11-1. 11-2 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings 11...

11-2

Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

11Learning Objectives

Discuss the major characteristics of a corporation.

Explain how to account for the issuance of common and preferred stock.

Explain how to account for treasury stock.3

Explain how to account for cash dividends.

2

1

4

Explain how to account for stock dividends and splits.5

Discuss how stockholders’ equity is reported and analyzed.6

11-3

An entity separate and distinct from its owners.

Classified by Purpose

Not-for-Profit

For Profit

Classified by Ownership

Publicly held

Privately held

► McDonald’s► Nike► PepsiCo► Google

► Salvation Army► American Cancer

Society

► Cargill Inc.

Alternative TerminologyPrivately held corporationsare also referred to asclosely held corporations.

LO 1

LEARNINGOBJECTIVE

Discuss the major characteristics of a corporation.

1

11-4

Characteristics that distinguish corporations from

proprietorships and partnerships.

Advantages

Disadvantages

Characteristics of a Corporation

Separate Legal Existence

Limited Liability of Stockholders

Transferable Ownership Rights

Ability to Acquire Capital

Continuous Life

Corporate Management

Government Regulations

Additional Taxes

LO 1

11-5

Corporation acts under its own name rather than in the name of its stockholders.








Continuous Life



Additional Taxes

LO 1

11-6

Limited to their investment.








Continuous Life



Additional Taxes

LO 1

11-7

Shareholders may sell their stock.








Continuous Life



Additional Taxes

LO 1

11-8

Corporation can obtain capital through the issuance of stock.








Continuous Life



Additional Taxes

LO 1

11-9

Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer.








Continuous Life



Additional Taxes

LO 1

11-10

Separation of ownership and management often reduces an owner’s ability to actively manage the company.

Characteristics that distinguish corporations

from proprietorships and partnerships.






Continuous Life



Additional Taxes

LO 1

11-11





Continuous Life



Additional Taxes




LO 1

11-12








Continuous Life



Additional Taxes

Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends.

LO 1

11-13

Stockholders

Chairman and Board of Directors

President andChief Executive

Officer

General Counsel/Secretary

Vice PresidentMarketing

Vice PresidentFinance/Chief

Financial Officer

Vice PresidentOperations

Vice PresidentHuman

Resources

Treasurer Controller

Illustration 11-1 Corporation organization chart


LO 1

11-14

File application with the Secretary of State.

State grants charter.

Corporation develops by-laws.

Initial Steps:

Companies generally incorporate in a state whose laws are

favorable to the corporate form of business (Delaware, New

Jersey).

Corporations engaged in interstate commerce must obtain a

license from each state in which they do business.

Forming a Corporation

Alternative TerminologyThe charter is oftenreferred to as the articlesof incorporation.

LO 1

11-15

A Thousand Millionaires!

Traveling to space or embarking on an expedition to excavate lost Mayan ruins are normally the stuff of adventure novels. But for employees of Facebook, these and other lavish dreams moved closer to reality when the world’s No. 1 online social network went public through an initial public offering (IPO) that may have created at least a thousand millionaires. The IPO was the largest in Internet history, valuing Facebook at over $104 billion. With all these riches to be had, why did Mark Zuckerberg, the founder of Facebook, delay taking his company public? Consider that the main motivation for issuing shares to the public is to raise money so you can grow your business. However, unlike a manufacturer or even an online retailer, Facebook doesn’t need major physical resources, it doesn’t have inventory, and it doesn’t really need much money for marketing. So in the past, the company hasn’t had much need for additional cash beyond what it was already generating on its own. Finally, as head of a closely held, nonpublic company, Zuckerberg was subject to far fewer regulations than a public company.

Source: “Status Update: I’m Rich! Facebook Flotation to Create 1,000 Millionaires Among Company’s Rank and File,” Daily Mail Reporter (February 1, 2012).

Accounting Across the Organization

LO 1

11-16

1. Vote in election of board of

directors and on actions that

require stockholder approval.

2. Share the corporate earnings

through receipt of dividends.

Stockholder Rights

LO 1

Illustration 11-3Ownership rights ofstockholders

11-17

3. Keep the same percentage ownership when new shares

of stock are issued (preemptive right).

* A number of companies have eliminated the preemptive right.

LO 1

Stockholder Rights


11-18

4. Share in assets upon liquidation in proportion to their

holdings. This is called a residual claim.

LO 1

Stockholder Rights


11-19

When a corporation decides to issue stock, it must

resolve a number of basic questions:

1. How many shares should it authorize for sale?

2. How should it issue the stock?

3. What value should the corporation assign to the

stock?

Stock Issue Considerations

LO 1

11-20

Charter indicates the amount of stock that a corporation

is authorized to sell.

Number of authorized shares is often reported in the

stockholders’ equity section.

No formal accounting entry.

AUTHORIZED STOCK


LO 1

11-21

Name of corporation

Stockholder’s name

Shares

Signature of corporate official

Prenumbered Illustration 11-4


LO 1

11-22

Companies issue common stock directly to investors or

indirectly through an investment banking firm.

Factors in setting price for a new issue of stock:

1. Company’s anticipated future earnings.

2. Expected dividend rate per share.

3. Current financial position.

4. Current state of the economy.

5. Current state of the securities market.

ISSUANCE OF STOCK


LO 1

11-23

Stock of publicly held companies is traded on organized

exchanges.

Interaction between buyers and sellers determines the

prices per share.

Prices tend to follow the trend of a company’s earnings

and dividends.

Factors beyond a company’s control may cause day-to-

day fluctuations in market prices.

MARKET PRICE OF STOCK


LO 1

11-24 LO 1

Investor Insight Nike

11-25

Years ago, par value determined the legal capital per

share that a company must retain in the business for the

protection of corporate creditors.

Today many states do not require a par value.

No-par value stock is fairly common today.

In many states, the board of directors assigns a stated

value to no-par shares.

PAR AND NO-PAR VALUE STOCK


LO 1

11-26

Question

Which of these statements is false?

a. Ownership of common stock gives the owner a voting right.

b. The stockholders’ equity section begins with paid-in capital.

c. The authorization of capital stock does not result in a formal accounting entry.

d. Legal capital is intended to protect stockholders.


LO 1

11-27

Indicate whether each of the following statements is true or false.

______ 1. Similar to partners in a partnership, stockholders of a

corporation have unlimited liability.

______ 2. It is relatively easy for a corporation to obtain capital

through the issuance of stock.

______ 3. The separation of ownership and management is an

advantage of the corporate form of business.

______ 4. The journal entry to record the authorization of capital stock

includes a credit to the appropriate capital stock account.

______ 5. All states require a par value per share for capital stock.

False

True

False

False

False

LO 1

DO IT! Corporate Organization1a

11-28

Paid-in CapitalPaid-in Capital

Retained EarningsAccount


Paid-in Capital in Excess of Par

Account


Account

Two Primary Sources of

Equity

Common StockAccount

Common StockAccount

Preferred StockAccount


Paid-in capital is the total amount of cash and other assets paid in

to the corporation by stockholders in exchange for capital stock.

Corporate Capital

LO 1

11-29





Equity

Common StockAccount

Common StockAccount



Retained earnings is net income that a corporation retains for

future use.

Corporate Capital


Account


Account

LO 1

11-30

If Delta Robotics has a balance of $800,000 in common stock

and $130,000 in retained earnings at the end of its first year,

its stockholders’ equity section is as follows.

Corporate Capital

Illustration 11-5Stockholders’ equity section

LO 1

11-31

Comparison of the owners’ equity (stockholders’ equity)

accounts reported on a balance sheet for a proprietorship and

a corporation.

Corporate Capital

Illustration 11-6Comparison of owners’ equity accounts

LO 1

11-32

(a) Income Summary 122,000

Retained Earnings 122,000

(b) Stockholders’ equity

Paid-in capital common Stock $750,000

Retained earnings 122,000

Total stockholders’ equity $872,000

LO 1

DO IT! Corporate Capital1b

At the end of its first year of operation, Doral Corporation has

$750,000 of common stock and net income of $122,000. Prepare

(a) the closing entry for net income and (b) the stockholders’ equity

section at year-end.

Solution

Advance slide in slide show to reveal solution.

11-33 LO 2

Primary Objectives:

1) Identify the specific sources of paid-in capital.

2) Maintain the distinction between paid-in capital and

retained earnings.

Other than consideration received, the issuance of common

stock affects only paid-in capital accounts.

Accounting for Common Stock

LEARNINGOBJECTIVE

Explain how to account for the issuance of common and preferred stock.

2

11-34

b.

Cash 1,000

Common Stock (1,000 x $1) 1,000

Cash 5,000

Common Stock (1,000 x $1) 1,000

Paid-in Capital in Excess of Par Value 4,000

ISSUING PAR VALUE COMMON STOCK FOR CASH


Illustration: Assume that Hydro-Slide, Inc. issues 1,000 shares

of $1 par value common stock. Prepare Hydro-Slide’s journal

entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000

shares are issued for $5 per share.

a.

LO 2

11-35


Alternative TerminologyPaid-in Capital in Excess of Par is also called Premium on Stock.

LO 2

Illustration 11-7Stockholders’ equity—paid-incapital in excess of par

11-36

Illustration: Assume that instead of $1 par value stock, Hydro-

Slide, Inc. has $5 stated value no-par stock and the company

issues 5,000 shares at $8 per share for cash.

Cash 40,000

Common Stock 25,000

Paid-in Capital in Excess of Stated Value 15,000

ISSUING NO-PAR COMMON STOCK FOR CASH


LO 2

11-37

Illustration: What happens when no-par stock does not have a

stated value?

Cash 40,000

Common Stock 40,000


LO 2

ISSUING NO-PAR COMMON STOCK FOR CASH

11-38

Corporations also may issue stock for:

Services (attorneys or consultants).

Noncash assets (land, buildings, and equipment).

Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable.


ISSUING COMMON STOCK FOR SERVICES OR NONCASH ASSETS

LO 2

11-39

Illustration: Attorneys have helped Jordan Company incorporate.

They have billed the company $5,000 for their services. They agree

to accept 4,000 shares of $1 par value common stock in payment of

their bill. At the time of the exchange, there is no established

market price for the stock. Prepare the journal entry for this

transaction.

Organization Expense 5,000

Common Stock (4,000 x $1) 4,000

Paid-in Capital in Excess of Par 1,000

COMMON STOCK FOR SERVICES

LO 2

11-40

Illustration: Athletic Research Inc. is an existing publicly held

corporation. Its $5 par value stock is actively traded at $8 per

share. The company issues 10,000 shares of stock to acquire land

recently advertised for sale at $90,000. Prepare the journal entry for

this transaction.

Land 80,000

Common Stock (10,000 x $5) 50,000


LO 2

COMMON STOCK FOR NONCASH ASSET

11-41

Typically, preferred stockholders have a priority as to:

1. Distributions of earnings (dividends).

2. Assets in event of liquidation.

Generally do not have voting rights.

Accounting for preferred stock at issuance is similar to that for

common stock.

Accounting for Stock Transactions

LO 2

Accounting for Preferred Stock

11-42

Illustration: Stine Corporation issues 10,000 shares of $10

par value preferred stock for $12 cash per share. The journal

entry to record the issuance is:

Preferred stock may have a par value or no-par value.

Accounting for Preferred Stock

Cash 120,000

Preferred Stock (10,000 x $10) 100,000


LO 2

11-43





Account


Account

Less:Treasury Stock

Account

Less:Treasury Stock

Account


Equity

Common StockAccount

Common StockAccount



LO 3

LEARNINGOBJECTIVE

Explain how to account for treasury stock.

3

11-44

Treasury stock is a corporation’s own stock that it has

reacquired from shareholders but not retired.

Corporations acquire treasury stock for various reasons:

1. To reissue the shares to officers and employees under

bonus and stock compensation plans.

2. To enhance the stock’s market value.

3. To have additional shares available for use in the acquisition

of other companies.

4. To increase earnings per share.

Accounting for Treasury Stock

LO 3

11-45

Purchase of Treasury Stock

Companies generally use the cost method.

Debit Treasury Stock for the price paid to

reacquire the shares.

Treasury stock is a contra stockholders’ equity

account. Reduces stockholders’ equity.

Accounting for Treasury Stock

Helpful Hint Treasury shares do not have dividend rights or voting rights.

LO 3

11-46

Treasury Stock (4,000 x $8) 32,000

Cash 32,000

Illustration: On February 1, 2017, Mead acquires 4,000 shares of

its stock at $8 per share.

Purchase of Treasury StockIllustration 11-8Stockholders’ equity with no treasury stock

LO 3

11-47

Both the number of shares issued (100,000) and the number of shares held as treasury (4,000) are disclosed.

Illustration 11-9Stockholders’ equity with treasury stock

LO 3

Purchase of Treasury Stock

11-48

Sale of Treasury Stock

Above Cost

Below Cost

Both increase total assets and stockholders’ equity.

Disposal of Treasury Stock

Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved.

LO 3

11-49

Illustration: On July 1, Mead sells for $10 per share 1,000

shares of its treasury stock previously acquired at $8 per share

and makes the following entry.

Cash 10,000

Treasury Stock 8,000

Paid-in Capital from Treasury Stock 2,000

A corporation does not realize a gain or suffer a loss from

stock transactions with its own stockholders.

SALE OF TREASURY STOCK “ABOVE” COST

LO 3

11-50

Illustration: On Oct. 1, Mead sells an additional 800 shares of

treasury stock at $7 per share and makes the following entry.

Illustration 11-10Treasury stock accounts

SALE OF TREASURY STOCK “BELOW” COST

Cash 5,600

Paid-in Capital from Treasury Stock 800


LO 3

11-51

Cash 15,400


Retained Earnings 1,000


Illustration: On Dec. 1, assume that Mead, Inc. sells its

remaining 2,200 shares at $7 per share and makes the following

entry.

Limited to balance on hand

LO 3

SALE OF TREASURY STOCK “BELOW” COST

11-52

Why Did Reebok Buy Its Own Stock?

In a bold (and some would say risky) move, Reebok at one time bought back nearly a third of its shares. This repurchase of shares dramatically reduced Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed its stock was severely underpriced. The repurchase of so many shares was meant to signal management’s belief in good future earnings. Skeptics, however, suggested that Reebok’s management was repurchasing shares to make it less likely that another company would acquire Reebok (in which case Reebok’s top managers would likely lose their jobs). By depleting its cash, Reebok became a less attractive acquisition target. Acquiring companies like to purchase companies with large cash balances so they can pay off debt used in the acquisition.

Accounting Across the Organization

LO 3

11-53

July 1 Treasury Stock 180,000

Cash 180,000

Nov. 1 Cash 70,000



LO 3

DO IT! Treasury Stock3

Santa Anita Inc. purchases 3,000 shares of its $50 par value

common stock for $180,000 cash on July 1. It will hold the shares in

the treasury until resold. On November 1, the corporation sells

1,000 shares of treasury stock for cash at $70 per share. Journalize

the treasury stock transactions.

Solution

11-54

Distribution of cash or stock to stockholders on a pro rata

(proportional to ownership) basis.

Types of Dividends:

1. Cash dividends.

2. Property dividends.

Dividends are generally reported quarterly as a dollar amount

per share.

3. Stock dividends.

4. Scrip (promissory note).

LO 4

LEARNINGOBJECTIVE

Explain how to account for cash dividends.

4

11-55

For a corporation to pay a cash dividend, it must have:

1. Retained earnings - Payment of cash dividends from

retained earnings is legal in all states.

2. Adequate cash.

3. A declaration of dividends by the Board of Directors.

Cash Dividends

LO 4

11-56

Three dates are important: Illustration 11-11Key dividend dates

LO 4

Cash Dividends

11-57

Illustration: On Dec. 1, the directors of Media General declare a 50

cents per share cash dividend on 100,000 shares of $10 par value

common stock. The dividend is payable on Jan. 20 to shareholders of

record on Dec. 22.

Dec. 1 (Declaration Date)

Cash Dividends 50,000

Dividends Payable 50,000

Dec. 22 (Date of Record)

Jan. 20 (Payment Date)


Cash 50,000

No entry

LO 4

Cash Dividends

11-58

Right to receive dividends before common stockholders.

Per share dividend amount is stated as a percentage of

the preferred stock’s par value or as a specified amount.

Cumulative Dividend

Preferred stockholders must be

paid both current-year

dividends and any unpaid prior-

year dividends before common

stockholders receive dividends.

Dividend Preferences

LO 4

11-59

CUMULATIVE DIVIDEND

Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par

value, cumulative preferred stock outstanding. Each $100 share

pays a $7 dividend (.07 x $100). The annual dividend is $35,000

(5,000 x $7 per share). If dividends are two years in arrears,

preferred stockholders are entitled to receive the following

dividends in the current year.Illustration 11-12Computation of total dividends to preferred stock

LO 4


11-60

ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON STOCK

Holders of cumulative preferred stock must be paid any

unpaid prior-year dividends and their current year’s dividend

before common stockholders receive dividends.

LO 4


11-61

Illustration: On December 31, 2017, IBR Inc. has 1,000 shares

of 8%, $100 par value cumulative preferred stock. It also has

50,000 shares of $10 par value common stock outstanding. At

December 31, 2017, the directors declare a $6,000 cash dividend.

Prepare the entry to record the declaration of the dividend.



Preferred Dividends: 1,000 shares x $100 par x 8% = $8,000

ALLOCATING CASH DIVIDENDS

LO 4

11-62

2017 2018

Dividends declared 6,000$

Dividends in arrears

Allocation to preferred 6,000

Remainder to common -$

* 1,000 shares x $100 par x 8% = $8,000

*

** 2017 Pfd. dividends $8,000 – declared $6,000 = $2,000

**

Illustration: At December 31, 2018, IBR declares a $50,000

cash dividend. Show the allocation of dividends to each class of

stock.

$ 50,000

2,000

8,000

$ 40,000

LO 4


11-63

Illustration: At December 31, 2018, IBR declares a $50,000 cash

dividend. Prepare the entry to record the declaration of the

dividend.



LO 4


11-64

Preferred stockholders are paid only this year’s dividend.

Preferred stockholders = $12,000 (2,000 x .06 x $100).

Common stockholders = $48,000 ($60,000 - $12,000).

LO 4

DO IT! Dividends on Preferred and Common Stock4

MasterMind Corporation has 2,000 shares of 6%, $100 par value

preferred stock outstanding at December 31, 2017. At December 31,

2017, the company declared a $60,000 cash dividend. Determine the

dividend paid to preferred stockholders and common stockholders

under each of the following scenarios.

1. The preferred stock is noncumulative, and the company has

not missed any dividends in previous years.

Solution

11-65

Past unpaid dividends do not have to be paid.

Preferred stockholders = $12,000 (2,000 x .06 x $100).


LO 4







2. The preferred stock is noncumulative, and the company did

not pay a dividend in each of the two previous years.

Solution

11-66

Dividends that have been missed (dividends in arrears) must be paid.

Preferred stockholders = $36,000 (3 x 2,000 x .06 x $100).


LO 4







3. The preferred stock is cumulative, and the company did not

pay a dividend in each of the two previous years.

Solution

11-67

A pro rata (proportional to ownership) distribution of the

corporation’s own stock to stockholders.

Reasons why corporations issue stock dividends:

1. Satisfy stockholders’ dividend expectations without

spending cash.

2. Increase marketability of the corporation’s stock.

3. Emphasize a portion of stockholders’ equity has been

permanently reinvested in the business.

Stock Dividends

LO 5

LEARNINGOBJECTIVE

Explain how to account for stock dividends and splits.

5

11-68

Small stock dividend (less than 20–25% of the

corporation’s issued stock, recorded at fair market value)

Large stock dividend (greater than 20–25% of issued

stock, recorded at par value)

* Accounting based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares.

*

Stock Dividends

LO 5

11-69

Illustration: Medland Corporation declares a 10% stock dividend on

its 50,000 shares of $10 par value common stock. The current fair

market value of its stock is $15 per share. Record the entry on the

declaration date:

Stock Dividends (50,000 x 10% x $15) 75,000

Common Stock Dividends Distributable 50,000

Paid-in Capital in Excess of Par—Common 25,000

Illustration 11-14Statement Presentation

Stock Dividends

LO 5

11-70

Illustration: Medland Corporation declares a 10% stock dividend on

its 50,000 shares of $10 par value common stock. The current fair

market value of its stock is $15 per share. Record the entry on the

declaration date:

Stock Dividends (50,000 x 10% x $15) 75,000


Paid-in Capital in Excess of Par—Common 25,000


Common Stock 50,000

Record the journal entry when Medland issues the dividend shares.

Stock Dividends

LO 5

11-71

EFFECTS OF STOCK DIVIDENDSIllustration 11-15

Stock Dividends

LO 5

11-72

Which of the following statements about small stock dividends

is true?

a. A debit to Stock Dividends for the par value of the shares

issued should be made.

b. A small stock dividend decreases total stockholders’

equity.

c. Market value per share should be assigned to the

dividend shares.

d. A small stock dividend ordinarily will have an effect on par

value per share of stock.

Question

Stock Dividends

LO 5

11-73

In the stockholders’ equity section, Common Stock Dividends

Distributable is reported as a(n):

a. deduction from total paid-in capital and retained earnings.

b. current liability.

c. deduction from retained earnings.

d. addition to capital stock.

Question

Stock Dividends

LO 5

11-74

THE MISSING CONTROLIndependent internal verification. The company’s board of directors should haveensured that the awards were properly administered. For example, the date on theminutes from the board meeting could be compared to the dates that were recordedfor the awards. In addition, the dates should again be confirmed upon exercise.

Total take: $1.7 million

ANATOMY OF A FRAUD

The president, chief operating officer, and chief financial officer of SafeNet, a software encryption company, were each awarded employee stock options by the company’s board of directors as part of their compensation package. Stock options enable an employee to buy a company’s stock sometime in the future at the price that existed when the stock option was awarded. For example, suppose that you received stock options today, when the stock price of your company was $30. Three years later, if the stock price rose to $100, you could “exercise” your options and buy the stock for $30 per share, thereby making $70 per share. After being awarded their stock options, the three employees changed the award dates in the company’s records to dates in the past, when the company’s stock was trading at historical lows. For example, using the previous example, they would choose a past date when the stock was selling for $10 per share, rather than the $30 price on the actual award date. In our example, this would increase the profit from exercising the options to $90 per share.

Advance slide in slide show to reveal the missing control. LO 5

11-75

Stock Splits

Issuance of additional shares to stockholders according to

their percentage ownership.

Reduction in the par or stated value per share.

Increase in number of shares outstanding.

Reduces the market value of shares.

No journal entry recorded.Helpful Hint A stock split changes the par value per share but does not affect any balances in stockholders’ equity.

LO 5

11-76

Effect of 4-for-1 stock split for stockholdersIllustration 11-16

Stock Splits

LO 5

11-77

Effects for Medland Corporation, assuming that it splits its

50,000 shares of common stock on a 2-for-1 basis.Illustration 11-17

Stock Splits

LO 5

11-78

DO IT! Stock Dividends and Stock Splits5

Sing CD Company has had five years of record earnings. Due to

this success, the market price of its 500,000 shares of $2 par value

common stock has tripled from $15 per share to $45. During this

period, paid-in capital remained the same at $2,000,000. Retained

earnings increased from $1,500,000 to $10,000,000. President Joan

Elbert is considering either a 10% stock dividend or a 2-for-1 stock

split. She asks you to show the before-and-after effects of each

option on retained earnings, total stockholders’ equity, and par value

per share.

LO 5

11-79

DO IT! Stock Dividends and Stock Splits5

Sing CD Company has had five years of record earnings. Due to

this success, the market price of its 500,000 shares of $2 par value

common stock has tripled from $15 per share to $45. President

Joan Elbert is considering either a 10% stock dividend or a 2-for-1

stock split.

Advance slide in slide show to reveal the missing amounts. LO 5

11-80 LO 6

Retained earnings is net income that a company retains in

the business.

Part of the stockholders’ claim on the total assets of the

corporation.

Debit balance in Retained Earnings is identified as a

deficit.

LEARNINGOBJECTIVE

Discuss how stockholders’ equity is reported and analyzed.

6

Illustration 11-20Stockholders’ equity with deficit

11-81

Restrictions can result from:

1. Legal restrictions.

2. Contractual restrictions.

3. Voluntary restrictions.

RETAINED EARNINGS RESTRICTIONS

Retained Earnings

Illustration 11-21Disclosure of restriction

LO 6

11-82

Correction of an error in previously issued financial

statements.

Result from:

► mathematical mistakes.

► mistakes in application of accounting principles.

► oversight or misuse of facts.

Adjustment made to the beginning balance of retained

earnings.

PRIOR PERIOD ADJUSTMENTS

Retained Earnings

LO 6

11-83

Balance, January 1 1,050,000$ Net income 360,000 Dividends (300,000) Balance, December 31 1,110,000$

For the Year Ended December 31, 2017Statement of Retained Earnings

Woods, Inc.

Before issuing the report for the year ended December 31, 2017, you discover a $50,000 error (net of tax) that caused the 2016 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2016. Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2017?

RETAINED EARNINGS STATEMENT

LO 6

11-84

Balance, January 1, as previously reported 1,050,000$ Prior period adjustment - error correction (50,000) Balance, January 1, as restated 1,000,000 Net income 360,000 Dividends (300,000) Balance, December 31 1,060,000$

For the Year Ended December 31, 2017Statement of Retained Earnings

Woods, Inc.

Advance slide in slide show to reveal answer. LO 6


11-85

Debits and Credits to Retained Earnings

Illustration 11-23

LO 6


11-86

Illustration 11-24Retained earnings statement

LO 6


11-87

All but one of the following is reported in a retained

earnings statement. The exception is:

a. cash and stock dividends.

b. net income and net loss.

c. some disposals of treasury stock below cost.

d. sales of treasury stock above cost.

Question

LO 6


11-88

DO IT! Retained Earnings Statement6a

Vega Corporation has retained earnings of $5,130,000 on

January 1, 2017. During the year, Vega earned $2,000,000 of

net income. It declared and paid a $250,000 cash dividend. In

2017, Vega recorded an adjustment of $180,000 due to the

understatement (from a mathematical error) of 2016

depreciation expense. Prepare a retained earnings statement

for 2017.

LO 6

11-89

Prepare a retained earnings statement for 2017.

Advance slide in slide show to reveal the missing amounts. LO 6

DO IT! Retained Earnings Statement6a

11-90

Statement Presentation and Analysis

LO 6

Illustration 11-25Comprehensive stockholders’equity section

11-91

Ratio shows how many dollars of net income the company earned

for each dollar invested by the common stockholders.

Statement Presentation and Analysis

ANALYSIS

To illustrate, Walt Disney Company’s beginning-of-the-year and end-

of-the-year common stockholders’ equity were $31,820 and $30,753

million, respectively. Its net income was $4,687 million, and no

preferred stock was outstanding. Illustration 11-27

LO 6

11-92

DO IT! Stockholders’ Equity6b

LO 6Advance slide in slide show to reveal the missing amounts.

11-93

Illustration 11A-1

When a stockholders’ equity statement is presented, a retained

earnings statement is not necessary.

LEARNINGOBJECTIVE

APPENDIX 11A: Describe the use and content of the stockholders’ equity statement.7

LO 7

11-94

The equity a common stockholder has in the net assets of

the corporation.

Book Value per Share

Book Value—Another per Share AmountLEARNINGOBJECTIVE

APPENDIX 11B: Compute book value per share.

8

Illustration 11B-1Book value per share formula

LO 8

11-95

The computation of book value per share involves the following

steps.

1. Compute the preferred stock equity. This equity is equal to

the sum of the call price of preferred stock plus any

cumulative dividends in arrears. If the preferred stock does

not have a call price, the par value of the stock is used.

2. Determine the common stock equity. Subtract the

preferred stock equity from total stockholders’ equity.

3. Determine book value per share. Divide common stock

equity by shares of common stock outstanding.

Book Value—Another per Share AmountBook Value per Share

LO 8

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Illustration: Using the stockholders’ equity section of Graber

Inc. shown in Illustration 11-25. Graber’s preferred stock is

callable at $120 per share and is cumulative. Assume that

dividends on Graber’s preferred stock were in arrears for one

year, $54,000 (6,000 x $9). The computation of preferred stock

equity (Step 1 in the preceding list) is:Illustration 11B-2


LO 8

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Computation of book value:

Illustration 11B-2

Illustration 11B-3


LO 8

11-98

The correlation between book value and the annual range

of a company’s market value per share is often remote.

Illustration 11B-4

Book Value—Another per Share AmountBook Value versus Market Value

LO 8

11-99

Key Points

Similarities

Aside from the terminology used, the accounting transactions for the issuance of shares and the purchase of treasury stock are similar.

Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares.

The accounting related to prior period adjustment is essentially the same under IFRS and GAAP.

LEARNINGOBJECTIVE

Compare the accounting for stockholders’ equity under GAAP and IFRS.

9

LO 9

11-100

Key Points

The income statement using IFRS is called the statement of comprehensive income. A statement of comprehensive income is presented in a one- or two-statement format. The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic. In the two-statement approach, a traditional income statement is prepared. It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items. Regardless of which approach is reported, income tax expense is required to be reported.

The computations related to earnings per share are essentially the same under IFRS and GAAP.

LO 9

11-101

Key Points

Differences

Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.

Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors.

LO 9

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Key Points

There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology.

LO 9

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Key Points

A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital.

IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.

Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and share holders’ funds.

LO 9

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Looking to the Future

The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. For example, it is likely that the statement of stockholders’ equity and its presentation will be examined closely.

Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations.

LO 9

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Under IFRS, a statement of comprehensive income must

include:

a) accounts payable.

b) income tax expense.

c) retained earnings.

d) preference stock.

IFRS Self-Test Questions

LO 9

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Which of the following is true?

a) In the United States, the primary corporate stockholders are

financial institutions.

b) Share capital means total assets under IFRS.

c) The IASB and FASB are presently studying how financial

statement information should be presented.

d) The amount to treasury stock is very different between U.S.

GAAP and IFRS.

LO 9

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A Look at IFRS


Under IFRS, the amount of capital received in excess of par

value would be credited to:

a) Retained Earnings.

b) Contributed Capital.

c) Share Premium.

d) Par value is not used under IFRS.

LO 9

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