ch11 Analyzing Stock Holders Equity

11-1
11
REPORTING AND
ANALYZING
STOCKHOLDER’S EQUITY
Financial Accounting, Sixth Edition

11-2
Study Objectives
1. Identify and discuss the major characteristics of a corporation.
2. Record the issuance of common stock.
3. Explain the accounting for the purchase of treasury stock.
4. Differentiate preferred stock from common stock.
5. Prepare the entries for cash dividends and understand the

effect of stock dividends and stock splits.
6. Identify the items that affect retained earnings.
7. Prepare a comprehensive stockholders’ equity section.
8. Evaluate a corporation’s dividend and earnings performance

from a stockholder’s perspective.
11-3
Reporting and Analyzing Stockholders’ Equity
The Financial
Accounting Dividends Statement
Corporate Stock Issue Preferred
for Treasury and Retained Presentation
Form of Considerations Stock
Stock Earnings and Corporate
Organization Performance
Characteristics Authorized Purchase of Dividend Cash Balance sheet

Formation stock treasury stock preferences dividends Statement of
Stockholder Issuance Liquidation Stock cash flows
rights Par and no-par preference dividends Dividend
value Stock splits record
Accounting for Retained Earnings
common stock earnings performance
issues restrictions Debt vs.
equity
decision
11-4
The Corporate Form of Organization
An entity separate and distinct from its owners.
Classified by Purpose Classified by Ownership

Not-for-Profit Publicly held
For Profit Privately held
► Salvation Army ► Nike ► Cargill Inc.

► American Cancer ► General Motors
Society ► IBM
► Gates Foundation ► General Electric
11-5
Characteristics of a Corporation
 Separate Legal Existence
 Limited Liability of Stockholders
 Transferable Ownership Rights
Advantages
 Ability to Acquire Capital
 Continuous Life
 Corporate Management
 Government Regulations Disadvantages
 Additional Taxes
11-6 SO 1 Identify and discuss the major characteristics of a corporation.

 Separate Legal Existence Corporation acts
under its own name
 Limited Liability of Stockholders rather than in the
 Transferable Ownership Rights name of its
stockholders.
 Continuous Life
 Government Regulations

Limited to their
investment.
 Continuous Life

Shareholders may
sell their stock.
 Continuous Life

 Transferable Ownership Rights Corporation can
 Ability to Acquire Capital obtain capital
through the issuance
 Continuous Life of stock.

 Transferable Ownership Rights Continuance as a
 Ability to Acquire Capital going concern is not
affected by the
 Continuous Life withdrawal, death, or
 Corporate Management incapacity of a
stockholder,
employee, or officer.

 Ability to Acquire Capital Separation of
ownership and
 Continuous Life
management
 Corporate Management prevents owners from
having an active role
in managing the
 Additional Taxes company.

 Continuous Life

 Ability to Acquire Capital Corporations pay
income taxes as
 Continuous Life
 a separate legal
 Corporate Management entity and
 Government Regulations  stockholders pay
 Additional Taxes taxes on cash
dividends.

Stockholders
Illustration 11-1
Corporation
organization chart Chairman and
Board of
Directors
President and
Chief Executive
Officer
General Vice President Vice President

Vice President Vice President
Counsel and Finance/Chief Human
Marketing Operations
Secretary Financial Officer Resources
Treasurer Controller

11-16
Other Forms of Business Organization
 Limited partnerships
 Limited liability partnerships (LLPs)
 Limited liability companies (LLCs)
 S Corporation
► no double taxation
► cannot have more than 75 shareholders

Forming a Corporation
Initial Steps:
 File application with the Secretary of State.
 State grants charter.
 Corporation develops by-laws.
Companies generally incorporate in a state whose laws are

favorable to the corporate form of business (Delaware, New Jersey).
Corporations engaged in interstate commerce must obtain a license

from each state in which they do business.

Stockholders Rights Illustration 11-3
1. Vote in election of board of

directors and on actions that
require stockholder approval.
2. Share the corporate earnings

through receipt of dividends.

3. Keep the same percentage ownership when new

shares of stock are issued (preemptive right).

4. Share in assets upon liquidation in proportion to

their holdings. This is called a residual claim.

Stock Issue Considerations
Authorized Stock
 Charter indicates the amount of stock that a
corporation is authorized to sell.
 Number of authorized shares is often reported in the

stockholders’ equity section.

Prenumbered Shares Illustration 11-4
Name of corporation
Stockholder’s
name
Signature of
corporate official

Issuance of Stock
 Corporation can issue common stock
► directly to investors or
► indirectly through an investment banking firm.
 U.S. securities exchanges

► New York Stock Exchange
► American Stock Exchange
► 13 regional exchanges
► NASDAQ national market

11-25
Par and No-Par Value Stocks

 Capital stock that has been assigned a value per share.
 Years ago, par value determined the legal capital per
share that a company must retain in the business for the
protection of corporate creditors.
 Today many states do not require a par value.
 No-par value stock is quite common today.
 In many states the board of directors assigns a stated
value to no-par shares.

Review Question
Which of these statements is false?
a. Ownership of common stock gives the owner a
voting right.
b. The stockholders’ equity section begins with paid-in
capital.
c. The authorization of capital stock does not result in a
formal accounting entry.
d. Legal capital is intended to protect stockholders.

Common Stock
Account
Paid-in Capital in
Paid-in Capital
Excess of Par
Account
Preferred Stock
Account
Two Primary
Sources of Retained Earnings
Account
Equity
Paid-in capital is the total amount of cash and other assets paid in
to the corporation by stockholders in exchange for capital stock.
11-28 SO 2 Record the issuance of common stock.

Common Stock
Account
Paid-in Capital in
Paid-in Capital
Excess of Par
Account
Preferred Stock
Account
Two Primary
Account
Equity
Retained earnings is net income that a corporation retains for

future use.

Accounting for Common Stock Issues

Primary objectives:
1) Identify the specific sources of paid-in capital.
2) Maintain the distinction between paid-in capital and

retained earnings.
Other than consideration received, the issuance of common

stock affects only paid-in capital accounts.


Illustration: Assume that Hydro-Slide, Inc. issues 1,000
shares of $1 par value common stock at par. Prepare the
journal entry.
Cash 1,000
Common stock (1,000 x $1) 1,000


Illustration: Now assume Hydro-Slide, Inc. issues an
additional 1,000 shares of the $1 par value common stock for
cash at $5 per share. Prepare Hydro-Slide’s journal entry.
Cash 5,000
Common stock (1,000 x $1) 1,000
Paid-in capital in excess of par value 4,000

Stockholders’ equity section assuming Hydro-Slide, Inc. has

retained earnings of $27,000.
Illustration 11-5

Review Question
ABC Corp. issues 1,000 shares of $10 par value common
stock at $12 per share. When the transaction is recorded,
credits are made to:
a. Common Stock $10,000 and Paid-in Capital in Excess of
Stated Value $2,000.
b. Common Stock $12,000.
c. Common Stock $10,000 and Paid-in Capital in Excess of
Par Value $2,000.
d. Common Stock $10,000 and Retained Earnings $2,000.

11-35
Accounting for Treasury Stock
Common Stock
Account
Paid-in Capital in
Paid-in Capital
Excess of Par
Account
Preferred Stock
Account
Two Primary
Account
Equity
Less:
Treasury Stock
Account
11-36 SO 3 Explain the accounting for the purchase of treasury stock.

Treasury stock - corporation’s own stock that it has

reacquired from shareholders, but not retired.
Corporations purchase their outstanding stock:
1. To reissue shares to officers and employees under bonus and
stock compensation plans.
2. To increase trading of the company’s stock in the securities
market.
3. To have additional shares available for use in acquiring other
companies.
4. To increase earnings per share.
Another infrequent reason is to eliminate hostile shareholders.

Purchase of Treasury Stock

 Generally accounted for by the cost method.
 Debit Treasury Stock for the price paid.
 Treasury stock is a contra stockholders’ equity

account, not an asset.
 Purchase of treasury stock reduces stockholders’

equity.

Illustration 11-6
Illustration: On February 1, 2012, Mead acquires 4,000 shares

of its stock at $8 per share. Prepare the entry.
Treasury stock (4,000 x $8) 32,000

Cash 32,000
Stockholders’ Equity with Treasury stock

Illustration 11-7
Both the number of shares issued (100,000), outstanding (96,000), and

the number of shares held as treasury (4,000) are disclosed.

Review Question
Treasury stock may be repurchased:
a. to reissue the shares to officers and employees under
bonus and stock compensation plans.
b. to signal to the stock market that management believes
the stock is underpriced.
c. to have additional shares available for use in the
acquisition of other companies.
d. more than one of the above.

Preferred Stock
Features often associated with preferred stock.

 Preference as to dividends.
 Preference as to assets in liquidation.
 Nonvoting.
Each paid-in capital account title should identify the stock

to which it relates:
 Paid-in Capital in Excess of Par Value—Preferred Stock
 Paid-in Capital in Excess of Par Value—Common Stock
11-42 SO 4 Differentiate preferred stock from common stock.

Preferred Stock
Illustration: Stine Corporation issues 10,000 shares of

$10 par value preferred stock for $12 cash per share.
Journalize the issuance of the preferred stock.
Cash 120,000
Preferred stock (10,000 x $10) 100,000
Paid-in capital in excess of par –
Preferred stock 20,000
Preferred stock may have a par value or no-par value.

Preferred Stock
Dividend Preferences
 Right to receive dividends before common
stockholders.
 Per share dividend amount is stated as a percentage

of the preferred stock’s par value or as a specified
amount.
 Cumulative dividend – holders of preferred stock must

be paid their annual dividend plus any dividends in
arrears before common stockholders receive dividends.

Preferred Stock
Liquidation Preference
 Preference on corporate assets if the corporation fails.
 Preference may be
► for the par value of the shares or
► for a specified liquidating value.

Preferred Stock
Review Question
M-Bot Corporation has 10,000 shares of 8%, $100 par
value, cumulative preferred stock outstanding at December
31, 2010. No dividends were declared in 2008 or 2009. If M-
Bot wants to pay $375,000 of dividends in 2010, common
stockholders will receive:
a. $0.
b. $295,000.
c. $215,000.
d. $135,000.

Dividends
A distribution of cash or stock to stockholders on a pro

rata (proportional to ownership) basis.
Types of Dividends:
1. Cash dividends. 3. Stock dividends.

2. Property dividends. 4. Scrip (promissory note)
Dividends expressed: (1) as a percentage of the par or

stated value, or (2) as a dollar amount per share.
SO 5 Prepare the entries for cash dividends and understand the

11-47
Dividends
Cash Dividends
For a corporation to pay a cash dividend, it must have:
1. Retained earnings - Payment of cash dividends

from retained earnings is legal in all states.
2. Adequate cash.
3. Declaration by the Board of Directors.

11-48
Dividends
Dividends require information concerning three dates:

11-49
Dividends
Illustration: On Dec. 1, the directors of Media General declare a
50¢ per share cash dividend on 100,000 shares of $10 par value
common stock. The dividend is payable on Jan. 20 to
shareholders of record on Dec. 22:
December 1 (Declaration Date)
Cash dividends 50,000
Dividends payable 50,000
December 22 (Record Date) No entry
January 20 (Payment Date)

Dividends payable 50,000
Cash 50,000
11-50
Dividends
Review Question
Entries for cash dividends are required on the:
a. declaration date and the record date.
b. record date and the payment date.
c. declaration date, record date, and payment date.
d. declaration date and the payment date.

11-51
Dividends
Stock Dividends Illustration 11-10
Pro rata distribution of the corporation’s own stock.
Results in decrease in retained earnings and increase in paid-in capital.

11-52
Dividends
Stock Dividends
Reasons why corporations issue stock dividends:
1. Satisfy stockholders’ dividend expectations without
spending cash.
2. Increase the marketability of the corporation’s stock.
3. Emphasize that a portion of stockholders’ equity has

been permanently reinvested in the business.

11-53
Dividends
Effects of Stock Dividends

 Changes the composition of stockholders’ equity.
 Total stockholders’ equity remains the same.
 No effect on the par or stated value per share.
 Increases the number of shares outstanding.

11-54
Dividends
Illustration: Medland Corp. declares a 10% stock dividend on

its $10 par common stock when 50,000 shares were
outstanding. The market price was $15 per share.
Illustration 11-9

11-55
Dividends
Stock Split
 Reduces the market value of shares.
 No entry recorded for a stock split.
 Decrease par value and increase number of

shares.

11-56
Dividends
Illustration: Assuming that instead of issuing a 10% stock

dividend, Medland splits its 50,000 shares of common stock on
a 2-for-1 basis.
Illustration 11-11

11-57
Dividends
Differences between the effects of stock dividends and

stock splits.
Illustration 11-12

11-58
Dividends
Review Question
Which of these statements about stock dividends is true?
a. Stock dividends reduce a company’s cash balance.
b. A stock dividend has no effect on total stockholders’
equity.
c. A stock dividend decreases total stockholders’ equity.
d. A stock dividend ordinarily will increase total
stockholders’ equity.

11-59
Retained Earnings
 Retained earnings is net income that a company

retains for use in the business.
 Net income increases Retained Earnings and a

net loss decreases Retained Earnings.
 Retained earnings is part of the stockholders’

claim on the total assets of the corporation.
 A debit balance in Retained Earnings is identified

as a deficit.
11-60 SO 6 Identify the items that affect retained earnings.

Retained Earnings
Illustration 11-14

Retained Earnings
Retained Earnings Restrictions

Restrictions can result from:
1. Legal restrictions.
2. Contractual restrictions.
3. Voluntary restrictions.

Presentation of Stockholders’ Equity
Balance Sheet Presentation

Two classifications of paid-in capital:
1. Capital stock
2. Additional paid-in capital
11-63 SO 7 Prepare a comprehensive stockholders’ equity section.

Presentation of Stockholders’ Equity
Illustration 11-16
Balance
Sheet
Presentation
11-64 SO 7 Prepare a comprehensive stockholders’ equity section.

Measuring Corporate Performance
Dividend Record
Illustration: The following is the calculation of the payout ratio for
Nike in 2009 and 2008.
Illustration 11-18
Illustration 11-18
The payout ratio measures the percentage of earnings a company distributes in

the form of cash dividends.
SO 8 Evaluate a corporation’s dividend and earnings
11-65
performance from a stockholder’s perspective.
Earnings Performance
Illustration: The following is the calculation of Nike’s return on
common stockholders’ equity ratios for 2009 and 2008. Illustration 11-20
This ratio shows how many dollars of net income a company earned for each dollar
of common stockholders’ equity.
11-66
Debt Versus Equity Decision

Illustration 11-21

11-67
Debt Versus Equity Decision

Illustration 11-22

11-68
Illustration: Microsystems Inc. currently has 100,000 shares of
common stock outstanding issued at $25 per share and no debt. It is
considering two alternatives for raising an additional $5 million: Plan
A involves issuing 200,000 shares of common stock at the current
market price of $25 per share. Plan B involves issuing $5 million of
12% bonds at face value. Income before interest and
taxes will be $1.5 million; income taxes are expected to be 30%.
Illustration 11-23
11-69
SO 8
Entries for Stock
appendix 11A Dividends
Illustration: Medland Corporation declares a 10% stock dividend on its

50,000 shares of $10 par value common stock. The current fair market
value of its stock is $15 per share. Record the entry on the declaration
date:
Retained earnings (50,000 x 10% x $15) 75,000

Common stock dividends distributable 50,000
Paid-in capital in excess of par 25,000
Illustration 11A-1
11-70 SO 9 Prepare entries for stock dividends.

Entries for Stock
appendix 11A Dividends
Illustration: Record the journal entry when Medland issues the dividend
shares.
Common stock dividends distributable 50,000

Common stock 50,000
11-71 SO 9 Prepare entries for stock dividends.

Key Points
 Under IFRS, the term reserves is used to describe all equity
accounts other than those arising from contributed capital. This
would include, for example, reserves related to retained
earnings, asset revaluations, and fair value differences.
 Many countries have a different mix of investor groups than in
the United States. For example, in Germany, financial
institutions like banks are not only major creditors of
corporations but often are the largest corporate stockholders
as well. In the United States, Asia, and the United Kingdom,
many companies rely on substantial investment from private
investors.
11-72
Key Points
 There are often terminology differences for equity accounts.
The following summarizes some of the common differences in
terminology.
11-73
Key Points
 The accounting for treasury stock differs somewhat between
IFRS and GAAP. (However, many of the differences are beyond
the scope of this course.) Like GAAP, IFRS does not allow a
company to record gains or losses on purchases of its own
shares. One difference worth noting is that, when a company
purchases its own shares, IFRS treats it as a reduction of
stockholders’ equity, but it does not specify which particular
stockholders’ equity accounts are to be affected. Therefore, it
could be shown as an increase to a contra equity account
(Treasury Stock) or a decrease to retained earnings or share
capital. IFRS requires that the number of treasury shares held
be disclosed.
11-74
Key Points
 A major difference between IFRS and GAAP relates to the
account Revaluation Surplus. Revaluation surplus arises under
IFRS because companies are permitted to revalue their
property, plant, and equipment to fair value under certain
circumstances. This account is part of general reserves under
IFRS and is not considered contributed capital.
 As indicated earlier, the term reserves is used in IFRS to
indicate all noncontributed (non–paid-in) capital. Reserves
include retained earnings and other comprehensive income
items, such as revaluation surplus and unrealized gains or
losses on available-for-sale securities.
11-75
Key Points
 IFRS often uses terms such as retained profits or accumulated
profit or loss to describe retained earnings. The term retained
earnings is also often used.
 The accounting related to prior period adjustments is
essentially the same under IFRS and GAAP.
 Equity is given various descriptions under IFRS, such as
shareholders’ equity, owners’ equity, capital and reserves, and
shareholders’ funds.
11-76
Looking into the Future
The IASB and the FASB are currently working on a project related
to financial statement presentation. An important part of this study
is to determine whether certain line items, subtotals, and totals
should be clearly defined and required to be displayed in the
financial statements. The options of how to present other
comprehensive income under GAAP will change in any converged
standard. Also, the FASB has been working on a standard that will
likely converge to IFRS in the area of hybrid financial instruments,
such as bonds that are convertible to common stock.
11-77
Under IFRS, a purchase by a company of its own shares
is recorded by:
a) an increase in Treasury Stock.
b) a decrease in contributed capital.
c) a decrease in share capital.
d) All of these are acceptable treatments.
11-78
The term reserves is used under IFRS with reference to all
of the following except:
a) gains and losses on revaluation of property, plant,

and equipment.
b) capital received in excess of the par value of issued

shares.
c) retained earnings.
d) fair value differences.
11-79
Under IFRS, the amount of capital received in excess of
par value would be credited to:
a) Retained Earnings.
b) Contributed Capital.
c) Share Premium.
d) Par value is not used under IFRS.
11-80
Copyright
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Reproduction or translation of this work beyond that permitted in
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express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
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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.”
11-81

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11-1

Financial Accounting, Sixth Edition

1. Identify and discuss the major characteristics of a corporation.

2. Record the issuance of common stock.

3. Explain the accounting for the purchase of treasury stock.

4. Differentiate preferred stock from common stock.

5. Prepare the entries for cash dividends and understand the

6. Identify the items that affect retained earnings.

7. Prepare a comprehensive stockholders’ equity section.

8. Evaluate a corporation’s dividend and earnings performance

Characteristics Authorized Purchase of Dividend Cash Balance sheet

An entity separate and distinct from its owners.

Classified by Purpose Classified by Ownership

► Salvation Army ► Nike ► Cargill Inc.

11-6 SO 1 Identify and discuss the major characteristics of a corporation.

11-7 SO 1 Identify and discuss the major characteristics of a corporation.

11-8 SO 1 Identify and discuss the major characteristics of a corporation.

11-9 SO 1 Identify and discuss the major characteristics of a corporation.

11-10 SO 1 Identify and discuss the major characteristics of a corporation.

11-11 SO 1 Identify and discuss the major characteristics of a corporation.

11-12 SO 1 Identify and discuss the major characteristics of a corporation.

11-13 SO 1 Identify and discuss the major characteristics of a corporation.

11-14 SO 1 Identify and discuss the major characteristics of a corporation.

General Vice President Vice President

11-15 SO 1 Identify and discuss the major characteristics of a corporation.

11-17 SO 1 Identify and discuss the major characteristics of a corporation.

Companies generally incorporate in a state whose laws are

Corporations engaged in interstate commerce must obtain a license

11-18 SO 1 Identify and discuss the major characteristics of a corporation.

Stockholders Rights Illustration 11-3

1. Vote in election of board of

2. Share the corporate earnings

11-19 SO 1 Identify and discuss the major characteristics of a corporation.

Stockholders Rights Illustration 11-3

3. Keep the same percentage ownership when new

11-20 SO 1 Identify and discuss the major characteristics of a corporation.

Stockholders Rights Illustration 11-3

4. Share in assets upon liquidation in proportion to

11-21 SO 1 Identify and discuss the major characteristics of a corporation.

 Number of authorized shares is often reported in the

11-22 SO 1 Identify and discuss the major characteristics of a corporation.

11-23 SO 1 Identify and discuss the major characteristics of a corporation.

 U.S. securities exchanges

11-24 SO 1 Identify and discuss the major characteristics of a corporation.

Par and No-Par Value Stocks

11-26 SO 1 Identify and discuss the major characteristics of a corporation.

11-27 SO 1 Identify and discuss the major characteristics of a corporation.

11-28 SO 2 Record the issuance of common stock.

Retained earnings is net income that a corporation retains for

11-29 SO 2 Record the issuance of common stock.

Accounting for Common Stock Issues

2) Maintain the distinction between paid-in capital and

Other than consideration received, the issuance of common

11-30 SO 2 Record the issuance of common stock.

Accounting for Common Stock Issues

11-31 SO 2 Record the issuance of common stock.

Accounting for Common Stock Issues

11-32 SO 2 Record the issuance of common stock.

Stockholders’ equity section assuming Hydro-Slide, Inc. has

11-33 SO 2 Record the issuance of common stock.

11-34 SO 2 Record the issuance of common stock.

11-36 SO 3 Explain the accounting for the purchase of treasury stock.

Treasury stock - corporation’s own stock that it has