Ch. 11: Reporting & Analysing Stockholder's Equity

Question 1

Contributed capital

Answer 1

Represents cumulative cash inflows received from the sale of various classes of stock

Includes two classes of stock

1. Common stock
2. Preferred stock

Additional paid-in capital (also labeled as Paid-in capital in excess of par)

Treasury stock as a deduction

Question 2

Earned capital

Answer 2

Represents:
1. Retained earnings -> Cumulative profits and losses of the company less any dividends to shareholders, and

2. Accumulated other comprehensive income (AOCI) -> Changes to equity which are not part of income and not reflected in retained earnings

Question 3

Common stock

Answer 3

The primary ownership unit in a company.

Share in any assets left at liquidation (after paying of claims by debt holders).

Acquire more shares of subsequently issued stock (preemptive rights allow current stockholders to retain the same proportion of ownership)

Limited liability:
▪ Creditors have claims only on the company’s assets
▪ Stockholders’ personal assets are not at risk

Question 4

Authorised shares

Answer 4

The upper limit on the number of shares that the corporation can issue

Established in the articles of incorporation

Can be increased by shareholder vote

Question 5

Issued shares

Answer 5

Actual number of shares that have been issued to shareholders

Question 6

Outstanding shares

Answer 6

Number of issued shares less the number of shares repurchased as treasury stock

Question 7

Par value

Answer 7

An arbitrary value often assigned to each share of stock.

Specified in the articles or incorporation at the time the corporation is formed.

Specifies the allocation of proceeds from stock issuances between common stock and additional paid-in capital on the balance sheet

Old way of stating the minimum value of each stock -> Basically meaningless today but still used in accounting

Question 8

Preferred stock

Answer 8

Generally has some preference, or priority, with respect to common stock

Typically don’t have voting rights

Common preferences:
1. Dividend preference
▪ Generally preferred shares have a fixed dividend
▪ Preferred shareholders receive dividends on their shares before common shareholders
2. Liquidation preference
▪ If a company fails, assets sold in liquidation go first to pay debtors, next to preferred shareholders, and finally to common stockholders

Question 9

Typical features of preferred stock

Answer 9

1. Don’t have voting rights.
2. Call feature (issuer right) -> Provides the issuer the right, but not obligation, to repurchase the preferred shares at a specified price
3. Conversion feature (shareholder right) -> Allows to convert their shares into common shares at their option at a predetermined conversion ratio.

Question 10

Reasons for stock repurchase

Answer 10

In a buyback press release: “we don’t see any better investment than in ourselves”

To have stock available to distribute to employees for
bonuses

Push-up share price with “artificial demand for shares”

Want to return cash to shareholders without creating expectations for permanent increases in dividends

Improve ratios: Return on Equity (ROE), Return on Assets
(ROA), Earnings per Share (EPS)

Question 11

Treasury stock

Answer 11

Repurchased stock

Question 12

Earned capital = Retained earnings

Answer 12

Represents cumulative profit that has been retained by the company.

Increased by net income
Decreased by net losses
Decreased by dividends to shareholders
Cash dividends 
Stock dividends

Includes positive and negative effects of accumulated other comprehensive income (AOCI)

Question 13

Comprehensive income

Answer 13

Is a more inclusive notion of company performance than net income

Includes effects that are considered outside of management’s control

Includes net income plus…
▪ Foreign currency adjustments
▪ Unrealised changes in market values of available-for- sale securities and derivatives

Not closed to retained earnings at year-end

Closed to a separate earned capital account called ‘Accumulated Other Comprehensive Income’ (AOCI)

Question 14

Cash dividends

Answer 14

Dividends are payments to shareholders

Reasons for dividend payments vary

Most paid in cash

To pay cash dividends a corporation must have:
▪ Cash (uncommitted to current/future needs)
▪ Retained earnings (state laws often limit the amount of dividends payable to the amount of unrestricted retained earnings)
▪ Bond covenants that allow dividends

Declared by the board of directors - not automatic

Question 15

Stock dividends

Answer 15

Additional shares of stock distributed to shareholders

Retained earnings is reduced

Contributed capital is increased