Chapter 13 19th Edition Equity Financing Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 13-1 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 13-2 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 13-3 Common Stock Unless restricted by terms of the articles of incorporation, certain basic rights are held by each common stockholder: To vote in the election of directors and in the determination of certain corporate policies 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 13-4 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 Common Stock (at par value) XXX Additional Paid-In Capital XXX XXX (continued) 13-5 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) 13-6 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) 13-7 Preferred Stock Rights of ownership given up by preferred stockholders: • 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 not get to share in the success (continued) 13-8 Preferred Stock The protections enjoyed by preferred stockholders, relative to common stockholders, are: • 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 13-9 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 13-10 Large Dividend Example Declaration of Dividend: Retained Earnings Stock Dividends Distributable 50,000 50,000 OR Paid-In Capital in Excess of Par Stock Dividends Distributable Issuance of Dividend: 50,000 Stock Dividends Distributable Common Stock, $1 par 50,000 50,000 50,000 13-65 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 13-66 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 13-67 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) 13-68 Liquidating Dividends Declaration of Dividend: Dividends Paid-In Capital in Excess of Par Dividends Payable 150,000 of Dividend: Payment 100,000 50,000 Dividends Payable Cash 150,000 150,000 13-69 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) 13-70 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 13-71 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) 13-72 Unrealized Gains and Losses on Available-for-Sale Securities • The unrealized gains and losses from market value fluctuations in available-forsale securities are shown as a direct adjustment to equity 13-73 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) 13-74 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 13-75 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 13-76 Disclosures Related to the Equity Section In accounting for capital stock, it should be recognized that stock may be:  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 13-77 Chapter 13 ₵ The The End End $ 13-78 13-79 ... that the stock is currently undervalued by the market 13- 24 Treasury Stock • • • • Treasury stock is stock issued by a corporation and subsequently reacquired by the corporation and held for possible... treasury stock Retained Earnings can be decreased by treasury stock transactions but never increased by such transactions 13- 25 Cost Method of Accounting for Treasury Stock 2012—Newly organized... Excess of Par 2 013 Reacquired 1,000 shares of common 140,000 stock at $40 per share: Treasury Stock Cash 40,000 40,000 (continued) 13- 26 Cost Method of Accounting for Treasury Stock 2 013 Sold 200