Pier 1 FY 2011-2010 Balance Sheet

Chapter 11 Stockholders' Equity

Advantages of a corporation Simple to become an owner Easy to transfer ownership Provides limited liability Indefinite life (beyond owners) Separate entity for contracting purposes

Creating a Corporation
State

laws govern the creation of corporations (Delaware permits anti-takeover provisions

approved by the Board of Directors, not the Shareholders)

An

application for a charter (or articles of incorporation) must include the corporation s name and purpose, kinds and amounts of capital stock authorized, and other detailed information. Stockholders elect the Board of Directors

Authorized Capital Stock

Authorized Shares

The maximum number of shares of capital stock that can be sold to the public.

Authorized, Issued, and Unissued Capital Stock

Authorized Shares
Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold.

Authorized, Issued (Outstanding and Treasury), and Unissued Capital Stock

Authorized Shares
Issued: Outstanding shares are held by stockholders Issued: Treasury Shares were issued shares to stockholders and repurchased by the corporation

Unissued shares are authorized shares of stock that never have been sold.

Common Stock

The basic voting stock of the corporation Rights of ownership:

Voting (in person or by proxy). Distributions of profits (dividends). Distributions of assets in a liquidation.

Ranks last (after creditors and preferred stockholders) for dividend and liquidation distribution. Dividend rates are determined by the board of directors based on the corporation s profitability.

Common Stock: Par Value

Is

a nominal value per share of capital stock specified in the charter Has NO relationship to market value Serves as the basis for legal capital Legal Capital is the amount of capital, required by the state, that must remain invested in the business (serves as a cushion for creditors)

Preferred Stock
Stock with attributes of both debt and equity, typically No voting rights Fixed dividend rate that is stated as a percentage of the par value Dividend and liquidation preference over common stock

Features of Preferred Stock

Convertible preferred stock may be exchanged for common stock. Callable preferred stock may be repurchased by the corporation at a predetermined price. Mandatorily Redeemable preferred stock must be redeemed by the corporation at a specified future date (in Liability Section of Balance Sheet).

Accounting for Capital Stock

Two primary sources of stockholders equity:
Contributed capital
Par or stated value of issued stock. Additional paid-in capital in excess of par (contributed capital in excess of par) or stated value.

Retained earnings
The cumulative net income earned by the corporation less the cumulative dividends declared by the corporation.

Netflix Stockholders equity (2008 and 2007)

Blockbuster Stockholders equity (2008 and 2007)

Sale and Issuance of Capital Stock

An

initial public offering (IPO) is the very first time a corporation sells stock to the public. A seasoned new issue is the subsequent sale of new stock to the public.

Sale and Issuance of Capital Stock

On July 6, East Corporation issued 100,000 shares of $0.10 par value common stock for $25 per share. On August 8, Jessica, a shareholder sells 100 shares of East Corp stock for $31 per share. Journal entry on July 6?

Journal entry on August 8?

Sale and Issuance of Capital Stock

On July 6, East Corporation issued 100,000 shares of $0.10 par value common stock for $25 per share. On August 8, Jessica, a shareholder sells 100 shares of East Corp stock for $31 per share.

Journal entry on July 6? Cash 2,500,000 Common stock Additional paid-in capital (APIC) Journal entry on August 8? No Entry

10,000 2,490,000

Capital Stock Sold for Noncash Assets and/or Services

Assets

or services acquired in exchange for stock should be recorded at the market value of the stock at the date of the transaction. the market value of the stock cannot be determined, then the market value of the assets or services received should be used.

If

Capital Stock Sold for Noncash Assets and/or Services

On March 14, East Corporation issued 10,000 shares of common stock ($0.10 par value) to King and Associates for legal services. The stock was selling for $25 per share. Journal entry on March 14? Legal expense Common Stock APIC

250,000 1,000 249,000

Employee Stock Options

Some stock options granted to employees (either executives or more widely) allow those employees to purchase the company s stock over some future time period from the corporation at a specified price that may be lower than the prevailing market price. Should these options be viewed as compensation expense at the time of grant?

Employee Stock Options

1/1/2010: 1,000 Options Granted when Striking Price: $10 Common Stock Market Value: $10 Common Stock Par Value: $1 Exercisable over 5 years Option Value: $2.50 Recognize compensation expense over the period the options are earned (the vesting period): $2,500 / 5years = $500 per year for 2010-2014. Compensation Expense 500 Stock Options Outstanding 500

Employee Stock Options Exercised

Five years later, all the options have vested and all are exercised because the market value of the stock has increased to $14 per share. Cash Stock Options Outstanding Common Stock APIC 10,000 2,500 1,000 11,500

Employee Stock Options Lapse

Five years later, all the options have vested but none are exercised because the market value of the stock has dropped to $9 per share. Stock Options Outstanding 2,500 APIC: Stock Options 2,500

Treasury Stock
A corporation s own stock that had been issued but was subsequently reacquired and is still being held by that corporation. Why would a corporation reacquire its own stock?

Treasury Stock
Issued stock but not outstanding stock
Has

no voting or dividend rights

Reduces

total stockholders equity on the Balance Sheet -- treasury stock is a contra stockholders equity account

Treasury Stock Cost method

On May 1 Netflix reacquired 3,000 shares of its common stock at $55 per share. Journal entry on May 1 Treasury stock Cash 165,000 165,000

Treasury Stock
On December 3 Netflix reissued 1,000 shares of the stock at $75 per share. Journal entry on December 3?
Cash Treasury stock APIC from treas stock transactions 75,000 55,000 20,000

No gain or loss!

Cash Dividends
Must

be declared by the Board of Directors The Corporation is not legally required to pay dividends, but if cash dividends are declared a liability is created (dividends payable) Cash dividends require both sufficient cash and retained earnings to cover the dividend

Dividend Dates
Declaration date
l l

Board of directors declares the dividend. Record a liability.

Entry for dividends declared of $10,000: On date of declaration: Dividends declared (or RE) 10,000 Dividends payable 10,000

Dividend Dates
Date of Record
Stockholders holding shares on this date will receive the dividend. (No journal entry)

Date of Payment
Record the payment of the dividend to stockholders: Dividends payable Cash 10,000 10,000

Dividend Dates: Example

On June 1 a corporation s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. What is the entry (if any) on June 1? Amount of dividend = $100 8% 2,500 = $20,000 6/1 PS Dividends declared (or RE) 20,000 Dividends payable 20,000

Dividends on Preferred Stock

Current Dividend Preference -- dividends must be paid to Preferred stockholders before paying any dividends to common stockholders If a preferred dividend is not paid, the unpaid amount is either cumulative (in arrears) or noncumulative Cumulative: Unpaid dividends in arrears must be paid before current year preferred dividends or common dividends Noncumulative: Preferred shareholders lose the right to dividends not declared in previous years

Dividends on Preferred Stock

A company has the following stock outstanding: Common stock: $1 par, 100,000 shares Preferred stock: 3%, $100 par, cumulative, 5,000 shares Preferred stock: 6%, $50 par, noncumulative, 3,000 shares
Dividends were not paid last year. The 6% preferred stock is subordinate to the 3% preferred stock. In the current year, the board of directors declared dividends of $50,000. How much will each class of stock receive?

Dividends on Preferred Stock

Total dividend declared 3% Preferred stock (cumulative) Dividends in arrears ($100 x 3% x 5,000) Current year dividends ($100 x 3% x 5,000) Total 6% Preferred stock (noncumulative) Current year dividends ($50 x 6% x 3,000) Common stock Current dividends ($50,000 - $30,000 - $9,000) $ 50,000 15,000 15,000 30,000

9,000

11,000

Accounting for Stock Dividends

Stock dividends are distributions to stockholders of additional shares of stock Why issue a stock dividend? Low on cash To decrease market price of stock

Accounting for Stock Dividends

Stock

dividends are denoted by a percentage of outstanding shares stockholders increase the number of shares owned, but percentage ownership does not change Stock dividends do not affect Assets or Liabilities No change in total stockholders equity No change in par values.

Accounting for Stock Dividends

Accounting Differs based on Size of the Stock Dividend
A stock dividend that is less than 2025% of the outstanding shares is a small stock dividend.
Record at the current market value of the stock.

A stock dividend that is greater than 2025% is a large stock dividend.

Record at the par or stated value of the stock.

Journal Entries for Stock Dividend

Small stock dividend (<25%)
Retained earnings Common stock APIC Market Value Par Value Plug

Large stock dividend (>25%)

Retained Earnings Common Stock Par Value Par Value

Stock Dividend Example

Case Corporation has 1,000,000 shares of common stock, par $1, issued and outstanding. On 6/1/20A,when its common stock is trading at $8 per share, Case issues a 10% stock dividend. Give the entry to reflect the stock dividend.

Stock Dividend Example

Case Corporation has 1,000,000 shares of common stock, par $1, issued and outstanding. On 6/1/20A,when its common stock is trading at $8 per share, Case issues a 10% stock dividend. Give the entry to reflect the stock dividend.
This is a small stock dividend. Record at Market Value = 100,000 @ $8 Retained earnings Common stock (at par) APIC 800,000 100,000 700,000

Stock Dividend Example

Suppose Case had issued a 50% stock dividend on 6/1/20A. Give the entry to reflect the stock dividend.
This is a large stock dividend and is recorded at par value of $1 per share. Retained earnings 500,000 Common stock (at par) 500,000

Accounting for Stock Splits

Stock splits are NOT stock dividends The effect of Stock Splits is similar to stock dividends Each stockholder increases the number of shares owned, but percentage ownership does not change Stock splits are distributions of additional stock to stockholders with a corresponding decrease in par value Increases number of outstanding shares Decreases par value of stock No change in total stockholders equity

Stock Splits
Assume that a corporation had 5,000 shares of $1 par value common stock outstanding before a 2for1 stock split.
Before Split Common Stock Shares Par Value per Share Total Par Value 5,000 $ 1.00 $ 5,000 After Split 10,000 $0.50 $ 5,000

Stock Split vs. Stock Dividend

Using the information from the previous slide what would happen if the Company decides to issue a 100% stock dividend rather than split the stock 2:1
Number of shares outstanding? Increase by 5,000 shares Par value per share? No change Change in Retained Earnings? Decrease by $5,000 Change in Common Stock? Increase by $5,000

Earnings per share

EPS =
Net income available to common shareholders Average number of common shares outs tan ding

EPS must be reported in annual financial statements.

Netflix EPS (basic): $1.36 in 2008 $.99 in 2007 Blockbuster EPS: $(2.01) in 2008 $(.45) in 2007

Basic versus diluted EPS?

Dividend yield per share

Dividend per share Dividend yield per share = Market price per share

Measures dividend return on the current price of common stock. Netflix paid no dividends Blockbuster paid no dividends to common shareholders