13-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint...

13-1

Intermediate Accounting,17E

Stice | Stice | Skousen

© 2010 Cengage Learning

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Equity Financing

13-3

Nature and Classifications of Paid-In Capital

• A corporation is a legal artificial entity separate from its owners.

• Individuals contribute capital for which the corporation issues certificates making them stockholders.

• The board of directors is elected by the stockholders, and it is in charge of overseeing the long-run plan for the organization.

13-4

Common and Preferred Stock

• When a corporation is formed, a single class of stock, known as common stock, usually is issued.

• Corporations may later find that there are advantages to issuing one or more additional classes of stock with varying rights and priorities. Stock with certain preferences (rights) over common stock is called preferred stock.

13-5

Common Stock

Unless restricted by terms of the articles of incorporation, certain basic rights are held by each common stockholder.1. To vote in the election of directors and in

the determination of certain corporate policies.

2. To maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued. This right is known as the preemptive right.

13-6

Par or Stated Value

• Historically, par value was equal to the market value of the shares at issuance.

• Today, most stocks have a nominal par value or no par value.

• No-par stock sometimes has a stated value that for financial reporting purposes acts like a par value.

13-7

Preferred Stock

Rights of ownership given up by preferred stockholders:1. Voting—in most cases, preferred

stockholders are not allowed to vote for the board of directors

2. Sharing in success—cash dividends received by preferred stockholders are usually fixed in amount. If the firm does extremely well, their dividend amount is not adjusted

13-8

Preferred Stock

Rights enjoyed by preferred stockholders:

1. Cash dividend preference. Preferred stockholders are entitled to receive their full cash dividend before any cash dividends are paid to common stockholders.

2. Liquidation preference. In the event of bankruptcy, preferred stockholders are entitled to have their investments repaid before common stockholders.

13-9

Cumulative and Noncumulative Preferred Stock

When a corporation fails to declare dividends on cumulative preferred stock, such dividends accumulate and require payment in the future before any dividends may be paid to common stockholders.

13-10

Good Time Corporation has outstanding 100,000 shares of 9% cumulative preferred stock, $10 par. Dividends were last paid in 2008. Total dividends of $300,000 are declared in 2011.


13-11

• Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.

• With noncumulative preferred stock, it is not necessary to provide for passed dividends.

(continues)


13-12

•Dividends may be declared on common stock as long as the noncumulative preferred stock receives its preferred rate.


13-13

Participating Preferred Stock

Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders after dividends of a specified amount are paid to the common stockholders. A participative provision makes preferred stock more like common stock.

13-14

Convertible Preferred Stock

• Preferred stock is convertible when it can be exchanged by its owner for some other security of the issuing corporation.

• Conversion rights generally provide for the exchange of preferred stock into common stock.

13-15

Callable Preferred Stock

• Many preferred issues are callable, meaning they may be called and canceled at the option of the corporation.

• The call price is usually specified in the original agreement and provides for payment of dividends in arrears as part of the repurchase price.

13-16

Redeemable Preferred Stock

• Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder or upon other conditions not within the control of the issuer.

• Redeemable preferred stock is somewhat like a loan in that the issuing corporation may be forced to repay the stock proceeds.

13-17

Capital Stock Issued for Cash

• The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value.

• When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to Paid-In Capital in Excess of Par.

13-18

Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2011, for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 4,000Paid-In Capital in Excess of Par 41,000

2011

Par Value StockPar Value Stock


(continues)

13-19

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock with a $1 stated value.

Apr. 1 Cash 45,000Common Stock 4,000Paid-In Capital in Excess of Stated Value 41,000

2011

Stated Value StockStated Value Stock


(continues)

13-20

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock for $45,000 cash.

Apr. 1 Cash 45,000Common Stock 45,000

2011

No-Par StockNo-Par Stock


(continues)

13-21

Capital Stock Sold on Subscription

Received subscriptions on November 1 for 5,000 shares of $1 par common stock at $12.50 per share with 50% down, balance due in 60 days. The entries for November 1 are as follows:

Common Stock Subscriptions Receivable 62,500

Common Stock Subscribed 5,000Paid-In Capital in Excess of Par 57,500

Cash 31,250Common Stock Subscriptions Receivable 31,250

(continues)

13-22

Capital Stock Sold on Subscription

On December 31, received balance due on one-half of subscriptions and issued stock to the fully paid subscribers, 2,500 shares.

Cash 15,625Common Stock Subscriptions Receivable 15,625

Common Stock Subscribed 2,500Common Stock 2,500

13-23

Capital Stock Issued for Consideration Other Than Cash

AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share.

Land 10,000

Common Stock 100Paid-In Capital in Excess of Par 9,900

13-24

Capital Stock Issued for Consideration Other Than Cash

The land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value.

Land 12,000

Common Stock 100Paid-In Capital in Excess of Par 11,900

13-25

Reasons Companies Repurchase Stock

1. Provide shares for incentive compensation and employee savings plans.

2. Obtain shares needed to satisfy requests by holders of convertible securities.

3. Reduce the amount of equity relative to the amount of debt.

4. Invest excess cash temporarily.

(continues)

13-26

Reasons Companies Repurchase Stock

5. Remove some shares from the open market in order to protect against a hostile takeover.

6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.

7. Display confidence that the stock is currently undervalued by the market.

13-27

Treasury Stock

• Treasury stock is stock issued by a corporation and subsequently reacquired by the corporation and held for possible future reissuance or retirement.

• Reported as a contra-equity account, not as an asset.

• Does not create a gain or loss on reacquisition, reissuance, or retirement.

• May decrease Retained Earnings, but cannot increase it.

13-28

2010—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15:Cash 150,000

Common Stock 10,000Paid-In Capital in Excess of Par 140,000

2011—Reacquired 1,000 shares of common stock at $40 per share:

Treasury Stock 40,000Cash 40,000

2011—Sold 200 shares of treasury stock at $50 per share:

Cash 10,000Treasury Stock (200 × $40) 8,000Paid-In Capital from Treasury Stock 2,000

Cost Method of Accounting for Treasury Stock

(continues)Note: No gain is recorded on saleNote: No gain is recorded on sale

13-29


Cash 17,000Paid-In Capital from Treasury Stock 2,000Retained Earnings 1,000

Treasury Stock (500 × $40) 20,000


Because the treasury stock is reissued at a price greater than the $40 repurchase price, the excess is recorded in an additional paid-in capital account.

(continues)

Note: No loss is recorded on saleNote: No loss is recorded on sale

13-30

2011—Retired remaining 300 shares of treasury stock:

Common Stock 300Paid-In Capital in Excess of Par 4,200Retained Earnings [300 × ($40 – $15)] 7,500

Treasury Stock (300 × $40) 12,000

Because the treasury stock is reissued at a price less than the $40 repurchase price, Retained Earnings is debited for the difference; any paid-in capital from prior treasury stock transactions may first be debited.


13-31

Par (or Stated) Value Method of Accounting for Treasury Stock2010—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15:Cash 150,000

Common Stock 10,000Paid-In Capital in Excess of Par 140,000

2011—Reacquired 1,000 shares of common stock at $40 per share:

Treasury Stock 1,000Paid-In Capital in Excess of Par 14,000Retained Earnings [1,000 × ($40 – $15)] 25,000

Cash 40,000

(continues)

13-32


Cash 17,000Treasury Stock 500Paid-In Capital in Excess of Par 16,500

2011—Retired remaining 300 shares of treasury stock:

Common Stock 300Treasury Stock 300

Par (or Stated) Value Method of Accounting for Treasury Stock

13-33

Stock Rights, Warrants, and Options

• Stock rights—issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.

• Stock warrants—sold by the corporation for cash, generally in conjunction with the issuance of another security.

• Stock options—granted to officers or employees, usually as part of a compensation plan.

13-34

Stock Rights

• When announcing rights to purchase additional shares of stock, the directors of a corporation specify a date on which the rights will be issued.

• All stockholders of record are entitled to the rights. Thus, between the announcement date and the issue date, the stock is said to sell rights-on. (continues)

13-35

Stock Rights

• After the rights are issued, the stock sells ex-rights, and the rights may be sold separately by those receiving them from the corporation.

13-36

Stock Warrants

• Detachable warrants are similar to stock rights because they can be traded separately from the security with which they were originally issued.

• Nondetachable warrants cannot be separated from the security with which they were issued.

13-37

Stock Warrants

Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

13-38

Stock Warrants

Value assigned to

warrants=

Total issue price

xMarket value of warrants

Market value of security

without warrants

+ Market value of warrants

$57 + $3

Value assigned to

warrants= $58,000 x

$3 = $2,900

13-39

Stock Warrants

The entry on Stewart’s books to record the sale of the preferred stock with detachable warrants is:

Cash 58,000Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par— Preferred Stock 5,100Common Stock Warrants (from Slide

13-38) 2,900

13-40

Stock Warrants

If the warrants are exercised:Common Stock Warrants 2,900Cash 25,000

Common Stock, $2 par 2,000Paid-In Capital in Excess of Par— Common Stock 25,900

If the warrants expire:Common Stock Warrants 2,900

Paid-In Capital from Expired Warrants 2,900

13-41

The company estimates a grant date value of $10 for each of the employee stock options. The total fair value of the options granted is $100,000. Compensation expense is allocated over three years from January 1, 2009 (the grant date) to January 1, 2012 (the vesting date). The year-end entry is as follows:

$100,000/3

Dec. 31 Compensation Expense 33,333Paid-In Capital from Stock Options 33,333

2009

Share-Based Compensation

13-42

On December 31, 2012, all 10,000 of the options are exercised to purchase Neff’s no-par common stock:Dec. 31 Cash (10,000 x $50) 500,000

Paid-In Capital from Stock Options 100,000

Common Stock (no par) 600,000

2012

If the options are allowed to expire unexercised:

Dec. 31 Paid-In Capital from Stock Options 100,000

Paid-In Capital from Expired Options 100,000

2012

Share-Based Compensation

13-43

Accounting for Performance-Based Plans

In a performance-based stock option plan, the plan terms are dependent on how well the individual or company performs after the date the options are granted.

13-44


• On January 1, 2009, the board of directors of Neff Company authorized the granting of stock options to supplement the salaries of certain employees.

• Each stock option permits the purchase of one share of Neff common stock at a price of $50 per share; the market price on January 1, 2009, is also $50 per share.

• Each option is computed to have a value of $10.

(continues)

13-45


• The options vest, or become exercisable, beginning on January 1, 2012, and only if the employee stays with the company for the entire 3-year period. The options expire on December 31, 2012.

• The number of options granted is contingent on Neff’s level of sales for 2011. If Neff sales are less than $50 million, only 10,000 options will vest.

(continues)

13-46


• If Neff’s 2011 sales are between $50 million and $80 million, an additional 2,000 options will vest. If Neff’s 2011 sales exceed $80 million, a total of 15,000 options will vest.

• Neff’s share price changed as follows over the 3-year vesting period: Jan. 1, 2009, $50; Dec. 31, 2009, $56; Dec. 31, 2010, $57; Dec. 31, 2011, $59

13-47


Recognition of compensation of $40,000 for each of the three years [(12,000 options × $10)/3]:

Dec. 31 Compensation Expense 40,000Paid-In Capital from Stock Options 40,000

2009

Sales are expected to be only $40 million, so only 10,000 options will vest on January 1, 2012:

Dec. 31 Compensation Expense ($66,667 – $40,000) 26,667


2010

(continues)

13-48


Actual sales for 2011 are $85 million, so 15,000 options will vest on January 1, 2012:



2011

On December 31, 2012, all 15,000 options are exercised to purchase Neff’s no-par common stock:Dec. 31 Cash ($15,000 × $50) 750,000

Paid-In Capital from Stock Options 150,000Common Stock (no par) 900,000

2012

13-49

Accounting for Awards That Call for Cash Settlement

• Assume that Neff Company has decided instead of granting its employees 10,000 stock options, it will grant an equal number of cash stock appreciation rights (SARs).

• A cash SAR awards an employee a cash amount equal to the market value of the issuing firm’s shares above a specified threshold price.

13-50

Neff Company Example• Neff’s share price:

– January 1, 2009 $50– December 31, 2009 56– December 31, 2010 57– December 31, 2011 59– December 31, 2012 61

• As of December 31, 2009, the $56 is used as the best estimate for the cash SARs. The amount of cash involved will be $60,000 [10,000 × ($56 – $50)].

(continues)

13-51

Neff Company Example

Dec. 31 Compensation Expense 20,000Share-Based Compensation Liability 20,000

2009

At the end of 2010, the stock price is $57. The new estimation for compensation expense is $70,000 [10,000 × ($57 – $50).

(continues)


Share-Based Compensation Liability 26,667

2010

13-52

Neff Company Example

Neff’s stock price is $59 at the end of 2011. Aggregate compensation expense is $90,000 [10,000 × ($59 – $50)]. Of this amount, $46,667 has already been recognized.

Dec. 31 Compensation Expense ($90,000 ─ $46,667) 43,333

Share-Based Compensation Liability 43,333

2011

(continues)

13-53

Neff Company ExampleBy the end of 2012, the price of Neff’s stock is $61. An entry is required to reflect this increase in stock value [10,000 × ($61 – $59).

Dec. 31 Compensation Expense 20,000Share-Based Compensation Liability 20,000

2012

Cash payments are made to the holders of the 10,000 SARs on December 31, 2012.

Dec. 31 Share-Based Compensation Liability 110,000Cash [10,000 × ($61 – $50)] 110,000

2012

13-54

Mandatorily Redeemable Preferred Shares

• Historically, the SEC required that firms not include mandatorily redeemable preferred stock under the Stockholders’ Equity heading.

• Given a “mezzanine” treatment.• FASB Statement No. 150 requires

these items to be reported as liabilities in the balance sheet.

13-55

Written Put Options

• A put option is an agreement that allows investors to sell the issuing corporation shares they hold at set prices on specific dates.

• If the stock price stays above a set level per share, the issuing corporation pays nothing.

• Historically recorded as part of equity. (continues)

13-56

Written Put Options

• In Statement No.150, the FASB instructs companies to record the fair value of the obligation under written put options on a company’s own shares as a liability.

13-57

Obligation to Issue Shares of a Certain Dollar Value

• Companies occasionally agree to satisfy their obligations by delivering shares of their own stock rather than by paying cash.

• This is especially true for startup companies.

• Can be recorded as equity or as a liability, depending on how the contract is written.

13-58

Noncontrolling Interest

• When a parent company owns less than 100% of the subsidiary’s assets and liabilities, there are minority stockholders.

• Financing provided by minority stockholders is called minority interest.

• Under SFAS No. 160, the FASB uses the term noncontrolling interest.

13-59

Stock Conversions

On December 31, 2011, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $1).

Case 1Case 1

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par— Preferred 10,000

Common Stock, $1 par 4,000Paid-In Capital in Excess of Par—Common 56,000

2011

13-60

Stock Conversions

On December 31, 2011, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $20).

Case 2Case 2

Dec. 31 Preferred Stock, $50 par 50,000Paid-In Capital in Excess of Par— Preferred 10,000Retained Earnings 20,000

Common Stock, $20 par 80,000

2011

13-61

Factors Affecting Retained Earnings

13-62

Net Income and Dividends

• The primary source of retained earnings is the net income generated by a business.

• When operating losses or other debits to Retained Earnings produce a debit balance in the account, the debit balance is referred to as a deficit.

• Use of the term dividends without qualification normally implies the distribution of cash.

13-63

Prior-Period Adjustments

In some situations, errors made in past years are discovered and corrected in the current year by an adjustment to Retained Earnings, referred to as a prior-period adjustment.

13-64

Accounting for Dividends

In setting dividend policy, the board of directors must answer two questions:

1. Do we have the legal right to declare a dividend?

2. Is a dividend distribution financially advisable?

13-65

Accounting for Dividends

• Declaration date—date the corporation’s board of directors formally declares a dividend will be paid

• Date of record—date on which stockholders of record are identified as those who will receive a dividend

• Date of payment—date when the dividend is actually distributed to stockholders

13-66

Cash Dividends

ABC Corporation declares a $100,000 dividend; the following journal entries should be made:Declaration of Dividend:Dividends (or Retained Earnings) 100,000

Dividends Payable 100,000

Payment of Dividend:Dividends Payable 100,000

Cash 100,000

13-67

Property Dividends

• A property dividend is a distribution to stockholders that is payable in some asset other than cash.

• Bigler Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value $3,000,000, or $30 per share. There are 1,000,000 shares of Bigler stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigler stock outstanding.

13-68

Property DividendsDeclaration of Dividend:Dividends (or Retained Earnings) 3,000,000

Property Dividends Payable 2,700,000

Gain on Distribution of Property

Dividends 300,000

Payment of Dividend:Property Dividends Payable 2,700,000

Investment in Tri-State Oil Co. Stock2,700,000

13-69

Stock Dividends

• Small:– Less than 20–25% of the outstanding

shares.– Debit Retained Earnings for the market

value of the shares.• Large:

– Greater than 20–25% of the shares outstanding.

– Debit Retained Earnings for the par value of the shares.

13-70

Small Dividend Example

The stockholders’ equity section for the Fuji Company on July 1 is as follows:

Common Stock, $1 par, 100,000

shares outstanding

$ 100,000Paid-In Capital in Excess of Par

1,100,000Retained Earnings

750,000

The company declares a 10% stock dividend. Before the stock dividend, the stock is selling for $22 per share. After the stock dividend, each original share sells for $20.

(continues)

13-71

Small Dividend Example

Declaration of Dividend:Retained Earnings 200,000

Stock Dividends Distributable 10,000

Paid-In Capital in Excess of Par 190,000

Payment of Dividend:Stock Dividends Distributable 10,000

Common Stock, $1 par10,000

13-72

Large Dividend Example

The stockholders’ equity section for the Fuji Company on July 1 is as follows:

Common Stock, $1 par, 100,000

shares outstanding

$ 100,000Paid-In Capital in Excess of Par

1,100,000Retained Earnings

750,000

The company declares a 50% stock dividend. Before the stock dividend, the stock is selling for $22 per share.

(continues)

13-73

Large Dividend ExampleDeclaration of Dividend:Retained Earnings 50,000


OR

Paid-In Capital in Excess of Par 50,000


Payment of Dividend:Stock Dividends Distributable 50,000

Common Stock, $1 par 50,000

13-74

Stock Dividends versus Stock Splits

• A corporation may effect a stock split by reducing the par or stated value of each share of capital stock and proportionately increasing the number of shares outstanding.

• A stock dividend results in an increase in the number of shares outstanding. The par or stated value remains unchanged.

• A stock split divides the existing Capital Stock balance into more parts, with a reduction in par or stated value of each share.

13-75

Liquidating Dividends

• A liquidating dividend is a distribution representing a return to stockholders of a portion of contribution capital.

• Example: Stubbs Corporation declared and paid a cash dividend ($10 cash dividend) totaling $100,000 and a partial liquidating dividend of $50,000.

13-76

Foreign Currency Translation Adjustment

• The foreign currency translation adjustment arises from the change in the equity of foreign subsidiaries (as measured in terms of U.S. dollars) that occurs as a result of changes in foreign currency exchange rates.

• These changes are recorded as direct adjustments to equity.

13-77

Unrealized Gains and Losses on Available-for-Sale Securities

• Available-for-sale securities are those that were not purchased with immediate intention to resell, but that a company also doesn’t necessarily plan to hold forever.

• Reported on the balance sheet at their current market value.

13-78

Unrealized Gains and Losses on Derivatives

• A derivative is a financial instrument, such as an option or a future, that derives its value from the movement of a price, an exchange rate, or an interest rate associated with some other item.

• Derivatives are used to manage risk associated with sales or purchases that will not occur until a future period.

13-79

International Accounting: Equity Reserves

• In foreign countries, the payment of cash dividends is linked to the amount of distributable equity.

• Equity is divided among various equity reserve accounts, each with legal restrictions dictating whether it can be distributed to stockholders.

13-80

International Accounting

• Capital stock may be: Authorized but unissued Subscribed for and held for issuance

pending receipt of cash for the full amount of the subscription price

Outstanding in the hands of stockholders Reacquired and held by the corporation

for subsequent reissuance Canceled by appropriate corporate action

13-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint...

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