ACCT 101 LECTURE NOTES CH.

ACCT 101 LECTURE NOTES CH. 11 Crprate Reprting and Analysis Gals: 1) Be familiar with characteristics f a crpratin and with different surces f equity. 2) Be familiar with varius cmmn stck transactins, and related jurnal entries, including: Issuance f Stck Calculating and Distributing Dividends Calculating Dividends per share 3) Be familiar with ther cmmn stck transactins, including: Treasury Stck Stck Splits Stck Dividends 4) Be familiar with the ratis addressed in the chapter. 1

THE CORPORATE FORM OF ORGANIZATION Characteristics f Crpratins A crpratin is a business entity that is legally separate frm its wners. Ownership in a crpratin by its stckhlders is evidenced by wning shares f stck. The wners are called stckhlders. The fllwing are imprtant characteristics f crpratins: Stckhlders have limited liability. Shuld the crpratin g bankrupt the mst a stckhlder can lse is his investment. Stckhlders may transfer their shares t smene else. Due t the limited liability feature f stck wnership, crpratins can usually accumulate financing frm stckhlders mre easily than ther frms f business entities. Crpratins pay a crprate incme tax, in additin t payrll taxes and prperty taxes. Dividends paid t stckhlders are nt tax-deductible fr the crpratin, but are taxable t the sharehlder recipient f the dividend. Stckhlders vte fr a Bard f Directrs. The directrs have ultimate cntrl f the crpratin, and must act in the best interest f the stckhlders. Basics f Capital Stck Capital stck refers t any shares issued t btain funding frm wners. The fllwing are imprtant terms assciated with capital stck. 1. Authrized stck the ttal amunt f stck that the charter authrizes fr sale. a. Outstanding stck refers t issued stck held by stckhlders. b. N frmal jurnal entry is required fr stck authrizatin; the number f shares authrized is disclsed in the financial statements. 2. Selling (issuing) stck can be sld directly r indirectly t stckhlders a. T sell directly, the crpratin advertises its stck issuance t ptential buyers. b. T sell indirectly, a crpratin pays a brkerage huse (investment banker) t issue its stck. c. A brkerage huse may underwrite issuance (buy the stck frm the crpratin and take all gains r lsses frm its resale). 3. Market value per share the price at which a stck is bught r sld. a. Influenced by expected future earnings, dividends, grwth, and ther cmpany and ecnmic events. b. Current market value f previusly issued shares des nt impact that crpratin s stckhlders equity accunts. 2

4. Classes f stck a. Cmmn stck is called cmmn stck when all classes have same rights and privileges. b. Additinal classes crpratin is smetimes authrized t issue mre than ne class f stck, such as preferred stck. 5. Par value stck assigned a value per share by the crpratin in its charter. a. Printed n the stck certificate. b. Establishes the minimum legal capital. 6. N-par value stck nt assigned a value per share by the crprate charter. 7. Stated value stck n-par stck that is assigned a stated value per share by the directrs; becmes the minimum legal capital per share. 8. Stckhlder s Equity has tw parts a. Paid-in (r cntributed) capital the ttal amunt f cash and ther assets received by the crpratin frm its stckhlders in exchange fr stck. b. Retained earnings the cumulative net incme (and lss) retained by a crpratin. COMMON STOCK Issuing stck with a par value When issuing cmmn stck with a par value, the stck is usually issued at par r abve par. Here are examples f the jurnal entries required fr each f these situatins. I-Tech Crpratin has authrized 100,000 shares f $1 par cmmn stck. It issues 1,000 shares at par t its funders. The jurnal entry wuld be: Cash (1,000 * $1 par) 1,000 Cmmn Stck (1,000 * $1 par) 1,000 Later, I-Tech issues 5,000 shares t additinal investrs at a price f $11 per share. The jurnal entry t recrd this stck issuance wuld be: Cash (5,000 * $11) 55,000 Cmmn Stck (5,000 * $1 par) 5,000 Paid-in Capital in Excess f Par Value, Cmmn Stck 50,000 Paid-in Capital in Excess f Par Value, Cmmn Stck is classified as a stckhlders equity accunt. Generally accepted accunting principles prhibit recgnizing gains r lsses when transacting their wn stck. Crpratins can als give its prmters, r funders, shares f stck in exchange fr their services in rganizing the crpratin. Fr example, if I-Tech gave its funders 500 3

shares f cmmn stck, at par, in exchange fr such services, the jurnal entry wuld be: Organizatin Expense (500 * $1 par) 500 Cmmn Stck (500 * $1 par) 500 Additinally, crpratins can exchange their stck fr assets. If I-Tech acquired equipment with a market value f $10,000 by exchanging 6,000 shares f its cmmn stck, the jurnal entry t recrd the purchase f the equipment is: Equipment (market value) 10,000 Cmmn Stck (6,000 * $1 par) 6,000 Paid-in Capital in Excess f Par Value, Cmmn Stck 4,000 Issuing n-par value stck Sme crpratins d nt assign a par value t stck. In this case, the Cmmn Stck accunt is credited fr the cash, services, r ther asset received in exchange fr the stck. If a crpratin has n-par value stck with an assigned stated value, then the stated value is treated just like a par value. DIVIDENDS Dividend payments must be apprved by the Bard f Directrs. Additinally, the crpratin must have a psitive (credit) balance in Retained Earnings t pay a dividend. Dividends have three imprtant dates: 1. declaratin date, the date the Bard f Directrs declares (apprves) the dividend 2. date f recrd, the date stckhlders are identified wh will receive the dividend 3. payment date, the date the dividend payment is actually made Jurnal entries are made n the declaratin and payment dates. Fr example, I-Tech has 12,500 shares f cmmn stck utstanding. The crpratin wishes t pay a dividend f $0.10 per share. The Bard declares the dividend n Nvember 1, payable n Nvember 15. The jurnal entries t recrd the declaratin and payment fllw. Declaratin n Nvember 1: Retained Earnings (12,500 * $0.10) 1,250 Cash Dividends Payable 1,250 Payment n Nvember 15: Cash Dividends Payable 1,250 Cash 1,250 Sme crpratins issue stck dividends. In a stck dividend, additinal shares f stck are distributed t stckhlders. In a small stck dividend, where the stck issued is less than 25% f shares utstanding, the dividend is valued using the market value f the stck. In a large stck dividend, where the stck issued is mre than 25% f shares utstanding, the dividend is valued at par. Examples f each fllw. 4

Small stck dividend: assume I-Tech has 12,500 shares f cmmn stck utstanding, and declares a 10% stck dividend n December 1, payable n December 31. The market value f I-Tech stck n December 1 is $10 per share. The jurnal entries fr declaratin and payment are: Declaratin n December 1: Retained Earnings (12,500 * 10% * $10) 12,500 Cmmn Stck Dividend Distributable (12,500 * 10% * $1 par) 1,250 Paid-in Capital in Excess f Par Value, Cmmn Stck 11,250 Payment n December 31: Cmmn Stck Dividend Distributable 1,250 Cmmn Stck 1,250 Large stck dividend: assume I-Tech has 12,500 shares f cmmn stck utstanding, and declares a 40% stck dividend n December 1, instead f 10%. The stck dividend is payable n December 31. The jurnal entries fr declaratin and payment are: Declaratin n December 1: Retained Earnings (12,500 * 40% * $1 par) 5,000 Cmmn Stck Dividend Distributable 5,000 Payment n December 31: Cmmn Stck Dividend Distributable 5,000 Cmmn Stck 5,000 All accunts invlved in issuing a stck dividend, whether large r small, are part f stckhlders equity. The issuance and payment f a stck dividend has n effect n assets, liabilities, r ttal stckhlders equity. Stck Splits Many crpratins split their stck. A stck split is the distributin f additinal shares t existing stckhlders. Fr example, in a 2-fr-1 stck split, the par value is reduced by half and the number f shares utstanding is dubled. Mst stck splits are made t decrease the market value per share. N jurnal entry is made t recrd a stck split. PREFERRED STOCK Preferred Stck has special rights that give it pririty ver cmmn stck in ne r mre areas such as preference fr receiving dividends and fr the distributin f assets if the 5

crpratin is liquidated. Preferred stckhlders usually d nt have the right t vte. By issuing preferred stck, the cmpany can raise funds withut giving up cntrl. Preferred Stck usually has a par value. As with cmmn stck it can be sld at a price different frm par. Separate paid-in capital accunts are used t accunt fr preferred stck. The Preferred Stck accunt is used t recrd the par value f shares issued; Paid- In Capital in Excess f Par Value, Preferred Stck is used t recrd any value received abve par value. Preferred stckhlders are allcated their dividends befre any dividends are allcated t cmmn stckhlders. Characteristics f preferred stcks Dividend rights: a. Cumulative preferred stck has a right t be paid bth current and all prir perids' unpaid dividends befre any dividend is paid t cmmn stckhlders. These unpaid dividends are referred t as dividends in arrears. b. Nncumulative preferred stck has n right t prir perids' unpaid dividends if they were nt declared. c. Nnparticipating preferred stck dividends are limited each year t a maximum amunt determined by applying the preferred percentage t the par value. d. Participating preferred stck gives its wners the right t share in dividends in excess f the stated percentage r amunt. This stck is used as a pisn pill against unfriendly r hstile takevers. The full disclsure principle requires that the amunt f preferred dividends in arrears be reprted as f the balance sheet date, nrmally in a nte t the financial statements. Cnvertible preferred stck gives hlders the ptin f exchanging their preferred shares int cmmn shares at a specified rate. If a cmpany s cmmn stck increases in value, the cnvertible preferred stckhlders can share in this success by cnverting their preferred stck int mre valuable cmmn stck. Callable preferred stck gives the issuing crpratin the right t purchase (retire) this stck frm its hlders at specified future prices and dates. Amunt paid t call and retire a preferred share is its call price, r redemptin value, and is set when the stck is issued. Any dividends in arrears must als be paid when stck is called. TREASURY STOCK 6

When a crpratin acquires shares f its wn stck, thse shares are called Treasury Stck. A crpratin usually buys back its wn stck in rder t raise the market price f the stck. The crpratin may als acquire their wn shares fr ther reasns, such as t acquire anther cmpany, avid a hstile takever, r t use fr emplyee cmpensatin. Once purchased, the crpratin can reissue the treasury stck. Examples f hw such transactins wuld be recrded are belw. Assume I-Tech Crpratin purchases 1,000 f its shares at a price f $5.00 per share n Nvember 15, and then sells 500 f these shares fr $6.00 n December 18. The transactins wuld be recrded as fllws. Purchase f 1,000 treasury shares n Nvember 15: Treasury Stck (1,000 * $5) 5,000 Cash 5,000 Sale f 500 treasury shares n December 18: Cash (500 * $6) 3,000 Treasury Stck (500 * $5 cst) 2,500 Paid-in Capital, Treasury Stck 500 Paid-in Capital, Treasury stck is classified as a stckhlders equity accunt. Althugh I-Tech sld the treasury stck n December 18 fr $500 mre than they paid fr the stck, GAAP prhibits recrding gains r lsses frm transacting the crpratin s wn stck. When sld belw cst, entry depends n whether the Paid-in Capital, Treasury Stck accunt has a balance. If the Paid-in Capital, Treasury Stck accunt has n balance, the excess f cst ver sales price is debited t Retained Earnings. If the Paid-in Capital, Treasury Stck accunt has a balance, then it is debited fr the excess f the cst ver the sales price, but nt t exceed the balance in the accunt. Retiring Stck When stck is purchased fr retirement, all cntributed capital amunts that relate t the retired shares are remved frm the accunts. If the cst t retire the stck is less than the amunt the stck was riginally issued fr, the difference shuld be credited t Paid-In Capital frm Retirement f Stck. If the cst t retire the stck was mre than the amunt the stck was riginally issued fr, the difference wuld be debited t Retained Earnings. REPORTING OF EQUITY Retained Earnings Statement 7

Retained Earnings generally cnsist f the cmpany s accumulated net incme, less any net lsses and less any dividends, since its beginning. If a crpratin has transactins invlving stcks, it will need t prepare a Statement f Stckhlders Equity (see belw). If a crpratin has n transactins invlving stcks during the year, it will reprt changes in its Retained Earnings accunt using a Statement f Retained Earnings. The Statement f Retained Earnings was cvered earlier in the curse. Retained Earnings may be apprpriated vluntarily by the crpratin, r restricted legally. If s, the apprpriated r restricted Retained Earnings may nt be used fr dividends. If a crpratin discvers a material errr in its prir year(s) financial statements, it must crrect the errr with a prir perid adjustment. Prir perid adjustments are reprted in the Statement f Retained Earnings, net f any incme tax effects. Statement f Stckhlders Equity A Statement f Stckhlders Equity is prvided by mst cmpanies rather than a separate statement f retained earnings. The Statement f Stckhlders Equity presents the beginning and ending balances f each equity accunt, including Retained Earnings, and describes the changes that ccurred during the year in each accunt. Stck Optins A stck ptin is a right t purchase cmmn stck at a fixed price ver a specified perid f time. Many crpratins issue stck ptins t key emplyees. Recrding stck ptins is explained in the Intermediate Accunting curse. IMPORTANT EQUITY RATIOS The fllwing table summarizes key equity ratis. Name Purpse Frmula Earnings per share Price-earnings rati Dividend yield Bk value per share (cmmn nly) The amunt f incme earned per each share f cmmn stck. Indicates hw much the market is willing t pay fr a cmpany s earnings. Shws the annual amunt f cash dividends relative t the stck s market value. Hw much equity each share f cmmn stck wns. Net Incme Preferred Stck Dividends / Weighted-avg. # f cmmn shares Market Price f Stck / Earnings per Share Dividends per Share / Market Price f Stck Stckhlders Equity / Number f Cmmn Shares 8