Chapter 18

Accounting for Treasury Stock

•Purchase of treasury stock is viewed as a temporary reduction of shareholders' equity. •Cost of acquiring the shares is "temporarily" debited to the treasury stock account. •Sharesare considered to beissued, but not outstanding. •Purchaseof treasury stock and its subsequent resale is considered to bea "single transaction." •This approach to accounting for treasury stock is referred to as the "cost method."

Date of record

•Stated specific date as to when the determination will be made of the recipients of the dividends. •Registered ownersof shares of stock on this date are entitled to receive the dividend.

Stock Splits

•Toinduce the per share market price decline that follows. •The motivation for reducing the per share market price is to increase the stock's marketabilityby making it attractive to a larger number of potential investors.

Share Repurchases

•Viewedas a way to"distribute" company profits without paying dividends. •Decreasing the supply of shares in the marketplace supports the price of remaining shares. •Acquisition of a company's own shares does not create an asset. •Companies buy back shares to offset the increase in shares issued to employees in compensation plans.

A stock distribution of 25% or higher can be accounted for in one of two ways:

•As a "large" stock dividend (stock split effected in the form of a stock dividend). •As a stock split (thus, a 100% stock dividend could be labeled a 2-for-1 stock splitand accounted for as such).

We report two attributes of OCI:

•Components of comprehensive income created during the reporting periodin the statement of comprehensive income. •The comprehensive income accumulated(AOCI) over the current and prior periods in the balance sheet.

Dividends

•Distributions of assets the company has earned on behalf of its shareholders. Dividends paid >Assets earned by the company. Management is returning to shareholders a portion of their investments.

Liquidating Dividend

•Dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend. •Any portion of a dividend not representing a distribution of earnings should be debited to additional paid-in capital.

Paid-in Capital Consists primarily of amounts:

•Invested by shareholders when they purchase shares of stock from the corporation or •Arise from the company buying backsome of those shares or •From share-based compensation activities.

Stock Market Reaction to Stock Distributions

•Market price per share will declinein proportion to the increase in the number of shares distributed in a stock dividend. •Early rule-makers felt that per share market prices do not adjust in response to an increase in the number of shares. •Capitalizing retained earnings for a stock dividend artificially reclassifies earned capital as invested capital. •A corporation cannot increase its market value simply by distributing additional stock certificates.

Shares Issued for Noncash Consideration

•May be to pay for promotional and legal services with shares rather than with cash. •Shares may be given in payment for land, or for equipment, or for some other noncash asset. Issuance of shares should be recorded at grant-date fair value. This treatment is consistent with the accounting requirement for employee share-based payment awards and with the general rule for accounting for noncash transactions.

The Concept of Par Value

•Most shares continue to bear arbitrarily designated par amounts. •Shares with nominal par amounts became common to dodge elaborate statutory rules pertaining to par value shares. •Like the designations of common and preferred shares, the concepts of par value and legal capital have been eliminated entirely from the Model Business Corporation Act.

Cash Dividends

•No legal obligation exists for paying dividends to shareholders. •Liability is not recorded until a company's board of directorsvotes to declare a dividend.

Reverse Stock Split

•Occurs when a company decreasesits outstanding shares. •No journal entry is necessary. •Market price per share theoretically would increase. •Often done by struggling companies trying to increase the stock price.

shareholders equity=

Assets- liabilities (Net assets)

Preferred shares may be:

Cumulative or noncumulative -Dividends in arrears accumulate and must be made up in a later dividend year before any dividends are paid on common shares. Participating or nonparticipating -Allows preferred shareholders to receive additional dividends beyond the stated amount

shares sold for cash journal entry

Debit: Cash credit: Common stock credit: paid in capital- excess of par

Shares sold for non cash journal entry

Debit: Property, plant, equipment Credit: common stock Credit: paid-in capital- excess of par

no-par shares sold journal entry

Debit: cash credit: common stock

declaration date, dividend date, date of record, payment date journal entry

Debit: retained earnings credit: cash dividends payable No entry no entry Debit: cash dividends payable Credit: cash

Retained Earnings

Earnings accumulated on behalf of the shareholders and reported as a single amount.

Common shares

Ownership rights held by common shareholders, unless specifically withheld by agreement with the shareholders, are: •The right to vote on matters that come before the shareholders. Including the election of corporate directors. -Including the election of corporate directors. •The right to share in profits when dividendsare declared. •The right to share in the distribution of assets if the company is liquidated. (fundamental share rights)

Ownership interest is made of what two parts

Paid-in capital retained earnings

Often,shares with certain preferences or features that distinguish them from common shares are designated as __________

Preferred stock

Preemptive right

Right to maintain one's percentage share of ownership when new shares are issued. (fundamental share rights)

shares might be reacquired to distribute in a: (3)

Stock dividend proposed merger defense against a hostile takeover

Resale of Shares

Subsequent sale of shares after shares are retired is recorded exactly like any sale of shares. Resale of treasury shares is viewed as the consummation of the "single transaction" begun when the treasury shares were purchased. •Allocating the cost of treasury shares occurs when the shares are resold.

Preferred shareholders sometimes have the right of ____________ or a _________ __________

conversion redemption privilege

Retirement of stock journal entry

debit: common stock debit: paid-in capital-excess of par Credit: paid-in capital-share repurchase credit:cash or debit: common stock debit: paid-in capital-excess of par debit: paid-in capital-share repurchase Debit: retained earnings credit: cash

Treasury stock journal entry

debit: treasury stock credit: cash

to be a registered owner

investor must purchase the shares before the ex-dividend date (usually is one business day before the date of record)

Accounting treatment of a stock split

no journal entry. Since the total par represents twice as many shares in a 2-for-1 stock split, the par value per share will reduce by one-half. All records that refer to the previous amount must be changed to reflect the new amount. Account for the large stock distribution as stock split effected in the form of a stock dividend avoids the change to the records by recording an entry to change the balance in the stock account.

Shareholders' equity consist of (4)

paid-in capital retained earnings treasury stock accumulated other comprehensive income

directors declare cash dividend then...

retained earnings is reduced liability is recorded before the payment actually can be made, a listing must assembled of shareholders entitled to receive the dividend

Shareholders' Equity other names

shareholders investment shareowners' equity stockholders' investment stockholders' equity shareholders' equity

How to account for the buyback?

shares can be formally retired shares can be called treasury stock

Distribution of additional shares of stock

•Affects neither the assets nor the liabilities of the firm. •Shareholders' proportional interest in the firm remains unchanged.

Accumulated Other Comprehensive Income

•Extends our view of income beyond net income reported in an income statement to include four types of gains and losses not included in income statements: 1.Net holding gains (losses) on available-for-sale investment in debt securities. 2.Gains (losses) from and amendments to postretirement benefit plans. 3.Deferred gains (losses) on derivatives. 4.Adjustments from foreign currency translations.

Are preferred shares equity or debt?

•Preferred shares are somewhat hybrid securities—a cross between equity and debt. •Equity because preferred shareholders receive dividends each year the company pays dividends. •Debt because the company is obligated to pay cash (or other assets) at a fixed or determinable rate in the future. Mandatorily redeemable preferred shares must be reported in the balance sheet as a liability, not as shareholders' equity

Characteristics of Retained Earnings

•Retained earnings represents a corporation's accumulated, undistributed net income (or net loss). •A more descriptive title would be reinvested earnings. credit balance: indicates a dollar amount of asset previously earned and reinvested by the firm debit balance: indicates deficit

External Financing=

Debt + Equity Creditors interest owners' interest

Typical Rights of Preferred Shares include one or both f the following:

If the board of directors declares dividends, preferred shareholders will receive the designated dividend before any dividends are paid to common shareholders. Preferred shareholders customarily have a preference over common shareholders as to the distribution of assets in the event the corporation is dissolved.

Treasury Stock

Shares previously sold to shareholders that are bought back by the corporation.