1 chapter 11: stockholders’ equity 1.debt versus equity 2.preferred stock 3.common stock...

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1 Chapter 11: Stockholders’ Chapter 11: Stockholders’ Equity Equity 1. Debt versus equity 2. Preferred stock 3. Common stock 4. Accounting for preferred and common stock 5. Treasury stock 6. Retained Earnings and dividends 7. Statement of stockholders’ equity

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Page 1: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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Chapter 11: Stockholders’ EquityChapter 11: Stockholders’ Equity1.Debt versus equity

2.Preferred stock

3.Common stock

4.Accounting for preferred and common stock

5.Treasury stock

6.Retained Earnings and dividends

7. Statement of stockholders’ equity

Page 2: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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1. Debt versus Equity1. Debt versus Equity

Debt Equity

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

Formal legal contract No legal contract

Interest expense deductible Dividends not deductible

Double taxation

Page 3: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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2. Preferred Stock2. Preferred Stock Advantages

– Preference over common in liquidation– Stated dividend – Variety of features regarding dividends– Preference over common in dividend payout

Disadvantages– Subordinate to debt in liquidation– Stated dividend can be skipped– No voting rights (versus common)

Debt or equity?– components of both– usually (but not always) classified with equity

Page 4: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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3. Common Stock3. Common StockAdvantages

– Voting rights: election of board of directorsvote on significant activities of

management– Rights to residual profits (after preferred)

Disadvantages– Last in liquidation– No guaranteed return

Page 5: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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4. Accounting for Common Stock 4. Accounting for Common Stock (CS) and Preferred Stock (PS) (CS) and Preferred Stock (PS)

Par value - initially established to create a “minimum legal capital”.– Ex: Minimum legal capital in some states is

$1,000 for new corporations, so issue: 1,000 shares at $1par, or 100 shares at $10 par, or other combination. . .

Par value is not market value. Credit CS or PS for par value. Excess over par credited to “Paid in Capital in

Excess of Par or Stated Value” or abbreviated: “Additional Paid-in Capital” (APIC).

Some newer stock issues (for common stock) are “no par” stock.

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4.4. Journal EntriesJournal EntriesIssue PS at greater than par value:

Cash xx mkt. valuePreferred Stock xx total parAPIC - PS xx excess(plug)

Issue CS at greater than par value:Cash xx mkt. value

Common Stock xx total parAPIC - CS xx excess(plug)

Note: most states do not allow companies to issue at less than par value.

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4.4. Journal Entries -continuedJournal Entries -continuedIssue no par common stock:

Cash xx mkt. valueCommon Stock xx mkt. value

Note: many companies have newer stock issues that are no par, but most companies still have older stock issues which contain a par value and APIC.

The Stockholders’ Equity section of the balance sheet of Sample Company (next slide) illustrates many of the components of SE discussed in this chapter.

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4.Sample Co. Stockholders’ Equity4.Sample Co. Stockholders’ EquityCommon stock, $1 par value, 500,000 shares

authorized, 80,000 shares issued, and75,000 shares outstanding $ 80,000

Preferred stock, $100 par value, 1,000 sharesauthorized, 100 shares issued and outstanding 10,000

Paid in capital on common $ 20,000Paid in capital on preferred 5,000 25,000

Retained earnings 22,000

Less: Treasury stock, 5,000 shares (at cost) (6,000)

Total Stockholders’ Equity $131,000

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4.4. Journal Entries-Sample Co.Journal Entries-Sample Co.Now, using Sample Company information,

record the following additional issues of common and preferred stock:

Issued 100 shares of PS at $102 per share:

Issued 500 shares of CS at $5 per share:

Page 10: 1 Chapter 11: Stockholders’ Equity 1.Debt versus equity 2.Preferred stock 3.Common stock 4.Accounting for preferred and common stock 5.Treasury stock 6.Retained

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5. Treasury Stock5. Treasury Stock Created when a company buys back shares of

its own common stock. Reasons for buyback:

– reissue to employees for compensation.– hold in treasury (or retire) to increase market

price and earnings per share.– reduce total dividend payouts while

maintaining per share payouts.– thwart takeover attempts by reducing

proportion of shares available for purchase.– give cash back to existing shareholders.

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5.5. Treasury Stock - continuedTreasury Stock - continued The debit balance account called “Treasury

Stock” is reported in stockholders’ equity as a contra (reduces SE). Note: not an asset.

The stock remains issued, but is no longer outstanding.– does not have voting rights– cannot receive cash dividends

May be reissued (to the market or to employees) or retired.

No gains or losses are ever recognized from these equity transactions.

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5. Treasury Stock(TS) - Journal Entries5. Treasury Stock(TS) - Journal EntriesThere are two techniques for recording TS transactions (Par Value method and Cost method). We will use only the Cost method. This technique establishes a “cost” for TS equal to the amount paid to acquire the TS. Par value is not used for TS transactions.

To record purchase of TS from market:TS xx “cost”

Cash xx market(cost equals the cash paid)

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5. Treasury Stock(TS) - Journal Entries5. Treasury Stock(TS) - Journal EntriesTo reissue TS to market at greater than cost:

Cash xx marketAPIC - TS xx over costTS xx cost

To reissue TS to market at less than cost:Cash xx market

APIC - TS xx if availableRetained Earnings xx if needed*

TS xx cost*debit RE if no APIC-TS available to absorb the

remaining debit difference.

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5.5. TS - Example ProblemTS - Example ProblemTT Corporation has 100,000 shares of $1 par value

stock authorized, issued and outstanding at January 1, 2008. The stock had been issued at an average market price of $5 per share, and there have been no treasury stock transactions to this point.

Assume that, in February of 2008, TT Corp. repurchases 10,000 shares of its own stock at $7 per share. In July of 2008, TT Corp. reissues 2,000 shares of the treasury stock for $8 per share. In December of 2008, TT Corp. reissues the remaining 8,000 shares for $6 per share. Prepare the journal entries for 2008 regarding the treasury stock.

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5. TS Example -Journal Entries5. TS Example -Journal EntriesFeb: repurchase 10,000 sh. @ $7 =

$70,000.

July: reissue 2,000 sh @ $ 8 = $16,000

(cost = 2,000 @ $7 = 14,000)

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5. TS Example -Journal Entries5. TS Example -Journal EntriesDec: reissue 8,000 sh. @ $ 6 = $48,000

(cost = 8,000 sh.@ $7 = 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).

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6. Retained Earnings - Cash Dividends6. Retained Earnings - Cash DividendsAs cash dividends are declared:

Dividends (RE) - common xxDividends (RE)- preferred xx

Dividends Payable xxAs cash dividends are paid:

Dividends Payable xxCash xx

Preferred dividends may be issued with extra privileges such as “cumulative” and “participating.

Cumulative preferred dividends that are skipped in a particular year must be settled before any dividends are paid to common shares.

Participating preferred stock may receive a cash dividend in excess of its stated amount.

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7. Statement of Stockholders’ Equity7. Statement of Stockholders’ EquityIn this chapter, we have discussed the

Statement of Retained Earnings as the link between the balance sheet and the income statement.

However, earlier chapters introduced the Statement of Stockholders’ Equity, which has become the default statement for large companies in recent years.

The Statement of Stockholders’ Equity details the change in retained earnings, including all the changes discussed in this chapter, and it also shows the change during the year in all of the stockholders’ equity accounts.