Financial accounting 10th pratt peters chapter 12

Chapter 12: Shareholders’ Equity Learning Objective List the three forms of financing and distinguish debt from equity Shareholders’ Equity How to Finance a Corporation: Borrow (focus of chapter 11) • • 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 Contributed capital Retained Earnings (profitable operations) • Earned capital The 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 dividend Security in case of default No direct voice in payments Residual asset interest management – influence Vote for board of directors through debt covenants Dividends are not an expense Interest is an expense but a distribution of retained earnings Distinctions Between Debt and Equity Interested Party Investors / Creditors Debt Equity Lower investment risk Fixed cash receipts Contractual future cash Higher investment risk Variable cash receipts Dividends are discretionary payments Management Effects on credit Effects of dilution/ takeover rating Interest is tax deductible Accountants/ Auditors Dividends are not tax deductible Liabilities section Shareholders’ equity of the balance sheet of the balance sheet Income statement No income statement effects from debt effects from equity Concept Practice Learning Objective Define and distinguish contributed capital from earned capital Accounting for Shareholders’ Equity The Shareholders’ equity section of a corporate balance sheet consists of two major components •Contributed Capital • • • • • Contributions from shareholders Preferred stock Common stock Additional paid-in capital Treasury stock (decrease) •Earned Capital • Assets earned and retained by the corporation • • Retained earnings Accumulated comprehensive income 10 Stock Splits 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 38 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 Stockholders’ Equity is still $100,000: • • Common stock Retained earnings $20,000 80,000 The market price per outstanding share would now be $25 per share Note: No journal entry is necessary 39 Stock Dividends vs Stock Splits Going back to the original IZM information Assume instead that IZM declared a 4% stock dividend Prepare the Journal Entry to record the declaration and distribution of the stock dividend for new shares {10,000 shares x 4% = 400 new shares x $50 per share = $20,000 This will be split between Common Stock (400X $2 par = 800) and APIC}: Stock Dividends (RE) 20,000 Common Stock APIC – Common Stock 800 19,200 This journal entry moves dollars from retained earnings into Common Stock and Additional Paid-In Capital 40 Stock Dividends vs Stock Splits Note the new description for the stock dividend: Common stock, $2 par value, 100,000 shares authorized, 10,400 shares issued and outstanding The total value in Shareholders’ Equity is still $100,000: • • • Common Stock Retained Earnings $40,000 60,000 $20,000 has been moved from RE to Common Stock & APIC Note that the total market price per share would change to approximately $48.08 per share {(10,000X$50)/10,400 shares} Total shareholders’ equity is the same for the stock split or the stock dividend 41 Stock Dividends vs Stock Splits To summarize the effects on IZM Company: 4% Stock After: Total sh outstanding for Dividend Stock Split 10,400 sh 20,000 sh Par value per share $2 $1 Market price per share $48.08 $25 Total shareholders’ eq: $100,000 $100,000 General ledger results: CS & APIC accounts RE account $ 40,000 $ 60,000 $ 20,000 $ 80,000 Common Stock (CS) was $20,000 and Retained Earnings (RE) was $80,000 before the split or dividend The stock dividend required journal entries, and the amounts for CS, APIC and RE changed The stock split does not require a journal entry and the amounts for CS and RE not change 42 Why Companies Declare Stock Dividends and Stock Splits? • Note • Stock splits and stock dividends not distribute additional assets to shareholders • Proportionate ownership of the company is the same before and after a stock split or stock dividend • Reduce the per-share price of outstanding shares to make them easier to purchase • Signal of ‘good news’ from the company meaning that it may spark interest in the stock 43 Comprehensive Class Problem - Shareholders’ Equity Given the following SE balances for Company G at 1/1/17: Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued and outstanding $200,000 APIC on common stock 400,000 Retained earnings 400,000 During 2017, Company G had the following activity: 1.Net income for the year was $250,000 2.Cash dividends of $2 per share were declared and paid on February 3.On June 1, Company G repurchased 2,000 shares of its own stock at $20 per share (using the cost method) 4.On December 1, Company G reissued 500 shares of treasury stock at $18 per share 5.On December 15, Company G declared a 100% stock dividend, to be distributed to all of its shareholders (including treasury), on Jan 15, 2018 44 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 2017 C Prepare the stockholders’ equity section of the balance sheet for Company G for 2017, including the appropriate description for the common stock 45 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 3.Calc: 2,000 shares x $20 = $40,000 Treasury Stock 40,000 Cash 40,000   46 Comprehensive Class Problem - Solution Part A: Journal Entries Calc: 500 shares x $18 market = $9,000 500 shares x $20 cost = $10,000 Cash 9,000 market Retained Earnings 1,000 Treasury Stock 10,000 cost Calc: 20,000 new shares x $10 par = $200,000   Stock Dividend (RE) 200,000 Stock Div Distributable 200,000 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 of stock to be distributed in the future 47 Comprehensive Class Problem - Solution Part B: Statement of SE (in thousands) CS CSDD APIC Balance 1/1/17 $200 RE $400 $400 Net income 250 Cash dividends (40) Stock dividends $200 (200) Purchase of TS $(40) Reissue of TS Balance, 12/31/17 TS ( 1) $200 $200 10 $400 $409 $(30) Note: CSDD is Common Stock Dividends Distributable When shares are distributed, then CS is increased 48 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 49 Learning Objective Interpret the information on a statement of shareholders’ equity, and discuss the rise of international equity markets 50 The Statement of Shareholders’ Equity GAAP requires changes during the period in dollar values of separate •accounts comprising the shareholders’ equity section be disclosed in the financial report 51 International Perspective: The Rise of International Equity Markets U.S companies have found it increasingly important to raise money in •international equity markets International companies have previously found it challenging to enter U.S •equity markets due to differing accounting requirements, but U.S exchanges now accept IFRS financial reports Accountants must provide the financial reports necessary to support this •investment activity 52 .. .Chapter 12: Shareholders’ Equity Learning Objective List the three forms of financing and distinguish debt from equity Shareholders’ Equity How to Finance a Corporation: Borrow (focus of chapter. .. comprehensive income 10 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’... Concept Practice Learning Objective Define and distinguish contributed capital from earned capital Accounting for Shareholders’ Equity The Shareholders’ equity section of a corporate balance sheet