Ch 15- Stockholder's Equity

What is the accounting treatment if donated shares (now treasury shares) are later resold?

The same as when any other treasury stock is sold.

How is stock sold on a subscription basis handled?

The selling price is payable in installments rather than in total at the time of the sale The stock certificates are not handed over until the final installment is paid A temporary account called Common Stock Subscribed (or Preferred Stock Subscribed) is credited at the sale time and is later replaced by the regular Common Stock account when the stock is issued.

What is the formula for retained earnings?

Beginning RE + Net Income - Dividends Ending RE

What is another name for "lump-sum" sales?

"package sales" *these sales often have discounts

What are examples of the costs associated with issuing stock? And, how should they be accounted for?

*attorney's fees *CPA fees *underwriters' fees *printing expenses The current practice treats these costs as a reduction of the amount paid for the stock by debiting the paid-in capital account

Why keep treasury stock?

*to meet employee stock compensation contracts, *to stabilize stock price- create demand by "signaling theory". allows company to communicate that they think their stock is underpriced and that they have great confidence. *Have access to Cash *to increase earnings per share *to thwart hostile takeover attempts.

What are the characteristics of Corporations?

-Higher regulations (especially if Public) -issue stock

The brown corporation issued 1,000 shares of $10 par common stock and $2,000 shares of $20 par preferred stock for a lump sum of $100,000. The market values per share are $20 and $30 respectively. Thus the total market values are $20k (common) & $60k (preferred). Using the PROPORTIONAL method- what is the allocation of the $100,000 for each type of share?

Common $20k 20/80 * $100k = $25k Preferred $60k 60/80 * $100k = $75k Total Market Value: $80k

If a corporation has just one class of stock, what is it called?

Common Stock

If the stock is issued at exactly par, a capital account called _______________ or ________________ is credited?

Common Stock or Preferred Stock *these accounts are always recorded at par. Any excess above or below par value is recorded in the Paid-in Capital in Excess of Par account.

What is a stock certificate?

Evidence of an individual's ownership in a company. When a person buys shares of stock directly from the corporation, he or she is contributing assets (usually cash) in exchange for an ownership interest

True or False State incorporation laws normally do NOT provide information concerning the legal restrictions related to payment of dividends.

False- they do provide information surrounding legal restrictions on payment of dividends

What qualifies as a large stock dividend and how are they valued?

GAAP requires that accounting for LARGE stock dividends (more than 20-25%) be recorded as follows: R/E $xx(par value) Common Stock Distributable $xx *There is no additional paid-in capital

What qualifies as a small stock dividend and how are they valued?

GAAP requires that the accounting for small stock dividends (less than 20-25%) rely on the fair market value of the stock issued.

What happens if the board does not declare " pass" a dividend in a given year for preferred stock?

If the preferred stock is cumulative, the preferred stock holders are entitled to a double share next year in order to make up for the lost year (called dividends in arrears). If the preferred stock is NOT cumulative then back payment is not required.

What would the entry look like for the below example? A corporation incurs stock issuance costs of $1,000 for the issuance of 1,000 shares of $100 par common stock at $150 per share.

Issuance of stock entry: Dr. Cash $150k Cr. Common Stock $100k Cr. Paid-in Capital in Excess of Par $50k Issuance cost entry: Dr. Paid-in Capital in Excess of Par $1,000 Cr. Cash $1,000

What is par, in relation to shares of stock?

It is a number printed on the stock certificate- issued for each share of stock It sets the maximum amount of responsibility for liability to be borne by the stockholder. If, for example, both the par and the selling price are $100, the stockholder cannot lose more than this amount. Stockholders have a limited liability and no more than price paid for their stock can be demanded from them.

How is Stock holder's equity in a corporation divided?

It is divided into a large number of individual units called shares. with in each class of stock all shares are the same and equal to each other. In a corporation with 100 shares, a person owning 50 shares owns 50% and a person owning 10 shares has 10% ownership.

What is Earned capital?

It is the capital that develops if the business operates profitably. It consists of all undistributed income that remains invested in the company. And is the sum of earnings since the start of the business. It is this portion of capital from which dividends are paid.

In relation to shares of stock, what is limited liability?

It means that a corporation can't pay its liabilities, can creditors demand payment from the personal assets of the stockholders. Stockholders simply loose the dollar amount of their original investment.

Treasury stock can be retired. What does it mean if a share is retired?

It means that a decision is made not to reissue these shares again. -- When this happens, all the accounts relating to these shares are canceled. Any accounts with a debit balance (Treasury Stock) are credited, and accounts with a credit balance (Common Stock and Paid-in Capital in Excess of par) are debited. If a debit is needed to balance this entry, it goes to Retained Earnings; if a credit, it goes to an account called Paid-in Capital from Retirement of Treasury Stock

What does a stock split result in?

It results in an INCREASE or DECREASE in the number of shares outstanding, with a corresponding DECREASE or INCRASE in the par or stated value per share. No entry is required in a stock split.

Is treasury stock an asset?

NO! it is not an asset (a company cannot own a part of itself!) it is simply a reduction of its capital. When shares are originally issued- assets and capital when up When they are bought back, the opposite takes place- assets and capital go down.

Is investing assets in a corporation by buying its stock different than investing assets in a partnership of sole partnership?

No- in respect to the accounting equation (A-L=C) The assets of a company have gone up, liabilities have stayed the same and capital has also gone up.

In relation to shares of stock, Is par value the same thing as market value, ?

No- very often the market value will be higher than the par value.

If the stock is issued above par (above) or below par (discount) what account will be credited or debited for the difference?

Paid- in Capital in Excess of Par - Credited for a premium or Debited for a discount In the case of a discount the Paid- in Capital account acts as a contra to the Common Stock account.

How is the annual fixed dividend for preferred stock expressed?

As a percentage of par For example, $100 par, 5% preferred stock: receives $5 in dividends every year. Sometimes it is expressed as a dollar value instead. For example $100 par, $6 preferred - means that the dividend is $6

A corporation is authorized to issue 100,000 shares. It issues 25k then buys back 5k. What is the amount of stock that the company has in issued/outstanding & treasury stock?

Authorized shares 100,000 Issued shares 25,000 Treasury shares 5,000 Outstanding 20,000

A stock dividend is a capitalization of __________________________ that reduces _____________________ and increases certain _________________ accounts.

Retained earnings / retained earnings / contributed capital

Companies often provide a statement of stockholders' equity. What are some common ratios that use stockholders' equity amounts?

Return on Common Stock Equity Payout Ratio Book value per share

Sometimes stockholders donate shares of the corporation's own stock back to the corporation. How is this accounted for?

Since there is no cost involved, Treasury Stock would be debited at the fair market value of these shares with a credit going to Donated Capital for the same amount *If 100 shares of $5 par stock are donated to the corporation, and their market value is $7: Treasury Stock $700 Donated Capital $700

How does paying for stock at a discount play out with the limited liability concept?

Stock issued at a discount, the stockholders are contingently liable for the amount of the discount. Should the corporation be unable to pay its debts, its creditors may go to the personal assets of the stockholders and collect the discount. If the par value is $10,000 but the stock was obtained for $8,000. Or if it was obtained for $11,000 premium the stock holder may end up loosing the full $11k

If stock is issued for assets other than cash- how is the value assigned to these assets?

The assets should be valued at their own market value or at the market value of the stock. Which ever is more clearly able to be defined. *If BOTH values are clear, then they will probably be the same since this is an arm's -length transaction. *If NEITHER one is clear, then the value should be set by the board of directors based upon independent appraisals.

A corporation does not have to pay dividends unless so declared by whom?

The board of directors.

What method is used when preferred stock is converted?

The book value method

How do you know whether preferred stock is cumulative or not?

The courts have ruled that unless the stock specifically states that it is Noncumulative, then it is cumulative by default.

What does authorized shares mean?

The number of shares that a corporation may issue according to its charter.

Assume a corporation has $1,00 shares of $100 par, 5% preferred stock outstanding, and 1,000 shares of $200 par common stock outstanding. The dividend declared is $13,000 and there are no dividends in the arrears. how much of the dividends go to preferred stock vs common stock holders?

The preferred stockholders would get 5% x $100 x1,000 = $5k The remainder of $8k (13-5k) goes to common stock holders

Assume a corporation has $1,00 shares of $100 par, 5% preferred stock outstanding, and 1,000 shares of $200 par common stock outstanding. The dividend declared is $13,000. Preferred stock is cumulative and last year's dividend is in arrears how much of the dividends go to preferred stock vs common stock holders?

The preferred stockholders would get 5% x $100 x1,000 = $5k for this year and last year so $10k total The remainder of $3k (13-10k) goes to common stock holders

What does issued shares mean?

They are the number of shares actually sold (out of the authorized shares).

What does outstanding shares mean?

They are the number of shares physically in the hands of the public (stock held by outside investors). The number of issued shares is not necessarily equal to outstanding shares b/c issued stock includes treasury stock Outstanding Stock = Issued Stock - Treasury Stock

Many states permit stock to be issued without a par value. Why?

To avoid the contingent liability associated with discounts. In these states, Common Stock or Preferred Stock is credited for the full amount received. At most a company's board of directors may ORALLY assign a par value to the stock. This is called a stated rate. And, anything above or below a stated value is credited/debited to the Paid-in Capital in Excess(below) of Stated Value

In absence of restrictive provisions, each share of stock carries the right to share proportionately in what 4 ways?

To share proportionately in: 1) profits and losses 2) management (the right to vote for directors) 3) corporate assets upon liquidation 4) any new issues of stock of the same class (called the preemptive right).

How are the Treasury Stock and Paid-in Capital from Treasury Stock accounts recorded?

Treasury Stock account- negative (contra) account and appears on the balance sheet as a subtraction from contributed capital in the Stockholder's Equity section. Paid-in Capital from Treasury Stock account- appears in the same section as a normal capital account. It is not considered to be a revenue item and therefore will NOT appear on the income statement.

Define treasury stock?

Treasury stock (treasury shares) are the portion of shares that a company keeps in its own treasury. Treasury stock may have come from a repurchase or buyback from shareholders, or it may have never been issued to the public in the first place.

True or false The par value per share and total stockholders' equity remain unchanged with a stock dividend, and all stock holders retain their same proportionate share of ownership.

True

Preferred stock has certain special privileges. What is an example?

Unlike common stock, preferred stock may have: 1) guarantee of a dividend at a fixed rate before any dividends can be distributed to the common stock. 2) preference as to assets in the event of liquidation 3) convertible into common stock 4) callable at the option of the corporation 5) non voting

Treasure Stock, when purchased, is accounted for at cost (when using the cost method). What happens when it is then resold for over or under the cost at which it was purchased?

We only recognize gains and losses on assets. T/S is a contra capital account and not an asset. Therefore, any Gain/Loss for reselling the T/S above/below cost is NOT recorded and is an "artificial" gain/loss. GAAP requires that we NOT record gains in transactions w/ shareholders.

Why are pre-emptive rights important for stockholders?

When new stock is issued it can affect or dilute stockholder's percentage of ownership. It allows current stockholders the option to maintain their percentage of ownership in the company.

What is participating preferred stock?

When preferred stock receives an additional share of the dividends over and above its fixed amount. It may be fully or partially participating.

May Treasury stock be issued again?

Yes- they may be retired or issued again.

What accounts are kept for No-par stock?

common stock and additional paid-in capital accounts, if stated value used

What are the two categories of stockholder's equity?

contributed capital earned capital

What are the 4 different types of dividends?

1) Cash dividends 2) Property dividends 3) liquidating dividends -(dividends based on other than retained earnings) 4) Stock dividends (the issuance by a corporation of is own stock to its stock holders on a pro rata basis but without receiving consideration.

There are two methods for handling treasury stock transactions, what are they? Which is preferred? In what circumstances are each used?

1) Cost method - Most common. Used because the INTENT when the T/S is bought is to keep it on hand and retirement, although not eliminated as an option, is not originally intended. 2) Par method- Used when the INTENT of purchasing the T/S is to immediately retire it. It then becomes as if the stock were authorized but never issued. *under both methods, the stock holder's equity is the same- although the individual components are different.

What steps are followed for FULLY participating preferred stock?

1) First give the preferred its fixed percentage 2) Then give the common the same matching percentage 3) Divide any remainder according to the ratio of par.

What are 3 characteristics of the corporate form that affect accounting?

1) Influence of state corporate law 2)use of capital stock or share system 3) development of a variety of ownership interests

What two questions must a company ask when declaring dividend(s)?

1) Is the condition of the corporation such that the dividend is legally permissible? 2) Is the condition of the corporation such that a dividend is economically sound?

What four categories of businesses are there?

1) LLC 2) Partnership 3) Corporation 4) Sole Proprietorship (s-corp can be like a partnership or sole proprietorship)

Accounts are kept for what different types of stock?

1) Par Value stock 2) No- par stock 3) Stock issued in combination with other securities (lump-sum sales) 4) stock issued in noncash transactions

How do corporations transfer wealth to shareholders?

1) Pay Dividends 2) Treasury Stock- (a contra equity account that holds a debit balance)

What accounts are kept for Par value stock?

1) preferred stock or common stock 2) paid-in capital in excess of par or additional paid-in capital 3) discount on stock

What are the two methods of allocation in relation to Stock issued in combination with other securities ( lump-sum sales)? This includes instances with common and preferred stock are both sold for one lump sum.

1) the proportional method- used when market values of all items sold is known. 2) the incremental method- used when the market value of only one or some of the items sold is known.

What are four other terms that could be used for "Capital" when referring to the accounting equation?

A-L = *Owner's Equity *Stockholder's Equity *Equity *Net Assets

Define additional paid-in-capital

Additional paid-in-capital represents the excess paid by an investor over and above the par-value price of a stock issue and is often included in the contributed surplus account in the shareholders' equity section of a company's balance sheet.

What is Contributed capital?

Aka Paid-in capital- the amount that stockholders invested in the corporation for use in the business. It includes items such as the par value of all outstanding stock and premiums less any discounts on insurance

What does the stock holders' equity section of a balance sheet include?

Capital Stock Additional paid-in capital Retained Earnings *a company may also present additional items such as: Treasury stock Accumulated & Other Comprehensive Income

The brown corporation issued 1,000 shares of $10 par common stock and $2,000 shares of $20 par preferred stock for a lump sum of $100,000. The market values per share are $20 for common stock ($20k) and preferred stock is unknown. Using the INCREMENTAL method- what is the allocation of the $100,000 for each type of share?

Common $20k Preferred $80k *Assigned by $100k (lump-sum) less known market value of $20k) Total Market value: Assume same as lump sum paid $100k

How are direct and indirect costs accounted for, in relation to stock?

Direct Costs, decrease the amount of APIC (these are usually one time fees like underwriting fees). Indirect Costs, are expensed (these are typically recurring fees like registration fees)

Corporations rarely pay dividends in an amount equal to the legal limit. Why?

Partly because companies use assets represented by undistributed earnings to finance future operations of the business.

Sometimes, in order to appeal to all types of investors, a corporation may also issue another class of stock called what?

Preferred stock