Financial accounting in an economic context 8e chapter 012

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1 Chapter 12 Shareholders’ Equity Chapter 12: Shareholders’ Equity How to Finance the Corporation?  Borrow – Notes, Bonds, Leases – The debt holders are legally entitled to repayment of their principal and interest claims  Issue Equity – Common and Preferred Stock – The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets  Retained Earnings Relative Importance of Liabilities, Capital, and Retained Earnings (% of total assets) Debt versus Equity Debt Formal legal contract Fixed maturity date Fixed periodic payments Security in case of default No voice in management Interest expense deductible Equity No legal contract No fixed maturity date Discretionary dividends Residual asset interest Voting rights - common Dividends not deductible Double taxation Distinctions between Debt and Equity Interested Party Debt Equity Investors / Creditors Lower investment risk Higher investment risk Fixed cash receipts Variable cash receipts Management Contractual future cash payments Dividends are discretionary Effects on credit rating Interest is tax deductible Effects of dilution/ takeover Dividends are not tax deductible Accountants/ Auditors Shareholders’ equity Liabilities section of the balance sheet of the balance sheet No income statement Income statement effects from equity effects from debt Preferred Stock vs Common Stock Advantages Preferred Stock Common Stock Preference over common in liquidation Voting Rights Stated dividend Rights to residual profits (after preferred) Preference over common in dividend payout Disadvantages Subordinate to debt in liquidation Last in liquidation Stated dividend can be skipped No guaranteed return No voting rights (versus common) Debt or Equity? Components of both Usually classified as equity Sample Co Shareholders’ Equity Common stock, $1 par value, 500,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding $ 80,000 Common stock dividends distributable 2,000 Preferred stock, $100 par value, 1,000 shares authorized, 100 shares issued and outstanding 10,000 Paid in capital on common $ 20,000 Paid in capital on preferred 3,000 Paid in capital on treasury stock 2,000 25,000 Retained earnings: Unappropriated $18,000 Appropriated 4,000 22,000 Less: Treasury stock, 5,000 shares (at cost) (6,000) Less: Other comprehensive income items (unrealized loss on AFS securities) (2,000) Total Shareholders’ Equity $131,000 Journal Entries-Sample Co Now, using Sample Company information, record the following additional issues of common (CS) and preferred stock (PS): Issued 100 shares of PS at $102 per share: Cash (100 x $102) 10,200 PS (100 x $100 par) 10,000 APIC - PS (plug) 200 Issued 500 shares of CS at $5 per share: Cash (500 x $5) 2,500 CS (500 x $1 par) 500 APIC - CS (plug) 2,000 Treasury Stock       Created when a company buys back shares of its own common stock Reasons for buyback? The debit balance account called “Treasury Stock” is reported in shareholders’ equity as a contra account to SE – Note: Treasury Stock is 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 10 Retained Earnings We will be expanding the basic retained earnings formula in this chapter Now the Statement of Retained Earnings will include the following: RE, beginning (unadjusted) xx Add/Subtract: Prior period adjustment xx RE, beginning (restated) xx Add: net income xx Less dividends: Cash dividends-common xx Cash dividends - preferred xx Stock dividends xx Property dividends xx Less: Adjustment for TS transactions xx Appropriation of RE xx RE, ending xx 16 Example of Stock Split IZM Company has 100,000 shares of $2 par value stock authorized, 10,000 shares issued and outstanding The SE section of the balance sheet shows: – Common stock $20,000 – Retained earnings 80,000 The market price of the outstanding shares is $50 per share before the split is distributed 17 Example of Stock Split    If IZM declared a for stock split, the old shares would be turned in and new shares would be issued with the following description: Common stock, $1 par value, 200,000 shares authorized, 20,000 shares issued and outstanding The total SE is still $100,000: – Common stock – Retained earnings   $20,000 80,000 The market price per outstanding share would now be $25 per share Note: No journal entry is necessary 18 Stock Dividends vs Stock Splits Going back to the original IZM information Assume instead that IZM declared a 100% stock dividend First, prepare the JEs to record the declaration and distribution of the stock dividend for new shares (10,000 shares x 100% = 10,000 new shares x $2 per share = $20,000): Stock Dividends (RE) 20,000 Stock Div Distributable 20,000 Stock Div Distributable 20,000 Common Stock 20,000 19 Stock Dividends vs Stock Splits Now note the new description for the stock dividend:  Common stock, $2 par value, 100,000 shares authorized, 20,000 shares issued and outstanding  The total value in SE is still $100,000: – Common Stock $40,000 – Retained Earnings 60,000  Note that the total market price per share would change to $25 per share  Thus, a for stock split and a 100% stock dividend have the same effect on: – total shareholders’ equity and – market price per share 20 Stock Dividends vs Stock Splits To summarize the effects on IZM Company: 100% Stock for After: Dividend Stock Split Total sh outstanding 20,000 sh 20,000 sh Par value per share $2 $1 Market price per share $25 $25 Total shareholders’ eq: $100,000 $100,000 General ledger results: CS account $ 40,000 $ 20,000 RE account $ 60,000 $ 80,000 Reminder: CS was $20,000 and RE was $80,000 before the split or dividend Since the stock dividend required journal entries, the amounts for CS and RE changed Since the stock split does not require a journal entry, the amounts for CS and RE not change 21 Other Comprehensive Income   “Other Comprehensive Income” includes certain direct equity adjustments that are not part of the current income statement, but which may have an eventual effect on income We already discussed one of these direct equity adjustments when reviewing Available-for-sale Investments We found that any unrealized gains/losses from revaluation to market are shown in SE (as “other comprehensive income”) rather than on the income statement 22 Comprehensive Class Problem Shareholders’ Equity Given the following SE balances for Company G at 1/1/07: Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued and outstanding $200,000 APIC on common stock 400,000 Retained earnings 400,000 During 2007, Company G had the following activity: Net income for the year was $250,000 Cash dividends of $2 per share were declared and paid on February On June 1, Company G repurchased 2,000 shares of its own stock at $20 per share (using the cost method) On December 1, Company G reissued 500 shares of treasury stock at $18 per share On December 15, Company G declared a 100% stock dividend, to be distributed to all of its shareholders (including treasury), on Jan 15, 2008 At Dec 31, Company G recorded an AJE to revalue its available for sale investments from $20,000 to $32,000 23 Comprehensive Class Problem Shareholders’ Equity (continued) Required: A Prepare journal entries for items through (item would require detailed information for revenues and expenses to prepare - just know that the credit is to retained earnings for $250,000) B the Statement of Stockholders’ Equity for Company G for 2007 C Prepare the stockholders’ equity section of the balance sheet for Company G for 2007, including the appropriate description for the common stock 24 Comprehensive Class Problem - Solution A Journal entries No entry required Calc: 20,000 x $2 = 40,000 Cash Dividends (RE) 40,000 Dividends Payable 40,000 Dividends Payable 40,000 Calc: 2,000 shares x $20 = $40,000 Cash 40,000 Treasury Stock Cash 40,000 40,000 25 Comprehensive Class Problem - Solution Part A: Journal Entries Calc: 500 shares x $18 market = $9,000 500 shares x $20 cost = $10,000 Cash Retained Earnings Treasury Stock 9,000 market 1,000 plug 10,000 cost Calc: 20,000 new shares x $10 par = $200,000 Stock Dividend (RE) 200,000 Stock Div Distributable 200,000 Note: in Item 5, the stock has not yet been distributed, so we cannot credit common stock, or show it issued yet This “Stock Dividends Distributable” account is a related equity account, and indicates that there are shares of stock to be distributed in the future 26 Comprehensive Class Problem - Solution Part A: Journal Entries Calc: value up $12,000 AFS Investment 12,000 Unrealized Gain on AFS 12,000 Note that the Unrealized Gain account is part of shareholders’ equity (not the income statement), and it is located at the bottom of the shareholders’ equity section of the balance sheet, in Other Comprehensive Income (OCI) 27 Comprehensive Class Problem - Solution Part B: Statement of SE (in thousands) CS CSDD APIC RE OCI TS Balance 1/1/07 $200 $400 $400 Net income 250 Cash dividends (40) Stock dividends $200 (200) Purchase of TS $(40) Reissue of TS ( 1) 10 Revalue AFS Invest $12 Balance, 12/31/07 $200 $200 $400 $409 $12 $(30) Note: CSDD is Common Stock Dividends Distributable When shares are distributed, then CS is increased Note: OCI is Other Comprehensive Income and reflects the unrealized gain on Available-for-sale investments 28 Comprehensive Class Problem - Solution Part C: Shareholders’ Equity Section of B/S Common stock, $10 par value, 50,000 shares authorized, 20,000 shares issued, 18,500 shares outstanding $ 200,000 Common stock dividends distributable, 20,000 shares 200,000 Additional paid-in capital, common stock 400,000 Retained earnings 409,000 Other comprehensive income (unrealized gain on AFS investment) 12,000 Less: Treasury stock, 1,500 shares at cost (30,000) Total shareholders’ equity $1,191,000 29 Copyright Copyright © 2011 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser 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 30 [...]... (2) debit RE if necessary for any remaining balance (this is only necessary when we are decreasing equity) 15 Retained Earnings We will be expanding the basic retained earnings formula in this chapter Now the Statement of Retained Earnings will include the following: RE, beginning (unadjusted) xx Add/Subtract: Prior period adjustment xx RE, beginning (restated) xx Add: net income xx Less dividends: Cash... shown in SE (as “other comprehensive income”) rather than on the income statement 22 Comprehensive Class Problem Shareholders’ Equity Given the following SE balances for Company G at 1/1/07: Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued and outstanding $200,000 APIC on common stock 400,000 Retained earnings 400,000 During 2007, Company G had the following activity: 1 Net income... the amounts for CS and RE do not change 21 Other Comprehensive Income   “Other Comprehensive Income” includes certain direct equity adjustments that are not part of the current income statement, but which may have an eventual effect on income We already discussed one of these direct equity adjustments when reviewing Available-for-sale Investments We found that any unrealized gains/losses from revaluation... Property dividends xx Less: Adjustment for TS transactions xx Appropriation of RE xx RE, ending xx 16 Example of Stock Split IZM Company has 100,000 shares of $2 par value stock authorized, 10,000 shares issued and outstanding The SE section of the balance sheet shows: – Common stock $20,000 – Retained earnings 80,000 The market price of the outstanding shares is $50 per share before the split is distributed... be turned in and new shares would be issued with the following description: Common stock, $1 par value, 200,000 shares authorized, 20,000 shares issued and outstanding The total SE is still $100,000: – Common stock – Retained earnings   $20,000 80,000 The market price per outstanding share would now be $25 per share Note: No journal entry is necessary 18 Stock Dividends vs Stock Splits Going back... issued and outstanding  The total value in SE is still $100,000: – Common Stock $40,000 – Retained Earnings 60,000  Note that the total market price per share would change to $25 per share  Thus, a 2 for 1 stock split and a 100% stock dividend have the same effect on: – total shareholders’ equity and – market price per share 20 Stock Dividends vs Stock Splits To summarize the effects on IZM Company:... at January 1, 2007 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 2007, Tiger Corp repurchases 10,000 shares of its own stock at $7 per share In July of 2007, Tiger Corp reissues 2,000 shares of the treasury stock for $8 per share In December of 2007, Tiger Corp reissues the remaining... All that remains of those transactions is the APIC -TS 11 Sample Co Shareholders’ Equity Common stock, $1 par value, 500,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding $ 80,000 Common stock dividends distributable 2,000 Preferred stock, $100 par value, 1,000 shares authorized, 100 shares issued and outstanding 10,000 Paid in capital on common $ 20,000 Paid in capital on... declared and paid on February 1 3 On June 1, Company G repurchased 2,000 shares of its own stock at $20 per share (using the cost method) 4 On December 1, Company G reissued 500 shares of treasury stock at $18 per share 5 On December 15, Company G declared a 100% stock dividend, to be distributed to all of its shareholders (including treasury), on Jan 15, 2008 6 At Dec 31, Company G recorded an AJE to... again at the information for Sample Co Note that Sample Company has 5,000 shares of TS at a total cost of $6,000, or a cost of $1.20 per share The journal entry to record that purchase would have been: TS 6,000 Cash 6,000 Note that Sample Company also has APIC - TS of $2,000 in the balance sheet This must be from previous TS transactions, where the TS was purchased, then reissued for more than original
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