Chap 18 - Anna Lee

Chapter 18
Shareholders’ Equity
The Nature of Shareholders’ Equity
18-1
Assets – Liabilities = Shareholders’ Equity
Amounts invested
by shareholders
Net Assets
Sources of
Shareholders’
Equity
Shareholders’ Equity
Paid-in Capital
Retained Earnings
Accumulated Other
Comprehensive Income
Amounts earned
by corporation
Other
gains and
losses not
included in
net income

18-2
Financial Reporting Overview
Shareholders' Equity
Paid-in capital:
Captial stock:
Preferred stock - $100 par value; 1,000 shares
authorized; 400 shares issued and
outstanding $ 40,000
Common stock - $10 par value; 60,000 shares
authorized; 20,000 shares issued and
outstanding 200,000
Additional paid-in capital in excess of par value
From issuance of preferred stock 10,000
From issuance of common stock 300,000
Total paid-in capital $ 550,000
Retained earnings 121,500
Accumulated other comprehensive income:
Net unrealized holding gains (losses) on investments (35,000)
Gains (losses) from foreign currency translation 22,000 (13,000)
Treasury stock (at cost) (10,000)
Total shareholders' equity $ 648,500

Accumulated Other Comprehensive Income
Accumulated other comprehensive income
includes four types of gains and losses
not included in net income.
18-3
Net holding
gains (losses) on
investments.
Gains (losses)
from and
amendments to
retirement
benefit plans
(e.g., Prior
service costs).
Gains (losses) from
foreign currency
translations
(exchange rates).
Deferred gains
(losses) from
derivatives.

18-4
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration:
Securities Fair Value Adjustment (AFS) 99,800
Unrealized Holding Gain or Loss—Equity 99,800

Unrealized Holding Gain or Loss - OCI
12/31/2010 35,550 12/31/2011 99,800
12/31/11 close 64,250
12/31/2011 64,250
Security Fair Value Adjustment
12/31/2011 99,800 12/31/2010 35,550
12/31/2011 64,250
Accum Other Comprehensive Income (AOIC)
12/31/11 64,250

Accumulated Other Comprehensive Income
Comprehensive income reporting:
18-6
• Comprehensive income created during the
reporting period is reported either in the
“statement of comprehensive income”
immediately following the income statement
or as “an additional section of the income
statement”.
• The comprehensive income accumulated
over the current and prior periods is also
reported as accumulated other
comprehensive income (AOIC) in the
“balance sheet”.

18-7
Defining Derivatives
Financial instruments that derive their value from values of
other assets (e.g., stocks, bonds, or commodities).
Three different types of derivatives:
1. Financial forwards or financial futures.
2. Options.
3. Swaps (e.g. interest rate Swaps, Currency Swaps)

18-8
Who Uses Derivatives, and Why
‣ Producers and Consumers
‣ Speculators and Arbitrageurs
(Arbitrageur: One who profits from the
differences in price when the same, or
extremely similar, security , currency, or
commodity is traded on two or more
markets.)
LO 9 Explain who uses derivative and why.

18-9
Basic Principles in Accounting for Derivatives
Recognize derivatives in the financial statements as
assets and liabilities.
Report derivatives at fair value.
Recognize gains and losses resulting from
speculation in derivatives immediately in income.
Report gains and losses resulting from hedge
transactions differently, depending on the type of
hedge.

18-10
U.S. GAAP vs. IFRS
Terminology Differences
Capital stock:
Common stock.
Preferred stock.
Paid‐in capital—excess of
par, common.
Paid‐in capital—excess of
par, preferred.
Share capital:
Ordinary shares.
Preference shares.
Share premium, ordinary
shares.
Share premium, preference
shares.

18-11
U.S. GAAP vs. IFRS
Terminology Differences
Accumulated other
comprehensive income:
Reserves:
Net gains (losses) on
investment ― AOCI.
Investment revaluation
reserve.
Net gains (losses) foreign
currency translation —AOCI.
Translation reserve.
PP&E Fair value adjustments not
permitted.
Revaluation reserve.
Retained earnings.
Retained earnings.
Total shareholders’ equity.
Total equity.
Presented after liabilities
Often presented before liabilities.

18-12
The Corporate Organization
Advantages of a corporation
Continuous
existence
Easy
ownership
transfer
Easy to
raise capital
Limited
liability
Disadvantages of a corporation
Double
taxation
Government
regulation

18-13
Types of Corporations
Not-for-profit corporations include
hospitals, charities, and government
agencies such as FDIC.
Publicly-held corporations
whose shares are widely
owned by the general public.
Privately-held corporations
whose shares are owned by
only a few individuals.

18-14
Hybrid Organizations
S Corporation
Limited liability protection of a corporation.
Maximum number of owners.
Limited liability company
Limited liability protection of a corporation.
All owners may be involved in management
without losing limited liability protection.
No limit on number of owners.
Limited liability partnership
Owners are liable for their own actions but not
entirely liable for actions of other partners.
Double
taxation
avoided.

The Model Business Corporation Act
(serves as a guide for the corporation statutes of most states)
18-15
Nature and location of business activities.
Number and classes of shares authorized.
Articles of incorporation
are filed with the state.
State issues a
corporate charter.
Shares of
stock issued.
Board of directors
appoint officers.
Board of directors
elected by
shareholders.

18-16
Fundamental Share Rights
Right to vote.
Preemptive
right to maintain
percentage
ownership.
Right to share
in profits when
dividends are
declared.
Right to share
in distribution of
assets if company
is liquidated.

Authorized, Issued, and
Outstanding Shares
18-17
Authorized shares are the maximum
number of shares of capital stock that
can be sold to the public.
Issued
shares are
authorized
shares of
stock that
have been
sold.
Unissued
shares are
authorized
shares of
stock that
never have
been sold.

Authorized, Issued, and
Outstanding Shares
18-18
Authorized
Shares
Outstanding shares are
issued shares that are
owned by stockholders.
Issued
Shares
Retired shares:
Repurchased and
retired; have the
same status as
authorized but
unissued shares.
Outstanding
Shares
Treasury
Shares
Retired
Shares
Unissued
Shares
Treasury shares: issued
shares that have been
repurchased by the
corporation, but not
retired.

Capital Stock
18-19
Par value stock
No-par stock
Dollar amount per share is
stated in the corporate
charter, no restriction on the
assigned value. It is the
minimum legal capital.
Par value has no relationship
to market value.
Dollar amount per share
is not designated in
corporate charter.
Corporations can assign a
stated value per share
(treated as if par value).
Legal capital is . . .
The amount recorded as common stock or preferred stock.
The least amount the stock buyers must contribute to the firm
when stock is issued, otherwise it constitutes a legal capital
deficiency.
The amount of capital, required by state law, that must remain
invested in the business.
Refers to par value, stated value, or full amount paid for no-par
stock.

18-20
Capital Stock
Common stock is the basic voting stock of the
corporation. It ranks after preferred stock for dividend
and liquidation distribution. Dividends are determined
by the board of directors.
Generally does not
have voting rights.
Usually has a
par or stated value.
Preferred
Stock
Dividend and liquidation
preference over
common stock.
May be convertible ( holder’s
option), or callable (by co. at a
stated value; to retire).

18-21
Preferred Stock Dividends
Are usually stated as a % of the par or stated value.
May be cumulative or noncumulative.
May be partially participating, fully participating,
or nonparticipating.
Unpaid dividends must be paid in full before
any distributions to common stock.
Dividends in arrears are not liabilities, but
the per share and aggregate amounts must
be disclosed.

18-22
U.S. GAAP vs. IFRS
Distinction between Debt and Equity
for Preferred Stock
Preferred stock normally is
reported as equity, but is reported
as debt with the dividends
reported in the income statement
as interest expense if it is
“mandatorily redeemable”
preferred stock.
Most non-mandatorily redeemable
preferred stock (preference
shares) also is reported as debt as
well as some preference shares
that aren’t redeemable. Under
IFRS (IAS No. 32), the critical
feature that distinguishes a liability
is if the issuer is or can be
required to deliver cash (or
another financial instrument) to
the holder.

18-23
Shares Issued for Cash
10,000 shares of stock are issued for $100,000 cash.
$1 Par
Value
Cash ....................................................... 100,000
Common stock, par value .............. 10,000
Paid-in capital – excess of par …… 90,000
To record issue of common stock.
No Par
Value
Cash ....................................................... 100,000
Common stock ............................. 100,000
To record issue of common stock.
No Par,
$1 Stated
Value
Cash ................................................................... 100,000
Common stock, stated value ..................... 10,000
Paid-in capital – excess of stated value …. 90,000
To record issue of common stock.

Shares Issued for
Noncash Consideration
18-24
Apply the general valuation principle by using fair
value of stock given up or fair value of asset
received, whichever is more clearly evident.
If market values cannot be determined, use
appraised values.

More Than One Security
Issued for a Single Price
18-25
Allocate the lump-sum received based on the relative fair
values of the two securities.
If only one fair value is known, allocate a portion of the lumpsum
received based on that fair value and allocate the
remainder to the other security.
Toys Inc. issued 5,000 shares of common stock, $10 par value,
and 3,000 shares of preferred stock, $5 par value, for $450,000.
The market values of the common stock and
preferred stock were $55 and $75, respectively.
Calculate the additional paid-in
capital for each class of stock.

More Than One Security
Issued for a Single Price
18-26
Market* % Allocation** Par^ Excess^^
Common Stock $ 275,000 55% $ 247,500 $ 50,000 $ 197,500
Preferred Stock 225,000 45% 202,500 15,000 187,500
Total $ 500,000 100% $ 450,000 $ 65,000 $ 385,000
* Market Value: ^ Par Value:
Common: $55 × 5,000 shares Common: $10 × 5,000 shares
Preferred: $75 × 3,000 shares Preferred: $5 × 3,000 shares
**Allocation:
^^Excess:
Common: $450,000 × 55% Common: $247,500 - $50,000 par
Preferred: $450,000 × 45% Preferred: $202,500 - $15,000 par
Cash ............................................................................ 450,000
Common stock, $10 par ..................................... 50,000
Paid-in capital – excess of par common ……….. 197,500
Preferred stock, $5 par 15,000
Paid-in capital – excess of par preferred ………. 187,500
To record issue of common and preferred stock.

18-27
Share Issue Costs
Registration fees
Underwriter commissions
Printing and clerical costs
Legal and accounting fees
Promotional costs
Share issue costs reduce net proceeds
from selling shares, resulting in a lower
amount of additional paid-in capital.

18-28
Share Buybacks
A corporation might reacquire shares of its stock to . . .
support the market price.
increase earnings per share.
distribute in stock option plans.
issue as a stock dividend.
use in mergers and acquisitions.
thwart takeover attempts.
Companies can account
for the reacquired
shares by retiring them
or by holding them as
treasury shares.

18-29
Accounting for Retired Shares
When shares are formally retired, we reduce the same capital
accounts that were increased when the shares were issued –
common or preferred stock, and additional paid-in capital.
Price paid is less than issue price.
5,000 shares of $2 par value stock that were issued
for $20 per share are reacquired for $17 per share.
Common stock ............................................................ 10,000
Paid-in capital – excess of par common …………….... 90,000
Paid-in capital – share repurchase …………….. 15,000
Cash ……………………………………………….. 85,000
To record repurchase and retirement of common stock.

18-30
Accounting for Retired Shares
Price paid is more than issue price.
5,000 shares of $2 par value stock that were issued
for $20 per share are reacquired for $25 per share.
Common stock ............................................................ 10,000
Paid-in capital – excess of par common ………………. 90,000
Paid-in capital – share repurchase …………………….. 25,000
Cash ……………………………………………….. 125,000
To record repurchase and retirement of common stock.
Reduce Retained Earnings if the Paid-in Capital- share repurchase
has an insufficient credit balance.

18-31
Accounting for Treasury Stock
Treasury stock usually does not have:
Voting rights.
Dividend rights.
Preemptive rights.
Liquidation rights.
Treasury stock is reported as an unallocated reduction
of total Shareholders’ Equity.
Acquisition of Treasury Stock
Recorded at cost to acquire (cost method).
Resale of Treasury Stock
Treasury Stock credited for cost.
Difference between cost and issuance price is (generally)
recorded in paid-in capital—share repurchase.

18-32
Accounting for Treasury Stock
On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its
common stock at $55 per share. On 12/3/13, Photos-in-a-Second
reissued 1,000 shares of the stock at $75 per share. Which of the
following would be included in the 12/3/13 entry
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
May 1, 2012:
Treasury stock .............................................. 165,000
Cash ................................................... 165,000
To record purchase of treasury stock.
December 3, 2013:
Cash ............................................................. 75,000
Treasury stock ....................................
55,000 (cost)
Paid-in capital – share repurchase …. 20,000
To record reissue of treasury stock.

18-33
Where We’re Headed
The FASB and IASB are working to establish a common standard for
presenting information in the financial statements, An important part
of the proposal involves the organization of elements of the balance
sheet, statement of comprehensive income, and statement of cash
flows into a common set of classifications.
A key feature of the new format is that each of the financial
statements will include classifications by operating, investing, and
financing activities (similar to the current statement of cash flows).
Operating and investing activities will be included within a new
category, “business” activities. Each statement also will include three
additional groupings: discontinued operations, income taxes, and multicategory
transactions (if needed).

Retained Earnings
Represents the undistributed earnings of the
company since its inception.
18-34
Balance January 1, 2013 $ 106,500
Net income 25,000
Cash dividends (10,000)
Balance December 31, 2013 $ 121,500
The statement of retained earnings may also contain the
correction of a prior period accounting error, called a prior
period adjustment.
Any portion of a dividend not representing a distribution of
earnings (liquidating dividend) should be debited to additional
paid-in capital rather than retained earnings.
Any restrictions on retained earnings must be disclosed in
the notes to the financial statements.

18-35
Accounting for Cash Dividends
Declared by board of
directors.
Creates liability at
declaration.
Not legally
required.
Requires sufficient
Retained Earnings and
Cash.
Declaration date
Board of directors declares a $10,000 cash dividend.
Record a liability.
Declaration Date:
Retained earnings ........................................ 10,000
Dividends payable .............................. 10,000
To record declaration of cash dividend.

Dividend Dates
Ex-dividend date
A stock is said to be selling ex-dividend on the day that it
loses the right to receive the latest declared dividend,
usually 2 business days before the date of record. A person
who buys the stock before the ex-dividend date is entitled
for the dividend. The first day the shares trade without the
right to receive the declared dividend. (No entry)
Date of Record
Stockholders holding shares on this date will receive
the dividend. (No entry)
Date of Payment
Record the dividend payment to stockholders.
Date of Payment:
Dividends payable ........................................ 10,000
Cash ……………….............................. 10,000
To record payment of cash dividend.
18-36

Property Dividends (P 1104 for JE)
Distributions of non-cash assets.
Record at fair value of noncash asset (via revaluating the
asset) at the date of declaration.
Recognize gain or loss for difference between book value and
fair value.
Accounting for Stock Dividends (P 1105 for JE)
Corporations may issue stock dividends to
• Reduce the market price per share of stock to make the shares more
affordable for investors to purchase.
• Signal that the management expects strong financial performance
in the future.
• Remind stockholders of the accounting wealth in the company,
while preserving cash and reduce the existing balance in
retained earnings.
18-37

18-38
Accounting for Stock Dividends
Distribution of additional shares of stock to owners.
No change in total
stockholders’ equity,
because dr. retained
earnigns cr. stock and
APIC. .
Small
Stock dividend < 25% of
outstanding shares
Record at current fair
value of stock.
All stockholders retain same
percentage ownership.
No change in
par values.
Large
Stock dividend > 25%
Record at par
value of stock.

18-39
Accounting for Stock Dividends
CarCo declares and distributes a 20% stock
dividend on 5 million common shares. Par value
is $1 and market value is $20. The required
journal entry would be:
Retained earnings ..................................................... 20,000,000
Common stock …………………………………. 1,000,000
Paid-in capital – excess of par common …….. 19,000,000
To record declaration and distribution of small stock dividend.
5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000

18-40
Stock Splits
Stock splits change the par value per share and the number of
shares outstanding, but the total par value is unchanged, and no
journal entry is required.
Assume that a corporation had 3,000 shares of
$2 par value common stock outstanding before
a 2–for–1 stock split.
Before
Split
After
Split
Common Stock Shares 3,000 6,000
Par Value per Share $ 2.00 $ 1.00
Total Par Value $ 6,000 $ 6,000
Increase
Decrease
No
Change

Stock Splits Effected in the
Form of Large Stock Dividends
A stock distribution of 25% or higher, can be accounted as
(1) a large stock dividend or (2) a stock split. Thus a
100% stock dividend could be labeled as a 2-for-1 stock split. However,
it is costly to have the par value per share changed. Thus count it as a
stock dividend rather than stock split.
Matrix Inc. declares and distributes a 2-for-1 stock split effected in
the form of a 100% stock dividend. The company has 1,000,000, $1
par value common stock outstanding. The stock is trading in the
open market for $14 per share. The per share par value of the
shares is not to be changed.
18-41
Paid-in capital – excess of par common …................. 1,000,000
Common stock ……………..……………………. 1,000,000
To record declaration and distribution of 2-for-1 stock
split effected in the form of a 100% stock dividend.

Reverse Stock Split and Fractional Shares
Reverse Stock Split:
1. The motivation for declaring a reverse stock split is to increase market price.
2. It occurs particular during stock market downturn.
3. No journal entry is required.
e.g., a 1-for-4 reverse stock split, a 1MM shares, $1 par per share, would become
250K shares, $4 per share.
Fractional Shares:
1. A stock dividend or stock split results in some shareholders being entitled to
fractional of whole shares.
e.g., a 25% stock dividend or a 5-for-4 stock split; a shareholder owning
10 shares would be entitled to 2.5 shares.
2. Cash payments are made to the fractional shares. In above example, the
shareholder would receive 2 shares plus $5 assuming the market value at the
declaration is $10 per share.