Unit 6 Part 1 Stockholder's Equity Journal entries, ratios, formulas and important Information

On January 20, 2020, Pacific acquires 10,000 shares of its stock at $11 per share. Pacific records the reacquisition as follows.

(DR) Treasury Stock 110,000 (CR)Cash 110,000

The accounting for preferred stock at issuance is similar to that for common stock. A corporation allocates proceeds between the par value of the preferred stock and additional paid-in capital. To illustrate, assume that Bishop Co. issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Bishop records the issuance as follows.

(DR)Cash 120,000 (CR) Preferred Stock 100,000 (CR) Paid-in Capital in Excess of Par—Preferred Stock 20,000

Sale of T Stock Above Cost: When the selling price of shares of treasury stock exceeds its cost, a company credits the difference to Paid-in Capital from Treasury Stock. To illustrate, assume that Pacific acquired 10,000 shares of its treasury stock at $11 per share. It now sells 1,000 shares at $15 per share on March 10. Pacific records the entry as follows.

(DR)Cash 15,000 (CR)Treasury Stock 11,000 (CR)Paid-in Capital from Treasury Stock 4,000

A company's balance sheet displays common stock of $150,000, preferred stock of $50,000, additional paid-in capital from common stock of $100,000 and retained earnings of $80,000. Which amount represents total stockholders' equity?

150,000+50,000+ 100000+80000 Accounting Rule: stockholders' equity is comprised of a. Capital stock - common stock and preferred stock. b. Additional paid-in capital. c. Retained earnings. d. Treasury stock as a contra account.

A stock dividend is considered small when it is a dividend of

25% or less of the corporation's outstanding stock.

A company reported the following information in its financial statements • Net income $70,000 • Preferred dividends $10,000 • Beginning common stockholders' equity $100,000 • Ending common stockholders' equity $200,000 • Common shares outstanding 50,000 What is the return on common stockholders' equity?

40% average total common stockholders' equity =$100,000 + $200,000) ÷ 2 = $150,000. (Net income of $70,000 - preferred dividends of $10,000) ÷ Average total common stockholders' equity of $150,000

A company has a net income of $100,000; cash dividends to common stockholders of $7,500; and cash dividends to preferred shareholders of $2,500. Which value is the company's payout ratio?

7.7% $7,500 / ($100,000 - $2,500)

Liquidating Dividends

A dividend NOT based on retained earnings. Any dividend not based on profits/earnings reduces paid-in capital. A dividend which is a return to stockholders of a portion of their original investments.-paid from contributed capital, not retained earnings -when the dividend is greater than the balance in retained earnings -a return of capital rather than a return on capital -in some cases, management simply decides to cease business and declares a liquidating dividends At Declaration D-Retained Earnings (Dividends declared)D- Additional paid-in capitalC- Dividends Payable Date of Payment:D- Dividends PayableC-Cash

Treasury Stock

After reacquiring shares, a company may either retire them or hold them in the treasury for reissue. If not retired, such shares are referred to as treasury stock (treasury shares). Technically, treasury stock is a corporation's own stock, reacquired after having been issued and fully paid. Treasury stock is not an asset. When a company purchases treasury stock, a reduction occurs in both assets and stockholders' equity. It is inappropriate to imply that a corporation can own a part of itself. A corporation may sell treasury stock to obtain funds, but that does not make treasury stock a balance sheet asset. When a corporation buys back some of its own outstanding stock, it has not acquired an asset; it reduces net assets Treasury stock is essentially the same as unissued capital stock.

. A company reported the following information in its financial statements • Net income: $70,000 • Preferred dividends: $10,000 • Common stockholders' equity: $200,000 • Common shares outstanding: 50,000 What is the book value per share?

Ans $4.00 $200,000 / 50,000

On December 31, a company has the following data available Net Income $180,000 Interest expense $10,000 Total assets at the beginning of the year $810,000 Total assets at the end of the year $740,000 Total common stockholders' equity at the beginning of the year $520,000 Total common stockholders' equity at the end of the year $510,000 What is return on equity? (Round your final answer to two decimal places, X.XX%)

Ans 34.95% average total common stockholders' equity =$520,000 + $510,000) ÷ 2 = $515,000. (Net income of $180,000) ÷ Average total common stockholders' equity of $515,000

Question 22 Page 3 Cost method Which transaction includes a debit to paid-in capital from treasury stock for $10,000? a. first sale of 1,000 shares. b. second sale of 5,000 shares. c. the retirement of 1,000 shares. d. third sale of 5,000 shares.

Ans d Journal entry for 1st sale debit cash (1,000 x $10) 10,000 credit treasury stock (sales = cost) 10,000 Journal entry for 2nd sale debit cash (5,000 x $12) 60,000 credit treasury stock (at cost) 50,000 credit paid-in capital from treasury stock ($12 -$10) 10,000 Journal entry for 3rd sale debit cash (5,000 x $6) 30,000 debit paid-in capital from treasury stock (remove previous credit balance) 10,000 debit retained earnings (plug) 10,000 credit treasury stock (at cost) 50,000

articles of incorporation

Anyone who wishes to establish a corporation must submit articles of incorporation to the state in which incorporation is desired. After fulfilling requirements, the state issues a corporation charter, thereby recognizing the company as a legal entity subject to state law. Regardless of the number of states in which a corporation has operating divisions, it is incorporated in only one state.

To make a market in the stock

As one company executive noted, "Our company is trying to establish a floor for the stock." Purchasing stock in the marketplace creates a demand. This may stabilize the stock price or, in fact, increase it.

For example, Trendler, Inc. transferred to stockholders some of its equity investments costing $1,250,000 by declaring a property dividend on December 28, 2019, to be distributed on January 30, 2020, to stockholders of record on January 15, 2020. At the date of declaration, the securities have a fair value of $2,000,000. Trendler makes the entries shown in Figure 6.11.

At date of declaration(December28,2019) (DR)Equity Investments 750,000 (CR) Unrealized Holding Gain or Loss—Income ($2,000,000 − $1,250,000) 750,000

To thwart takeover attempts or to reduce the number of stockholders.

By reducing the number of shares held by the public, existing owners and managements bar "outsiders" from gaining control or significant influence. When Ted Turner attempted to acquire CBS, CBS started a substantial buyback of its stock. Companies may also use stock purchases to eliminate dissident stockholders.

Book Value Per Share

CSE/Outstanding shares

Corporations purchase their outstanding stock for several reasons: To provide tax-efficient distributions of excess cash to shareholders.

Capital gain rates on sales of stock to the company by the stockholders have been approximately half the ordinary tax rate for many investors. This advantage has been somewhat diminished by recent changes in the tax law related to dividends.

The following four categories normally appear as part of stockholders' equity:

Capital stock. Additional paid-in capital. Retained earnings. Accumulated other comprehensive income.

Sale of T Stock Below Cost: When a corporation sells treasury stock below its cost, it usually debits the excess of the cost over selling price to Paid-in Capital from Treasury Stock. Thus, if Pacific sells an additional 1,000 shares of treasury stock on March 21 at $8 per share, it records the sale as follows.

Cash 8000 PIC from T stock 3,000 T Stock 11,000

Payout ratio

Cash Dividends/NI-preferred stock outstanding

Companies generally base dividend distributions either on accumulated profits (that is, retained earnings) or on some other capital item such as additional paid-in capital. Dividends are of the following types.

Cash dividends. Property dividends (dividends in kind). Liquidating dividends. All dividends, except for stock dividends, reduce the total stockholders' equity in the corporation.

Cumulative Preferred stock

Cumulative preferred stock requires that if a corporation fails to pay a dividend in any year, it must make it up in a later year before paying any dividends to common stockholders. If the directors fail to declare a dividend at the normal date for dividend action, the dividend is said to have been "passed." Any passed dividend on cumulative preferred stock constitutes a dividend in arrears. Because no liability exists until the board of directors declares a dividend, a corporation does not record a dividend in arrears as a liability but discloses it in a note to the financial statements. A corporation seldom issues noncumulative preferred stock because a passed dividend is lost forever to the preferred stockholder. As a result, this stock issue would be less marketable.

Property Dividends

Dividends payable in assets of the corporation other than cash e.g., merchandise, real-estate, investments (securities of other companies). Most common is a transfer of securities in other entities. -The dividend is measured at fair value at date of declaration -A gain or loss is recorded on the asset distributed -The company records the declared dividend as a debit to retained earnings and a credit to property dividends payable, at an amount equal to the fair value of the distributed property. At Declaration: D- Investment in stock C- Gain on investment D-Retained Earnings (Property Dividends Declared)C-Property Dividends Payable At Payment:Upon distribution of the dividend, the company debits property dividends payable and credits the account containing the distributed asset (restated at fair value). D-Property Dividends Payable C-Investment in stock

Participated Preferred stock

Holders of participating preferred stock share ratably with the common stockholders in any profit distributions beyond the prescribed rate. That is, 5 percent preferred stock, if fully participating, will receive not only its 5 percent return, but also dividends at the same rates as those paid to common stockholders if paying amounts in excess of 5 percent of par or stated value to common stockholders. Note that participating preferred stock may be only partially participating.

To provide stock for employee stock compensation contracts or to meet potential merger needs.

Honeywell Inc. reported that it would use part of its purchase of one million common shares for employee stock compensation contracts. Other companies acquire shares to have them available for business acquisitions.

Stock Splits (not a dividend)

It results in an increase in the number of shares outstanding with a corresponding decrease in the par or stated value per share. It is not a dividend.-2-for-1 stock split: decreases the total par value of the stock and increase the number of shares outstanding; has no effect on retained earnings -no entry is recorded for a stock split as the total dollar amount of all stockholders' equity accounts remains unchanged-a memorandum note is entered to indicate the changed par value of the shares and the increased number of shares-has no effect on total stockholders' equity-reduces the market price of the stock as well-a lot of companies declare a stock split to decrease the market price of their stock because their target investors may not be able to afford their stock

Stock Dividend (Large Order)

Large Stock Dividend If the dividend exceeds 25%, the par value method is used. At Declaration: D-Retained earnings (stock's par value)C-Common stock dividend distributable (stock's par value) At Distribution:D-Common Stock dividend distributableC- Common Stock -decreases retained earnings but does not change total stockholders' equity

Preferred Stock

In an effort to broaden investor appeal, corporations may offer two or more classes of stock, each with different rights or privileges. As indicated in the preceding section, each share of stock of a given issue has the same inherent rights as other shares of the same issue. By special stock contracts between the corporation and its stockholders, however, the stockholder may sacrifice certain of these rights in return for other special rights or privileges. Thus, special classes of stock, usually called preferred stock, are created. In return for any special preference, the preferred stockholder always sacrifices some of the inherent rights of common stock ownership.

The special characteristics of the corporate form that affect accounting include:

Influence of state corporate law. Use of the capital stock or share system. Development of a variety of ownership interests.

No Par Stock

Many states permit the issuance of capital stock without par value, called no-par stock. The reasons for issuance of no-par stock are twofold. First, issuance of no-par stock avoids the contingent liability (see footnote 5) that might occur if the corporation issued par value stock at a discount. Second, some confusion exists over the relationship (or rather the absence of a relationship) between the par value and fair value. If shares have no-par value, the questionable treatment of using par value as a basis for fair value never arises. This is particularly advantageous whenever issuing stock for property items such as intangible or tangible fixed assets. A major disadvantage of no-par stock is that some states levy a high tax on these issues. In addition, in some states the total issue price for no-par stock may be considered legal capital, which could reduce the flexibility in paying dividends.

Marlowe cannot readily determine the fair value of the patent, but it knows the fair value of the stock is $140,000

Patents 140,000 Common Stock (10,000 shares × $10 per share) 100,000 Paid-in Capital in Excess of Par—Common Stock 40,000

Par Value Stock To show the required information for issuance of par value stock, corporations maintain accounts for each class of stock as follows.

Preferred Stock or Common Stock. Together, these two stock accounts reflect the par value of the corporation's issued shares. The company credits these accounts when it originally issues the shares. It makes no additional entries in these accounts unless it issues additional shares or retires them. Paid-in Capital in Excess of Par (also called Additional Paid-in Capital). The Paid-in Capital in Excess of Par account indicates any excess over par value paid in by stockholders in return for the shares issued to them. Once paid in, the excess over par becomes a part of the corporation's additional paid-in capital. The individual stockholder has no greater claim on the excess paid in than all other holders of the same class of shares.

Redeemable Preferred stock

Recently, more and more issuances of preferred stock have features that make the security more like debt (legal obligation to pay) than an equity instrument. For example, redeemable preferred stock has a mandatory redemption period or a redemption feature that the issuer cannot control. Previously, public companies were not permitted to report these debt-like preferred stock issues in equity, but they were not required to report them as a liability either. There were concerns about classification of these debt-like securities, which may have been reported as equity or in the "mezzanine" section of balance sheets between debt and equity. There also was diversity in practice as to how dividends on these securities were reported. The FASB now requires debt-like securities, such as redeemable preferred stock, to be classified as liabilities and be measured and accounted for similar to liabilities.

To increase earnings per share and return on equity.

Reducing both shares outstanding and stockholders' equity often enhances certain performance ratios. However, strategies to hype performance measures might increase performance in the short-run, but these tactics add no real long-term value.

Stock Dividends (Small Order)

Small (ordinary) Stock Dividend-when the stock dividend is less than 20-25 percent of the common shares outstanding at the time of the dividend declaration -has no effect on total assets or total stockholders' equity At Declaration:D-Retained earnings (fair market value)C-Common Stock dividend distributable (par value)C-Paid-in capital in excess of par- common stock Date of Issue: D-Common stock dividend distributableC-Common stock

Stock Issued in Noncash Transactions

The general rule is: Companies should record stock issued for services or property other than cash at either the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.

Stock Dividends

The issuance by a corporation of its own stock to its stockholders on a pro rata basis, without receiving any consideration. A distribution by a firm of its stock to its shareholders in proportion to their existing holdings. -dividends not paid in cash but in additional shares of stock -a capitalization of retained earnings that results in a reduction in retained earnings and a corresponding increase in certain contributed capital accounts-total stockholders' equity remains unchanged when a stock dividend is distributed-increases the number of shares outstanding -all stockholders retain their same proportionate share of ownership in the corporation-it does not affect total equity but transfers amounts between equity components-no affects on assets or liabilities-merely reflects a reclassification of stockholders' equity from retained earnings to other capital accounts (change in composition of equity accounts)

A company declares a property dividend in the form of shares of stock held as an investment and accounted for by the fair value method. The shares were purchase earlier in the year for $400,000. At the date of declaration, the shares have a value of $430,000. What is the amount of dividends payable?

The journal entries at declaration date are debit investment in stock 30,000 credit gain on investment 30,000 debit retained earnings 430,000 credit property dividends payable 430,000 The journal entry at payment date is debit property dividends payable 430,000 credit investment in stock 430,000

A company issues 1,000 shares of $1 par value common stock upon conversion of 1,000 shares of $5 par value preferred stock that was originally issued for a $150 premium. How much should be credited to the common stock account?

The original journal entry to record the issuance of preferred stock was debit cash 5,150 credit preferred stock 5,000 credit additional paid-in capital 150 The journal entry to record the conversion is debit preferred stock 5,000 debit additional paid-in capital 150 credit common stock 1,000 credit additional paid-in capital 4,150

Very few companies pay dividends in amounts equal to their legally available retained earnings. The major reasons are as follows.

To maintain agreements (bond covenants) with specific creditors, to retain all or a portion of the earnings, in the form of assets, to build up additional protection against possible loss. To meet state corporation requirements, that earnings equivalent to the cost of treasury shares purchased be restricted against dividend declarations. To retain assets that would otherwise be paid out as dividends, to finance growth or expansion. This is sometimes called internal financing, reinvesting earnings, or "plowing" the profits back into the business. To smooth out dividend payments from year to year by accumulating earnings in good years and using such accumulated earnings as a basis for dividends in bad years. To build up a cushion or buffer against possible losses or errors in the calculation of profits.

Each share of stock has certain rights and privileges.

To share proportionately in profits and losses. To share proportionately in management (the right to vote for directors). To share proportionately in corporate assets upon liquidation. To share proportionately in any new issues of stock of the same class—called the preemptive right.2

Cash Dividends

When a corporation distributes a dividend in cash to the stockholders. It is a distribution of profits/earnings from retained earnings (a return of stockholders' profits) -the board of directors vote on the declaration of a cash dividend before declaring it -there is usually a time lag between declaration and payment e.g., the board of directors might approve a resolution at the January 10 (date of declaration) meeting and declare it payable February 5 (date of payment) to all stockholders of record January 25 (date of record) -a declared cash dividend is usually a current liability -dividend per share is multiplied by the number of shares outstanding -declaration reduces owner's equity At Declaration: D-Retained earnings (cash dividends declared)C-Dividends Payable At record:No journal entry. At Payment:D-Dividends PayableC-Cash -Companies do not declare or pay cash dividends on treasury stock.

Convertible preferred stock

Convertible preferred stock allows stockholders, at their option, to exchange preferred shares for common stock at a predetermined ratio. The convertible preferred stockholder not only enjoys a preferred claim on dividends but also has the option of converting into a common stockholder with unlimited participation in earnings.

At the beginning of the year, a company has 490,000 shares of $10 par value common stock outstanding. During the year, the company declared a 15% stock dividend when the market price of the stock was $36 per share. Three months later Masterson declared a $.60 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by

$2,984,100 a (490,000 X 15% x $36) + (490,000 x 1.15 X $0.60)

In this case, Pacific debits $1,000 of the excess to Paid-in Capital from Treasury Stock. It debits the remainder to Retained Earnings. The entry is:

((Dr)Cash 8,000 (DR)Paid-in Capital from Treasury Stock 1,000 (DR)Retained Earnings 2,000 (CR)Treasury Stock 11,000

Return on Equity

NI - Preferred Dividends / Average CSE

The preemptive right of a common stockholder is the right to

share proportionately in any new issues of stock of the same class.

A company issues 1,000 shares of $5 par value common stock for $10,000 and paid issuance costs of $750. What is the journal entry to record the common stock issuance?

debit cash 10,000 credit common stock 5,000 credit additional paid-in capital 5,000 debit additional paid-in capital 750 credit cash 750 The above journal entries can be rewritten as debit cash 9,250 credit common stock 5,000 credit additional paid-in capital 4,250 The debit and credit to the cash cancel each other.

A company exchanges 20,000 shares of its $10 par value for land. What is the journal entry to record this exchange if the fair value of the stock is $13 and the fair value of the land is unknown?

debit land 260,000 credit common stock 200,000 credit additional paid-in capital 60,000

A company, which has 50,000 shares of $10 par value common stock outstanding, declares a 10% stock dividend on December 1. On the date of declaration, the stock has a fair market value of $25 per share. What is the journal entry to record the stock dividend when declared? What is the journal entry to record the stock issued?

debit retained earnings (5,000 shares x $25 per share) 125,000 credit common stock dividend distributable (5,000 shares x $10 per share) 50,000 credit paid-in capital in excess of par-common stock 75,000 debit common stock dividend distributable 50,000 credit common stock 50,000

A company announces a $500,000 dividend payable to common stockholders. The cash dividend announcements noted that stockholders should consider $400,000 of the dividend as income and the remainder as a return of capital. Which journal entry should be used to record this dividend?

debit retained earnings for $400,000; debit paid-in capital in excess of par - common stock for $100,000; credit dividends payable for $500,000.

A company declares a cash dividend on May 1, the date of record is May 15, and the date of payment is June 11. The dividend is $3.00 per share. The company only has common stock, and there are 10,000 shares authorized, 8,000 shares issued, and 5,000 shares outstanding. Which account should be debited on June 11?

dividends payable for $15,000.

Common stock

is the residual corporate interest that bears the ultimate risks of loss and receives the benefits of success. Common stockholders are not guaranteed dividends or assets upon dissolution. But common stockholders generally control the management of the corporation and tend to profit most if the company is successful. In the event that a corporation has only one authorized issue of capital stock, that issue is by definition common stock, whether so designated in the charter or not.

Callable preferred stock

permits the corporation at its option to call or redeem the outstanding preferred shares at specified future dates and at stipulated prices. Many preferred issues are callable. The corporation usually sets the call or redemption price slightly above the original issuance price and commonly states it in terms related to the par value. The callable feature permits the corporation to use the capital obtained through the issuance of such stock until the need has passed or it is no longer advantageous.

A company declares and distributes a 10% common stock dividend when it has 20,000 shares of $10 par value common stock outstanding. If the market value of the common stock is $30, the journal entry to record the stock dividend would include a

credit to paid-in capital in excess of par - common stock $40,000. debit retained earnings (10% x 20,000 shares x $30) 60,000 credit common stock (10% x 20,000 shares x $10) 20,000 credit paid-in capital in excess of par - common stock ($60,000 - $20,000) 40,000