ISSUING NO-PAR COMMON STOCK FOR CASH Illustration: What happens when no-par stock does not have a stated value? Cash 40,000 Common Stock 40,000 11-36 LO 2  Accounting for Common Stock ISSUING COMMON STOCK FOR SERVICES OR NONCASH ASSETS Corporations also may issue stock for:  Services (attorneys or consultants).  Noncash assets (land, buildings, and equipment). Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable. 11-37 LO 2  COMMON STOCK FOR SERVICES Illustration: Attorneys have helped Jordan Company incorporate. They have billed the company $5,000 for their services. They agree to accept 4,000 shares of $1 par value common stock in payment of their bill. At the time of the exchange, there is no established market price for the stock. Prepare the journal entry for this transaction. Organization Expense 5,000 Common Stock (4,000 x $1) 4,000 Paid-in Capital in Excess of Par 1,000 11-38 LO 2  COMMON STOCK FOR NONCASH ASSET Illustration: Athletic Research Inc. is an existing publicly held corporation. Its $5 par value stock is actively traded at $8 per share. The company issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000. Prepare the journal entry for this transaction. Land 80,000 Common Stock (10,000 x $5) 50,000 Paid-in Capital in Excess of Par 30,000 11-39 LO 2  Accounting for Stock Transactions Accounting for Preferred Stock Typically, preferred stockholders have a priority as to: 1. Distributions of earnings (dividends). 2. Assets in event of liquidation. Generally do not have voting rights. Accounting for preferred stock at issuance is similar to that for common stock. 11-40 LO 2  Accounting for Preferred Stock Illustration: Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. The journal entry to record the issuance is: Cash 120,000 Preferred Stock (10,000 x $10) 100,000 Paid-in Capital in Excess of Par 20,000 Preferred stock may have a par value or no-par value. 11-41 LO 2  Investor Insight Facebook 11-42 LO 2  DO IT! 2a Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 1 Cash 1,200,000 Common Stock (100,000 × $1) 100,000 Paid-in Capital in Excess of Par Value— Common Stock 1,100,000 11-43 LO 2  DO IT! 2a Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 15 Organizational Expense 50,000 Common Stock (5,000 × $1) 5,000 Paid-in Capital in Excess of Par Value— Common Stock 45,000 11-44 LO 2  DO IT! 2a Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 28 Cash 45,000 Preferred Stock (1,500 × $10) 15,000 Paid-in Capital in Excess of Par Value— Preferred Stock 30,000 11-45 LO 2  Accounting for Treasury Stock Preferred PreferredStock Stock Account Account Paid-in Paid-inCapital Capital Paid-in Paid-inCapital Capital in inExcess ExcessofofPar Par Account Account Common CommonStock Stock Account Account Two Primary Sources of Retained RetainedEarnings Earnings Account Account Equity Less: Less: Treasury TreasuryStock Stock Account Account 11-46 LO 2  Accounting for Treasury Stock Treasury stock is a corporation’s own stock that it has reacquired from shareholders but not retired. Corporations acquire treasury stock for various reasons: 1. To reissue the shares to officers and employees under bonus and stock compensation plans. 2. To enhance the stock’s market value. 3. To have additional shares available for use in the acquisition of other companies. 4. To increase earnings per share. 11-47 LO 2  Accounting for Treasury Stock PURCHASE OF TREASURY STOCK  Companies generally use the cost method.  Debit Treasury Stock for the price paid to reacquire the shares.  Treasury stock is a contra stockholders’ equity account. Reduces stockholders’ equity. Helpful Hint Treasury shares do not have dividend rights or voting rights. 11-48 LO 2  PURCHASE OF TREASURY STOCK Illustration 11-8 Stockholders’ equity with no treasury stock Illustration: On February 1, 2019, Mead acquires 4,000 shares of its stock at $8 per share. Treasury Stock (4,000 x $8) 32,000 Cash 32,000 11-49 LO 2  PURCHASE OF TREASURY STOCK Illustration 11-9 Stockholders’ equity with treasury stock Both the number of shares issued (100,000) and the number of shares held as treasury (4,000) are disclosed. 11-50 LO 2  DISPOSAL OF TREASURY STOCK Sale of Treasury Stock  Above Cost  Below Cost Both increase total assets and stockholders’ equity. Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved. 11-51 LO 2  SALE OF TREASURY STOCK “ABOVE” COST Illustration: On July 1, Mead sells for $10 per share 1,000 shares of its treasury stock previously acquired at $8 per share and makes the following entry. Cash 10,000 Treasury Stock 8,000 Paid-in Capital from Treasury Stock 2,000 A corporation does not realize a gain or suffer a loss from stock transactions with its own stockholders. 11-52 LO 2  SALE OF TREASURY STOCK “BELOW” COST Illustration: On Oct. 1, Mead sells an additional 800 shares of treasury stock at $7 per share and makes the following entry. Cash 5,600 Paid-in Capital from Treasury Stock 800 Treasury Stock 6,400 Illustration 11-10 Treasury stock accounts 11-53 LO 2  SALE OF TREASURY STOCK “BELOW” COST Illustration: On Dec. 1, assume that Mead, Inc. sells its remaining 2,200 shares at $7 per share and makes the following entry. Cash 15,400 Limited to Paid-in Capital from Treasury Stock 1,200 balance on hand Retained Earnings 1,000 Treasury Stock 17,600 11-54 LO 2  Accounting Across the Organization A Bold Repurchase Strategy In a bold (and some would say risky) move, Reebok at one time bought back nearly a third of its shares. This repurchase of shares dramatically reduced Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed its stock was severely underpriced. The repurchase of so many shares was meant to signal management’s belief in good future earnings. Skeptics, however, suggested that Reebok’s management was repurchasing shares to make it less likely that another company would acquire Reebok (in which case Reebok’s top managers would likely lose their jobs). By depleting its cash, Reebok became a less attractive acquisition target. Acquiring companies like to purchase companies with large cash balances so they can pay off debt used in the acquisition. 11-55 LO 2  DO IT! 2b Treasury Stock Santa Anita Inc. purchases 3,000 shares of its $50 par value common stock for $180,000 cash on July 1. It will hold the shares in the treasury until resold. On November 1, the corporation sells 1,000 shares of treasury stock for cash at $70 per share. Journalize the treasury stock transactions. Solution July 1 Treasury Stock 180,000 Cash 180,000 Nov. 1 Cash 70,000 Treasury Stock 60,000 Paid-in Capital from Treasury Stock 10,000 11-56 LO 2  LEARNING Explain how to account for cash 3 OBJECTIVE dividends. Distribution of cash or stock to stockholders on a pro rata (proportional to ownership) basis. Types of Dividends: 1. Cash dividends. 3. Stock dividends. 2. Property dividends. 4. Scrip (promissory note). Dividends are generally reported quarterly as a dollar amount per share. 11-57 LO 3  Cash Dividends For a corporation to pay a cash dividend, it must have: 1. Retained earnings - Payment of cash dividends from retained earnings is legal in all states. 2. Adequate cash. 3. A declaration of dividends by the Board of Directors. 11-58 LO 3  Cash Dividends Three dates are important: Illustration 11-11 Key dividend dates 11-59 LO 3  Cash Dividends Illustration: On Dec. 1, the directors of Media General declare a 50 cents per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is payable on Jan. 20 to shareholders of record on Dec. 22. Dec. 1 (Declaration Date) Cash Dividends 50,000 Dividends Payable 50,000 Dec. 22 (Date of Record) No entry Jan. 20 (Payment Date) Dividends Payable 50,000 Cash 50,000 11-60 LO 3  Dividend Preferences  Right to receive dividends before common stockholders.  Per share dividend amount is stated as a percentage of the preferred stock’s par value or as a specified amount.  Cumulative Dividend Preferred stockholders must be paid both current-year dividends and any unpaid prior- year dividends before common stockholders receive dividends. 11-61 LO 3  Dividend Preferences CUMULATIVE DIVIDEND Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding. Each $100 share pays a $7 dividend (.07 x $100). The annual dividend is $35,000 (5,000 x $7 per share). If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends in the current year. Illustration 11-12 Computation of total dividends to preferred stock 11-62 LO 3  Dividend Preferences ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON STOCK Holders of cumulative preferred stock must be paid any unpaid prior-year dividends and their current year’s dividend before common stockholders receive dividends. 11-63 LO 3  ALLOCATING CASH DIVIDENDS Illustration: On December 31, 2019, IBR Inc. has 1,000 shares of 8%, $100 par value cumulative preferred stock. It also has 50,000 shares of $10 par value common stock outstanding. At December 31, 2019, the directors declare a $6,000 cash dividend. Prepare the entry to record the declaration of the dividend. Cash Dividends 6,000 Dividends Payable 6,000 Preferred Dividends: 1,000 shares x $100 par x 8% = $8,000 11-64 LO 3  ALLOCATING CASH DIVIDENDS Illustration: At December 31, 2020, IBR declares a $50,000 cash dividend. Show the allocation of dividends to each class of stock. 2019 2020 Dividends declared $ 6,000 $ 50,000 Dividends in arrears 2,000 ** Allocation to preferred 6,000 8,000 * Remainder to common $ - $ 40,000 * 1,000 shares x $100 par x 8% = $8,000 ** 2019 Pfd. dividends $8,000 – declared $6,000 = $2,000 11-65 LO 3  ALLOCATING CASH DIVIDENDS Illustration: At December 31, 2020, IBR declares a $50,000 cash dividend. Prepare the entry to record the declaration of the dividend. Cash Dividends 50,000 Dividends Payable 50,000 11-66 LO 3  Dividends on Preferred and DO IT! 3a Common Stock MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, 2019. At December 31, 2019, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. 1. The preferred stock is noncumulative, and the company has not missed any dividends in previous years. Solution Preferred stockholders are paid only this year’s dividend. Preferred stockholders = $12,000 (2,000 x.06 x $100). Common stockholders = $48,000 ($60,000 - $12,000). 11-67 LO 3  Dividends on Preferred and DO IT! 3a Common Stock MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, 2017. At December 31, 2017, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. 2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years. Solution Past unpaid dividends do not have to be paid. Preferred stockholders = $12,000 (2,000 x.06 x $100). Common stockholders = $48,000 ($60,000 - $12,000). 11-68 LO 3  Dividends on Preferred and DO IT! 3a Common Stock MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, 2017. At December 31, 2017, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. 3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years. Solution Dividends that have been missed (dividends in arrears) must be paid. Preferred stockholders = $36,000 (3 x 2,000 x.06 x $100). Common stockholders = $24,000 ($60,000 - $36,000). 11-69 LO 3  Stock Dividends A pro rata (proportional to ownership) distribution of the corporation’s own stock to stockholders. Reasons why corporations issue stock dividends: 1. Satisfy stockholders’ dividend expectations without spending cash. 2. Increase marketability of the corporation’s stock. 3. Emphasize a portion of stockholders’ equity has been permanently reinvested in the business. 11-70 LO 3  Stock Dividends  Small stock dividend (less than 20–25% of the corporation’s issued stock, recorded at fair market value) *  Large stock dividend (greater than 20–25% of issued stock, recorded at par value) * Accounting based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares. 11-71 LO 3  ENTRIES FOR STOCK DIVIDENDS Illustration: Medland Corporation declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair market value of its stock is $15 per share. Record the entry on the declaration date: Stock Dividends (50,000 x 10% x $15) 75,000 Common Stock Dividends Distributable 50,000 Paid-in Capital in Excess of Par—Common 25,000 Illustration 11-14 Statement presentation of common stock dividends distributable 11-72 LO 3  Stock Dividends Illustration: Medland Corporation declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair market value of its stock is $15 per share. Record the entry on the declaration date: Stock Dividends (50,000 x 10% x $15) 75,000 Common Stock Dividends Distributable 50,000 Paid-in Capital in Excess of Par—Common 25,000 Record the journal entry when Medland issues the dividend shares. Common Stock Dividends Distributable 50,000 Common Stock 50,000 11-73 LO 3  Stock Dividends EFFECTS OF STOCK DIVIDENDS Illustration 11-15 Stock dividend effects 11-74 LO 3  Stock Dividends Question Which of the following statements about small stock dividends is true? a. A debit to Stock Dividends for the par value of the shares issued should be made. b. A small stock dividend decreases total stockholders’ equity. c. Market value per share should be assigned to the dividend shares. d. A small stock dividend ordinarily will have an effect on par value per share of stock. 11-75 LO 3  Stock Dividends Question In the stockholders’ equity section, Common Stock Dividends Distributable is reported as a(n): a. deduction from total paid-in capital and retained earnings. b. current liability. c. deduction from retained earnings. d. addition to capital stock. 11-76 LO 3  Stock Splits  Issuance of additional shares to stockholders according to their percentage ownership.  Reduction in the par or stated value per share.  Increase in number of shares outstanding.  Reduces the market value of shares.  No journal entry recorded. Helpful Hint A stock split changes the par value per share but does not affect any balances in stockholders’ equity. 11-77 LO 3  Stock Splits Effect of 4-for-1 stock split for stockholders Illustration 11-16 11-78 LO 3  Stock Splits Effects for Medland Corporation, assuming that it splits its 50,000 shares of common stock on a 2-for-1 basis. Illustration 11-17 Stock split effects LO 3 11-79  Investor Insight Berkshire Hathaway https://finance.yahoo.com/quote/BRK-A/ 11-80 LO 3  Stock Dividends and Stock DO IT! 3b Splits Sing CD Company has had five years of record earnings. Due to this success, the market price of its 500,000 shares of $2 par value common stock has tripled from $15 per share to $45. During this period, paid-in capital remained the same at $2,000,000. Retained earnings increased from $1,500,000 to $10,000,000. President Joan Elbert is considering either a 10% stock dividend or a 2-for-1 stock split. She asks you to show the before-and-after effects of each option on retained earnings, total stockholders’ equity, and par value per share. 11-81 LO 3  Stock Dividends and Stock DO IT! 3b Splits Sing CD Company has had five years of record earnings. Due to this success, the market price of its 500,000 shares of $2 par value common stock has tripled from $15 per share to $45. President Joan Elbert is considering either a 10% stock dividend or a 2-for-1 stock split. 11-82 LO 3  LEARNING Discuss how stockholders’ equity is 4 OBJECTIVE reported and analyzed. Retained earnings is net income that a company retains in the business.  Part of the stockholders’ claim on the total assets of the corporation.  Debit balance in Retained Earnings is identified as a deficit. Illustration 11-20 Stockholders’ equity with deficit 11-83 LO 4  Retained Earnings Restrictions Restrictions can result from: 1. Legal restrictions. 2. Contractual restrictions. 3. Voluntary restrictions. Illustration 11-21 Disclosure of unrestricted retained earnings 11-84 LO 4  Balance Sheet Presentation of Stockholders’ Equity Companies report  paid-in capital, 1. Capital stock 2. Additional paid-in capital  retained earnings,  accumulated other comprehensive income, and  treasury stock. 11-85 LO 4  Illustration 11-22 Stockholders’ equity section of balance sheet 11-86  Reporting Stockholders’ DO IT! 4a Equity Jennifer Corporation has issued 300,000 shares of $3 par value common stock. It is authorized to issue 600,000 shares. The paid-in capital in excess of par value on the common stock is $380,000. The corporation has reacquired 15,000 shares at a cost of $50,000 and is currently holding those shares. It also had a cumulative other comprehensive loss of $82,000. The corporation also has 4,000 shares issued and outstanding of 8%, $100 par value preferred stock. It is authorized to issue 10,000 shares. The paid-in capital in excess of par value on the preferred stock is $97,000. Retained earnings is $610,000. Prepare the stockholders’ equity section of the balance sheet. 11-87 LO 4 11-88 LO 4  Analysis of Stockholders’ Equity PAYOUT RATIO To illustrate, Nike’s dividends were recently $821 million (2013-14 year, May 31) and net income was $2,693 million. Illustration 11-23 shows Nike’s payout ratio. Illustration 11-23 The payout ratio measures the percentage of earnings a company distributes in the form of cash dividends to common stockholders. Evolution: https://www.financecharts.com/stocks/NKE/dividends/dividend-payout-ratio 11-89 LO 4  RETURN ON COMMON STOCKHOLDERS’ EQUITY To illustrate, Walt Disney Company’s beginning-of-the-year and end- of-the-year common stockholders’ equity were $31,820 and $30,753 million, respectively. Its net income was $4,687 million, and no preferred stock was outstanding. Illustration 11-25 Ratio shows how many dollars of net income the company earned for each dollar invested by the common stockholders. 11-90 LO 4  Analyzing Stockholders’ DO IT! 4b Equity Compute return on common stockholders’ equity for each year. 11-91 LO 4  LEARNING APPENDIX 11A: Describe the use and content of OBJECTIVE 5 the stockholders’ equity statement. Illustration 11A-1 When a stockholders’ equity statement is presented, a retained earnings statement is not necessary. 11-92 LO 5  LEARNING APPENDIX 11B: Compute book value per 6 Book Value—Another per Share Amount OBJECTIVE share. Book Value per Share The equity a common stockholder has in the net assets of the corporation. Illustration 11B-1 Book value per share formula 11-93 LO 6  Book Value per Share Book Value—Another per Share Amount The computation of book value per share involves the following steps. 1. Compute the preferred stock equity. This equity is equal to the sum of the call price of preferred stock plus any cumulative dividends in arrears. If the preferred stock does not have a call price, the par value of the stock is used. 2. Determine the common stock equity. Subtract the preferred stock equity from total stockholders’ equity. 3. Determine book value per share. Divide common stock equity by shares of common stock outstanding. 11-94 LO 6  Book Value per Share Book Value—Another per Share Amount Illustration: Using the stockholders’ equity section of Graber Inc. shown in Illustration 11-22. Graber’s preferred stock is callable at $120 per share and is cumulative. Assume that dividends on Graber’s preferred stock were in arrears for one year, $54,000 (6,000 x $9). The computation of preferred stock equity is: Illustration 11B-2 Computation of preferred stock equity—Step 1 11-95 LO 6  Book Value per Share Book Value—Another per Share Amount Illustration 11B-2 Computation of book value: Illustration 11B-3 11-96 LO 6  Book Value versus BookMarket Value Value—Another per Share Amount The correlation between book value and the annual range of a company’s market value per share is often remote. Illustration 11B-4 Book value and market prices compared 11-97 LO 6  LEARNING Compare the accounting for stockholders’ OBJECTIVE 7 equity under GAAP and IFRS. Key Points Similarities  Aside from the terminology used, the accounting transactions for the issuance of shares and the purchase of treasury stock are similar.  Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares.  The accounting related to prior period adjustment is essentially the same under IFRS and GAAP. 11-98 LO 7  Key Points  The income statement using IFRS is called the statement of comprehensive income. A statement of comprehensive income is presented in a one- or two-statement format. The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic. In the two-statement approach, a traditional income statement is prepared. It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items. Regardless of which approach is reported, income tax expense is required to be reported.  The computations related to earnings per share are essentially the same under IFRS and GAAP. 11-99 LO 7  Key Points Differences  Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.  Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors. 11-100 LO 7  Key Points  There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology. 11-101 LO 7  Key Points  A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital.  IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.  Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and share holders’ funds. 11-102 LO 7  Looking to the Future The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. For example, it is likely that the statement of stockholders’ equity and its presentation will be examined closely. Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations. 11-103 LO 7  IFRS Self-Test Questions Under IFRS, a statement of comprehensive income must include: a) accounts payable. b) income tax expense. c) retained earnings. d) preference stock. 11-104 LO 7  IFRS Self-Test Questions Which of the following is true? a) In the United States, the primary corporate stockholders are financial institutions. b) Share capital means total assets under IFRS. c) The IASB and FASB are presently studying how financial statement information should be presented. d) The amount to treasury stock is very different between U.S. GAAP and IFRS. 11-105 LO 7  A Look at IFRS IFRS Self-Test Questions Under IFRS, the amount of capital received in excess of par value would be credited to: a) Retained Earnings. b) Contributed Capital. c) Share Premium. d) Par value is not used under IFRS. 11-106 LO 7  Copyright “Copyright © 2017 John Wiley & Sons, Inc. 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