13-1 intermediate financial accounting earl k. stice james d. stice © 2012 cengage learning...

13-1

Intermediate Financial Accounting

Earl K. Stice James D. Stice

© 2012 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Equity Financing

Chapter 13Chapter 13

18th Edition

13-2

Nature and Classifications of Paid-In Capital

• A corporation is a legal artificial entity separate from its owners.

• Individuals contribute capital for which the corporation issues stock certificates evidencing ownership interests.

• Stockholders elect a board of directors whose members oversee the strategic and long-run planning of the corporation.

13-3

Common and Preferred Stock

• When a corporation is formed, a single class of stock, known as common stock, is usually issued.

• Corporations may later find that there are advantages to issuing one or more additional classes of stock with varying rights and priorities. Stock with certain preferences (rights) over common stock is called preferred stock.

13-4

Common Stock

Unless restricted by terms of the articles of incorporation, certain basic rights are held by each common stockholder:

1. To vote in the election of directors and in the determination of certain corporate policies.

2. To maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued. This right is known as the preemptive right.

13-5

Par or Stated Value of Stocks

The journal entry to record the issuance of common stock in exchange for cash frequently looks something like this:

Cash XXXCommon Stock (at par value) XXXAdditional Paid-In Capital XXX

(continued)

13-6

Par or Stated Value of Stocks

• Historically, par value was equal to the market value of the shares at issuance.

• Today, most stocks have a nominal par value or no par value at all.

• No-par stock sometimes has a stated value that for financial reporting purposes acts like a par value.

(continued)

13-7

Preferred Stock

• The term preferred stock is somewhat misleading because it gives the impression that preferred stock is better than common stock.

• Preferred stock isn’t better—it’s different.

• Preferred stockholders give up many of the rights of ownership in exchange for some of the protection enjoyed by creditors.

(continued)

13-8

Preferred Stock

Rights of ownership given up by preferred stockholders:

(continued)

• Voting. In most cases, preferred stockholders are not allowed to vote for the board of directors.

• Sharing in success. The cash dividends received by preferred stockholders are usually fixed in amount. Therefore, if the company does exceptionally well, preferred stockholders do not get to share in the success.

13-9

Preferred Stock

• Cash dividend preference. Preferred stockholders are entitled to receive the full cash dividend before any cash dividends are paid to common stockholders.

• Liquidation preferences. If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid, in full, before common stockholders receive anything.

The protections enjoyed by preferred stockholders, relative to common stockholders, are:

13-10

Cumulative and Noncumulative Preferred Stock

• When a corporation fails to declare dividends on cumulative preferred stock, such dividends accumulate and require payment in the future before any dividends may be paid to common stockholders.

• Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.

• With noncumulative preferred stock, it is not necessary to provide for passed dividends.

13-11

Participating Preferred Stock

• Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders after dividends of a specified amount are paid to the common stockholders.

• A participating provision makes preferred stock more like common stock.

• Participating preferred stocks are now relatively rare.

13-12

Convertible Preferred Stock

• Preferred stock is convertible when it can be exchanged by its owner for some other security of the issuing corporation.

• Conversion rights generally provide for the exchange of preferred stock into common stock.

• In some instances, preferred stock may be converted into bonds.

13-13

Callable Preferred Stock

• Many preferred issues are callable, meaning they may be called and canceled at the option of the corporation.

• The call price is usually specified in the original agreement and provides for payment of dividends in arrears as part of the repurchase price.

13-14

Redeemable Preferred Stock

• Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder or upon other conditions not within the control of the issuer.

• Redeemable preferred stock is somewhat like a loan in that the issuing corporation may be forced to repay the stock proceeds.

13-15

Current Development in The Accounting for Preferred Stock

• In the Preliminary Views document, the FASB recommends the “basic ownership approach” to identifying equity.

• This approach hinges on the idea that equity claims are those that remain when all other claims have been satisfied.

• The basic ownership approach would be very restrictive. In fact, all preferred stock, whether redeemable or not, would be reported as a liability under this approach.

(continued)

13-16

Current Development in The Accounting for Preferred Stock

• Users prefer a “perpetual approach,” which describes an equity instrument as one for which there is no requirement to repay the invested funds, and the holder of the instrument is entitled to some assets if the company is liquidated.

• Both the FASB and IASB are leaning toward the “perpetual approach.”

13-17

Capital Stock Issued for Cash

• The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value.

• When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to an additional paid-in capital account.

(continued)

13-18

Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2011, for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 4,000Paid-In Capital in Excess of Par 41,000

2011

Par Value StockPar Value StockPar Value StockPar Value Stock


(continued)

13-19

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock with a $1 stated value.

Apr. 1 Cash 45,000Common Stock 4,000Paid-In Capital in Excess of Stated Value 41,000

2011

Stated Value StockStated Value StockStated Value StockStated Value Stock


(continued)

13-20

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 45,000

2011

No-Par StockNo-Par StockNo-Par StockNo-Par Stock


13-21

Capital Stock Sold on Subscription

• A subscription is a legally binding contract between the subscriber (purchaser of stock) and the corporation (issuer of stock).

• The contract states the number of shares subscribed, the subscription price, the terms of payment, and other conditions of the transaction.

• Ordinarily, stock certificates are not issued until the full subscription price has been received by the corporation.

13-22

Subscription Defaults

If a subscriber defaults on a subscription, a corporation may:

1) return to the subscriber the amount paid,

2) return to the subscriber the amount paid less any reduction in price or expense incurred on the resale of the stock,

3) declare the amount paid by the subscriber as forfeited, or

4) issue to the subscriber shares equal to the number paid for in full.

13-23

Reasons Companies Repurchase Stock

1. Provide shares for incentive compensation and employee savings plans.

2. Obtain shares needed to satisfy requests by holders of convertible securities.

3. Reduce the amount of equity relative to the amount of debt.

4. Invest excess cash temporarily.5. Remove some shares from the open market

in order to protect against a hostile takeover.

(continued)

13-24

6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.

7. Display confidence that the stock is currently undervalued by the market.

Reasons Companies Repurchase Stock

13-25

Treasury Stock

• Treasury stock is stock issued by a corporation and subsequently reacquired by the corporation and held for possible future reissuance or retirement.

• Treasury stock should not be viewed as an asset; report as a reduction in owner’s equity.

• There is no income or loss on the reacquisition, reissuance, or retirement of treasury stock.

• Retained Earnings can be decreased by treasury stock transactions but never increased by such transactions.

13-26

2012—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15:

Cash 150,000Common Stock 10,000Paid-In Capital in Excess of Par 140,000

2013—Reacquired 1,000 shares of common stock at $40 per share:

Treasury Stock 40,000Cash 40,000

Cost Method of Accounting for Treasury Stock

(continued)

13-27

2013—Sold 200 shares of treasury stock at $50 per share:

Cash 10,000Treasury Stock (200 × $40) 8,000Paid-In Capital from Treasury

Stock 2,000

Note: Note: No gain is recorded on the No gain is recorded on the sale. The excess is credited sale. The excess is credited to Paid-in Capital from to Paid-in Capital from Treasury Stock.Treasury Stock.

Note: Note: No gain is recorded on the No gain is recorded on the sale. The excess is credited sale. The excess is credited to Paid-in Capital from to Paid-in Capital from Treasury Stock.Treasury Stock.


(continued)

13-28


Cash 17,000Paid-In Capital from Treasury Stock 2,000Retained Earnings 1,000

Treasury Stock (500 × $40) 20,000


(continued)

Note: Note: No loss is recorded on the No loss is recorded on the sale. The difference is debited sale. The difference is debited to Retained Earnings.to Retained Earnings.

Note: Note: No loss is recorded on the No loss is recorded on the sale. The difference is debited sale. The difference is debited to Retained Earnings.to Retained Earnings.

13-29

Common Stock 300Paid-In Capital in Excess of Par 4,200Retained Earnings [300 × ($40 – $15)] 7,500

Treasury Stock (300 × $40) 12,000

2013—Retired remaining 300 shares of treasury (3% of original issue of 10,000 shares):


Alternatively, the entire $11,700 difference between Common Stock and the cost to acquire the treasury stock may be debited to Retained Earnings.

13-30

Par (or Stated) Value Method of Accounting for Treasury Stock

Treasury Stock 1,000Paid-In Capital in Excess of Par 14,000Retained Earnings [1,000 x ($40 – $15)] 25,000

Cash 40,000

Same entry as the cost method Same entry as the cost method (Slide 13-46).(Slide 13-46).Same entry as the cost method Same entry as the cost method (Slide 13-46).(Slide 13-46).

2013—Reacquired 1,000 shares of common stock at $40 per share:

2012—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15:

(continued)

13-31



Cash 10,000Treasury Stock 200Paid-In Capital in Excess of Par 9,800


Cash 17,000Treasury Stock 500Paid-In Capital in Excess of Par

16,500(continued)

13-32


2013—Retired remaining 300 shares of treasury stock:

Common Stock 300Treasury Stock 300

13-33

Stock Rights, Warrants, and Options

• Stock rights—issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.

• Stock warrants—sold by the corporation for cash, generally in conjunction with the issuance of another security.

• Stock options—granted to officers or employees, usually as part of a compensation plan.

13-34

Stock Rights

• When announcing rights to purchase additional shares of stock, the directors of a corporation specify a date on which the rights will be issued.

• All stockholders of record on the issue date are entitled to the rights. Thus, between the announcement date and the issue date, the stock is said to sell rights-on.

(continued)

13-35

• After the rights are issued, the stock sells ex-rights, and the rights may be sold separately by those receiving them from the corporation.

• An expiration date is also designated when the rights are announced, and rights not exercised by this date are worthless.

Stock Rights

13-36

Stock Warrants

• Detachable warrants are similar to stock rights because they can be traded separately from the security with which they were originally issued.

• Nondetachable warrants cannot be separated from the security with which they were issued.

(continued)

13-37

Stock Warrants

The value assigned to the warrants is determined by the relative fair value method which is illustrated in the following equation:

Value assigned to

warrants

Total issue price

Market value of warrants

Market value of security

without warrants

Market value of warrants

+

x=

13-38

Stock Option Compensation Expense

• Whether or not to expense stock options is a “hot potato” issue in accounting.

• The FASB kept bringing up the issue of stock option accounting only to find that there were strong feelings against expensing the cost of stock options.

• Recognition of a stock option compensation expense would reduce reported earnings.

(continued)

13-39

Stock Option Compensation Expense

• In December 2004, the FASB adopted pre-Codification Statement No. 123 which requires the expensing of the fair value of stock options granted as compensation.

• This standard is now found in FASB ASC Topic 718.

13-40

Accounting for Performance-Based Plans

In a performance-based stock option plan, the plan terms are dependent on how well the individual performs after the date the options are granted or how well the company performs during the vesting period.

13-41

Mandatorily Redeemable Preferred Shares

• Historically, the SEC required that firms not include mandatorily redeemable preferred stock under the Stockholders’ Equity heading.

• Given a “mezzanine” treatment.

• The FASB now requires mandatorily redeemable preferred shares to be reported as liabilities in the balance sheet.

(continued)

13-42


On January 1, 2011, Tarazi Company issued mandatorily redeemable preferred shares in exchange for $100 cash. The shares must be redeemed on January 1, 2012, for $110. The interest rate implicit in this agreement is 10%.

Jan. 1 Cash 100Mandatorily Redeemable Preferred Shares (liability) 100

2011

Dec. 31 Interest Expense ($100 x 0.10) 10Mandatorily Redeemable Preferred Shares (liability) 10

(continued)

13-43


Jan. 1 Mandatorily Redeemable Preferred Shares (liability) 100 Cash 100

2012

13-44

Written Put Options

• A put option is an agreement that allows investors to sell the issuing corporation shares they hold at set prices on specific dates.

• If the stock price stays above a set level per share, the issuing corporation pays nothing.

• Historically, companies have recorded these put options as part of equity. The FASB now instructs companies to record the fair value of the obligation as a liability.

13-45

Obligation to Issue Shares of a Certain Dollar Value

• Companies occasionally agree to satisfy their obligations by delivering shares of their own stock rather than by paying cash.

• This is especially true for startup companies trying to conserve their limited cash supply.

• Depending on how the contract is written, this promise to deliver shares of one’s stock to satisfy the obligation can be recorded as equity or as a liability.

(continued)

13-46


Example 1: On October 1, 2011, Lily Company experienced trouble with its office air conditioning system. The repair bill is $5,000. Lily agrees to deliver 200 shares of no-par common stock to the repairperson on February 1, 2012. On October 1, 2011, Lily’s shares have a market value of $25.

Oct. 1 Maintenance Expense (200 x $25) 5,000

Common Stock Issuance Obligation (equity) 5,000

2011

(continued)Similar to Common Stock SubscribedSimilar to Common Stock Subscribed

13-47


Example 2: On October 1, 2011, Lily Company received air conditioning repair services costing $5,000. Lily agrees to deliver shares of Lily’s no-par common stock with a market value of $5,000 to the repairperson on February 1, 2012. On October 1, 2011, Lily’s shares have a market value of $25, and on February 1, 2012, the shares have a market value of $20.

Feb. 1 Common Stock Issuance Obligation (equity) 5,000

Common Stock 5,000

2012

(continued)

13-48


Feb. 1 Common Stock Issuance Obligation (liability) 5,000

Common Stock (250 x $20) 5,000

2012

Oct. 1 Maintenance Expense 5,000Common Stock Issuance Obligation (liability) 5,000

2011

13-49

Noncontrolling Interest

• Financing provided by minority stockholders is called minority interest.

• Minority interest is the amount of equity investment made by outside shareholders to consolidated subsidiaries that are not 100% owned by the parent.

• The FASB uses the term noncontrolling interest to replace “minority interest” in the consolidated balance sheet.

13-50

The capital section of Sorensen Corporation on December 31, 2013, is as follows:

Preferred stock, $50 par, 10,000 $ 500,000Paid-in capital in excess of par— preferred 100,000Common stock, $1 par, 100,000 shares 100,000Paid-in capital in excess of par— common 2,900,000Retained earnings 1,000,000

Stock Conversions

13-51

Stock Conversions

On December 31, 2013, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $1).

Case 1: One Preferred for Four Common ($1)Case 1: One Preferred for Four Common ($1)Case 1: One Preferred for Four Common ($1)Case 1: One Preferred for Four Common ($1)

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par— Preferred 10,000

Common Stock, $1 par 4,000Paid-In Capital in Excess of Par—Common 56,000

2013

(continued)

13-52

On December 31, 2011, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $20).

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par— Preferred 10,000Retained Earnings 20,000

Common Stock, $20 par 80,000

2011

Stock Conversions

Case 2: One Preferred for Four Common ($20)Case 2: One Preferred for Four Common ($20)Case 2: One Preferred for Four Common ($20)Case 2: One Preferred for Four Common ($20)

13-53

Net Income and Dividends

• The primary source of retained earnings is the net income generated by a business.

• When operating losses or other debits to retained earnings produce a debit balance in the account, the debit balance is referred to as a deficit.

• Use of the term dividends without qualification normally implies the distribution of cash.

13-54

Prior-Period Adjustments

In some situations, errors made in past years are discovered and corrected in the current year by an adjustment to Retained Earnings, referred to as a prior-period adjustment:• Mathematical mistakes

• Failure to apply appropriate accounting procedures

• Misstatement or omission of certain information

• Change from a non-GAAP principle to a GAAP principle

13-55

Appropriated Retained Earnings

• Retained Earnings may be restricted at the discretion of the board of directors. Example: Expansion of plant facilities

• The restricted portion may be designed as appropriated retained earnings and the unrestricted portion as unappropriated (or free) retained earnings.

• The main idea behind this restriction is to notify stockholders that some of the assets may not be available for dividends.

13-56

Recognition and Payment of Dividends

• Declaration date—date the corporation’s board of directors formally declares a dividend will be paid

• Date of record—date on which stockholders of record are identified as those who will receive a dividend

• Date of payment—date when the dividend is actually distributed to stockholders

13-57

Cash Dividends

Entries to record the declaration and payment of a $100,000 cash dividend by a corporation follows:Declaration of Dividend:

Dividends (or Retained Earnings) 100,000

Dividends Payable100,000Payment of Dividend:

Dividends Payable 100,000

Cash100,000

13-58

Property Dividends

• A dividend to stockholders that is payable in some asset other than cash is generally referred to as a property dividend.

• Frequently, the assets to be distributed are securities of other companies owned by the corporation. The corporation thus transfers to stockholders the ownership interest in such securities.

(continued)

13-59

Property Dividends

• This type of transfer is sometimes referred to as a nonreciprocal transfer to owner inasmuch as nothing is received by the company in return for its distribution to stockholders.

13-60

Stock Dividends

• A corporation may distribute to stockholders shares of the company’s own stock as a stock dividend.

• A stock dividend involves no transfer of cash or any other asset to stockholders.

• From a shareholder’s standpoint, receipt of a stock dividend is an economic nonevent.

13-61

Small versus Large Stock Dividends

• Small: Less than 20–25% of the outstanding

shares. Debit Retained Earnings for the market

value of the shares.• Large:

Greater than 20–25% of the shares outstanding.

Debit Retained Earnings for the par value of the shares.

13-62

Small Dividend Example

The stockholders’ equity section for the Fuji Company on July 1 is as follows:

Common Stock, $1 par, 100,000

shares outstanding

$ 100,000Paid-In Capital in Excess of Par

1,100,000Retained Earnings

750,000

The company declares a 10% stock dividend. Before the stock dividend, the stock is selling for $22 per share. After the stock dividend, each share will have a value of $20 ($22/1.1).

(continued)

13-63

Declaration of Dividend:Retained Earnings 200,000

Stock Dividends Distributable10,000

Paid-In Capital in Excess of Par190,000Payment of Dividend:

Stock Dividends Distributable 10,000

Common Stock, $1 par10,000

Small Dividend Example

13-64

Large Dividend Example

The stockholders’ equity section for the Fuji Company on July 1 is as follows:

Common Stock, $1 par, 100,000

shares outstanding

$ 100,000Paid-In Capital in Excess of Par

1,100,000Retained Earnings

750,000

The company declares a 50% stock dividend. Before the stock dividend, the stock is selling for $22 per share. Entries for declaring of the dividend and issuance of the 50,000 new shares (100,000 x 0.50) are on Slide 13-121.

(continued)

13-65

Declaration of Dividend:Retained Earnings 50,000


ORPaid-In Capital in Excess of Par 50,000


Issuance of Dividend:Stock Dividends Distributable 50,000

Common Stock, $1 par50,000

Large Dividend Example

13-66

Stock Dividends versus Stock Splits

• A corporation may effect a stock split by reducing the par or stated value of each share of capital stock and proportionately increasing the number of shares outstanding.

• A stock dividend results in an increase in the number of shares outstanding. The par or stated value remains unchanged.

• A stock split divides the existing Capital Stock balance into more parts, with a reduction in par or stated value of each share.

13-67

Reverse Stock Split

• A reverse stock split is the consolidation of shares outstanding into a smaller number of shares.

• Share of stock trading for less than $10 are viewed with some skepticism, and a reverse split can make the stock look more respectable.

• A reverse split is almost always viewed as bad news by investors.

13-68

Liquidating Dividends

• A liquidating dividend is a distribution representing a return to stockholders of a portion of contribution capital.

• Example: Stubbs Corporation declared and paid a cash dividend ($10 cash dividend on 10,000 shares of common stock) totaling $100,000 and a partial liquidating dividend of $50,000. The liquidating dividend is a $5-per-share dividend. The declaration and payment entries are on Slide 13-126.

(continued)

13-69

Liquidating Dividends

Declaration of Dividend:Dividends 100,000

Paid-In Capital in Excess of Par 50,000

Dividends Payable150,000Payment of Dividend:

Dividends Payable 150,000

Cash150,000

13-70

Equity Items That Bypass the Income Statement and are

Reported as Part of Accumulated Other Comprehensive Earnings

Since 1980, the Equity sections of the U.S. balance sheets have begun to fill up with a strange collection of times, each the result of an accounting controversy. These items are summarized in the following slides.

(continued)

13-71

Foreign Currency Translation Adjustment

• The foreign currency translation adjustment arises from the change in the equity of foreign subsidiaries (as measured in terms of U.S. dollars) that occurs as a result of changes in foreign currency exchange rates.

• These changes are recorded as direct adjustments to equity, insulating the income statement from the aspect of foreign currency fluctuations.

13-72

Unrealized Gains and Losses on Available-for-Sale Securities

• Available-for-sale securities are those that were not purchased with immediate intention to resell, but that a company also doesn’t necessarily plan to hold forever.

• The unrealized gains and losses from market value fluctuations in trading securities are included in the income statement.

(continued)

13-73

Unrealized Gains and Losses on Available-for-Sale Securities

• The unrealized gains and losses from market value fluctuations in available-for-sale securities are shown as a direct adjustment to equity.

13-74

Unrealized Gains and Losses on Derivatives

• A derivative is a financial instrument, such as an option or a future, that derives its value from the movement of a price, an exchange rate, or an interest rate associated with some other item.

• Derivatives are used to manage risk associated with sales or purchases that will not occur until a future period.

(continued)

13-75

Balance Sheet Reporting

The accumulated amount of comprehensive income is reflected in the Equity section of the balance sheet in two ways:

• Net income (less dividends) is cumulated in retained earnings.

• Other comprehensive income is cumulated in accumulated other comprehensive income.

13-76

International Accounting: Equity Reserves

• In foreign countries, the payment of cash dividends is linked to the amount of distributable equity.

• Equity is divided among various equity reserve accounts, each with legal restrictions dictating whether it can be distributed to stockholders.

13-77

Disclosures Related to the Equity Section

Authorized but unissued Subscribed for and held for issuance pending

receipt of cash for the full amount of the subscription price

Outstanding in the hands of stockholders Reacquired and held by the corporation for

subsequent reissuance Canceled by appropriate corporate action

In accounting for capital stock, it should be recognized that stock may be:

13-78

Chapter 13Chapter 13

The EndThe EndThe EndThe End

$

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13-1 intermediate financial accounting earl k. stice james d. stice © 2012 cengage learning...

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