Stockholders Equity:

Paid-In Capital
Chapter 11

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2012 The McGraw-Hill Companies, Inc.

Corporations
An entity created by law.

Existence is separate from owners.

Ownership can be

Privately, or Closely Held

Has rights and privileges.

Publicly Held

11-2

Advantages of Incorporation
Limited personal liability for stockholders Transferability of ownership

Professional management
Continuity of existence
11-3

Disadvantages of Incorporation
Heavy taxation
Greater regulation Cost of formation Separation of ownership and management
11-4

Formation of a Corporation
Each corporation is formed according to the laws of the state where it is located.
The application for corporate status is called the Articles of Incorporation.
11-5

The costs associated with incorporation are usually expensed immediately, but amortized over 5 years for tax purposes.

Rights of Stockholders
Voting (in person or by proxy). Rights Proportionate distribution of dividends. Proportionate distribution of assets in a liquidation.
11-6

Stockholders

Rights of Stockholders

Corporate Organization Chart

Ultimate control

Stockholders Board of Directors President

Stockholders usually meet once a year.

Secretary

Treasurer

Controller

Other Vice Presidents

11-7

Functions of the Board of Directors

Corporate Organization Chart

Stockholders Board of Directors President Secretary Treasurer Controller
Primary functions are to set corporate policies ad protect stockholders.

Other Vice Presidents

11-8

Functions of the Corporate Officers

Corporate Organization Chart

Contractual and legal representation Custodian of funds

Stockholders Board of Directors President

Chief Accountant

Secretary

Treasurer

Controller

Other Vice Presidents

11-9

Publicly Owned Corporations Face Different Rules

By law, publicly owned corporations must: Prepare financial statements in accordance with GAAP. Have their financial statement audited by an independent CPA. Comply with federal securities laws. Submit financial information for SEC review.

11-10

Stockholder Records in a Corporation

Stockholder ledgers are often maintained by a stock transfer agent or stock registrar. Stockholders usually meet once a year. Each unit of ownership is called a share of stock. Stock certificates serve as proof that a stockholder has purchased shares. When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.

11-11

Stockholders Equity of a Corporation

Stockholders' equity is increased in two ways.

Contributions by investors in exchange for capital stock.

Retention of profits earned by the corporation.

Paid-in Capital

Retained Earnings
11-12

Authorization and Issuance of Capital Stock

Authorized Shares

The maximum number of shares of capital stock that can be sold to the public.

11-13

Authorization and Issuance of Capital Stock

Authorized Shares
Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold.

Usually shares are sold through an underwriter.

11-14

Authorization and Issuance of Capital Stock

Authorized Shares Outstanding Shares
Outstanding shares are issued shares that are owned by stockholders.

Issued Shares

Unissued Shares
Treasury shares are issued shares that have been reacquired by the corporation.
11-15

Treasury Shares

Stockholders Equity
Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market.

11-16

Stockholders Equity
Common stock can be issued in three forms:

Par Value Common Stock

No-Par Common Stock

Stated Value Common Stock

Lets examine this form of stock.

All proceeds credited to Common Stock

Treated like par value common stock

11-17

Issuance of Par Value Stock

Record: 1. The cash received.

2. The number of shares issued the par value per share in the Common Stock account.
3. The remainder is assigned to Additional Paid-in Capital.

Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.

11-18

Issuance of Par Value Stock

Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.
Description Debit Credit

Cash Common Stock Additional Paid-in Capital

250,000 20,000 230,000

10,000 $2 = $20,000

11-19

Issuance of Par Value Stock

Stockholders' Equity with Common Stock
Stockholders' Equity Contributed capital: Common stock - $2 par value; 50,000 shares authorized; 10,000 shares issued and outstanding Additional paid-in capital Retained earnings Total stockholders' equity

20,000 230,000 65,000

$ 315,000

11-20

Common Stock and Preferred Stock

Show below is the stockholders equity section of Martin, Inc. The company has both common and preferred stock outstanding.
Stockholders' equity: Preferred stock, 4% cumulative, $100 par value, authorized 50,000 shares, issued and outstanding 5,000 shares Common stock, $4 par value, authorized 3,000,000 shares, issued and outstanding 750,000 shares Additional paid-in capital: Preferred stock Common stock Total paid-in capital Retained earnings Total stockholders' equity

500,000 3,000,000

75,000 10,500,000 14,075,000 1,922,500 $ 15,997,500

11-21

Preferred Stock
A separate class of stock, typically having priority over common shares in . . . Dividend distributions (rate is usually stated). Distribution of assets in case of liquidation. Other Features Include: Cumulative dividend rights. Usually callable by the company. Normally has no voting rights.
11-22

Cumulative Preferred Stock

Cumulative
Dividends in arrears must be paid before dividends may be paid on common stock.

Vs.

Noncumulative
Undeclared dividends from current and prior years do not have to be paid in future years.

11-23

Stock Preferred as to Dividends

Example: Consider the following partial Statement of Stockholders Equity.
Common stock, $50 par value; 4,000 shares authorized, issued and outstanding Preferred stock, 9%, $100 par value; 1,000 shares authorized, issued and outstanding Total contributed capital $ 200,000 100,000 $ 300,000

During 2010, the directors declare cash dividends of $5,000. In 2011, the directors declare cash dividends of $42,000.
11-24

Stock Preferred as to Dividends

Preferred If Preferred Stock is Noncumulative: Year 2010 $5,000 dividends declared Year 2011 Step 1: Current preferred dividend Step 2: Remainder to common shareholders If Preferred Stock is Cumulative: Year 2010 $5,000 dividends declared Year 2011 Step 1: Dividends in arrears Step 2: Current preferred dividend Step 3: Remainder to common shareholders Totals $ $ 5,000 9,000 $ 33,000 Common $ -

$ $

5,000 4,000 9,000 13,000

$ $

29,000 29,000

11-25

Other Features of Preferred Stock

I just converted 100 shares of preferred stock into 1,000 shares of common stock and ended up with a higher dividend yield! Gee, I cant do that with MY preferred stock!

Some preferred stock is convertible into shares of common stock.

11-26

Preferred Stock
Stockholders' Equity with Common and Preferred Stock Stockholders' Equity Contributed Capital: Preferred Stock - $100 par value; 1,000 shares authorized; 50 shares issued and outstanding $ Common Stock - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding Additional Paid-in Capital Retained Earnings Total Stockholders' Equity $

5,000

300,000 1,000 65,000 371,000

11-27

Book Value per Share of Common Stock

Preferred stock and preferred dividends in arrears are deducted from total stockholders equity.

Total Stockholders Equity Number of Common Shares Outstanding

Book Value Market Value

11-28

Book Value With Both Preferred and Common Stock

Davis company has paid no dividends in the current year. As of December 31st, dividends in arrears on cumulated preferred stock total $50,000. All equity belongs to common stockholders except the $500,000 applicable to preferred stock and the $50,000 dividends in arrears. Here is the calculation of book value for common stock:
Total stockholders' equity Less: Equity of preferred stockholders" Par value of preferred stock Dividends in arrears Equity of common stockholders Number of common shares outstanding Book value per share of common stock $ 1,950,000 $ 500,000 50,000

550,000 1,400,000 700,000 $ 2.00

11-29

Market Value
Common stock is carried at original issue price. Investments in marketable securities are carried at market value.
11-30

Accounting by the issuer.

Accounting by the investor.

Market Price of Preferred Stock

Factors affecting market price of preferred stock:

Dividend rate Risk Level of interest rates

The return based on the market value is called the dividend yield.
11-31

Market Price of Common Stock

Factors affecting market price of common stock: Investors expectations of future profitability. Risk that this level of profitability will not be achieved.

Changes in market value have no impact on the books of the issuer.

11-32

Stock Splits
Companies use stock splits to reduce market price.
Outstanding shares increase, but par value is decreased proportionately.

Ice Cream Parlor

Stock Splits Now Available

11-33

Stock Split
Assume a corporation has 5,000 shares of $1 par value common stock outstanding before a 2for1 stock split.
Before Split 5,000 $ $ 1.00 5,000 After Split 10,000 Increase $ $ 0.50 Decrease No 5,000 Change

Common Stock Shares Par Value per Share Total Par Value

11-34

Treasury Stock
No voting or dividend rights
Treasury shares are issued shares that have been reacquired by the corporation.

When stock is reacquired, the corporation records the treasury stock at cost.
11-35

Recording Purchases of Treasury Stock

Riley Corporation reacquires 3,000 of its common shares in the open market at $55 per share. Prepare the journal entry to record the purchase of treasury stock.
Description Debit Credit

Treasury Stock Cash

3,000 shares $55 = $165,000

165,000 165,000

11-36

Recording Purchases of Treasury Stock

Riley Corporation reissued 1,000 shares of the treasury stock originally purchased for $55 per share. The shares were reissued at $75 per share.
1,000 shares $75 = $75,000
Description Debit Credit

Cash Treasury Stock Additional Paid-in Capital: Treasury Stock

75,000 55,000 20,000

1,000 shares $55 cost = $55,000

11-37

Stockholders Equity Presentation

Stockholders' Equity Contributed capital: Preferred Stock - $100 par value; 1,000 shares authorized; 50 shares issued & outstanding Common Stock - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding Contributed Capital in Excess of Par Retained earnings Subtotal Less: Treasury stock Total Stockholders' equity

5,000

$ $

300,000 21,000 65,000 391,000 110,000 281,000

11-38

Stock Buyback Programs

Some corporations have buyback programs, in which they repurchase large amounts of their own common stock. As a result of these programs, treasury stock has become a material item in the balance sheet of many corporations. Stock option plans are an important part of employee compensation for many companies. Treasury stock purchases are an effective means by which the company can have available the shares of stock needed to satisfy the requirement of stock option plans to issue the shares of stock to employees.
11-39

Financial Analysis and Decision Making

Return on Total Assets = Net Income Average Total Assets

Return on Common Stockholders Equity =

Net Income Average Common Stockholders Equity

11-40

End of Chapter 11

11-41