Shareholders Equity

Chapter 18

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

Copyright2013byTheMcGrawHillCompanies,Inc.Allrightsreserved.

18-2

The Nature of Shareholders Equity

Assets Liabilities = Shareholders Equity
Net Assets

Sources of
Shareholders
Amounts invested Equity Amounts earned
by shareholders

by corporation

Shareholders Equity
Paid-in Capital
Retained Earnings
Accumulated Other
Comprehensive Income

Other
gains
and
losses
not

18-3

Financial Reporting Overview

18-4

Accumulated Other
Comprehensive Income
Accumulated
Accumulated other
other comprehensive
comprehensive
income
income includes
includes four
four types
types of
of gains
gains and
and
losses
losses
not
not included
included in
in net
net income.
income.
Net
Net holding
holding
gains
gains (losses)
(losses)
on
on
investments.
investments.
Gains
Gains
(losses)
(losses) from
from
and
and
amendments
amendments
to
to
postretireme
postretireme

Deferred
Deferred
gains
gains
(losses)
(losses) from
from
derivatives.
derivatives.
Gains
Gains
(losses)
(losses) from
from
foreign
foreign
currency
currency
translations.
translations.

Accumulated Other
Comprehensive Income

18-5

Comprehensive
Comprehensive income
income is
is reported
reported periodically
periodically
as
as it
it is
is created
created and
and also
also is
is reported
reported as
as a
a
cumulative
cumulative amount.
amount.
There
There are
are 2
2 options
options for
for
reporting
reporting
comprehensive
comprehensive income
income
created
created during
during the
the
reporting
reporting period.
period.

As
As an
an
additional
additional
section
section of
of the
the
income
income
statement.
statement.

The
The accumulated
accumulated
amount
amount of
of
comprehensive
comprehensive income
income
is
is reported
reported as
as aa
separate
separate item
item of
of
shareholders
shareholders equity
equity in
in
the
the balance
balance sheet.
sheet.

As
As aa separate
separate
statement
statement
immediately
immediately
following
following the
the
income
income statement
statement

18-6

U.S. GAAP vs. IFRS

Terminology Differences

Capital stock:
Common stock.
Preferred stock.
Paidin capitalexcess of
par, common.
Paidin capitalexcess of
par, preferred.

Share capital:
Ordinary shares.
Preference shares.
Share premium, ordinary
shares.
Share premium,
preference
shares.

18-7

U.S. GAAP vs. IFRS

Terminology Differences

Accumulated other
comprehensive income:

Reserves:

Investment revaluation
reserve.
Translation reserve.

Revaluation reserve.

Retained earnings.

Net gains (losses) on

investment AOCI.
Net gains (losses) foreign
currency translation AOCI.
Fair value adjustments not
permitted.

Retained earnings.

Total shareholders equity.

Presented after liabilities

Total equity.
Often presented before
liabilities.

18-8

The Corporate Organization

Advantages of a
corporation
Continuous
existence

Easy
ownership
transfer

Easy to
raise
capital

Limited
liability

Disadvantages of a
corporation
Double
taxation

Government
regulation

18-9

Types of Corporations
Not-for-profit corporations include
hospitals, charities, and government
agencies such as FDIC.
Publicly-held corporations
whose shares are widely
owned by the general public.
Privately-held corporations
whose shares are owned by
only a few individuals.

1810

Hybrid Organizations
S
S Corporation
Corporation

Limited
Limited liability
liability protection
protection of
of aa corporation.
corporation.
Maximum
Maximum number
number of
of owners.
owners.
Double

Limited
Limited liability
liability company
company

taxation
Limited
Limited liability
liability protection
protection of
of aa corporation.
corporation.
avoided.
All
All owners
owners may
may be
be involved
involved in
in management
management

without
without losing
losing limited
limited liability
liability protection.
protection.
No limit on number of owners .
No limit on number of owners .

Limited
Limited liability
liability partnership
partnership

Owners
Owners are
are liable
liable for
for their
their own
own actions
actions but
but
not
not entirely
entirely liable
liable for
for actions
actions of
of other
other
partners.
partners.

1811

The Model Business Corporation Act

Corporate
Charter

Nature and location of business

activities.
Number and classes of shares
authorized.

Articles of incorporation
are filed with the state.
State issues a
corporate charter.
Shares of
stock issued.

Board of directors
appoint officers.
Board of directors
elected by
shareholders.

1812

Fundamental Share Rights

Right to vote.

Preemptive
right to maintain
percentage
ownership.

Right to share
in profits when
dividends are
declared.

Right to share
in distribution of
assets if company
is liquidated.

Authorized, Issued, and

Outstanding Shares

Authorized shares are the

maximum
number of shares of capital stock
that
can be sold to the public.
Issued
Unissued
shares
shares are
are
authorize
authorize d shares
d shares
of stock
of stock that never
that have
have
been
been sold.
sold.

1813

Authorized, Issued, and

Outstanding Shares
Authorized
Shares

Outstanding
Shares
Treasury
Shares
Retired
Shares

Unissued
Shares

1814

1815

Capital Stock

Par value stock

Dollar amount per
share is stated in the
corporate charter.
Par value has no
relationship to market
value.

No-par stock
Dollar amount per share
is not designated in
corporate charter.
Corporations can assign
a stated value per share
(treated as if par value).

Legal capital is . . .
The portion of shareholders equity that must be
contributed to the firm when stock is issued.
The amount of capital, required by state law, that
must remain invested in the business.
Refers to par value, stated value, or full amount
paid for no-par stock.

1816

Capital Stock
Common stock is the basic voting stock of the
corporation. It ranks after preferred stock for
dividend and liquidation distribution.
Dividends are determined by the board of
directors.
Usually has a
Generally does not
par or stated value.
have voting rights.

Preferred
Stock
Dividend and liquidation
preference over
common stock.

May be convertible,
callable, and/or
redeemable.

1817

Preferred Stock Dividends

Are usually stated as a percentage of the
par
or stated value.
May be cumulative or noncumulative.
May be partially participating, fully
participating,
or nonparticipating.
Unpaid
dividends must be paid in

full before any distributions to

common stock.
Dividends in arrears are not
liabilities, but the per share and
aggregate amounts must be
disclosed.

1818

U.S. GAAP vs. IFRS

Distinction between Debt and Equity
for Preferred Stock

Preferred stock normally is

reported as equity, but is
reported as debt with the
dividends reported in the
income statement as
interest expense if it is
mandatorily redeemable
preferred stock.

Most non-mandatorily
redeemable preferred stock
(preference shares) also is
reported as debt as well as
some preference shares that
arent redeemable. Under
IFRS (IAS No. 32), the critical
feature that distinguishes a
liability is if the issuer is or
can be required to deliver
cash (or another financial
instrument) to the holder.

1819

Shares Issued for Cash

10,000 shares of stock are issued for
$100,000 cash.
$1 Par
Value

Cash .......................................................
Common stock, par value ..............
Paid-in capital excess of par

No Par
Value

Cash .......................................................
Common stock .............................

No Par,
$1 Stated
Value

100,000

10,000
90,000

To record issue of common stock.

100,000
100,000

To record issue of common stock.

Cash ................................................................... 100,000

Common stock, stated value .....................
10,000
Paid-in capital excess of stated value .
90,000
To record issue of common stock.

Shares Issued for

Noncash Consideration
Apply
Apply the
the general
general valuation
valuation principle
principle
by
by using
using fair
fair value
value of
of stock
stock given
given up
up
or
or fair
fair value
value of
of asset
asset received,
received,
whichever
whichever is
is more
more clearly
clearly evident.
evident.
If
If market
market values
values cannot
cannot be
be determined,
determined,
use
use appraised
appraised values.
values.

1820

More Than One Security

Issued for a Single Price

Allocate the lump-sum received based on the

relative fair values of the two securities.
If only one fair value is known, allocate a portion
of the lump-sum received based on that fair value
and allocate the remainder to the other security.

Toys Inc. issued 5,000 shares of common stock,

$10 par value, and 3,000 shares of preferred stock,
$5 par value, for $450,000. The market values of
the common stock and
preferred stock were $55 and $75, respectively.
Calculate the additional paid-in
capital for each class of stock.

1821

1822

More Than One Security

Issued for a Single Price

Cash ............................................................................
Common stock, $10 par .....................................
50,000
Paid-in capital excess of par common ..
Preferred stock, $5 par
Paid-in capital excess of par preferred .
To record issue of common and preferred stock.

450,000
197,500
15,000
187,500

1823

Share Issue Costs

Share issue costs reduce net proceeds

from selling shares, resulting in a lower
amount of additional paid-in capital.

1824

Share Buybacks
A
A corporation
corporation might
might reacquire
reacquire shares
shares of
of its
its stock
stock to
to .. ..
..
Companies can
support
the
market
price.
support the market price.
account for the
increase
increase earnings
earnings per
per share.
share. reacquired shares
distribute
distribute in
in stock
stock option
option plans.
plans.
by retiring them or
issue
by holding them as
issue as
as aa stock
stock dividend.
dividend.
treasury shares.
use
use in
in mergers
mergers and
and acquisitions.
acquisitions.
thwart
thwart takeover
takeover attempts.
attempts.

1825

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.

Price paid is less than issue price.

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 ....
Paid-in capital share repurchase ..
Cash ..
To record repurchase and retirement of common stock.

90,000
15,000
85,000

1826

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 ............................................................

Paid-in capital excess of par common .90,000

Paid-in capital share repurchase ..25,000
Cash ..

10,000

125,000

To record repurchase and retirement of common stock.

Reduce Retained Earnings if the Paid-in capitalshar

repurchase account balance is insufficient.

1827

Accounting for 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.
Acquisition of Treasury Stock
Recorded at cost to acquire.
Resale of Treasury Stock
Treasury Stock credited for cost.
Difference between cost and issuance price is
(generally)
recorded in paid-in capitalshare repurchase.

1828

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-aSecond reissued 1,000 shares of the stock at $75 per share.
Which of the following would be included in the 12/3/13
entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
May 1, 2012:
Treasury stock ..............................................
Cash ...................................................

165,000
165,000

To record purchase of treasury stock.

December 3, 2013:
Cash .............................................................
Treasury stock ....................................
Paid-in capital share repurchase .
To record reissue of treasury stock.

75,000
55,000
20,000

1829

Where Were Headed

The FASB and IASB are working to establish a common
standard for presenting information in the financial
statements, An important part of the proposal involves
the organization of elements of the balance sheet,
statement of comprehensive income, and statement of
cash flows into a common set of classifications.
A key feature of the new format is that each of the
financial statements will include classifications by
operating, investing, and financing activities (similar to
the current statement of cash flows). Operating and
investing activities will be included within a new
category, business activities. Each statement also will
include three additional groupings: discontinued
operations, income taxes, and multi-category
transactions (if needed).

1830

Retained Earnings
Represents the undistributed earnings of
the company since its inception.

The statement of retained earnings may also

contain the correction of an accounting error that
occurred in the financial statements of a prior
period, called a prior period adjustment.
Any restrictions on retained earnings must be
disclosed in the notes to the financial statements.

1831

Accounting for Cash Dividends

Declared by board
of directors.

Not legally
required.

Creates liability
at declaration.

Requires sufficient
Retained Earnings
and Cash.

Declaration date

Board of directors declares a $10,000 cash

dividend.
Record a liability.

Declaration Date:
Retained earnings ........................................
Dividends payable ..............................
To record declaration of cash dividend.

10,000
10,000

1832

Dividend Dates
Ex-dividend date
The first day the shares trade without the right
to
receive the declared dividend. (No entry)

Date of Record

Stockholders holding shares on this date will

receive
the dividend.
(No entry)
Date
of Payment
Record the dividend payment to stockholders.
Date of Payment:
Dividends payable ........................................
Cash ..............................
To record payment of cash dividend.

10,000
10,000

1833

Property Dividends
Distributions
Distributions of
of nonnon-

cash
cash assets.
assets.
Record
Record at
at fair
fair value
value
of
of noncash
noncash asset.
asset.
Recognize
Recognize gain
gain or
or
loss
loss for
for difference
difference
between
between book
book value
value
and
and fair
fair value.
value.

1834

Accounting for Stock Dividends

Distribution of additional shares of stock to
owners.
No change in
No change in total
par values.
stockholders
equity.
All stockholders retain
same percentage
ownership.

Small
Stock
Stock dividend
dividend <
<
25%
25%
Record
Record at
at current
current
fair
fair
value
value of
of stock.
stock.

Large
Stock
Stock dividend
dividend >
>
25%
25%
Record
Record at
at par
par
value
value of
of stock.
stock.

1835

Accounting for Stock Dividends

CarCo declares and distributes a 20%
stock dividend on 5 million common
shares. Par value is $1 and market value is
$20. The required journal entry would be:
Retained earnings .....................................................
Common stock .
Paid-in capital excess of par common ..

20,000,000
1,000,000
19,000,000

To record declaration and distribution of small stock dividend.

5,000,000
5,000,000 shares
shares
20
20 %
%=
= 1,000,000
1,000,000 shares
shares issued
issued
$20
$20
=
= $20,000,000
$20,000,000

1836

Stock Splits
Stock splits change the par value per share and the
number of shares outstanding, but the total par
value is unchanged, and no journal entry is
Assume that a required.
corporation had 3,000
shares of $2 par value common stock
outstanding before a 2for1 stock
split.
Increas
e
Decreas
e
No
Change

1837

Stock Splits Effected in the

Form of Large Stock Dividends
Matrix
Matrix Inc.
Inc. declares
declares and
and distributes
distributes aa 2-for-1
2-for-1
stock
stock split
split effected
effected in
in the
the form
form of
of aa 100%
100% stock
stock
dividend.
dividend. The
The company
company has
has 1,000,000,
1,000,000, $1
$1 par
par
value
value common
common stock
stock outstanding.
outstanding. The
The stock
stock is
is
trading
trading in
in the
the open
open market
market for
for $14
$14 per
per share.
share.
The
The per
per share
share par
par value
value of
of the
the shares
shares is
is not
not to
to
be
be changed.
changed.
Paid-in capital excess of par common .................
Common stock ...
To record declaration and distribution of 2-for-1 stock
split effected in the form of a 100% stock dividend.

1,000,000
1,000,000

1838

Appendix 18 Quasi Reorganizations

Purpose
To allow a company undergoing financial difficulty, but
with favorable future prospects, to get a fresh start by
writing down inflated assets and eliminating an
accumulated balance in retained earnings.
Procedures
Assets and liabilities are revalued to reflect market
values, with corresponding debits and credits to
retained earnings.
The debit balance in retained earnings is eliminated
first against additional paid-in capital, and then, if
necessary, against common stock.
Retained earnings is dated to indicate when the
new accumulation of earnings began.

1839

Quasi Reorganizations
Emerson-Walsch Corporation has incurred losses
for several years. The board of directors voted to
implement a
quasi reorganization, subject to shareholder
approval. (millions)
Cash
75
The balance sheet prior to$ restatement,
invalues:
Fair
Receivables
200
millions,
follows
:
Inventory
375
Inventory =
Property, plant, and equipment (net)
Total assets

Liabilities
Common stock (800 million shares @$1)
Additional paid-in capital
Retained earnings (deficit)
Total liabilities and equity

$
$

400
1,050

400
800
150
(300)
1,050

$300,000,000
and Property,
plant, and
equipment =
$225,000,000
.

Lets prepare the journal entries necessary for the quasi

1840

Quasi Reorganizations
To revalue assets
Retained earnings ..................
Inventory .
Property, plant, & equipment

250,000,000
75,000,000
175,000,000

To record reduction to fair value of assets.

To eliminate the deficit in retained

earnings
Paid-in capital excess of par common
..............
150,000,000
Common stock ..
Retained earnings ..

400,000,000
550,000,000

To eliminate the deficit in retained earnings.

$300,000,000 + $250,000,000

1841

Quasi Reorganizations
Balance
Balance sheet
sheet immediately
immediately after
after restatement.
restatement.

1842

End of Chapter 18