Accounting Chapter 11: Reporting and Analyzing Stockholders Equity

Issuance of Stock

A corporation can issue common stock directly to investors. Alternatively, it can issue common stock indirectly through an investment banking firm that specializes in bringing securities to the attention of prospective investors. Direct issue is typical in closely held companies, indirect issue is customary for publicly held corporation. The top five exchnages by value of shares traded are the New York Stock Exchnage, NAsdaq stock market, London Stock Exchange, Tokyo Stock Exchnage and Euronext.

No-par Value Stock

Capital stock that has not been assigned a value in the corporate charter. No par value stock is fairly common today. In many states, the board of directors assigns a stated value to the no par shares.

Liquidation Preference

Most preferred stocks have a preference on corporate assets if the corporation fail s. This feature provides security for the preferred stockholder. The preference to assets may be for the par value of the shares or for a specific liquidating value. The liquidation preference is used in litigation pertaining to bankruptcy lawsuits involving the respective claims of creditors and preferred stockholders.

Effects of Stock Dividends

Stock dividends change the composition of stockholders equity because they result in a transfer of a portion of retained earnings to paid in capital, however, total stockholders equity remains the same.Stock dividends also have no effect on the par or stated value per share, but the number of shares outstanding increases.

Authorized Stock

The amount of stock that a corporation is authorized to sell as indicated in his charter. If a corporation has sold all of its authorized stock, then it must obtain permission from the state to change its charter before it can issue additional shares. The authorization of common stock does not result in a formal accounting entry. The reason is that the event has no immediate effect on either corporate assets or stockholders equity. Howver, the corporation discloses in the stockholders equity section of the balance sheet the number of shares authorized.

Retained Earnings Restrictions

The balance in retained earnings is generally available for dividend declarations however there may be restrictions that make a portion of the balance currently unavailible for dividends due to legal, contractual or voluntary matters. Companies generally disclose retinaed earnings restrictions in the notes to the financial statements.

Declaration Date

The board of directors formally authorizes the cash dividend and announces it to its stockholders. The declaration of the cash dividend commits the corporation to a binding legal obligation. Thus the company must make an entry to recognize the increase in cash dividends and increase in the liability dividends payable.

Record Date

The company determines ownership of the outstanding shares for dividend purposes. The stockholders records maintained by the corporation supply this information.

Outstanding

The number of shares of issued stock that are being held by stockholders.

Purchase of Treasury Stock

The purchase of treasury stock is generally accounted for by the cost method. This method derives its name from the fact that the treasury stock account is maintained at the cost of the shares purchases. Under the cost method, companies increase (debit) treasury stock by the price paid to reacquire the shares. Treasury stock decreases by the same amount when the company later sells the shares. The treasury stock account would increase by the cost of shares purchased . The original paid in capital account, common stock, would not be affect because the number of issued shares does not change. Companies show treadury stock as a deduction from total paid in capital and retained earnings in teh stockholders equity setion of the balance sheet.

Treasury Stock

A corporations own stock that has been reacquired by the corporation and is being held for future use. A corporation may aquire treasury stock for various reasons: To reissue the shares to officers and employees under bonus and stock compensation plans, to increase trading of the companys stock in the securities market ( companies expect that buying their own stocks will signal that management believes the stock is underprices, which they hope will enhance its market price. To have additional shares availible for use in aquiring other companies. To reduce the number of shares outstanding and thereby increase earnings per share. A less frequent reason for purchasing treasury shares is to eliminate hostile shareholders by buying them out.

Dividend

A distribution by a corporation to its stockholders on a pro rata basis.Dividends can take four forms:cash, property, script, (promissory note to pay cash) or stock.

Cash Dividends

A pro rata distribution of cash to stockholders. Cash dividends are not paid on treasury shares. For a corporation to pay a cash dividend, it must have retained earnings, adequate cash, and must declare dividends. DIvidends are not a liability until they are declared.

Stock Dividend

A pro rata distribution of the corporations own stock to stockholders. Whereas a cash dividend is paid in cash a stock dividend is paid in stock. A dividend results in a decrease in retained earnings and an increase in paid in capital. unlike a cash dividend, a stock dividend does not decrease total stockholders equity or total assets. By issuing a stock dividend they "save face" by giving the appearance of distributing a dividend. Note that since stock dividend neither decreases or increases the assets in a company, investors are not receiving anything they didn't already own. The company disburses no cash and assumes no liabilities. You now own more shares of stock, but your ownership interest has not changed. Corporations issue a stock dividend for the following reasons: to satisfy stockholders dividend expectations without spending cash, to increase the marketability of the stock by increasing the number of shares outstanding and therby decreasing the market price per share.Decreasing the market price of the stock makes it easier for smaller investors to purchase the shares.When the dividend is declares, the board of directors determines the size of the stock dividend and the value per share to use to record the transaction. To meet legal requirements, the per share amount must be at least equal to the par or stated value. Small stock dividend is less than 20-25% of the corporations issued stock and a large stock dividend is greater than 20-25%

Par Value Stock

Capital stock that has been assigned a value per share in the corporate charter. Years ago par value determined the legal capital that must be retained in the business for the protection of corporate creditors. That amount is not available for withdrawal by stockholders. Thus in the past most states required the corporation to sell its shares at par or above. However, 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 companys stock in the securities markets-even at time of issue. Par value has no relationship with the market price.

Dividend Preferences

For preferred stock, companies state the per share dividend amount as a percentage of the par value of the stock or as a specified amount. Preferred stock contracts often contain a cumulative dividend feature. This means that they must be paid both current year dividends and any unpaid prior year dividends before common stockholders are paid dividends. When preferred stock is cumulative, preferred dividends not declared in a given period are called dividends in arrears. Dividends in arrears are not considered a liability. No obligation exists until the board of directors formally "declares" that the corporation will pay a diivdend. However, companies should disclose in teh notes to teh finanical statements the amount of dividends in arrears. Doing so enables the investors to asses the potential impact of this obligation on the corpoations financial position. The investment community doesnot look favorable on companies athat are not able to meet dividend obligations.

Preferred Stock

Have contractual provisions that give it preference or priority over common stock in certain areas. Typically preferred stockholders have a priority in relation to dividends and assets in the event of liquidation, however, they sometimes do not have voting rights. In the stockholders equity section of the balance sheet, companies show preferred stock first because of its dividend and liquidation preferences over common stock.Preferred stockholders have the right to share in the distribution of corporate income before common stockholders.

Stock Split

Like a stock dividend, it involves the issuance of additional shares of stock to stockholders according to their percentage ownership. However, a stock split results in a reduction in the par or stated value per share. The purpose of a stock split is to increase marketability of the stock by lowering its market prrice per share. This in turn, makes it easier for a corporation to issue additional stock. Like a stock dividend, a stock split increases the number of shares owned by a shareholder, but it does not change the percentage of total company that the shareholder owns.The effect of a split on market price is generally inversely proportional to the size of the split. In a stock split, the company increases the number of shares in the same proportion that it decreases the par or stated value per share. A stockps t does not have any effect on paid in capital, retained earnings, and total stockholders equity. However, the number of shares outstanding increases. Because a stock split doesnot affect the balances in a stockholder equity account, a company does not need to journalize a stock split, however, a memorandum entry explaining the entry is typically made.

Retained Earnings

Net income that a company retains in the business. The balance in retained earnings is part of the stockholders claim on the total assets of the corporation. It does not represent a claim on any specific asset. Nor can the amount of retained earnings be associated with the balance of any asset account. When exprenses exceed revenues, a net loss results. In contrast to net income, a net loss decreases retained earnings. In closing entries, a company debits a net loss to retained earnings account. It does not debit net losses to paid in capital accounts. If cumulative losses and dividends exceed cumulative income over a companys life, a debit balance in retained earnings results. A debit balance in retained earnings is a defecit. A company reports a defecit as a deduction in stockholders equity section of the balance sheet.

Payment Date

The company makes cash dividend payments to the stockholders on record as of a data nad also records the payment of the dividend. Note that the payment of the dividend on the payment date reduces both current assets and current liabilities, but it has no effect on stockholders equity. The cumulative effect of the declaration and payment of a cash dividend on a companys financial statements is to decrease both stockholders equity and total assets.

Issuance of Common Stock

The primary objectives in accounting for the issuance of common stock are (1) to indentify the specific sources of paid in capital and to maintain the distinction between paid in capital and retained earnings. The issuance of common stock affects only paid in capital accounts.When a company records the issuance of common stock for cash, it credits the par valye of the shares to common stock and records in a separate paid in capital account the portion o fhte proceeds that is above or below par value.

Fair Value per Share

The recommendation to use this to record small stock dividends, based on the assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding. Thus many stockholders considere small stock dividends to be distributions of earnings equal to the fair value that the shares distributed. Companies usually use par or stated vale per share.

Accounting for Issues of Common Stock

The stockholders equity section of a corporations balance sheet includes paid in contributed capital and retained earnings (earned capital). Paid in capital is the amount stockholders paid to the corporation in exchange for shares of ownership. Retained earnings is earned capital held for future use in the business.