Acc. 3010 Chap.18 (Shareholder's Equity)

Stock Split

A stock distribution of 25% or higher is a stock split. If referred to as a "stock split effected in the form of a stock dividend," the par value of the additional shares is reclassified within shareholders' equity:

Shareholder's Equity Equation

Assets - Liabilities = Shareholders' equity

Rules for Treasury Stock

At the time the treasury shares are resold, we treat the difference between the cash received and the amount the shares originally cost differently depending on whether that difference is positive (credit) or negative (debit): a. If a credit difference is created as in the first entry, we credit paid-in capital - share repurchase. b. If a debit difference is created as in the second entry, we debit retained earnings unless a credit balance already exists in paid-in capital - share repurchase (not present in this example).

Reacquired Shares

Companies sometimes reacquire shares previously sold. There is a variety of reasons why, but the most common motivation is to support the market price of the shares. Although, all share repurchases are functionally the same, accounting treatment depends on whether the company states that it is formally retiring the shares or purchasing treasury shares.

Par Value

From an accounting perspective, we need to be concerned only that when shares are issued, we record the par amount in common stock, the remainder of the proceeds in additional paid-in capital.

. Stock Dividends

In a stock dividend, additional shares of stock are distributed to current shareholders. It's important to note that a stock dividend affects neither the assets nor the liabilities of the firm. And, because each shareholder receives the same percentage increase in shares, a shareholder's percentage ownership of the firm remains unchanged. For a "small" stock dividend (less than 25%), the fair value of the additional shares distributed is transferred from retained earnings to paid-in capital.

RETAINED EARNINGS

In general, retained earnings represent a corporation's accumulated, undistributed, or reinvested net income (or net loss). Distributions of earned assets are dividends.

Shares Sold for Noncash Consideration

In those instances, the transaction should be recorded at the fair market value of the shares or the noncash consideration, whichever seems more clearly evident. This is consistent with the general rule for accounting for any noncash transaction.

Dividends

Most corporate dividends are paid in cash. At the declaration date, retained earnings is reduced and a liability is recorded. Registered owners of shares on the date of record are entitled to receive the dividend.

Property Dividends

Occasionally, a noncash asset is distributed. In that case, it is referred to as a property dividend. The fair market value of the assets to be distributed is the amount recorded for a property dividend. Before recording the property dividend, the asset may need to be written up or down to fair market value. This would create a gain or loss.

COMMON STOCKHOLDER

Ownership rights held by common shareholders usually include: a. The right to vote. b. The right to share in profits when dividends are declared. c. The right to share in the distribution of assets if the company is liquidated

Share Issue Costs

Share issue costs refer to the costs of obtaining the legal, promotional, and accounting services necessary to effect the sale of shares. The costs reduce the net cash proceeds from selling the shares and thus paid-in capital - excess of par, and are not recorded separately

Shares Treated as Treasury Stock

The cost of acquiring the shares is "temporarily" debited to the treasury stock account. Recording the effects on specific shareholders' equity accounts is delayed until later when the shares are reissued. In essence, we view the purchase of treasury stock as a temporary reduction of shareholders' equity, which is later reversed when the treasury stock is resold.

Preferred Stock

The special rights of preferred shareholders often include one or both of the following: a. A preference to a specified amount of dividends so that if the board of directors declares dividends, preferred shareholders receive the designated dividend before any dividends are paid to common shareholders. b. A preference (over common shareholders) as to the distribution of assets in the event the corporation is dissolved.

International Financial Reporting Standards

U.S. GAAP and IFRS are generally compatible with respect to accounting for shareholders' equity. Some differences exist in presentation format and terminology and in choices regarding reporting comprehensive income. Shareholders' equity is classified under IFRS into two categories: share capital and "reserves." The term reserves is considered misleading and thus is discouraged under U.S. GAAP.

IFRS for Preferred Stock

Under U.S. GAAP, preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is "mandatorily redeemable" preferred stock. Under IFRS, most nonmandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren't redeemable. Under IFRS, the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.

Rules for shares formally Retired

We treat the difference between the cash paid to buy the shares and the amount the shares originally sold for differently depending on whether that difference is positive (credit) or negative (debit): a. If a credit difference is created as in the first entry, we credit paid in capital - share repurchase. b. If a debit difference is created, we debit retained earnings unless a credit balance already exists in paid-in capital - share repurchase, as in the second entry

Quasi-Reorganizations

When a company undergoes financial difficulties, but has favorable future prospects, it may make use of a quasi-reorganization. The firm writes down inflated asset values and eliminates the accumulated deficit (debit balance in retained earnings) following these procedures: 1. Assets and perhaps liabilities are revalued (up or down) to reflect fair market values with corresponding credits or debits to retained earnings. The deficit usually is temporarily increased by this step. 2. Then the debit balance in retained earnings (deficit) is eliminated against additional paid-in capital. If additional paid-in capital is not sufficient to absorb the entire deficit, a reduction in capital stock may be necessary (with an appropriate restating of the par amount per share). 3. For several years, retained earnings is "dated" to indicate the date the deficit was eliminated and when the new accumulation of earnings began

Shares Formally Retired

When a corporation retires previously issued shares, those shares assume the same status as authorized but unissued shares - just the same as if they never had been issued. Payments made to retire shares are viewed as a distribution of corporate assets to shareholders. We reduce precisely the same accounts that previously were increased when the shares were sold - namely, common (or preferred) stock and paid-in capital - excess of par.

Shares Sold for Cash

When shares are sold for cash, shareholders' investment is allocated between stated capital and additional paid-in capital:

IFRS for Comprehensive income

With regard to the presentation of comprehensive income, both sets of standards permit either (1) single statement of comprehensive income or (2) two statements: a separate "income statement" and "statement of comprehensive income." U.S. GAAP permits a third alternative: (3) include in the statement of shareholders' equity.

Return on shareholders' equity

a summary measure of profitability popular among investors, common shareholders in particular. This ratio is calculated by dividing net income by average shareholders' equity and measures the ability of company management to generate net income from the resources that owners provide.

Cumulative

dividends declared in any given year must be paid

Participating

shareholders are entitled to no more than the designated dividend preference

Earnings-price Ratio

to relate earnings to the market value of equity rather than the book value of equity. This ratio is calculated as the earnings per share divided by the market price per share. A popular variation is the inverse - the price-earnings ratio.