Accounting Ch. 11

The stockholders' equity section of a corporation's balance sheet consists of two parts:

(1) paid-in (contributed) capital (2) retained earnings (earned capital).

Three dates are important in connection with dividends:

(1) the declaration date (2) the record date (3) the payment date

effects of stock dividends and stock splits

*Total paid-in capital Stock Dividend: increase Stock Split: no change *Total retained earnings Stock Dividend: decrease Stock Split: no change *Total par value (common stock) Stock Dividend: increase Stock Split: no change *Par value per share Stock Dividend: no change Stock Split: decrease *Shares outstanding Stock Dividend: increase Stock Split: increase *Total stockholders' equity Stock Dividend: no change Stock Split: no change

The amount and timing of a dividend are important issues for management to consider.

*payment of a large cash dividend could lead to liquidity problems for the company *a small dividend or a missed dividend may cause unhappiness among stockholders who expect to receive a reasonable cash payment from the company on a periodic basis.

Stockholders have a right to

1. Vote in election of board of directors at annual meeting and vote on actions that require stockholder approval 2. share the corporate earnings through receipt of dividends 3. Keep the same percentage ownership when new shares of stock are issued (Preemptive right) 4. share in assets upon liquidation in proportion to their holdings. This is called a residual claim because owners are paid with assets that remain after all other claims have been paid

paid-in capital, two classifications are recognized:

1. capital stock: consists of preferred and common stock. Report information about the par value, share authorized, shares issued, and shares outstanding for each class of stock 2. Additional paid-in capital: includes the excess of amounts paid in over par or stated value

for a corporation to pay a cash dividend, i must do the following:

1. retained earnings: payment of dividends from retained earnings is legal in all states 2. Adequate cash: 3. declared dividends: the board of directors has full authority to determine the amount of income to distribute in the form of dividends. Dividends are not a liability until they are declared.

Three primary advantages relative to common stock

1. stockholder control is not affected: bondholders do not have voting rights, so current owners (stockholders) retain full control of the company 2. tax savings result: bond interest is deductible for tax purposes; dividends on stock are not 3. Return on common stockholders' equity may be higher: although bond interest expense reduces net income, return on common stockholders' equity often is higher under bond financing because no additional shares of common stock are issued

Issuance of common stock

1. to identify the specific sources of paid-in capital 2. maintain the distinction between paid-in capital and retained earnings *issuance of common stock affects only paid-in capital accounts

various reasons to acquiring treasury stock

1.To reissue the shares to officers and employees under bonus and stock compensation plans. 2.To increase trading of the company's stock in the securities market. Companies expect that buying their own stock will signal that management believes the stock is underpriced, which they hope will enhance its market price. 3.To have additional shares available for use in acquiring other companies. 4.To reduce the number of shares outstanding and thereby increase earnings per share.

Corporations generally issue stock dividends for one of the following reasons:

1.To satisfy stockholders' dividend expectations without spending cash. 2.To increase the marketability of the stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes it easier for smaller investors to purchase the shares. 3.To emphasize that the company has permanently reinvested in the business a portion of stockholders' equity, which therefore is unavailable for cash dividends.

*Charter

A document that describes a corporation's name and purpose, types of stock and number of shares authorized, names of individuals involved in the formation, and number of shares each individual has agreed to purchase.

*cumulative dividend

A feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends

the company exchanges one share of $10 par value stock for two shares of $5 par value stock

A stock split does not have any effect on paid-in capital, retained earnings, and total stockholders' equity

eclares a 10% stock dividend on its $10 par common stock when 50,000 shares were outstanding. The market price was $15 per share

Before Dividend: Stockholders' equity Paid-in capital Common stock, $10 par 500,000 Paid-in capital in excess of par value - Total paid -in capital 500,000 Retained earnings 300,000 total stockholders' equity 800,000 outstanding shares 50,000 Pare value share $10 Change: Stockholders' equity Paid-in capital Common stock, $10 par 50,000 Paid-in capital in excess of par value 25,000 Total paid -in capital +75,000 Retained earnings 75,000 total stockholders' equity 0 outstanding shares +5,000 Pare value share $0 After Dividend: Stockholders' equity Paid-in capital Common stock, $10 par 550,000 Paid-in capital in excess of par value 25,000 Total paid -in capital 575,000 Retained earnings 225,000 total stockholders' equity 800,000 outstanding shares 55,000 Pare value share $10

number of shares outstanding increases

Before stock split: Stockholders' equity Paid-in capital Common stock (Before: 50,000 $10 par shares; after: 100,000 $5 par shares) 500,000 Paid-in capital in excess of par value 0 Total paid -in capital 500,000 Retained earnings 300,000 total stockholders' equity 800,000 outstanding shares 50,000 Pare value share $10 Change: Stockholders' equity Paid-in capital Common stock (Before: 50,000 $10 par shares; after: 100,000 $5 par shares) - Paid-in capital in excess of par value 0 Total paid -in capital 0 Retained earnings 0 total stockholders' equity 0 outstanding shares 5+0,000 Pare value share -$5 After stock split: Stockholders' equity Paid-in capital Common stock (Before: 50,000 $10 par shares; after: 100,000 $5 par shares) 500,000 Paid-in capital in excess of par value 0 Total paid -in capital 500,000 Retained earnings 300,000 total stockholders' equity 800,000 outstanding shares 100,000 Pare value share $5

*Preferred Stock

Capital stock that has contractual preferences over common stock in certain areas have a priority in relation to (1) dividends (2) assets in the event of liquidation

Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share

Cash (debit) ($12*10,000) 120,000 Preferred Stock (credit) (10,000*10) 100,000 Paid-in Capital in Excess of Par-Value-preferred stock (Credit) 20,000 To record the issuance of 10,000 shares of $10 par value preferred stock

Hydro-Slide, Inc. issues 1,000 shares of $1 par value common stock at par for cash.

Cash (debit) 1,000 Common Stock (credit)1,000 to record issuance of 1000 shares of $1 par common stock at par)

Hydro-Slide, Inc. issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share

Cash (debit) 5,000 Common Stock (credit) ($1,000*1) 1,000 Paid-in Capital in Excess of Par value (credit) 4,000 To record issuance of 1,000 shares of common stock in excess of par

When Medland issues the dividend shares, it decreases Common Stock Dividends Distributable and increases Common Stock as follows.

Common stock dividends distributable (debit) 50,000 Common stock (credit) 50,000 to record issuance of 5,000 shares in a stock dividend

Disadvantages

Corporation management—separation of ownership and management •Government regulations •Additional taxes

December 1, 2017, the directors of Media General declare a $0.50 per share cash dividend on 100,000 shares of $10 par value common stock

Dec. 1 Cash dividends (debit) 50,000 Dividends payable (credit) 50,000 to record declaration of cash dividend

On February 1, 2017, Mead acquires 4,000 shares of its stock at $8 per share.

Feb 1 Treasury Stock (debit) 32,000 Cash (credit) 32,000 to record purchase of 4,000 shares of treasury stock at $8 per share

The stockholders' equity section for Graber Inc. includes most of the accounts

Graber Inc. Balance Sheet (partial) Stockholders' equity paid-in capital capital stock 9% preferred stock, $100 par value cumulative, 10,000 shares authorized, 6,000 shares issued and outstanding: 600,000 Common stock, no par, $5 stated value, 500,000 shares authorized, 400,000 shares issues, and 390,000 outstanding: 2,000,000 total capital stock 2,600,000 Additional paid-in capital: Paid-in capital in excess of par value-preferred stock: 30,000 Paid-in capital in excess of stated value-common stock: 1,050,000 total additional paid-in capital: 1,080,000 total paid in capital:3,680,000 Retained earnings (see Note R): 1,050,000 Total paid-in capital and retained earnings: 4,730,000 Accumulated other comprehensive income: 110,000 Less: treasury stock (10,000 common shares): 80,000 total stockholders' equity: 4,760,000

A company reports a deficit as a deduction in the stockholders' equity section of the balance sheet

Groupon Inc. Balance Sheet (partial) In thousands Stockholders' equity Paid-in Capital Common Stock 70 Paid-in capital in excess of par value 1,885,301 Total paid-in capital 1,885,371 Accumulated deficit (921,970) Total paid-in capital and retained earnings 963,411 Less: Treasury stock 198,467 total stockholders' equity 764,944

When a corporation decides to issue stock, it must resolve a number of basic questions:

How many shares should it authorize for sale? How should it issue the stock? What value should it assign to the stock? We address these questions in the following sections.

The total paid-in capital from these two transactions is $6,000. If Hydro-Slide, Inc. has retained earnings of $27,000, the stockholders' equity section of the balance shee

Hydro-slide, inc. Balance sheet (partial) Stockholders' equity Paid in capital Common Stock 2,000 Paid-in capital 4,000 in excess of par value Total paid-in Capital 6,000 Retained Earnings 27,000 total stockholdes' 33,000 equity

January 20 is the payment date for Media General

Jan. 20 Dividends Payable (debit) 50,000 Cash (credit) 50,000 to record payment of cash dividend

Mead, Inc. has 100,000 shares of $5 par value common stock outstanding (all issued at par value) and retained earnings of $200,000

Mead Inc. Balance sheet stockholders' equity Paid- in capital Common stock, $5 par value, 400,000 shares authorized, 100,000 shares issued and outstanding: 500,000 Retained earnings 200,000 Total stockholders' equity 700,000

stockholders' equity

Mead Inc. Paid-in capital Common Stock, $5 par value, 400,000 shares authorized, 100,000 shares issued and 96,000 shares outstanding Retained earnings total paid-in capital and retained earnings 700,000 Less: treasury stock (4,000 shares) 32,000 Total stockholders' equity 668,000

If Medland prepares a balance sheet before it issues the dividend shares, it reports the distributable account in paid-in capital as an addition to common stock issued

Medland corporation Balance Sheet (partial) Paid-in capital Common Stock 500,000 Common Stock dividends distributable 50,000 Paid-in capital in excess of par-common stock 25,000 total paid-in capital 575,000

Additional taxes (disadvantage)

Owners of proprietorships and partnerships report their share of earnings on their personal income tax returns

alternative effects on the return on common stockholders' equity

Plan A: Income before interest and taxes Issue stock: 1,500,000 Issue bonds:1,500,00 Interest (12%*5,000,000) Issue stock: - Issue bonds: 600,000 Income before income taxes Issue stock: 1,500,000 Issue bonds: 900,000 Income tax expense (30%) Issue stock: 450,000 Issue bonds: 270,000 net income Issue stock: 1,050,000 Issue bonds: 630,000 common stockholders' equity Issue stock: 7,500,000 Issue bonds: 2,500,000 Return on common stockholders' equity Issue stock: 14% Issue bonds: 25.2%

Other forms of business organization

S corporation, allows for legal treatment as a corporation but tax treatment as a partnership—that is, no double taxation

Advantages

Separate legal existence •Limited liability of stockholders •Transferable ownership rights •Ability to acquire capital •Continuous life •Corporation management—professional managers

Medland Corporation has a balance of $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair value of its stock is $15 per share.

Stock dividends (debit) 75,000 Common stock dividends distributable (credit) 50,000 Paid-in capital in excess of par value (credit) 25,000 to record declaration of 10% stock dividend

Debt reduces solvency. The company locks in fixed payments that it must make in good times and bad.

The company must pay interest on a periodic basis and must pay the principal (face value) of the bonds at maturity

Corporations engaged in interstate commerce must also obtain a license from each state in which they do business

The license subjects the corporation's operating activities to the general corporation laws of the state.

under cost method to purchase treasury stock

Treasury stock (debit) price paid to reacquire the shares Treasury Stock decreases by the same amount when the company later sells the shares

Cetus declares a 10% stock dividend, it issues 100 shares (1,000×10%) of stock.

You receive two shares (2%×100), but your ownership interest remains at 2% (22÷1,100). You now own more shares of stock, but your ownership interest has not changed

*Corporation

a company organized as a separate legal entity, with most of the rights and privileges of a person *can be profitable *can be non-profitable

In general, as long as the return on assets rate exceeds the rate paid on debt

a company will increase the return on common stockholders' equity by the use of debt

*privately held corporation

a corporation that has only a few stockholders and whose stock is not available for sale to the general public

*publicly held corporation

a corporation that may have thousands of stockholders and whose stock is traded on a national securities market

*treasury stock

a corporation's own stock that has been reacquired by the corporation and is being held for future use

*deficit

a debit balance in retained earnings

*dividend

a distribution by corporation to its stockholders on a pro rata (proportional to ownership) basis *take 4 forms: cash, property, scrip (promissory not to pay cash), or stock

*return on common stockholders' equity (ROE)

a measure of profitability from the stockholders' point of view computed: (net income-preferred dividends)/ average common stockholders' equity

*payout ratio

a measure of the percentage of earnings a company distributes in the form of cash dividends to common stockholders Computed: total cash dividends declared to common shareholders/ net income *Companies attempt to set their dividend rate at a level that will be sustainable.

preferred stock has either

a par value or no-par value

*cash dividend

a pro rata (proportional to ownership) distribution of cash to stockholders

*stock dividend

a pro rata (proportional to ownership) distribution of the corporation's own stock to stockholders *decrease in retained earnings and an increase in paid-in capital *does not decrease total stockholders' equity or total assets

a company does not need to journalize

a stock split

*accumulated other comprehensive income

account includes the cumulative amount of all previous items reported as other comprehensive income

partnership

acts of the owners (partners) bind the partnership

The accounting profession distinguishes between a small stock dividend (less than 20%-25% of the corporation's issued stock)

and a large stock dividend (greater than 20%-25%).

dividends are generally reported quarterly

as a dollar amount per share

Companies that have high growth rates are characterized by low payout ratios

because they reinvest most of their net income in the business

a stock split increases the number of shares owned by a shareholder

but it does not change the percentage of the total company that the shareholder owns

The purchase of treasury stock is generally accounted for

by the cost method

regular dividend boosts in the face of irregular earnings

can be a warning signal

*par value stock

capital stock that has been assigned a value per share in the corporate charter *the usefulness of par value as a device to protect creditors was limited because par value was often immaterial relative to the value of the company's stock in the securities markets—even at the time of issue

*outstanding stock

capital stock that has been issued and is being held by stockholders

*no-par value stock

capital stock that has not been assigned a value in the corporate charter

How do stock dividends affect stockholders' equity

change the composition of stockholders' equity because they result in a transfer of a portion of retained earnings to paid-in capital *total stockholders equity remains the same

*retained earnings restrictions

circumstances that make a portion of retained earnings currently unavailable for dividends *must result from one or more of these causes: legal, contractual, or voluntary

Chief accounting officers is the controller

controller maintains: 1. maintains the accounting records 2. ensures an adequate systems of internal control 3. prepares financial statements, tax returns, and internal reports

stockholders are required to pay taxes on cash dividends

corporate income is taxed twice (double taxation)—once at the corporate level and again at the individual level

separate legal existence

corporation acts under its own name rather than in the name of its stockholders

government regulations (disadvantage)

corporation is subject to numerous state and federal regulations

Corporation management

corporation manage it indirectly through a board of director they elect *they formulate the operating policies of the company

Dividends payable

current liability

dividends (both cash dividends and stock dividends) closing entry

debit to retained earnings and credit dividends

a corporation can issue common stock

directly to investors

Scientific Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding

dividends in arrears ($35,000*2) 70,000 Current-year dividends 35,000 total preferred dividends 105,000

stock dividends are often issued by companies that

do not have adequate cash to issue a cash dividend.

authorization of common stock

does not result in a formal accounting entry *because the event has no immediate effect on either corporate assets or stockholdes' equity *the corporation discloses in the stockholders' equity section of the balance sheet the number of shares authorized

It recommends that the company use the

fair value per share to record small stock dividends

dividends in arrears are not considered a liability. No obligation exists until the board of directors

formally "declares" that the corporation will pay a dividend

federal security laws

govern the sale of capital stock to the general public

treasurer

has custody of the corporations funds and oversees the company's cash position

distinction between paid-in capital and retained earnings

important from both legal and a financial point of view

Preferred stockholders have the right to share in the distribution of corporate

income before common stockholders

Note that since a stock dividend neither increases nor decreases the assets in the company

investors are not receiving anything they didn't already own

Common Stock Dividends Distributable

is a stockholders' equity account

cumulative effect of the declaration and payment of a cash dividend on a company's financial statements

is to decrease both stockholders' equity and total assets

low dividend payments, or a cut in dividend payments, might signal that a company has liquidity or solvency problems and

is trying to conserve cash by not paying dividends

If a company wants to increase its return on common stockholders' equity

it can either increase its return on assets or increase its reliance on debt financing

he company increases the number of shares in the same proportion that

it decreases the par or stated value per share

limited liability of stockholders

liability of stockholders is normally limited to their investment in the corporation *creditors have no legal claim on the personal assets of the stockholders unless fraud has occured

Continuous life

life of a corporation is stated in its charter *going concern is not affected by withdrawal, death, or incapacity of a stockholder, employee, or officer

Companies with high dividends and rising debt

may be borrowing money to pay shareholders

corporations

must pay federal and state income taxes as a separate legal entity. These taxes can be substantial

retained earnings

net income that a company retains in business

*retained earnings

net income that a company retains in the business closing entry: debit to income summary and credit to retained earnings

Media General, the record date is December 22

no entry

CEO (chief executive officer)

overall responsibility for managing the business *delegates responsibility to other officers

transferable ownership rights

ownership of a corporation is held in shares of capital stock, which are transferrable units *stockholders may dispose of part or all of their interest in a corporation simply by selling their stock *no effect on operating activities, assets, liabilities, and total stockholders' equity

*dividend in arrears

preferred dividends that were supposed to be declared but were not declared during a given period

stock certificate

proof of stock ownership is evidenced by a printed or engraved form *shows name of corporation, the stockholder's name, the class and special features of the stock, the number of shares owned, and the signatures of authorized corporate officials

SEC (Securities and Exchange Commission)

quarterly and annual reports (10Q and 10K) publicly held corporations must disclose financial affair to

payment of dividend on the payment date

reduces both current assets and current liabilities and NO EFFECT on stockholders' equity

ability acquire capital

relatively easy for a corporation to obtain capital through the issuance of stock

*legal capital

the amount of capital that must be retained in the business for the protection of corporate creditors (in the past)

*authorized stock

the amount of stock that a corporation is authorized to sell as indicated in its charter

*paid-in capital

the amount of stockholders paid in to the corporation in exchange for shares of ownership

*stated value

the amount per share assigned by the board of directors

*payment date

the date cash dividend payments are made to stockholders

*declaration date

the date the board of directors formally authorizes the dividend and announces it to stockholders *binding legal obligation

*record date

the date when the company determines ownership of outstanding shares for dividend purposes

*stock split

the issuance of additional shares of stock to stockholders accompanied by a reduction in par or stated value per share *purpose: increase marketability of the stock by lowering its market price per share

Hydro-Slide the stock was no-par stock with a stated value of $1, the entries would be

the same as those presented for the par stock except the term "Par Value" would be replaced with "Stated Value

Hydro-Slide If a company issues no-par stock that does not have a stated value

then it credits to the Common Stock account the full amount received

If accumulated losses exceed gains, then the company reports accumulated other comprehensive loss

then the company reports accumulated other comprehensive loss

it can issue common stock indirectly

through an investment banking firm that specializes in bringing securities to the attention of prospective investors

a company debits a net loss

to the Retained Earnings account

the effect of a split on a market price is generally proportional

to the size of the split

Common stock

when a corporation has only one class of stock

low dividends may not be a negative sign because it may mean the company is reinvesting in itself

which may result in high returns through increases in the stock price

companies cannot pay dividends to common stockholders

while any preferred stock dividend is in arrears