ADA 2331 Ch 10 Notes PDF

ACCT 2331 Chapter 10 –Stockholders’ Equity A corporation is a legal entity, separate and distinct from its individual owners, created under the laws of a particular state. As a result, the corporation has an unlimited life, owners have lim...

ACCT 2331 Chapter 10 –Stockholders’ Equity A corporation is a legal entity, separate and distinct from its individual owners, created under the laws of a particular state. As a result, the corporation has an unlimited life, owners have limited legal liability and ownership interests (stocks) are easily transferable. The individual owners are called stockholders whose ownership in the corporation is evidenced by a stock certificate. Each stockholder has various stockholder’s rights which include: (a) the right to share in profits when a dividend is declared; (b) the right to vote in the election of directors and to establish corporate policies; (c) the pre-emptive right to maintain a proportionate interest in the ownership of the corporation by purchasing a proportionate share of additional capital stock, should the stock be issued; and (d) the right to share in the distribution of the assets of the corporation if it is liquidated. When only one class of capital stock is issued, it is called common stock. The common stockholders are the claimants to the residual interest in the corporation. The corporation may also have preferred stock. Three numbers associated with each class of stock: 1. Shares Authorized. Based on amount stated in charter. 2. Shares Issued. Shares put on the open market. 3. Shares Outstanding. Shares held by outside parties. If outstanding is less than issued, then the difference is found in treasury stock. The par value of each share of capital stock is a designated dollar amount per share established in the corporate charter. The par is required by some states so that creditors are protected with a minimum value called legal capital. The market value is the price at which the stock is issued or sold and has no direct relationship to par value. Journal entries associated with issuing stock: a. Issuance of 10 shares of $5 par value stock for $200. Cash (A +, amount received) 200 Common Stock (SE +, number of shares x par value) 50 Additional paid-in capital−common stock (SE +) 150 b. Issuance of 10 shares of $3 stated value stock for $200 Cash (A +, amount received) 200 Common stock (SE +, number of shares x stated value) 30 Additional Paid-in capital−common stock (SE +) 170 c. Issuance of 10 shares of no par and no stated value stock for $200 Cash (A +, amount received) 200 Common stock (SE +, amount of cash received) 200 ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 1 of 9 Issuing Stock for Assets Other than Cash. Put asset on books at FMV of asset or FMV of stock, whichever can be most easily determined. Example On 10-01-x7, gave 2,000 shares of $5 par value common stock for a machine. FMV of stock on day of exchange was $25/share. 10-01-x7 Machine (A +) (2,000 x 25) 50,000 Common stock (SE +) (2,000 x 5) 10,000 Additional Paid-in Capital (SE +) 40,000 Stock Split A stock split results in an increase or decrease in the number of shares outstanding with a corresponding decrease or increase in the par or stated value per share. No accounting entry is required for a stock split as the total dollar amount of all stockholders’ equity accounts remains unchanged. A stock split is usually intended to improve the marketability of the shares by reducing the market price of the stock being split. In general, the difference between a stock split and a stock dividend is based upon the size of the distribution. If the number of shares issued exceeds 20-25% of the shares outstanding, treatment as a stock split is warranted. Treasury Stock Treasury stock is a corporation’s own capital stock that: (1) has been fully paid for by stockholders; (2) has been legally issued; (3) is re-acquired by the corporation; and (4) is being held by the corporation. Among the more common reasons why a corporation acquires shares of its own stock are: (1) to have shares available for employee purchase plans; (2) to invest excess cash and help to maintain the market price of its stock; and (3) to use in the issuance of a stock dividend. When capital stock is re-acquired, the cost of the stock is recorded as an increase (debit) to a contra-stockholders’−equity account entitled Treasury Stock and as a credit to Cash. The par value of the stock is disregarded. For example, suppose that a corporation has previously issued 20,000 shares of $10 par common stock for $17 per share. The corporation re- acquires 500 shares of this stock at a market price of $20 per share. The journal entry to record the re-acquisition of the stock appears as follows: Treasury Stock (Contra SE +) ($20 x 500) 10,000 Cash (A +) 10,000 To record re-acquisition of 500 shares of common stock as treasury stock. Treasury stock is deducted from the total of contributed capital and retained earnings on the balance sheet. ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 2 of 9  Example--ACCOUNTING FOR TREASURY STOCK One thousand shares of $25 par value stock was issued at $60 per share on 01-04-x7. On 06-06-x7, 75 shares were re-acquired at $66 per share. On 07-11-x7, 20 shares of the treasury stock was re-issued at $68 per share. On 09-06-x7, 30 shares of treasury stock was re-issued at $58 per share. On 10-13-x7 200 shares were re-acquired at $56 per share. Cost Method 01-4-x7 Cash (1,000 x 60) 60,000 Common Stock (1,000 x 25) 25,000 Additional Paid-in Capital−Common Stock 35,000 Cost 06-06-x7 Treasury Stock (75 x 66) 4,950 Cash 4,950 07-11-x7 Cash (20 x 68) Cost 1,360 Treasury Stock (20 x 66) 1,320 Additional Paid-in Capital−Treasury Stock 40 09-06-x7 Cash (30 x 58) 1,740 Additional Paid-in Capital−Treasury Stock 40 (only up to its credit balance) Retained Earnings Cost 200 (remaining amount of debit needed) Treasury Stock (30 x 66) 1,980 Cost 10-13-x7 Treasury Stock (200 x 56) 11,200 Cash 11,200 Cash Dividends The accounting for a cash dividend requires information concerning three dates: (a) date of declaration; (b) date of record; and (c) date of payment. A liability is established by a charge to retained earnings on the declaration date for the amount of the dividend declared. No accounting entry is required on the date of record. The liability is liquidated on the payment date through a distribution of cash. Dividends – has three important dates. $10,000 cash dividend was declared on 7-1-x7 to all stockholders on record as of 8-15-x7, to be paid on 9-1-x7. (1) Date of Declaration 7-1-x7 Cash Dividends (Contra SE +) or Retained Earnings 10,000 Dividends Payable (L +) 10,000 (2) Date of Record 8-15-x7 No Journal Entry ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 3 of 9 (3) Date of Payment 9-1-x7 Dividends Payable (L -) 10,000 Cash (A -) 10,000 Cash Dividends is closed to Retained Earnings in closing entries. Dividends Payable is a Current Liability. To determine dollar amount of preferred dividend: Par Value or Stated Value x % = Preferred Dividend A preference to dividends is one right preferred stockholders have. That is, preferred stockholders must receive dividends before common stockholders, but only if dividends are declared. These dividends are usually expressed as a percentage of par value or as a specified dollar amount per share. Payment of dividends is never guaranteed. If a dividend on preferred stock is not declared in a particular year, but the undeclared dividends must be accumulated and paid in a later year when dividends are declared, the undeclared dividends are referred to as dividends in arrears and the stock is cumulative preferred stock. Otherwise the preferred stock is non-cumulative. Preferred stockholders of cumulative preferred stock must be paid all dividends in arrears before any dividends may be paid to common stockholders. Most preferred stock is cumulative. Stock Dividends A stock dividend that is less than 20-25% of the previously outstanding shares and is presumed to have no apparent effect on the market price per share, is defined as a small stock dividend. When the small stock dividend is declared, Retained Earnings is reduced (debited) by an amount equal to the fair market value of the additional shares issued, Common Stock to be Distributed is increased (credited) for the par or stated value and the excess of the fair market value over the par (stated) value is credited to the Additional Paid-In Capital from Stock Dividend. Common Stock to be Distributed is not a liability but a component of Contributed Capital until the stock dividend is issued and the account is eliminated. A large stock dividend, or split-up effected in the form of a dividend, is similar in nature to a stock split because of the resulting decrease in the market price per share. Therefore, it is recommended that only the par or stated value (the minimum amount legally required to be capitalized) be debited to Retained Earnings and credited to Common Stock to be Distributed when the dividend is declared. While this is theoretically inconsistent with the notion that a stock dividend is a distribution of earnings and should be based on the fair market value, the use of par value with large stock dividends is still a generally accepted accounting principle. ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 4 of 9 SMALL Dividend is LESS than 20-25% Use Market Price/share LARGE Dividend is GREATER than 20-25% Use Par value/share Shares Outstanding X Dividend % = Shares to be Issued as the stock dividend Example 1: ABC Company has 150,000 shares of common stock authorized and 40,000 shares issued and outstanding. The common stock has a $3 Par value and a market value of $26 per share on October 10, 2006. On October 10, 2006, ABC declares an 18% stock dividend to shareholders on record on October 15, 2006. The dividends are to be distributed on October 27, 2006. Record all necessary journal entries. SOLUTION: Since the dividend % is less than 20%, it is SMALL. 40,000 shares issued x.18 = 7,200 shares to be issued 10-10-06 Stock Dividend (7,200 x $26 Market) 187,200 Common Stock Dividend Distributable (7,200 x $3 Par) 21,600 Additional Paid-in Capital—Common 165,600 10-15-06 NO journal entry 10-27-06 Common Stock Dividend Distributable 21,600 Common Stock 21,600 Example 2: ABC Company has 150,000 shares of common stock authorized and 40,000 shares issued and outstanding. The common stock has a $3 Par value and a market value of $26 per share on October 10, 2006. On October 10, 2006, ABC declares an 30% stock dividend to shareholders on record on October 15, 2006. The dividends are to be distributed on October 27, 2006. Record all necessary journal entries. SOLUTION: Since the dividend % is greater than 20-25%, it is LARGE. 40,000 shares issued ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 5 of 9  x.30 = 12,000 shares to be issued 10-10-06 Stock Dividend (12,000 x $3 Par) 36,000 Common Stock Dividend Distributable (12,000 x $3 Par) 36,000 10-15-06 NO journal entry 10-27-06 Common Stock Dividend Distributable 36,000 Common Stock 36,000 Stockholders’ Equity Contributed Capital/Paid-In Capital Preferred Stock, 5%; $3 Par; 100,000 Shares Authorized; 40,000 Shares Issued & Outstanding Common Stock, No Par, $5 Stated Value; 500,000 Shares Authorized; 60,000 Shares Issued; 55,000 Shares Outstanding Additional Paid-In Capital Preferred Stock Common Stock Treasury Stock Total Contributed Capital + Retained Earnings = Total Contributed Capital and Retained Earnings - Treasury Stock (5,000 shares common) = Total Stockholders’ Equity Financial Ratios Return on Equity (ROE) measures the ability of the company management to generate earning from the resources that owners provide. Return on = Net Income Equity Average Stockholders’ Equity Return on the Market Value of Equity Return on the Market = Net Income Value of Equity Market Value of Equity* ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 6 of 9 *Market Value of Equity = Ending Stock Price x Number of Shares OUTSTANDING Earnings per Share (EPS) measures the net income earned per share of common stock. It is useful in comparing earnings performance for the same company over time. Earnings per = Net Income - Dividends on Preferred Stock Share Average Shares of Common Stock Outstanding Price-Earnings Ratio (PE Ratio) indicates how the stock is trading relative to current earnings. A high PE ratio indicates that the market has high hopes for a Company’s stock and has bid up the price. Price-Earnings = Stock Price Ratio Earnings per Share Journal Entries for Stock Transactions (Chapter 10) Serrato Company has the following information from its charter. Common Stock, $3 par, 150,000 shares authorized Preferred Stock, 7%, $20 Par, 90,000 shares authorized Record the transactions below in journal entry format. Sept. 1 Issued 4,000 shares of common stock at $11 per share. Sept. 15 Issued 1,000 shares of preferred stock at $52 per share. Sept. 23 Declared a Cash Dividend of $0.50 per share to common stockholders and $1.40 per share to preferred stockholders. Date of record is Sept. 30. Oct. 1 Paid the cash dividend declared on Sept. 23. Oct. 16 Issued 6,000 shares of common stock for $18 per share. Nov. 20 Purchased 500 shares of treasury common stock at $19/share. Nov. 29 Issued 2,880 share of preferred stock at $60/share. Dec. 10 Sold 200 shares of treasury common stock at $20/share. Dec. 22 Sold 180 shares of treasury common stock at $18.50/share Dec. 23 Declared a Cash dividend of $0.50 per share to common stockholders and $1.40 to preferred stockholders. Date of record is Dec. 30. Jan. 2 Paid the cash dividend declared on Dec. 23. Mar. 23 Declared a 15% stock dividend to common stockholders to be issued on Apr 4. On this date the market value was $21/share. Date of record is Mar. 30. Apr. 4 Issued the stock dividend ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 7 of 9 Sept 1 Cash (4000x11) 44,000 Common Stock (4000x3 par) 12,000 Additional Pd-In Cap-Com 32,000 15 Cash (1000x52) 52,000 Preferred Stock (1000x20) 20,000 Additional Pd-In Cap-Pref 32,000 23 Cash Dividend 3,400* Dividends Payable 3,400 * (4000 x $.50) + (1,000 x $1.40) Oct 1 Dividends Payable 3,400 Cash 3,400 Oct 16 Cash (6000x18) 108,000 Common Stock 18,000 Additional Pd-in Cap-Com 90,000 Nov 20 Treasury Stock-Com (500x19) 9,500 Cash 9,500 Nov 29 Cash (2880x60) 172,800 Preferred Stock (2880x20) 57,600 Additional Pd-In Cap-Pref 115,200 Dec 10 Cash (200x20) 4,000 Treasury Stock-Com (200x19) 3,800 Additional Pd-In Cap-Treas Com 200 Dec 22 Cash (180x18.50) 3,330 Additional Pd-In Cap-Treas Com 90 Treasury Stock-Com (180x19) 3,420 Dec 23 Cash Dividends 10,372** Dividends Payable 10,372 **Com = 4000 + 6000 – 500 + 200 + 180 = 9,880 Shares X $.50/Sh = 4940 Pref = 1000 + 2880 = 3880 Shares 3,880 Sh X $1.40/Sh = 5432 ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 8 of 9 Jan 2 Dividends Payable 10,387 Cash 10,387 Mar 23 Stock Dividend (9880x.15x21) 31,122 Com Stk Div Distributable (1482x3) 4,446 Additional Pd-In Cap-Com 26,676 Apr 4 Com Stk Div Distributable 4,446 Common Stock 4,446 ADA 2331 Ch 10 Notes.Corp.paid.in.Cap. Notes Spiceland,3rd.ed (2).docSpiceland, 3rd Ed. Page 9 of 9