Chapter 12 Shareholders’ Equity Shareholders’ Equity How to Finance a Corporation: Borrow Notes, Bonds, Leases The debt holders are legally entitled to repayment of their principal and interest claims Issue Equity Common and Preferred Stock The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets Retained Earnings (profitable operations) Relative Importance of Liabilities, Contributed Capital, and Earned Capital Figure 12-2 The relative importance of liabilities, contributed capital, and retained earnings (percentage of total assets) Debt and Equity Distinguished - Characteristics Debt Equity Formal legal contract No legal contract Fixed maturity date No fixed maturity date Fixed periodic payments Discretionary dividends Security in case of default Residual asset interest No voice in management Voting rights - common Interest expense deductible Dividends not deductible Double taxation Distinctions Between Debt and Equity Interested Party Debt Investors / Lower investment risk Creditors Fixed cash receipts Contractual future cash Equity Higher investment risk Variable cash receipts Dividends are discretionary payments Management Effects on credit Effects of dilution/ takeover rating Interest is tax deductible Dividends are not tax deductible Accountants/ Liabilities section Shareholders’ equity Auditors of the balance sheet of the balance sheet Income statement No income statement effects from debt effects from equity The Economic Consequences Associated with Accounting for Shareholders’ Equity Key business ratios rely on Shareholders’ equity which affects credit ratings and analysts evaluation of a company Figure 12-5 Shareholders’ equity section of balance sheet Preferred Stock vs Common Stock Preferred Stock Advantages Common Stock Preference over common in liquidation Voting Rights Stated dividend Rights to residual profits (after preferred) Preference over common in dividend payout Disadvantages Subordinate to debt in liquidation Last in liquidation Stated dividend can be skipped No guaranteed return No voting rights (versus common) Debt or Equity? Components of both Usually classified as equity Sample Co Shareholders’ Equity (Used for Examples) Common stock, $1 par value, 500,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding $ 80,000 Common stock dividends distributable 2,000 Preferred stock, $100 par value, 1,000 shares authorized, 100 shares issued and outstanding 10,000 Paid in capital on common $ 20,000 Paid in capital on preferred 3,000 Paid in capital on treasury stock 2,000 25,000 Retained earnings: Unappropriated $18,000 Appropriated 4,000 22,000 Less: Treasury stock, 5,000 shares (at cost) (6,000) Less: Other comprehensive income items (unrealized loss on AFS securities) (2,000) Total Shareholders’ Equity $131,000 Accounting for Common and Preferred Stock Issuances Using Sample Company’s information, record the following additional issues of common (CS) and preferred stock (PS) Par value of PS is $100 and par value of CS is $1 Issued 100 shares of PS at $102 per share: Cash (100 x $102) 10,200 PS (100 x $100 par) 10,000 APIC* - PS 200 Issued 500 shares of CS at $5 per share: Cash (500 x $5) 2,500 CS (500 x $1 par) APIC* - CS 500 2,000 APIC – Additional Paid-in Capital 10 Treasury Stock Example -Journal Entries Dec: reissue 8,000 sh @ $ = $48,000 (cost = 8,000 sh.@ $7 = 56,000) Cash 48,000 APIC - TS (1) 2,000 RE (2) 6,000 TS 56,000 Now we need to debit one or more accounts to compensate for the difference (1) debit APIC -TS (but lower limit is to -0-) (2) debit RE if necessary for any remaining balance (this is only necessary when we are decreasing equity) 15 Stock Options Give employees (typically executives) the right to purchase company stock at a given price for a period of time The idea is that if the stock price rises the executives purchase stock at a price less than its market value thereby getting a benefit Since value is given up in the lower than market stock price and existing stockholders give up a percentage of ownership, GAAP requires that an expense be booked when the options are granted 16 Retained Earnings We will be expanding the basic retained earnings formula in this chapter Now the Statement of Retaine Earnings will include the following: RE, beginning (unadjusted) xx Add/Subtract: Prior period adjustment xx RE, beginning (restated) xx Add: net income xx Less dividends: Cash dividends-common xx Cash dividends - preferred xx Stock dividends xx Property dividends xx Less: Adjustment for TS transactions Appropriation of RE RE, ending xx xx xx 17 Example of Stock Split IZM Company has 100,000 shares of $2 par value stock authorized, 10,000 shares issued and outstanding The SE section of the balance sheet shows: Common stock $20,000 Retained earnings 80,000 The market price of the outstanding shares is $50 per share before the split is distributed 18 Example of Stock Split If IZM declared a for stock split, the old shares would be turned in and new shares would be issued with the following description: Common stock, $1 par value, 200,000 shares authorized, 20,000 shares issued and outstanding The total SE is still $100,000: The market price per outstanding share would now be $25 per share Note: No journal entry is necessary Common stock Retained earnings $20,000 80,000 19 Stock Dividends vs Stock Splits Going back to the original IZM information Assume instead that IZM declared a 100% stock dividend First, prepare the JEs to record the declaration and distribution of the stock dividend for new shares (10,000 shares x 100% = 10,000 new shares x $2 per share = $20,000): Stock Dividends (RE) 20,000 Stock Div Distributable 20,000 Stock Div Distributable 20,000 Common Stock 20,000 20 Stock Dividends vs Stock Splits Note the new description for the stock dividend: Common stock, $2 par value, 100,000 shares authorized, 20,000 shares issued and outstanding The total value in SE is still $100,000: Common Stock $40,000 Retained Earnings 60,000 $20,000 has been moved from RE to Common Stock Note that the total market price per share would change to $25 per share Thus, a for stock split and a 100% stock dividend have the same effect on: total shareholders’ equity and market price per share 21 Stock Dividends vs Stock Splits To summarize the effects on IZM Company: 100% Stock for After: Dividend Stock Split Total sh outstanding 20,000 sh 20,000 sh Par value per share $2 $1 Market price per share $25 $25 Total shareholders’ eq: $100,000 $100,000 General ledger results: CS account $ 40,000 $ 20,000 RE account $ 60,000 $ 80,000 CS was $20,000 and RE was $80,000 before the split or dividend The stock dividend required journal entries, and the amounts for CS and RE changed The stock split does not require a journal entry and the amounts for CS and RE not change 22 Comprehensive Class Problem - Shareholders’ Equity Given the following SE balances for Company G at 1/1/15: Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued and outstanding $200,000 APIC on common stock Retained earnings 400,000 400,000 During 2015, Company G had the following activity: Net income for the year was $250,000 Cash dividends of $2 per share were declared and paid on February On June 1, Company G repurchased 2,000 shares of its own stock at $20 per share (using the cost method) On December 1, Company G reissued 500 shares of treasury stock at $18 per share On December 15, Company G declared a 100% stock dividend, to be distributed to all of its shareholders (including treasury), on Jan 15, 2016 23 Comprehensive Class Problem Shareholders’ Equity (continued) Required: A Prepare journal entries for items through (item would require detailed information for revenues and expenses to prepare - just know that the credit is to retained earnings for $250,000) B the Statement of Stockholders’ Equity for Company G for 2015 C Prepare the stockholders’ equity section of the balance sheet for Company G for 2015, including the appropriate description for the common stock 24 Comprehensive Class Problem - Solution A Journal entries No entry required Calc: 20,000 x $2 = 40,000 Cash Dividends (RE) 40,000 Dividends Payable Dividends Payable 40,000 40,000 Cash 40,000 Calc: 2,000 shares x $20 = $40,000 Treasury Stock Cash 40,000 40,000 25 Comprehensive Class Problem - Solution Part A: Journal Entries 4. Calc: 500 shares x $18 market = $9,000 500 shares x $20 cost = $10,000 Cash 9,000 market Retained Earnings 1,000 Calc: 20,000 new shares x $10 par = $200,000 Treasury Stock 10,000 cost Note: in Item 5, the stock has not yet been distributed, so we cannot credit common stock, or show it issued yet This “Stock Dividends Distributable” account is a related equity account, and indicates that there are shares stock to be distributed in the future StockofDividend (RE) 200,000 Stock Div Distributable 200,000 26 Comprehensive Class Problem - Solution Part B: Statement of SE (in thousands) CS CSDD APIC RE TS Balance 1/1/15 $200 Net income Cash dividends Stock dividends $400 $400 250 (40) $200 (200) Purchase of TS $(40) Reissue of TS ( 1) 10 Balance, 12/31/15 $200 $200 $400 $409 $(30) Note: CSDD is Common Stock Dividends Distributable. When shares are distributed, then CS is increased 27 Comprehensive Class Problem - Solution Part C: Shareholders’ Equity Section of B/S Common stock, $10 par value, 50,000 shares authorized, 20,000 shares issued, 18,500 shares outstanding $ 200,000 Common stock dividends distributable, 20,000 shares 200,000 Additional paid-in capital, common stock 400,000 Retained earnings Less: Treasury stock, 1,500 shares at cost Total shareholders’ equity 409,000 (30,000) $1,179,000 28 Copyright © 2014 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 29 .. .Chapter 12 Shareholders’ Equity Shareholders’ Equity How to Finance a Corporation: Borrow Notes,... Associated with Accounting for Shareholders’ Equity Key business ratios rely on Shareholders’ equity which affects credit ratings and analysts evaluation of a company Figure 12- 5 Shareholders’... operations) Relative Importance of Liabilities, Contributed Capital, and Earned Capital Figure 12- 2 The relative importance of liabilities, contributed capital, and retained earnings (percentage