Chapter 11
Chapter 11 Notes
The accounting course include detailed notes on stockholder equity, par value, common stock, preferred stock
stockholder equity
Stockholder equity consists of two main components
• A a Corporation and a sole proprietor or even a partnership balance sheet assets are the same
• Liabilities are also the same
• When we are dealing with the equity section on a sole proprietor balance sheet . It is known as capital
• It is known as stockholder equity in a corporation that is the difference. The difference is in the equity section
• When we are dealing with a sole proprietorship it is known as capital partnership is known as owners equity an in a Corporation is known as stockholder equity
Stockholder equity consists of two main components
• Stock: equity consists of capital stock (capital stock is the generic term that refers to all of the different types or class of stock
• Also retained earnings
For example, if a corporation have capital stock of $100,000 and retained earnings of 40,000
• Retained earnings would be the combination of the two which is 140,000
If the Corporation have capital stock= to $100,000 but the company have a deficit of retaining earnings due to period Of losses
• In that case, retained earnings would be 60,000
• This is due to the fact of the companies on profitable
If the Corporation have only one class of stock what is that class of stock going to automatically be
If they have more than one class of stock. Then the second one would be?
If the Corporation liquidates who would get first preference?
We are dealing with capital stock we referred to various classes of stock.
If the Corporation have only one class of stock what is that class of stock going to automatically be?
• That class of stock is going to be common stock
If they have more than one class of stock. Then the second one would be preferred stock
If the Corporation liquidates
• Creditors will be paid first. Then it will be owners preferred shareholders would get paid first then common
Par value is
• Is no indication of market value it is usually a lower number
• Par value is the amount that is credited to capital stock
• It is the amount entered into the capital stock account. It is the per-share value
•
You can have a stock that has a par value of a dollar that is selling for $100
• But when you recording capital stock it would credited at one dollar
• The purpose of it is that the reason it is a low number during the IPO public offering. The very first time, the stock is issued the stock cannot be issued below par value that’s why Corporation assigned par value of a very low amount they do not want to assign par value of a very high amount. They do not want to issue a stock at $100 because what if the stock is issued at $99
• That’s why this sign a very low amount like $.50, $1.02 dollars
• The issue with par value is also that, if it turns out that the stock is issued during the IPO for below par value then whoever bought those shares originally can’t be held liable for the difference. If a corporation goes bankrupt and the stock had a par value of $50 and the shares was sold for $40. That means that $10 difference whoever bought those shares is actually liable for the $10 difference if the corporation goes bankrupt the reason is whenever creditors are lending the money they can assume that the stock is issued for par value or above and if it was issue for below there is a liability that is basically the purpose for making it a very low amount you a call ring all of your bases
Ex one par value common stock is issued
When ever common stock is issued common stock is always going to be credited for the par value of the shares, regardless whether it is issued above or below par value
A Corporation issued 6000 shares of common stock with a $10 par value and the stock is issued at par
• The Journal entry would be
• Cash is debited for 60,000 (6000 multiplied by 10)
• Common stock is credit for 60,000(is always credited at par value)
stock is issued at par
• The Journal entry would be
• Cash is debited for 60,000 (6000 multiplied by 10)
• Common stock is credit for 60,000(is always credited at par value)
Assume a Corporation issue 6000 shares of common stock with a $10 par value, but the stock is issued above par it is issued at $15 per share (. Each year is issue five dollar above par)
Cash is debited at 90,000 whatever is received)
Common stock is carded at 60,000 (Comstock is always debited at par value)
The difference between the par value and the price of stock was sold for was five dollars per share. That gives us a total difference of $30,000 is credited to paid in capital in excess of par
Paid in capital in excess of par credited for 30,000 ( 90,000-60,000)
If stock is sold below par value if stock it was sold at nine dollars a share
• Cash debit for 54,000
• common stock is credited for 60,000 still the par value
• Paid in capital in excess of par would be debited for 60,000
• (When it is sold above we credit what is sold below. We debit paid in capital)
Authorised
Issued
Outstanding
Authorise-it specifies the maximum number of shares that they are authorised to sell
• If you are told that the Corporation is authorised to sell 100,000 shares it mean that they can sell up to amount of 100,000 shares
• If the Corporation is planning on selling 100,000 share they should apply for a larger authorization increase in the future. They want to sell more shares in order to raise more capital
Issued.
• The amount of share that is sold
Outstanding
• Shares that are in the hands of the public
There might be shared issues of 25,000, but outstanding shares of only 5000. The difference between shares that are issued, which are sold in shares that are in the hand of the public which is outstanding are
• Treasury stock is when a corporation buys back it own shares of the stock it was sold to the public and they choose to buy them back
• So basically shared issues are shared that have been sold, which was 25,000
• That must mean that if only 5000 were outstanding.that is 5000 which are in the hands of the public Then the Corporation bought back 20,000 of the shares that was originally sold and it is held in the treasury stock
• The difference between share issue and share outstanding is the shares that are held in the treasury
Assumed that 25,000 shared are sold
Whenever share is sold a second time it is is known as secondary issuing or secondary offering
review
review
when we are dealing with a Corporation balance sheet assets as far as proprietor versus a Corporation are the same and liabilities are the same. The differences is
• When We get to the equity section
• According to a sole proprietorship equity is known as capital
• If it was a partnership. It will be a equity
• If we are dealing with a Corporation. It would be a stockholder equity
The main advantage of a Corporation is
• Limited liability
• Easy to raise capital by issuing shares
Partnership and sole proprietorship.
• Unlimited liability
• Where the owners are liable if anything goes wrong
What is stockholders equity made of up
• Capital stock and retained earnings
o When we are dealing with capital stock we are dealing with all of the different classes of stock
o There is common stock, preferred stock, also include paid in capital access of par and it also includes retained earnings
If a business only had one kind of stock. What kind of stock would it be?
• It would be common stock
If there is more than one class. The second class would be preferred stock
If a corporation liquidates the creditors get paid
• first then it would be preferred shareholders then owners and then later common shareholders
par value is no indication of what market value is. It is the amount we would credit the capital stock account for
There is sometimes stock will be issued at par value and sometimes above and sometimes below par value
If stock is issued above par value . What will we credit, common stock for
• the par value of the share and that difference between the price it was sold for the par value is credited to an account known as paid-in capital in excess of par
• the difference between the selling price and upon value would be debited to an account known as paid in capital in excess of par
if a corporation is authorised to issue 100,000 shares what it mean to authorise is the maximum amount they can sell
The term issue means – those were the shares that was sold.
The term outstanding is – those are the shares that was old and still in the hands of the public(because the corporation can still buy them back)
No par stock
• stock went out a par value.
• When stock does not have a par value (meeting no par stock is issued) then the entire proceeds from the sale is simply credited to the common stock account (assuming if we are dealing with common stock
•
a corporation would issue no par stock because it avoids the liability of selling stock below par value during the IPO initial public offering (because stock officially has to be sold for at least part value or above)
another reason is sometime Corporation feels that par value can be confusing to investors
Assume a Corporation issues 100 shares of no par stock at $10 per share
• cash debited for 1000
• common stock credited for 1000
(whenever you are dealing with no par stock common stock is credited for the proceeds that was received. There is no par value to deal with)
If the next day the Corporation issues. Another 100 shares at $11 per share
• Cash debited 1100
• Common stock credit 1100
(basically, it would be the same thing)
There are certain states that require a corporation if they’re no par stock meaning stock without a par value they require that the stock have a stated value
Stated value
• Stated value is treated very similar to par value with exception of during the IPO is stock if sold below the stated value. There is no liability.
A Corporation issues 100 shares of no parts stock at $15 a share, with a stated value of $10
• Cash debit for 1500 (the proceedes)
• Common stock credit for 1000
• Paid-in capital in excess of stated value credit for 500
(we would record cash the proceeds of 5000
Common stock would be credited for the stated value of $1000, which is 100 x 10)
We would credit paid-in capital in excess of stated value, which is the difference between cash and common stock because it has to balance)
This is treated very similar to par value
Preferred stock
• Preferred stock tend to have a higher par value (might be 50, or hundred when we are dealing with common stock dividends will usually be different every year one year might be three $ one year maybe two)
• Generally what we are dealing with preferred stock, the dividends are set and they are very often expressed as a percentage of par value
If we had a preferred stock at 5% with a $50 par value
• Dividends are expressed as a percentage of par. That means that this preferred stock will receive a dividends of 5% of the par value
• Therefore, the dividends is $2.50 . This is how dividends are expressed . What we are dealing with preferred stock as a percentage of par value
o Sometimes when we are deal with prefer stock. There is no par value you still can have no par preferred stock and in that case the dividends will be expressed in terms of dollars and cents it might be preferred stock With dividends of three dollars or $4.50
One issue with preferred stock they do have preference as to divides as well that means if there’s not enough money for corporations to pay both the preferred shareholders and common shareholders for dividends. It will go to preferred shareholders they have preference upon liquidations and preference to dividends as well
Features of preferred stock
Cumulative preferred stock
Cumulative preferred stock
• It refers to dividends
• If you own stock in a corporation for the past 25 years
• (for example, when you are bored someone gave you a few shares of stock as a baby present and you was receiving dividends every single year. You are not automatically entitled to dividends this year unless it has been declared by the Board of Directors )
o Cumulative preferred stock is-
• When a corporation does not declare a dividend on cumulative preferred stock. What happened is that these dividends accumulate. For example, for the past two years they did not declare a dividends on preferred stock. Therefore, the shareholders were not entitled to it because it was not declared by the Board of Directors. Maybe the Corporation is trying to expand So the don’t want to pay out dividends if the stock is cumulative. What’s happened is, these dividends pileup accumulate and in the future if the Corporation does declare a dividends if it is declared by the board of directors all of these dividends that have accumulated in the past few years have to be paid out before common shareholders received anything
These dividends that are cumulative that have not been paid in the last two years are they a liability for the Corporation?
• No they are known as dividends and arrays
• They are dividends on cumulative preferred stock that have not been declared but are accumulating and that mean even if a corporation did not declare dividends for the past 10 years but they do have shares of stock. That are accumpulated preferred stock. If they want to declare dividend in year 11 they have to pay up all of the past 10 years of dividends before they can pay out anything to common shareholders and these dividends that accumulative are know as dividens in a rays
o It is not listed on the balance sheet at liabilities because is not a liability. Once it is declared
o It Is a liability from the time it is declared to the time it is paid. That is what the Corporation owns it. So if they never declared it. They never owed
o It would not be listed on the balance sheet as a liability but it would be disclosed to the notes in the financial statement
Dividends in arrays would be disclose to the note in the financial statement because (an investor will want to know if a Corporation have any dividends in a raise the reason is if they want to consider purchasing common stock because they feel the Corporation has been doing well and they will declare dividends shortly they will see 10 years of dividends in a rays, they would think twice because it will be a while for them to get paid because even if the Corporation does become more profitable. It will be a while for them to get paid because the cumulative preferred shareholders need to be paid up first )
non Cumulative preferred stock
• If dividends was not declared they do not accumulative
• And past dividends are lost
• (if year three they did not declare a dividend and year 4 they do year three dividends are lost and year 4 they will get paid), noncumulative preferred stock have no dividend in arrears
Participating preferred Stock
• That mean if the Corporation wants to declare a large dividend and there’s still some money left over after the common shareholder received their dividends instead of the extra money going to the common shareholders the preferred shareholders would share with that access known as participating preferred Stock if there is a extra dividends
• if it is not participating they would not get to share it with all got to the common shareholders
The difference between preferred and common stockholder
• When we are dealing with it . Dividends for preferred stock they get a set dividends every year (if dividends were expressed at percentage of par value . Whenever a dividends is declared it stays the same. For instance, 5% preferred stock would $50 per value whatever a dividends is declared they will receive that set the value of 2.50 per share it does not change
• If there were no par preferred stock the dividends will be expressed in terms of dollars and cents . It would be preferred stock with a three dollar dividends, difficult ration did well that year, they still get that same percentage
o What we are dealing with common stock dividends do fluctuate whenever it is declared. It is not a set amount, if the Corporation does well it will go up if the Corporation does not. They goes down
o A common shareholder will receive a higher amount when the Corporation is achieving success
o The Corporation does bad the preferred shareholder will receive high amount
Convertible preferred stock
• Shares of stock that can be convertible into other securities of the Corporation
• Usually it will be preferred to common stock and once in a while It can be converted into bonds
• A preferred shareholder would choose to convert to common stock because a corporation may do well and the common shareholders will receive a higher dividend
• They would choose to convert to bonds because they have higher guarantee of getting paid
Callable preferred stock
• Is when preferred stock can be called back meaning bought back by the Corporation usually the call price. The price they would buy back the shares back would be specified by the original agreement
• They would choose to call back their preferred stock because they do not want to pay out dividends ( they are doing well and they do not need to borrow money)
Issue of preferred stock
A Corporation issues 10,000 shares of $10 par value preferred stock at $12 par share
• Cash debited 120,000 (10000 x 12)
• Preferred stock credited 100,000. (the par value 10000 x 10)
• Paid in capital excess of par credited 20,000 (120000-100000(
(It is similar to common stock. Instead, we are using the term preferred stock that is basically the difference.
if a investor by stock in main reason would be because of dividends because they can make a profit and generate income.
If a investor what a stable dividends they would invest in blue-chip corporations example would be Disney because they are known to steadily pay out dividends
Because investor are demanding dividends corporations are really trying their best to do whatever they can to continue paying out dividends because.
Investors are demanding dividends because of the recent scandals , individuals are nervous and investing shares of stock because they are taking a risk. One issue. The government is they lower tax rate on dividends to get investors to purchase stock.
When someone buys shares of stock the do not know that a corporation are profitable the fact that the Corporation are declaring dividends. It shows that some of their profits that their reporting must be legitimate
When A Corporation declared dividends, the dividends are reduce to retain earnings it come out of retained earnings If a corporation have retained earnings of $5 billion they would not want to pay out all $5 billion of dividends because
Because they want to expand the company and keep the money
Even if they want to pay out all of their retained earnings as dividends, they would not be allowed to if they have bonds a bond covenant restricts the amount of dividends that Corporation can payout to stockholders, because they need money to pay interest on their bonds
Another reason is internal finance and because they need the profits to expand
Because the Corporation but I do well this year they might not do well next year so they keep some of the retained earnings on hand for a rainy day
So far we talked about stocks being issued as cash. However Stock may be issued in non-cash transaction
If the Corporation receives services and they need an attorney for some legal services. Instead of paying attorney legal fees they may issue shares of stock instead, in exchange of payment
They may issue a change of stock for real estate they want a piece of land. Instead of paying the seller. They will issues shares of stock
When shares are issued in a non-cash transaction.
When shares are issued in a non-cash transaction.
The way it works is the stock is recorded at either the market value of the shares or the market value of the goods and service receive whichever is more readily determinable
You would record the issuance at either the market value of the shares or the market value of the goods and services receive
Issuing stock for non-cash assets (exchange for services,real estate, property)
A corporation can receive assets other then cash in exchange for its stock it can also assume liabilities on the asset received such as a mortgage on property receive. The Corporation records asset received at their market value as of the date of the transaction. The stock given in exchange is recorded at is par or stated value with the excess recorded in the paid-in capital in excess of par or stated value account
To illustrate the entry to record receipt of land value at 105,000 in return for issuance of 4000 shares of $20 par value common stock on June is
(the company’s exchange and 4000 shares of common stock, which would help our value for piece of land which is valued at $105,000(if they gave you the fair value and appraised value will go by the fair value))
Land debited for 105,000.
Common stock $20 par value credited for 80,000. (20 x 4000)
Paid-in capital in excess of par value common stock credit for 25,000
o (land is debited at the fair market value
o Common stock is credited at the par value 20 x 4000
o The difference between the fair market value of the land and the par is credited for 25,000 paid-in capital in axis of part common stock because we are dealing with common stock)
A Corporation sometime gives shares of stock promoters in exchange for their services in organizing the corporations. Which the Corporation records as Organization expenses. The entry to record receipt of services valued at 12,000 in organizing the Corporation in return for 600 shares of $15 par value common stock on June 5 is
Organization expands debited 12000
Common stock $15 par value credited 9000
Paid in capital in excess of par value common stock Kurd 3000
o (we know the promoter fees is $12,000. Therefore, you would debit organization expenses for $12,000.
o Common stock is credited at the par value $15 a share x 600=9000
o And the difference between the services and the par value is credited to paid in capital excess of par value common stock
Page 465 accounting for cash dividends
Dividends payment involves three important dates. Declaration, record and payment.
Date of declaration
is the date the director’s vote to declare and pay a dividend. This creates a legal liability of the Corporation to its stockholders.
( if the date of declaration is January 1. That is what the dividends are declared and that is what becomes a liability until it is paid)
To illustrate the entry to record a January 9 declaration of one dollar per share cash dividend by the directors of Z Tech Inc. with $5000 outstanding shares is
Retained earnings debited for 5000
Common dividend payable credited for 5000
o Whatever a dividends is declared dividends can be debited or you can debit retained earnings
o Also, whenever if a dividend is not paid the same day it is declared instead of crediting cash you’d credit dividends payable in this case, it is common dividends payable
Date of record
is the future date specified by the director for identifying those stockholders listed in the Corporation records to receive dividends. The date of records usually follow the date of declaration by at least two weeks. Persons who owns stock on the date of record received dividends.
(basically, one a dividends is declared they do not know who owns the stock at that time, basically, you’ll go to the records and then they’ll choose a date and whoever owns the stock of that date are the shareholders will be entitled to that dividends)
( on the data records. There is no journal entry. It is simply Weber owns the shares on that date do not record a journal entry
. For example if the data of records is January 2, whoever owns the share as of January 2 will receive that one dollar per share)
Date of payment
is the date when the Corporation makes payment for dad dividends it follows the date of records by enough time to allow the Corporation to arrange checks, money transfers, or other means to pay dividends
in this case the date of payment. Is that were refers the journal entry of February 1 would be the date the cash is being given over
common dividends payable is debited for 5000
Cash is credited for 5000
o (since they are paying to dividends that are owed you would reduce the liability and debit, dividends payable for 5000
o And also catches credit)
Stock split
What happened is as a corporation does well as they have profit and higher net income. The price of the stock rises , the company issued stock and $50 per share . The price can go up to $100 per share (. Basically, as the price of a stock goes up it is less affordable for some investors and even if they can afford to buy the stock. They read about a few shares of stock at a lower price then simply one or two shares at a higher price . The because becomes less affordable . There are not enough investors that are interested
So what some corporations would do is perform a stock split what a stock split does is that it increases the the number of shares, and it reduces the par value per share
If incorporation have 100 shares of stock, and each year has a par value of 50 and if there is a 2-for-1 splits (. What we are dealing with a stock split. The number of shares increases and the par value per share decreases, (so if there is a 2-for-1 stock split. That mean If there is a 100 shares of stock for every 1 share there is now to therefore they’ll be 200 shares ( the number share increases) and the par value decreases
If each share have a par value of $50 the par value would be 25 per-share after the stock split
It can also be 3-1
If there was 100 shares, and there is a three – one stock split. How many shares were day after the split
It would be 300 shares ,
and if each share before the split have a $90 par value it would be a $30 par value after the split ( shares will be multiplied by three and par would be divided by three) (it can be a two – one, three – one or 10 – one stock split)
reverse stock split
There is also something known as a reverse stock split it is basically the opposite of a stock split
where shares would actually consolidate where they might be a 1 for 2
where if you had 2 shares it now becomes one share
o investors would choose to do a reverse stock split because
o to traded on Wall Street the price of a stock have to be at least a dollar if a price is below one dollar they would not be able to traded publicly. If the Corporation sees that the market prices is pretty low they will do a reverse stock split so they can be traded on Wall Street
Earnings per share ratio
think of statement reports earning per share also called EPS or net income per share, which is the amount of income are per-share of a company outstanding common stock. When a company has built preferred stock, and preferred stock dividends are zero. The weighted average common share outstanding is measured over the income reporting period.
you want to know the earnings per share when it comes to common shareholders. The formula is
net income minus preferred dividends/weighted average per-share outstanding
you would only take out preferred dividends if the company had preferred stock. If there is no preferred stock. There is no preferred dividend you one know what is basically available to common shareholders and if there’s preferred stock then whatever is given out to a dividends to preferred shareholders is not available to common shareholders. That is why you are removing it
Basic earnings per share= 40,000-75,000/5000 shares = $6.50
the Corporation had net income of $40,000 and 7500 dividends were declared on preferred stock and it was 5000 shares of common stock outstanding
submitted with a form of is we would take a net income of 40,000 reduce it on a preferred dividends of 7500. Divide that by the 5000 shares of common stock outstanding and that would give us a earnings per share of $6.50