CHAPTER 15 Stockholders’ Equity ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems Concepts for Analysis Corporate form: capital stock system 1, 2 Stockholders’ equity components 3, 4, 5, 6, 16, 18 7, 10, 11, 16, 17, 18 1, 2, 3, 9, 12 Issuance of stock 7, 10 1, 2, 6 1, 2, 4, 6, 9, 18 1, 3, 4, 9 12 Lump sum sales; non cash stock transactions; stock issue costs 8, 9, 10 4, 5, 6 3, 4, 5, 6, 18 1, 4, 9, 12 Treasury stock transactions 11, 12, 16, 17 7, 8 6, 7, 9, 10, 18 1, 2, 3, 5, 6, 7, 9, 12 6, 7 Preferred stock 3, 13, 14, 15 1, 3, 12 Dividend policy 19, 20, 21 10, 11, 12 12, 16 7, 10 5, 7 Cash, property, and liquidating dividends 16, 22, 25 10, 11, 12 8, 12, 15, 16, 18 3, 6, 7, 8, 10, 11 5, 6 13, 14 13, 14 8, 9, 11 4, 5 10, 19, 20 1, 2, 3, 5, 6, 9, 11, 12 Restrictions of retained earnings 27, 28 10. Stock dividends and stock splits 22, 23, 24 1, 3 11 Analysis of stockholders’ equity 12 Presentation of stockholders’ equity *13 Dividend preferences and book value 15, 18 7, 8, 10, 11, 16, 17, 18 29 15 21, 22, 23, 24 1, 3 3, 6 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 151 *This material is covered in an Appendix to the chapter 152 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Learning Objectives Brief Exercises Exercises Problems Discuss the characteristics of the corporate form of organization Identify the key components of stockholders’ equity Explain the accounting procedures for issuing shares of stock 1, 2, 4, 5, 6 1, 2, 3, 4, 5, 6, 8, 9, 10 1, 3, 4, 9, 12 Describe the accounting for treasury stock 3, 7, 8 6, 7, 9, 10, 18 1, 2, 3, 5, 6, 7, 9, 12 Explain the accounting for and reporting of preferred stock Describe the policies used in distributing dividends 10, 11, 12 16 Identify the various forms of dividend distributions. 11, 12 11, 12, 15, 16, 18 3, 6, 7, 8, 9, 11, 12 Explain the accounting for small and large stock dividends, and for stock splits 13, 14 11, 13, 14, 15, 16, 18 3, 8, 10, 11, 12 Indicate how to present and analyze stockholders’ equity 17, 19, 20 1, 2, 6, 9, 11, 12 *10 Explain the different types of preferred stock dividends and their effect on book value per share 15 21, 22, 23, 24 *11 Compare the procedures for accounting for stockholders’ equity under GAAP and IFRS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 153 ASSIGNMENT CHARACTERISTICS TABLE Item E151 E152 E153 E154 E155 E156 E157 E158 E159 E1510 E1511 E1512 E1513 E1514 E1515 E1516 E1517 E1518 E1519 E1520 *E1521 *E1522 *E1523 *E1524 P151 P152 P153 P154 P155 P156 P157 P158 P159 P1510 P1511 P1512 CA151 CA152 CA153 CA154 CA155 CA156 Description Recording the issuances of common stock Recording the issuance of common and preferred stock Stock issued for land Lumpsum sale of stock with bonds Lumpsum sales of stock with preferred stock Stock issuances and repurchase Effect of treasury stock transactions on financials Preferred stock entries and dividends Correcting entries for equity transactions Analysis of equity data and equity section preparation Equity items on the balance sheet. Cash dividend and liquidating dividend Stock split and stock dividend Entries for stock dividends and stock splits Dividend entries Computation of retained earnings Stockholders’ equity section Dividends and stockholders’ equity section Comparison of alternative forms of financing Trading on the equity analysis Preferred dividends Preferred dividends Preferred stock dividends Computation of book value per share Equity transactions and statement preparation Treasury stock transactions and presentation Equity transactions and statement preparation Stock transactions—lump sum Treasury stock—cost method Treasury stock—cost method—equity section preparation Cash dividend entries Dividends and splits Stockholders’ equity section of balance sheet Stock dividends and stock split Stock and cash dividends Analysis and classification of equity transactions Preemptive rights and dilution of ownership Issuance of stock for land Conceptual issues—equity Stock dividends and splits Stock dividends Stock dividend, cash dividend, and treasury stock Level of Difficulty Simple Simple Simple Moderate Simple Moderate Moderate Moderate Moderate Moderate Simple Simple Simple Simple Simple Simple Moderate Moderate Moderate Moderate Simple Moderate Complex Moderate Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Simple Moderate Simple Complex Moderate Moderate Moderate Simple Simple Moderate Time (minutes) 15–20 15–20 10–15 20–25 10–15 25–30 15–20 15–20 15–20 20–25 15–20 10–15 10–15 10–12 10–15 05–10 20–25 30–35 20–25 15–20 10–15 15–20 15–20 10–15 50–60 25–35 25–30 20–30 30–40 30–40 15–20 20–25 20–25 35–45 25–35 35–45 10–20 15–20 25–30 25–30 15–20 20–25 154 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) CA157 Treasury stock, ethics Moderate 10–15 *This material is presented in an appendix to the chapter Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 155 LEARNING OBJECTIVES *10 Discuss the characteristics of the corporate form of organization Identify the key components of stockholders’ equity Explain the accounting procedures for issuing shares of stock Describe the accounting for treasury stock Explain the accounting for and reporting of preferred stock Describe the policies used in distributing dividends Identify the various forms of dividend distributions Explain the accounting for small and large stock dividends, and for stock splits Indicate how to present and analyze stockholders’ equity Explain the different types of preferred stock dividends and their effect on book value per share *11 Compare the procedures for accounting for stockholders’ equity under GAAP and IFRS *This material is covered in an Appendix to the chapter 156 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) CHAPTER REVIEW Chapter 15 focuses on the stockholders’ equity section of the corporate form of business organization Stockholders’ equity represents the amount that was contributed by the shareholders and the portion that was earned and retained by the enterprise. There is a definite distinction between liabilities and stockholders’ equity that must be understood if one is to effectively grasp the accounting treatment for equity issues. This chapter addresses the accounting issues related to capital contributed by owners of a business organization, and the means by which profits are distributed through dividends The Corporate Form of Organization (L.O 1) The corporate form of business organization begins with the submitting of articles of incorporation to the state in which incorporation is desired. Assuming the requirements are properly fulfilled, the corporation charter is issued and the corporation is recognized as a legal entity subject to state law. The laws of the state of incorporation that govern owners’ equity transactions are normally set out in the state’s business corporation act Within a given class of stock, each share is exactly equal to every other share. A person’s percent of ownership in a corporation is determined by the number of shares he or she possesses in relation to the total number of shares owned by all stockholders. In the absence of restrictive provisions, each share carries the right to share proportionately in: (a) profits, (b) management, (c) corporate assets upon liquidation, and (d) any new issues of stock of the same class (preemptive right) Share System The transfer of ownership between individuals in the corporate form of organization is accomplished by one individual selling or transferring his or her shares to another individual. The only requirement in terms of the corporation involved is that it be made aware of the name of the individual owning the stock. A subsidiary ledger of stockholders is maintained by the corporation for the purpose of dividend payments, issuance of stock rights, and voting proxies. Many corporations employ independent registrars and transfer agents who specialize in providing services for recording and transferring stock The basic ownership interest in a corporation is represented by common stock. Common stock is guaranteed neither dividends nor assets upon dissolution of the corporation Common stockholders are considered to hold a residual interest in the corporation However, common stockholders generally control the management of the corporation and tend to profit most if the company is successful. In the event that a corporation has only one authorized issue of capital stock, that issue is by definition common stock, whether or not it is so designated in the charter Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 157 Corporate Capital (L.O 2) Owners’ equity in a corporation is defined as stockholders’ equity, share holders’ equity, or corporate capital. The following categories normally appear as part of stockholders’ equity a Capital stock b Additional paidin capital c Retained earnings Stockholders’ Equity: Contributed Capital Capital stock and additional paidin capital constitute contributed (paidin) capital; retained earnings represents the earned capital of the company not distributed as dividends. Contributed capital (paidin capital) is the total amount paid in on capital stock Earned capital is the capital that develops from profitable operations Stockholders’ equity is the difference between the assets and the liabilities of the company—also known as the residual interest. Stockholders’ equity is not a claim to specific assets, but a claim against a portion of the total assets Accounting for the Issuance of Stock 10 (L.O 3) The par value of a stock has no relationship to its fair value Par value associated with most capital stock issues is generally very low Low par values help companies avoid the contingent liability associated with stock that is issued below par 11 When par value stock is issued, the capital stock (common or preferred) account is credited for an amount equal to par value times the number of shares issued. Any amount received in excess of par value is credited to additional paidin capital. For example, if 200 shares of common stock with a par value of $2 per share are sold for $500, the following journal entry would be made: Cash Common Stock (200 × $2) Paidin Capital in Excess of Par 500 400 100 Par value stock is always credited at its issue date for its par value times the number of shares issued 12 When nopar stock is issued, the capital stock account is credited for an amount equal to the value of the consideration received. If nopar stock has a stated value, it may be accounted for in the same way as true nopar stock with the entire proceeds from issuance credited to the capital stock account, or the stated value may be treated similar to par value with any excess above stated value being accounted for as additional paidin capital 158 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LumpSum Sales 13 More than one class of stock is sometimes issued for a single payment or lump sum amount. Such a transaction requires allocation of the proceeds between the classes of securities involved. 14 The two methods of allocation used are (a) the proportional method and (b) the incremental method. The proportional method is used when the fair value for each class of security is readily determinable, and the incremental method is used when only one class’ fair value is known Stock Issued in Noncash Transactions 15 Stock issued for services or property other than cash should be recorded by using the fair value of the property or services or the fair value of the stock issued, whichever is more clearly determinable In cases where the fair value of both items is not clearly determinable, the board of directors has the authority to establish a value for the transaction Costs of Issuing Stock 16 Direct costs incurred to sell stock such as underwriting costs, accounting and legal fees, and printing costs should be debited to Paidin Capital in Excess of Par. Management salaries and other indirect costs related to the stock issue should be expensed as incurred Treasury Stock 17 (L.O. 4) Treasury stock is a corporation’s own stock that (a) was outstanding, (b) has been reacquired by the corporation, and (c) is not retired. Treasury stock is not an asset and is reported in the balance sheet as a reduction of stockholders’ equity. 18 The reasons corporations purchase their outstanding stock include: (a) to provide tax– efficient distributions of excess cash to shareholders; (b) to increase earnings per share and return on equity; (c) to provide stock for employee stock compensation contracts; (d) to thwart takeover attempts or to reduce the number of stockholders; and (e) to make a market in the stock 19 Two methods are used in accounting for treasury stock, the cost method and the par value method Under the cost method, treasury stock is recorded in the accounts at acquisition cost When the treasury stock is reissued, the Treasury Stock account is credited for the acquisition cost. If treasury stock is reissued for more than its acquisition cost, the excess amount is credited to Paidin Capital from Treasury Stock. If treasury stock is reissued for less than its acquisition cost, the difference is debited to any paidin capital account from previous treasury stock transactions. If the balance in this account is insufficient, the remaining difference is charged to retained earnings. 20 The following example shows the accounting for treasury stock under the cost method. No previous acquisitions or sales of treasury stock have occurred. Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 159 10,000 shares of common stock with a par value of $5 per share were originally issued at $12 per share A Entry for Purchase: 2,000 shares of common stock are reacquired for $20,000 Treasury Stock Cash 20,000 20,000 B Entry for Resale: 1,000 shares of treasury stock are resold for $8,000 Cash Retained Earnings Treasury Stock 8,000 2,000 10,000 21. Retirement of Treasury Stock. The retirement of treasury stock is similar to the sale of treasury stock except that the corporation debits the paidin capital accounts applicable to the retired shares instead of cash. 22 The cost of treasury stock is shown in the balance sheet as a deduction from the total of all stockholders’ equity accounts Preferred Stock 23 (L.O. 5) Preferred stock is the term used to describe a class of stock that possesses certain preferences or features not possessed by the common stock The dividend preference of preferred stock is normally stated as a percentage of the preferred stock’s par value However, a preference as to dividends does not assure the payment of dividends; it merely assures that corporations must pay the applicable amount to the preferred stock prior to paying any dividends on common stock 24 The following features are those most often associated with preferred stock issues: a Preference as to dividends b Preference as to assets in the event of liquidation c Convertible into common stock d Callable at the option of the corporation e Nonvoting Some features used to distinguish preferred stock from common stock tend to be restrictive For example, preferred stock may be nonvoting, noncumulative, and nonparticipating A corporation may attach whatever preferences or restrictions in whatever combination it desires to a preferred stock issue, so long as it does not specifically violate its state incorporation law. 1510 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) (1) Capital stock (2) Additional paidincapital (3) Retained earnings or deficit b On the statement of stockholders’ equity, the basic format is usually: Beginning balance + Additions – Deductions = Ending balance c Disclosures related to stockholders’ equity include dividend and liquidation preferences, participation rights, and call and conversion information Analysis. Several ratios use stockholders’ equity amounts to evaluate a company’s profitability and longterm solvency Net income – Preferred dividends Rate of Return = On Common Stock Equity Average common stockholders' equity Payout Ratio = Book Value Per Share= a Cash dividends Net income – Preferred dividends Common stockholders' equity Outstanding shares Trading on the equity at a gain occurs when the return on total assets is lower than the rate of return on the common stockholders’ investment TEACHING TIP Illustration 157 presents the ratios using stockholders’ equity amounts used to measure profitability and longterm solvency *L (L.O. 10) Dividend Preferences and Book Value per Share Dividend preferences a Preferred stock is noncumulative and nonparticipating b Preferred stock is cumulative and nonparticipating c Preferred stock is noncumulative and fully participating d Preferred stock is cumulative and fully participating Book value per share Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1521 Net assets a In simplest form: b Complications may occur if preferred stock exists. For example: Outstanding shares at end of year (1) Preferred dividends are in arrears (2) Preferred stock is participating (3) The redemption or liquidation value of the preferred stock is higher than its carrying amount c These complications require that the retained earnings be allocated between the preferred and common stockholders when computing the book value per share *M. IFRS Insights The primary IFRS related to stockholders’ equity are IAS 1 (“Presentation of Financial Statements”), IAS 32 (“Financial Instruments: Presentation”), and IAS 39 (“Financial Instruments: Recognition and Measurement”). Similarities a The accounting for the issuance of shares and purchase of treasury stock are similar under both IFRS and GAAP b The accounting for declaration and payment of dividends and the accounting for stock splits are similar under both IFRS and GAAP Differences a Major differences relate to terminology used, introduction of concepts such as revaluation surplus, and presentation of stockholders’ equity information b Many countries have different investor groups than the United States. For example, in Germany, financial institutions like banks are not only the major creditors but often are the largest shareholders as well In the United States and the United Kingdom, many companies rely on substantial investment from private investors c The accounting for treasury share retirements differs between IFRS and GAAP Under GAAP, a company has three options: (1) charge the excess of the cost of treasury shares over par value to retained earnings, (2) allocate the difference between paidin capital and retained earnings, or (3) charge the entire amount to paidin capital. Under IFRS, the excess may have to be charged to paidin capital, depending on the original transaction related to the issuance of the shares d The statement of changes in equity is usually referred to as the statement of stockholders’ equity (or shareholders’ equity) under GAAP 1522 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) e Both IFRS and GAAP use the term retained earnings. However, IFRS relies on the term “reserve” as a dumping ground for other types of equity transactions, such as other comprehensive income items as well as various types of unusual transactions related to convertible debt and share option contracts. GAAP relies on the account Accumulated Other Comprehensive Income (Loss). We also use this account in the discussion below, as it appears this account is gaining prominence within the IFRS literature. f Under IFRS, it is common to report “revaluation surplus” related to increases or decreases in items such as property, plant, and equipment; mineral resources; and intangible assets The term surplus is generally not used in GAAP In addition, unrealized gains on the above items are not reported in the financial statements under GAAP Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1523 ILLUSTRATION 151 COMPONENTS OF CAPITAL 1524 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 152 SOURCES OF CHANGES IN STOCKHOLDERS’ EQUITY Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1525 1526 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 153 ACCOUNTING FOR THE ISSUANCE OF STOCK Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1527 1528 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 154 TREASURY STOCK TRANSACTIONS—COST METHOD Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1529 ILLUSTRATION 154 (continued) 1530 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 155 JOURNAL ENTRIES FOR VARIOUS TYPES OF DIVIDEND DISTRIBUTIONS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1531 1532 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 156 EFFECTS OF COMMON STOCK DIVIDENDS AND STOCK SPLITS ON STOCKHOLDERS’ EQUITY Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1533 1534 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 157 STOCKHOLDERS’ EQUITY ANALYSIS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 1535 ... Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 153 ACCOUNTING FOR THE ISSUANCE OF STOCK ... Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 153 ASSIGNMENT CHARACTERISTICS TABLE... 154 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) CA157 Treasury stock, ethics Moderate