Chapter 18
Shareholder's Equity
-Paid-in capital -Retained Earnings -Treasury Stock -Accumulated Other Comprehensive Income
Accounting for Retired Shares
-When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued - common or preferred stock, and additional paid-in capital. -Retired shares assume the same status as authorized but unissued shares -When shares are sold - cash and shareholders equity increase -When shares are bought back and retired - cash and shareholders equity decrease (size of company decreases) -When shares are formally retired - reduce the accounts that were increased when the shares were sold (cash, common/preferred stock, PIC-EP) -Formally retiring shares restores balances in common stock and paid in capital - excess of par accounts as if the shares never had been issued at all Repurchase Price < Original Purchase Price -Credit Paid in Capital - Share Repurchase (to balance entry) -Excess creates additional Paid in Capital Repurchase Price < Original Purchase Price -Debt Paid in Capital - Share Repurchase (to balance entry); the amount is limited to an existing account balance -If needed debit retained earnings (to balance entry); amount is viewed as dividend to shareholders 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share. Common Stock 10,000 Paid in capital - excess of par common 90,000 Paid in capital- share repurchase 15,000 Cash 85,000
Illustration: Small Stock Dividend
Craft declares and distributes a 10% common stock dividend (10 million shares) when the market value of the $1 par common stock is $12 per share. Retained Earnings (10 mil x $12) 120 Common Stock (10 mil x $1) 10 Paid in capital - excess of par 110
Illustration: Stock Split Effected in the Form of a Stock Dividend
Craft declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend (100 million shares) when the market value of the $1 par common stock is $12 per share: Pd-in cap excess of par/Retained Earnings 100 Common Stock 100 100 mil x $1
Accounting for Stock Dividends
Distribution of additional shares of stock to owners. -Does not affect assets or liabilities -No change in total stockholders' equity. -No change in par values. -The market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend -All stockholders receive the same percentage increase in shares (proportional interest remains unchanged) 5% stock dividend declared: -Each shareholder receives additional shares of stock equal to 5% of shares they currently own Prescribed Accounting Treatment for Stock Dividends: -Shareholder equity items are reclassified by reducing one or more shareholder equity accounts -Reduce retained earnings by the same amount as if cash dividends were paid equal to the market value of shares issued -Simultaneously increasing one or more paid-in capital accounts Small Stock Dividend < 25% -Record at current fair value of stock. -Fair value of additional shares distributed is transferred from retained earnings to paid-in capital Large Stock dividend > 25% Record at par value of stock. Reasons for declaring stock dividends: -Gives shareholders the illusion that they are receiving a real dividend -Enable corporation to take advantage of the accepted accounting practice of capitalizing retained earnings Reduce existing balance in retained earnings ---> Reinvest earned assets represented by that balance
Illustration: Shares Sold for Noncash Consideration
DuMont Chemicals issues 1 million of its common shares, $1 par per share, in exchange for a custom-built factory for which no cash price is available. Today's issue of The Wall Street Journal lists DuMont's stock at $10 per share. Property, plant, and equipment 10 Common Stock 1 Paid in Capital - excess of par 9
The Nature of Shareholders' Equity
External Financing = Debt + Equity Debt = Creditors Interest Equity = Owners Interest Assets - Liabilities = Shareholders Equity Assets - Liabilities are Net Assets (meaning Shareholder's equity is Net Assets)
Accounting for Treasury Stock
On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/13, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. May 1, 2012 Treasury Stock 165,000 Cash 165,000 December 3, 2013 Cash 75,000 Treasury stock 55,000 Paid in capital - share repurchase 20,000
Illustration: Cash Dividends
On June 1, the board of directors of Craft Industries declares a cash dividend of $2 per share on its 100 million shares, payable to shareholders of record June 15, to be paid July 1: June 1 - Declaration Date Retained Earnings 200 Cash Dividends Payable 200 June 13—Ex-Dividend Date no entry June 15—Date of Record no entry July 1—Payment Date Cash Dividends Payable 200 Cash 200
Illustration: Property Dividends
On October 1, the board of directors of Craft Industries declares a property dividend of 2 million shares of Beaman Corporation's preferred stock that Craft had purchased in March as an investment (book value: $9 million). The investment shares have a fair value of $5 per share, $10 million, and are payable to shareholders of record October 15, to be distributed November 1: October 1—Declaration date Investment in Beaman Corporation 1 Gain on appreciation of investment ($10 - 9) 1 Retained Earnings 10 Property Dividends Payable 10 November 1—Payment Date Property dividends payable 10 Investment in Beaman Corporation preferred stock 10
Financial Reporting Overview
Paid-in Capital •Consists primarily of amounts: •invested by shareholders when they purchase shares of stock from the corporation Retained Earnings •Represents earned capital (accumulated amount of net income - the accumulated amount of dividends declared) Treasury Stock •Shares previously sold to shareholders that are bought back by the corporation
Typical Rights of Preferred Shares (continued)
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
Accounting for Retired Shares
Price paid is more than issue price 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share. Common Stock 10,000 Paid in capital - excess of par common 90,000 Paid in capital - share repurchase 25,000 Cash 125,000 Reduce Retained Earnings if the Paid-in capital—share repurchase account balance is insufficient.
Share Buybacks
Shares might be reacquired to distribute in a: -Stock Dividend -Proposed Merger -Defense against a hostile takeover How to account for the buyback? -Shares can be formally retired (no intention of reissuing) -Shares can be called treasury stock (may be resold) Decreasing the supply of shares in the marketplace supports the price of remaining shares Unlike an investment in another firm's shares, the acquisition of a companies own shares does not create an asset.
Dividends on Preferred Shares
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Shares Issued for Noncash Consideration
•A company might issue its shares for consideration other than cash. Examples: •Promotional and legal services •Land, equipment, or for some other noncash asset Issuance of shares should be recorded at fair value: Best evidence of fair value might be: • A quoted market price for the shares • A selling price established in a recent issue of shares for cash • The amount of cash that would have been paid in a cash purchase of the asset or service • An independent appraisal of the value of the asset received • Other available evidence
Large Stock Dividend
•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 split and accounted for as such.) Stock Split •Accounting treatment of a stock split is to make 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 Effected in the form of a stock dividend •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 -A frequent reason to issue a stock dividend is to induce a per-share market price decline -Motivation for reducing per share market price is to increase the stocks marketability and making it attractive to a larger number of people -Changing the par value is cumbersome and expensive - All records must be changed to reflect the new amount
More than One Security Issued for a Single Price
•Cash received usually is the sum of the separate market values of the two securities (record each at its market value) •If only one security's value is known, the second security's market value is inferred from the total selling price
Paid-in-Capital Fundamental Share Rights
•Common shares: •The right to vote on matters that come before the shareholders •Including the election of corporate directors •The right to share in profits when dividends are declared •The right to share in the distribution of assets if the company is liquidated •Preemptive right: Right to maintain one's percentage share of ownership when new shares are issued (by agreement)
Stock Dividends
•Distribution of additional shares of stock to current shareholders of the corporation •Affects neither the assets nor the liabilities of the firm •Shareholders' proportional interest in the firm remains unchanged •Market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend •Capitalizing retained earnings for a stock dividend artificially reclassifies earned capital as invested capital
Illustration: Shares Sold for Cash
•Dow Industrial sells 100 of its common shares, $1 par per share, for $10 per share: Cash 1,000 Common Stock 100 Paid in Capital - Excess of Par 900 •If the shares are no-par, the entry is as follows: Cash 1,000 Common Stock 1,000 Par: -Arbitrary amount designated in a corporate charter -Unrelated to the stock's value (must be recorded in separate amount) -Some state's corporate laws do not recognize par amounts
Cash Dividends
•No legal obligation exists for paying dividends to shareholders •Liability is not recorded until a company's board of directors votes to declare a dividend Before the payment actually can be made, a listing must be assembled of shareholders entitled to receive the dividend Declaration Date: -Date dividend is declared -Legal obligation does not exist until this point -Increase liabilities, decrease retained earnings Date of Record: -When the determination is made of the recipients of the dividend are entitled to receive the dividend-even if the shares are sold prior to actual cash payment -Registered owners of shares of stock on this date -No Journal Entry Ex-Dividend Date: -Registered owners of shares should have purchased shares before the ex-dividend date (usually two days before the date of record) -Shares purchased on the ex-dividend date are purchased as an ex-dividend (without the right to receive the dividend) -Market price of the share will decline by the amount of the dividend on the ex-dividend date Payment Date: -Date Dividends are paid to shareholders -Decrease both assets and liabilities Any dividends not representing a distribution of earnings should be debited to paid-in capital Dividends that exceed the balance of retained earnings is called a liquidated dividend Restriction of RE: Designates a portion as being unavailable for dividends -Does not set aside cash -Communicates intent not to distribute stated amount as dividends -Indicated by disclosure note
Property Dividends
•Noncash asset distributed to shareholders as dividend •Securities held as investments are the assets most often distributed in a property dividend •Should be recorded at the fair value of the assets to be distributed at the date of declaration (as in any non-cash transaction) •Recognize gain or loss for the difference between fair value and book value of the property (may need to reevaluate asset as fair value)
Typical Rights of Preferred Shares
•Often, shares with certain preferences or features that distinguish them from common shares are designated as preferred shares Rights include one or both of 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
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 (contra equity) •Shares are considered to be issued, but not outstanding (repurchased but not retired) •Purchase of treasury stock and its subsequent resale is considered to be a "single transaction" (resale of treasury stock increases shareholders equity with a credit to treasury stock) •Treasury stock usually does not have: }Voting rights. }Dividend rights. }Preemptive rights. }Liquidation rights. •Treasury stock is reported as an unallocated reduction of total Shareholders' Equity. Recording effects on shareholders equity accounts is done when shares are reissued -If Treasury Stock is sold for more than it cost, there is a net increase to cash and shareholder's equity -Investment in Treasury Stock is not an asset (Net increases in purchase and resale of treasury stock are not reported as gains in the company income statement)
Characteristics of Retained Earnings
•Retained earnings represents a corporation's accumulated, undistributed net income (or net loss) •Reinvested earnings Retained earnings Credit balance -Indicates a dollar amount of assets previously earned and reinvested by the firm Debit balance -Indicates deficit Buyback of shares and resale of treasury stock will decrease retained earnings
Share Issue Costs
•When a company sells shares, it incurs legal, promotional, and accounting services costs. These costs reduce the net cash proceeds from selling the shares and thus paid-in capital—excess of par •DuMont Chemicals issues 1 million of its common shares, $1 par per share, for $10 per share. DuMont incurred $200,000 in legal, promotional, and accounting services. Cash (10,000,000 - 200,000) 9.8 Common Stock 1 Pain-in capital - Excess of par 8.8
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 investments. 2.Gains (losses) from and amendments to postretirement benefit plans. 3.Deferred gains (losses) on derivatives. 4.Adjustments from foreign currency translation.