Chapter 15: Stockholders' Equity Flashcards
Incremental Method
for valuing stock issued with other securities
When fair value for all securities cannot be determined
uses whichever fair value is known as value for that part and then the remainder for the other
If no values are known the securities may require expert appraisal
Stockholders’ equity disclosures
Rights and privileges of securities outstanding
- dividend and liquidation preferences
- participation rights, unusual voting rights
- call prices and dates
- conversion or exercise prices and pertinent dates
- sinking fund requirements
- significant contract terms
Note to disclose restrictions on retained earnings
(some may go directly in the equity section, not the notes)
Statement of Stockholders’ Equity
Often in columnar format with columns or all SE accounts
Rows:
- beginning balance
- addition and deduction transactions (listed out)
- balance at end of period
Requirement to show changes in each SE account, can be done in multiple ways
Redeemable Preferred Stock
has mandatory redemption period
very like a debt
must now be classified as a liability and measured as such
Equity Ratios
Evaluate profitability and long-term solvency
- Return on common stockholders’ equity (ROE)
- Payout Ratio
- Book value per share
Return on Common Stockholder’s Equity
ROE
measures company profitability: dollars of net income for each dollar of investment
comparative between companies also helpful
= (net income - preferred dividends) / average common stockholders’ equity
Average common stockholders’ equity = total SE less PAR VALUE of preferred stock
expressed as a percentage
Trading on Equity
Using borrowed money or issuing preferred stocks in the hope of obtaining a higher rate of return on the money used
ROE > ROA (return on total assets)
Recording stock issued in non-cash transactions
Companies should record stock issued for services or property other than cash at either the fair value of the stock issued or the fair value of the non-cash consideration received - whichever is more clearly determinable
Avoid using book, par, or stated values to value
Recording preferred stock: cumulative vs non-cumulative
When a dividend is declared
Non-cumulative: preferred stockholders receive their dividend (% of par) and remaining is distributed to common stockholders
Cumulative: preferred stockholders receive their dividends PLUS any dividends on past non-dividend years, only then is remaining dividend distributed to common stockholders
Watered stock
Stock held at too high value due to overvaluation of property/ services received in exchange
Par/stated value method for recording purchase of treasury stock
Debit treasury stock at par value (may be debit common stock?)
shown on balance sheet as reduction to capital stock only
Cost method for recording purchase of treasury stock
More popular than the par/stated value method
Debit Treasury stock (at acquisition cost)
Credit Cash
Shown on balance sheet as a reduction to stockholder’s equity
No consideration for the original price on the sale of stock
Reporting Treasury stock on the balance sheet
Stockholders’ Equity section of the balance sheet
Paid in Capital
Common Stock
Reporting Treasury stock on the balance sheet
Stockholders’ Equity section of the balance sheet
Paid in Capital
Treasury Stock
Common Stock
PIC
Total Paid In Capital
Retained Earnings
Total Paid in capital and retained earnings
Less cost of treasury stock
Total stockholders' equity
Disclose number of shares
Secret Reserves
When a corporation undervalues its recorded assets
- excessive depreciation / amortization
- undervaluing exchanges
- misstating expenses vs capital expenditures
Understatement of an asset/ overstatement of liabilities
Convertible preferred stock
Allows stockholder to exchange preferred shares for common at a predetermined ratio
Book value method employed, no gain or loss recognized
Recording costs of issuing stock
Record as a reduction to amount paid in
ONLY direct costs
- underwriting, accounting/legal fees, printing, taxes
issue costs - cost of financing
Reporting preferred stock disclosures
Must disclose pertinent rights of any preferred stock outstanding
Recording stock issued for a receivable
Receivable recorded as contra-equity account
(risk of collection is high)
generally just don’t record equity until cash is received
Reasons companies buy back shares
- tax efficient distributions to stockholders (lower capital gain tax on sale of stock)
- increase EPS / return on equity
- increase ratios without changing performance
- to provide stock for employees compensation or merger needs
- to thwart takeover attempts / reduce number of stockholders
- to make a market for the stock (creates demand)
Leveraged buyout
(LBO)
company borrows money to finance stock repurchases
Treasury stock
Corporation’s own stock, reacquired after having been issued and fully paid
NOT AN ASSET + ownership does not give any rights to company to act as own shareholder
purchase recorded at cost (cost method - normally) or par (par method - occasionally)
in most states is a restriction on retained earnings
Considerations on declaring a dividend
- agreements with creditors and state requirements of restricted retained earnings
- need to hold earning to finance growth
- liquidity / flexibility of assets
- buffer for potential future issues
- availability of funds for dividends or liabilities
Characteristics of the corporate form
- influence state corporate law
- use of capital stock or share system
- development of a variety of ownership interests
Steps to issuing stock
1) state authorizes stock (certificate of incorporation/ charter)
2) corporation offers shares for sale & enters into contract to sell
3) in receipt for cash shares are issues (this is when journal entry occurs)
Recording sale of treasury stock
Use inventory costing methods for repurchase price
Debit cash
Credit treasury stock at repurchase cost
if sell ABOVE repurchase price:
Credit PIC - Treasury stock
If sell below repurchase price:
Debit PIC - Treasury stock if it is available
if not Debit retained earnings
Business incorporation acts
vary by state - account follows provisions of laws
Definition of terms may vary between states
Gains
Gains on sales only occurs when selling assets, additional money from stock is “additional paid in capital”
Retiring treasury stock
Board of directors decision
- treasury stock cancelled
- issued shares decrease
Retired = authorized and unissued
Debit paid in capital (common stock, preferred stock, APIC)
Credit Treasury stock
Dividend policy disclosures
Encouraged by SEC to include in annual report
Recording cash dividends
on date of declaration:
Debit Retained Earnings
Credit Dividends payable
(may potentially use “cash dividends declared” account that is closed to RE at year end
Date of record: no entry
Date of payment:
Debit Dividends Payable
Credit cash
Recording preferred stock dividends
non-participating vs participating
After preferred dividend is assigned
non-participating: all remaining dividend distributed among common stock
Participating- may be specified in the contract. otherwise:
- common stock receives like percentage of par value outstanding
- remainder of dividend is divided by TOTAL par value to find rate of participation
- multiple by part to determine amount of participation between common and preferred
Payout Ratio
Ratio of cash dividends to net income - if preferred stock exists do not include
= cash dividends on common stock / net income available to common stockholders
DO NOT subtract non-controlling interest
Book value per share
The amount each share would receive if the company were liquidated, based on the balance sheet
= common stockholders’ equity / outstanding common shares
Recording property dividends
1) record gain (credit) or loss (debit) as necessary
2) record dividend declared
Debit Retained Earnings or Property Dividends Declared
Credit Property Dividends Payable
3) at date of distribution:
debit property dividends payable
credit property account
Recording liquidating dividends
Date of declaration:
Debit Retained earnings
Debit PIC-Common stock
Credit dividends payable
Date of payment:
Debit Dividends Payable
Credit Cash
Recording Ordinary stock dividend
(ordinary dividend = less than 20-25%)
MUST BE PROPORTIONATE
Date of declaration:
Transfer retained earnings to paid in capital:
Debit Retained Earnings (fair value)
Credit common stock dividend distributable (par value)
Credit PIC - common stock
Distribution
Debit common stock distributable
Credit common stock
Large stock dividend
Should really be called stock split up
Stock dividend of more than 20-25% (SEC says 25%) number of shares previously outstanding
more resembles stock split than dividend and reduces unit market price
still require transfer par value of stock issued from retained earnings
split up effected in the form of a dividend
Recording a stock dividend
No assets paid out or liability incurred
Shareholder Rights
In the absence of restrictive provisions
- to share proportionately in profits and losses
- to share proportionately in management (by voting for directors
- to share proportionately in corporate assets upon liquidation
- to share proportionately in any new issue of stock of the same class (called the preemptive right, prevents dilution of ownership)
Registrar or transfer agent
provide services to corporations to record and transfer stock (maintaining required records)
Components of stockholders equity
contributed capital/ paid in capital: - capital stock - additional paid in capital Earned capital - retained earnings Other - accumulated other comprehensive income
Book value per share with preferred stock
Any dividends in arrears
current year requirements
+ participating
potential dividends for preferred stock must be removed from the stockholders’ equity before dividing by common shares outstanding
Accumulated other comprehensive income
Not retained earnings or contributed capital
ex: unrealized gains and losses on AFS debt/ investments/ derivative transactions
Preferred stock features
Depend on the contract,
- preference as to dividend (amount expressed as % of par value, or if no par value expressed as $/share)
- preference as to assets in event of liquidation
- convertible into common stock
- callable at the option of the corporation
- non-voting
Stock dividends
The issuance by a corporation of its own stock to its stockholders on a pro rata basis
essentially reclassifies retained earnings to contributed capital
stockholders maintain proportionate interest - book value per share is lower
Cumulative preferred stock
Accumulated dividends in arrears (must make up missed years of preferred stock before paying common stock)
no liability is recorded until the dividend is declared - cumulative status just disclosed in financial statements
most preferred stock is cumulative
Participating preferred stock
receives preferred dividends AND dividends at the same rate as common stockholders if excess over preferred
rare
Stockholders’ equity
Residual interest
= net assets (aka assets - liabilities)
a claim against a portion of total assets, not specific assets
amount depends on profitability
Recording a stock split
no accounting entry- just a memorandum note on the changed par value/ changed quantity
Callable preferred stock
company may call (redeem) all standing shares
call/ redemption price pre-set generally above issue price (which sets a ceiling on share price
when redeemed must pay dividends in arrears
Stock split
Reduces market price of stock - same total values - multiplied shares
Shareholders retain % ownership
now more shares for sale at a lower price
Reverse stock splits also happen (unsplitting)
Recording stock sold below par value
Rarely occurs
Discount on par value recorded as a DEBIT to additional paid-in capital (Equity account, credit NB)
may be able to call on purchaser/ holder to pay difference to avoid loss on liquidation
Recording issuance of par value stock
Debit Cash
Credit preferred stock/ common stock at par
Credit PIC - preferred stock/ common stock
No Par Stock
- illegal in some states
- may be considered legal capital - reduces flexibility of paying dividends
- may have higher taxes
- some states may require to have a stated value (minimum price of stock)
Recording issuance of no par stock
NO PIC
Debit Cash
Credit Common Stock
if has stated value may use APIC account for amount over stated value
Recording lump sum sales of stock with other securities
proportional method or incremental method
Proportional method for valuing stock issued with other securities
used if there is a sound basis for determining relative value
value allocated based on % of total fair value
Types of dividends
- Cash dividends
- property dividends (in kind0
- liquidating dividends
expect for stock dividends all dividends reduce total stockholders’ equity
Property dividends
dividends in kind: most often securities or stock in other companies (investments) (sometimes merchandise, real estate)
Date of declaration
- restate at fair value the property to be distributed (recognize gain or loss)
Cash dividend process
1) Date of declaration (dividend = current liability)
2) date of record - all stockholders on current list will receive a dividend
3) date of payment
generally a significant lag between one and three
may be an amount per share or a percent of par
no dividends on treasury stock
Other considerations for computing book value per share
- # of authorized and UN issued shares
- treasury shares on hand
- commitments of issuance of unissued / treasury shares
- rights and privileges of stock authorized
- if liquidating value of preferred stock is greater than carrying value of amount use liquidating amount in book value computation
Liquidating dividend
Dividend not based on retained earnings (base on paid in capital, REDUCES paid-in-capital)
a return of the stockholders’ investment
may take place over an extended period as company disposes of assets
DISCLOSE
Small (ordinary) stock dividend
Stock dividend less than 20-25% of common shares outstanding at time of declaration
company required to transfer the fair value of the stock issued from retained earnings
Treasury shares and stock dividends
May be state requirements
Balance sheet stockholders’ equity
Capital stock
List types of stock, par value/no par, any preferred dividends, shares outstanding, issued, and authorized
total capital stock
PIC
List types
Total paid in capital (stock + PIC)
Retained earnings
Total paid in capital and retained earnings
Less Treasury stock
+ accumulated comprehensive other loss/ income
Total stockholder’s equity
