Contributed Capital C hapter 16 An electronic presentation by Norman Sunderman Angelo State...

Contributed Capital

Chapter16

An electronic presentation by Norman Sunderman Angelo State University

An electronic presentation by Norman Sunderman Angelo State University

COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Intermediate AccountingIntermediate Accounting 10th edition 10th edition

Nikolai Bazley JonesNikolai Bazley Jones

2

1. Explain the corporate form of organization.

2. Know the rights and terms that apply to capital stock.

3. Account for the issuance of capital stock.

4. Describe a compensatory stock option plan.

5. Recognize compensation expense for a compensatory stock option plan using the fair value method.

Objectives

3

6. Account for a fixed compensatory stock option plan.

7. Account for a performance-based compensatory stock option plan.

8. Account for share appreciation rights.9. Describe the characteristics of preferred stock.10. Know the components of contributed capital.11. Understand the accounting for treasury stock.

Objectives

4

Types of Corporations

1. Private Corporations (stock and nonstock; open and closed)

2. Public corporations

3. Domestic corporations

4. Foreign corporations

universities, hospitals, churches

universities, hospitals, churches

Available for purchase by the public

Available for purchase by the public

Owned by governmental units (FDIC)

Owned by governmental units (FDIC)

Incorporated in the statethat it is operating in

Incorporated in the statethat it is operating in

Incorporated inanother state

Incorporated inanother state

5

Continued on next

slide

Changes in Equity Affecting Assets or Liabilities

Changes in Equity Affecting Assets or Liabilities

Transfers Between Transfers Between Entity and OwnersEntity and Owners

Comprehensive Comprehensive IncomeIncome

Net Income

Net Income

Other Comprehensive

Income

Revenues and

Expenses

Revenues and

Expenses

Gains and Losses Included in Net

Income

Gains and Losses Included in Net

Income

Investments by Owners

Distributions to Owners

6

Continued from

previous slide

Changes in Equity Not Affecting Assets or

Liabilities

Changes in Equity Not Affecting Assets or

Liabilities

Stock Dividends and Splits

Stock Dividends and Splits

Conversions of Preferred Stock

to Common Stock

Conversions of Preferred Stock

to Common Stock

7

Stockholders’ Rights

The right to share in the profits when a dividend is declared.

The right to elect directors and to establish corporate policies.

The right (called a preemptive right) to maintain a proportionate interest.

The right to share in the distribution of the assets of the corporation if it is liquidated.

8

Advantages of the Corporate Form

Limited liabilityCapital accumulationEase of transferability

9

Disadvantages of the Corporate Form

Increased taxationDifficulties of controlRegulation

10

Basic Terminology

Authorized capital stock--The

number of shares of capital stock

that a corporation may issue as stated in its

charter.




charter.

Issued capital stock--The


that a corporation has issued to its

stockholders as of a specific date.





Outstanding capital stock--

The number of shares of capital

stock that a corporation has

issued to its stockholders

and that are still being held by

them on a specific date.







11

Basic Terminology




charter.




charter.





















Treasury stock--The number of

shares of capital stock that a

corporation has issued to its

stockholders and has reacquired but not retired.

Treasury stock--The number of

shares of capital stock that a

corporation has issued to its

stockholders and has reacquired but not retired.

Subscribed capital stock--The


that a corporation will issue using an

installment purchase plan.

Subscribed capital stock--The


that a corporation will issue using an

installment purchase plan.

12

Basic Terminology

Authorized Capital Stock

Issued Capital StockIssued Capital Stock

* Outstanding capital stock

* Treasury stock

Unissued Capital StockUnissued Capital Stock

* Subscribed capital stock

13

Stockholders’ Equity Contributed capital (paid-in-capital)

Preferred stockCommon stockOther paid-in-capital

Retained earnings Less: Treasury stock (at cost)

Subscriptions receivable Accumulated other comprehensive income

1. Unrealized gains and losses on securities available-for-sale2. Change in Additional Liability related to pensions3. Certain gains and losses on derivative financial instruments4. Amount from foreign currency translation adjustments and

gains and losses from certain forward exchange contracts

14

Legal capital is the amount of stockholders’

equity that the corporation cannot

distribute to stockholders.

Legal capital is the amount of stockholders’

equity that the corporation cannot

distribute to stockholders.

Legal Capital

15

Issuance of Capital Stock

When only one class of stock is issued, it is

referred to as common stock.

When only one class of stock is issued, it is

referred to as common stock.

16

A corporation issues 500 shares of its $10 par common stock for $18.

A corporation issues 500 shares of its $10 par common stock for $18.

Cash 9,000Common Stock, $10 par 5,000Additional Paid-in Capital on Common Stock 4,000


17

A corporation issues 500 shares of its no-par stock common stock with a

stated value of $10 for $18 per share.

A corporation issues 500 shares of its no-par stock common stock with a

stated value of $10 for $18 per share.

Cash 9,000Common Stock, $10 stated value 5,000Additional Paid-in Capital on Common Stock 4,000


18


A corporation issues 500 shares of its no-par, no-stated value common stock

for $18 per share.

A corporation issues 500 shares of its no-par, no-stated value common stock

for $18 per share.

Cash 9,000Common Stock, no-par (500 shares) 9,000


19

Stock Issuance Costs

The FASB is planning to change GAAP so that all stock issuance costs are expensed as incurred.

20

Stock SubscriptionsA corporation enters into a subscription contract

with several subscribers that calls for the purchase of 1,000 shares of $6 par common stock at a price of $13 per share. A $3 per share down payment is required, with the remaining $10 due

in one month.

A corporation enters into a subscription contract with several subscribers that calls for the

purchase of 1,000 shares of $6 par common stock at a price of $13 per share. A $3 per share down payment is required, with the remaining $10 due

in one month.

Cash 3,000Subscription Receivable: Common Stock 10,000

Common Stock Subscribed 6,000Additional Paid-in Capital on Common Stock 7,000

$6 x 1,000$6 x 1,000$6 x 1,000$6 x 1,000

21

The $10 per share final payment was received from subscribers to 950 of the 1,000 shares.

The $10 per share final payment was received from subscribers to 950 of the 1,000 shares.

Cash 9,500Subscription Receivable: Common Stock 9,500

Common Stock Subscribed 5,700Common Stock, $6 par 5,700

950 x $6950 x $6950 x $6950 x $6

Stock Subscriptions

22

1. Return to the subscriber the entire amount paid in.

2. Return to the subscriber the entire amount paid in, less any costs incurred to reissue the stock.

3. Issue to the subscriber a lesser number of shares based upon the total amount of payment received.

4. Require the forfeiture of all amounts paid in.

When a default occurs, the accounting is determined by the relevant contract provisions, such as--

Stock Subscriptions

23

The subscriber to the 50 remaining shares defaults on the contract. The contract requires

the forfeiture of all amounts paid in.

The subscriber to the 50 remaining shares defaults on the contract. The contract requires

the forfeiture of all amounts paid in.

Common Stock Subscribed 300Additional Paid-in Capital on Common Stock 350

Subscription Receivable: Common Stock 500Additional Paid-in Capital from

Subscription Default 150

50 X $750 X $750 X $750 X $7

50 X $650 X $650 X $650 X $6

50 X $1050 X $1050 X $1050 X $10

Stock Subscriptions

24

Combined Sales of Stock

Common Stock: $16 x 2 shares x 100 = $ 3,200Preferred Stock: $60 x 1 share x 100 = 6,000 Total market value $9,200

A corporation issues 100 packages of securities for $82.80 per package. Each package consists of

two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share).



25





Common Stock: x $8,280 = $2,880$3,200

$9,200

Preferred Stock: x $8,280 = 5,400$6,000

$9,200$8,280


26





Cash 8,280Common Stock 2,000Additional Paid-in Capital on Com. Stock 880Preferred Stock, $50 par 5,000Additional Paid-in Capital on Pref. Stock 400


27

A stock split results in a decrease in the par value

per share of stock accompanied by a

proportional increase in the number of shares issued.

A stock split results in a decrease in the par value

per share of stock accompanied by a

proportional increase in the number of shares issued.

A stock split ordinarily is recorded by a memorandum entry.

A stock split ordinarily is recorded by a memorandum entry.

Stock Splits

28

Ollar Corporation issues a disproportionate stock split in which the reduction in par is not

proportionate to the increase in the number of shares. Assume the par is reduced from $10 to $4.

Ollar Corporation issues a disproportionate stock split in which the reduction in par is not

proportionate to the increase in the number of shares. Assume the par is reduced from $10 to $4.

Common Stock, $10 par 600,000Common Stock, $4 par 480,000Additional Paid-in Capital from Stock Split 120,00060,000 60,000

x $10x $10

60,000 60,000

x $10x $10

60,000 X60,000 X2 X $42 X $4

60,000 X60,000 X2 X $42 X $4

Stock Splits

29

Noncompensatory Stock Option Plans

Three criteria must be met for a share

option plan to qualify as

noncompensatory.

Three criteria must be met for a share

option plan to qualify as

noncompensatory.

An employee stock An employee stock purchase plan is purchase plan is

designed to raise capital designed to raise capital or obtain more or obtain more

widespread ownership widespread ownership of the corporate stock.of the corporate stock.

An employee stock An employee stock purchase plan is purchase plan is

designed to raise capital designed to raise capital or obtain more or obtain more

widespread ownership widespread ownership of the corporate stock.of the corporate stock.

30

1. Substantially all full-time

employees who meet limited employment

qualifications may participate in the

plan on an equitable basis.

1. Substantially all full-time

employees who meet limited employment

qualifications may participate in the

plan on an equitable basis.


2. The discount from the market price does not exceed

the per-share amount of stock issuance costs avoided by not issuing the stock to

the public. A purchase discount of 5% automatically complies with this criterion.

2. The discount from the market price does not exceed

the per-share amount of stock issuance costs avoided by not issuing the stock to

the public. A purchase discount of 5% automatically complies with this criterion.

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3. The plan has no option features other than the following:

3. The plan has no option features other than the following:


The purchase price is based solely on the market price of the stock on the purchase date, and

employees are permitted to cancel their participation before the purchase date and

receive a refund of any amounts previously paid.

The purchase price is based solely on the market price of the stock on the purchase date, and

employees are permitted to cancel their participation before the purchase date and

receive a refund of any amounts previously paid.

Employees are allowed a short time from the date the purchase price is set to decide whether to

enroll in the plan (no longer than 31 days), and...

Employees are allowed a short time from the date the purchase price is set to decide whether to

enroll in the plan (no longer than 31 days), and...

32

Compensatory Stock Option Plans

A share option plan that does not possess ALL

three of the criterion for a noncompensatory plan is a compensatory plan.

33


A corporation must use the fair value method to

account for its compensatory share

option plan.

34


35

Use Fair Value on

Grant Date

Measure Fair Value of Stock

Options

Measure Fair Value of Stock

Options

Recognize Periodic Cost

Recognize Periodic Cost

Report in Financial

Statements

Report in Financial

Statements

Allocate over Service Period

Income Statement

Balance Sheet

ContinuedContinuedContinuedContinued

The fair value method is required for measuring all stock options.


36

Report in Financial

Statements

Report in Financial

Statements

Income Statement

Balance Sheet

• Increase Compensation Expense (in Operating Expenses)

• Increase Contributed Capital (in Stockholders’ Equity)

• Description of Plan

• Information about Options Granted, Exercised, and Outstanding

• Other Information

Disclose in Notes to Financial StatementsDisclose in Notes to

Financial Statements


37

Recognition of Compensation Expense

On January 1, 2007, Fox Corporation adopts a On January 1, 2007, Fox Corporation adopts a compensatory stock option plan and grants 9,000 compensatory stock option plan and grants 9,000 stock options to 30 selected employees. The $50 stock options to 30 selected employees. The $50 exercise price is equal to the exercise price is equal to the fairfair market market priceprice of of the stock on this grant date. Turnover is about the stock on this grant date. Turnover is about

3%. Using an option pricing model in accordance 3%. Using an option pricing model in accordance with FASB123R, Fox values each option at $17.15 with FASB123R, Fox values each option at $17.15

on the grant date. on the grant date. Page 785Page 785

On January 1, 2007, Fox Corporation adopts a On January 1, 2007, Fox Corporation adopts a compensatory stock option plan and grants 9,000 compensatory stock option plan and grants 9,000 stock options to 30 selected employees. The $50 stock options to 30 selected employees. The $50 exercise price is equal to the exercise price is equal to the fairfair market market priceprice of of the stock on this grant date. Turnover is about the stock on this grant date. Turnover is about

3%. Using an option pricing model in accordance 3%. Using an option pricing model in accordance with FASB123R, Fox values each option at $17.15 with FASB123R, Fox values each option at $17.15

on the grant date. on the grant date. Page 785Page 785


38

Fox multiplies the fair value per stock option times the estimated stock options that will become vested

[$17.15 x (9,000 x 0.97 x 0.97 x 0.97)] = $140,871.Memorandum entry: On January 1, 2007, the company

granted a compensatory stock option plan to 30 employees. The plan allows each employee to exercise 300 stock options to acquire the same number of shares of the

company’s common stock at an exercise price of $50 per share. The option vest at the end of 3 years and expire at

the end of 10 years. The estimated value of the stock options expected to be exercised is $140,871. Page 785

Memorandum entry: On January 1, 2007, the company granted a compensatory stock option plan to 30 employees.

The plan allows each employee to exercise 300 stock options to acquire the same number of shares of the

company’s common stock at an exercise price of $50 per share. The option vest at the end of 3 years and expire at

the end of 10 years. The estimated value of the stock options expected to be exercised is $140,871. Page 785


Fixed Stock Option Plan with Cliff Vesting

39

Fixed Stock Option Plan with Cliff Vesting

At the end of 2008, Fox changes the estimated forfeiture rate to 6%.

At the end of 2009, a total of 7,500 stock options for 25 employees actually vest and the other 1,500 are forfeited.

40

Fraction of service period expired x 1/3 x 2/3 x 3/3 Est. compensation expense to date$46,957 $85,467 $128,625 Previously recognized com. exp. (0) (46,957) (85,467)Current compensation expense $46,957 $38,510 $43,158

300 x (30 employees x 0.97 x 0.97 x 0.97) x $17.15

(fair value per option)

300 x (30 employees x 0.97 x 0.97 x 0.97) x $17.15

(fair value per option) 300 x (30 employees x 0.94 x 0.94 x 0.94) x $17.15


300 x (30 employees x 0.94 x 0.94 x 0.94) x $17.15


300 x 25 x $17.15300 x 25 x $17.15300 x 25 x $17.15300 x 25 x $17.15

2007 2008 2009

Estimated (actual) total compensation cost $140,871 $128,201 128,625

Fixed Compensatory Stock Option Plan

41

On December 31, 2007, Fox Corporation records On December 31, 2007, Fox Corporation records the compensation expense by multiplying the the compensation expense by multiplying the

$140,871 by the fraction of the service period that $140,871 by the fraction of the service period that expired.expired.

On December 31, 2007, Fox Corporation records On December 31, 2007, Fox Corporation records the compensation expense by multiplying the the compensation expense by multiplying the

$140,871 by the fraction of the service period that $140,871 by the fraction of the service period that expired.expired.

Compensation Expense 46,957Common Stock Option Warrants 46,957 (Additional Paid-in-Capital)

ContinuedContinuedContinuedContinued$140,871 x 1/3$140,871 x 1/3


42

Based on new estimations, at the end of 2008 Fox Based on new estimations, at the end of 2008 Fox Corporation revises total compensation cost to Corporation revises total compensation cost to

$128,201 [$17.15 x (9,000 x 0.94 x 0.94 x 0.94)]. Two-$128,201 [$17.15 x (9,000 x 0.94 x 0.94 x 0.94)]. Two-thirds of $128,201, or $85,467, has expired. Fox thirds of $128,201, or $85,467, has expired. Fox

previously recorded $46,957 in 2004, so a “catch-up” previously recorded $46,957 in 2004, so a “catch-up” entry is needed ($85,467 - $46,957 = $38,510).entry is needed ($85,467 - $46,957 = $38,510).

Based on new estimations, at the end of 2008 Fox Based on new estimations, at the end of 2008 Fox Corporation revises total compensation cost to Corporation revises total compensation cost to

$128,201 [$17.15 x (9,000 x 0.94 x 0.94 x 0.94)]. Two-$128,201 [$17.15 x (9,000 x 0.94 x 0.94 x 0.94)]. Two-thirds of $128,201, or $85,467, has expired. Fox thirds of $128,201, or $85,467, has expired. Fox

previously recorded $46,957 in 2004, so a “catch-up” previously recorded $46,957 in 2004, so a “catch-up” entry is needed ($85,467 - $46,957 = $38,510).entry is needed ($85,467 - $46,957 = $38,510).

Compensation Expense 38,510Common Stock Option Warrants 38,510



43

On January 5, 2010, one employee exercises On January 5, 2010, one employee exercises options to purchase 300 shares of Fox options to purchase 300 shares of Fox

Corporation’s $10 par common stock. On this Corporation’s $10 par common stock. On this date the stock is selling for $70 per share. Fair date the stock is selling for $70 per share. Fair

market value of warrants, $17.15.market value of warrants, $17.15.

On January 5, 2010, one employee exercises On January 5, 2010, one employee exercises options to purchase 300 shares of Fox options to purchase 300 shares of Fox

Corporation’s $10 par common stock. On this Corporation’s $10 par common stock. On this date the stock is selling for $70 per share. Fair date the stock is selling for $70 per share. Fair

market value of warrants, $17.15.market value of warrants, $17.15.

Cash 15,000Common Stock Option Warrants 5,145

Common Stock, $10 par 3,000Additional Paid-in Capital on Common Stock 17,145

300 x $17.15300 x $17.15300 x $17.15300 x $17.15


44

Performance-Based Stock Option Plan

A performance-based plan is set up so that the

terms will vary depending on how well the selected

employee performs.

A performance-based plan is set up so that the

terms will vary depending on how well the selected

employee performs.

In other words, the better the employee

manages the corporation, the better the terms.

In other words, the better the employee

manages the corporation, the better the terms.

45

The terms for the stock option plan are the same as before except Fox grants each of the 30 selected

employees a maximum of 300 stock options.

The terms for the stock option plan are the same as before except Fox grants each of the 30 selected

employees a maximum of 300 stock options.

1. If the market share has increased 5 percent, at least 100 stock options will vest on that date.

2. If the market share has increased by at least 10 percent, another 100 stock options will vest.

3. If the market share has increased by more than 20%, all 300 stock options will vest.

Assume the option plan depends on the increase in market share of Fox’s products over the 3-year

service period. The terms are as follows for each employee:

Assume the option plan depends on the increase in market share of Fox’s products over the 3-year

service period. The terms are as follows for each employee:


46

Based on new estimations, at the end of 2008 Fox Based on new estimations, at the end of 2008 Fox Corporation changes the employee forfeiture rate to Corporation changes the employee forfeiture rate to

6%. At the end of 2009, 25 employees vest 7,500 stock 6%. At the end of 2009, 25 employees vest 7,500 stock options.options.

Based on new estimations, at the end of 2008 Fox Based on new estimations, at the end of 2008 Fox Corporation changes the employee forfeiture rate to Corporation changes the employee forfeiture rate to

6%. At the end of 2009, 25 employees vest 7,500 stock 6%. At the end of 2009, 25 employees vest 7,500 stock options.options.


On the grant date, Fox estimates that its market share will increase between 10 and 20 %, so it

assumes that 200 options will vest per employee.

On the grant date, Fox estimates that its market share will increase between 10 and 20 %, so it

assumes that 200 options will vest per employee.

Performance-Based Stock Option Plans

47

200 x (30 employees x 0.97 x 0.97 x 0.97) x $17.15


200 x (30 employees x 0.97 x 0.97 x 0.97) x $17.15

(fair value per option) 200 x (30 employees x 0.94 x 0.94 x 0.94) x $17.15


200 x (30 employees x 0.94 x 0.94 x 0.94) x $17.15


300 x 25 x $17.15300 x 25 x $17.15300 x 25 x $17.15300 x 25 x $17.15

2007 2008 2009

Estimated (actual) total compensation cost $93,914 $85,467 128,625 Fraction of service period expired x 1/3 x 2/3 x 3/3 Est. compensation expense to date$31,305 $56,978 $128,625 Previously recognized com. exp. (0) (31,305) (56,978)Current compensation expense $31,305 $25,673 $ 71,647


48

Although compensatory stock option plans provide selected employees with the opportunity to acquire shares of stock with a market value in excess of the option price, these plans have some disadvantages. At the time of the exercise, the employee must have

sufficient cash to pay the option price and any income taxes.

Although compensatory stock option plans provide selected employees with the opportunity to acquire shares of stock with a market value in excess of the option price, these plans have some disadvantages. At the time of the exercise, the employee must have

sufficient cash to pay the option price and any income taxes.

In certain situations, this places a significant cash flow burden on the employee. Share appreciation

rights enable the employee to receive cash, stock or a combination of both for the excess of the market

value over a stated price .

In certain situations, this places a significant cash flow burden on the employee. Share appreciation

rights enable the employee to receive cash, stock or a combination of both for the excess of the market

value over a stated price .

Share Appreciation Rights

49

A company accounts for share appreciation rights using the fair value method. Because the fair

value can only be determined on the exercise date, the company must estimate the compensation cost at the end of each year based on the fair value of

the SARs at that time.

A company accounts for share appreciation rights using the fair value method. Because the fair

value can only be determined on the exercise date, the company must estimate the compensation cost at the end of each year based on the fair value of

the SARs at that time.

Additional changes to expense are made each year until the rights are exercised.

Additional changes to expense are made each year until the rights are exercised.


50


Assume that on January 1, 2006, when the market price is $60 per share, Wolf

Corporation grants 1,000 share appreciation rights to one employee. The employee will receive cash for the excess between $60 and the quoted price on the

date of exercise. The service period is four years and the rights must be exercised

within ten years. The SARs are valued at $19 on the date of the grant.

51

Example 16-3

The employee exercises the rights on December 31, 2010, when the market price is $94.

The employee exercises the rights on December 31, 2010, when the market price is $94.

52

Example 16-3

Dec. 31 Compensation Expense 10,000 SAR Compensation Payable 10,000

2006

2010Dec. 31 Compensation Expense 8,000

SAR Compensation payable 26,000 Cash 34,000

53

Additional Disclosures About a Compensatory

Stock Option Plan 1. A description of the plan, including the general

terms.

2. The number and weighted-average exercise prices for options granted, exercised, outstanding, forfeited, and expired during the year.

3. The weighted-average grant-date fair values of options granted during the year.

4. A description of the method and assumptions used during the year to estimate the fair values of options.

5. The total compensation cost of the plan for the year.

54

Various Preferred Stock Characteristics

Preference as to dividends.Accumulation of dividends.Participation in excess dividends.Convertibility into common stock.Attachment of stock warrants (rights).Callability by the corporation.Redemption at a future maturity date.Preference as to assets upon liquidation of the

corporation. (no journal entry)Lack of voting rights.

55

Cumulative Preferred Stock

On cumulative preferred stock, if a corporation fails to declare adequate

dividends at the usual date, the amount of passed dividends becomes dividends in

arrears. These dividends accumulate and dividends cannot be paid to common

shareholders until all preferred dividends in arrears are paid.

On cumulative preferred stock, if a corporation fails to declare adequate

dividends at the usual date, the amount of passed dividends becomes dividends in

arrears. These dividends accumulate and dividends cannot be paid to common

shareholders until all preferred dividends in arrears are paid.

56


Dividends in arrears are not a liability because they have not

been declared, but must be disclosed in the footnotes to the

financial statements.

Dividends in arrears are not a liability because they have not

been declared, but must be disclosed in the footnotes to the

financial statements.

57


Richland Corporation has outstanding 1,000 shares of 10%, $100 par cumulative preferred stock. The dividends are two years in arrears when a $30,000

dividend is declared. Preferred stockholders would receive all of it.

Richland Corporation has outstanding 1,000 shares of 10%, $100 par cumulative preferred stock. The dividends are two years in arrears when a $30,000

dividend is declared. Preferred stockholders would receive all of it.

1,000 shares x $100 x 0.10 x 3 years = $30,000

58


Total Preferred CommonYear Dividends Dividends Dividends Arrears

1 $5,000 $5,000 0 $5,000

2 $11,000 $11,000 0 $4,000

3 $30,000 $14,000 $16,000 0

4 $30,000 $10,000 $20,000 0

Total Preferred CommonYear Dividends Dividends Dividends Arrears

1 $5,000 $5,000 0 $5,000

2 $11,000 $11,000 0 $4,000

3 $30,000 $14,000 $16,000 0

4 $30,000 $10,000 $20,000 0

Assume total dividends of $5,000, $11,000, $30,000 and $30,000 on the 10% cumulative preferred stock

with a par of $100,000.

Assume total dividends of $5,000, $11,000, $30,000 and $30,000 on the 10% cumulative preferred stock

with a par of $100,000.

59

Convertible Preferred Stock

Convertible preferred stock allows stockholders to

convert preferred stock into another security, usually

common stock.

Convertible preferred stock allows stockholders to

convert preferred stock into another security, usually

common stock.

60


Since corporations may not show a gain or loss by trading in their own stock, the book value method must

be used.

Since corporations may not show a gain or loss by trading in their own stock, the book value method must

be used.

No value is assigned to the convertible

feature.

No value is assigned to the convertible

feature.

61

Ness Corporation originally issued 500 shares of $100 par convertible preferred stock at $120 per

share. Each share of preferred stock may be converted into four shares of $20 par common stock.

Ness Corporation originally issued 500 shares of $100 par convertible preferred stock at $120 per

share. Each share of preferred stock may be converted into four shares of $20 par common stock.

Preferred Stock, $100 par 50,000Additional Paid-in Capital on Preferred Stock 10,000

Common Stock, $20 par 40,000Additional Paid-in Capital from Preferred Stock Conversion 20,000



62

Alternatively, assume each preferred share may be converted into seven shares of common stock.

Alternatively, assume each preferred share may be converted into seven shares of common stock.

Preferred Stock, $100 par 50,000Additional Paid-in Capital on Preferred Stock 10,000Retained Earnings 10,000

Common Stock, $20 par 70,000


63

Preferred Stock with Stock Warrants

A corporation may attach warrants to preferred stock to

enhance their attractiveness.

A corporation may attach warrants to preferred stock to

enhance their attractiveness.

These warrants represent rights to

purchase additional common shares at a specified price in the

future.

These warrants represent rights to

purchase additional common shares at a specified price in the

future.

64

Preferred Stock with Stock Warrants

The corporation is actually selling two different securities, preferred stock and

warrants.

The corporation is actually selling two different securities, preferred stock and

warrants.

Therefore, the proceeds must be

allocated to the two securities based upon

their fair values.

Therefore, the proceeds must be

allocated to the two securities based upon

their fair values.

65

Preferred Stock with Stock Warrants (Rights)

Ponce Corporation issues 1,000 shares of $100 par value preferred stock at a price of $121 per share. It attaches a warrant to each share of stock that allows the holder to purchase one share of $10 par common

stock at $40 per share. Immediately after the issuance, the preferred stock begins selling ex rights

for $119 per share and the warrants for $6 each.

Ponce Corporation issues 1,000 shares of $100 par value preferred stock at a price of $121 per share. It attaches a warrant to each share of stock that allows the holder to purchase one share of $10 par common

stock at $40 per share. Immediately after the issuance, the preferred stock begins selling ex rights

for $119 per share and the warrants for $6 each.

Preferred Stock: x $121,000 = $115,192$119,000

$119,000 + $6,000Common Stock

Warrants:$6,000

$119,000 + $6,000x $121,000 = 5,808


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When issuedWhen issued

Cash ($121 x 1,000) 121,000Preferred Stock, $100 par 100,000Additional Paid-in-Capital on Preferred Stock 15,192Common Stock Warrants (equity) 5,808


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All warrants are exercised.All warrants are exercised.

Cash ($40 x 1,000) 40,000Common Stock Warrants 5,808

Common Stock, $10 par 10,000

Additional Paid-in Capital on Common Stock 35,808


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Callable Preferred Stock

Callable preferred stock may be retired under

specified conditions by a corporation at its option.

Callable preferred stock may be retired under

specified conditions by a corporation at its option.

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Preferred Stock, $100 par 100,000Additional Paid-in Capital on

Preferred Stock 10,000Retained Earnings 2,000

Cash 112,000

Li Corporation has outstanding 1,000 shares of $100 par callable preferred stock that were

issued at $110 per share and no dividends are in arrears. The call price is $112 per share.




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Preferred Stock, $100 par 100,000Additional Paid-in Capital on Preferred Stock 10,000

Cash 105,000Additional Paid-in Capital from Recall of Preferred Stock 5,000






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Contributed Capital SectionStockholders’ EquityContributed Capital:

Preferred stock, $100 par (9%, cumulative, convertible, 10,000 shares authorized, 4,300 shares issued and outstanding) $430,000Common stock, $5 par (80,000 shares authorized, 32,800 shares issued and outstanding) 164,000Common stock subscribed, $5 par (3,600 shares at a subscription price of $34 per share) 18,000Common stock option warrants 23,000Additional paid-in capital on preferred stock 107,500Additional paid-in capital on common stock 590,400Additional paid-in capital from conversion of p.s. 10,100

Total Contributed Capital $1,343,000

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Treasury Stock

has been fully paid for by stockholders,

has been legally issued,

is reacquired by the corporation, and

is being held by the corporation for future reissuance.

Treasury stock is a corporation’s own capital stock that...

Treasury stock is a corporation’s own capital stock that...

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Reasons for Treasury Stock

To use for stock options, bonuses, and employee purchase plans

To use for convertible bonds and preferred stock

To use excess cash instead of paying dividendsTo use in acquiring other companiesTo reduce outstanding shares and increase EPSTo buy out hostile shareholdersTo use for stock dividends

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Cost MethodCost Method

Ball issues 6,000 shares of $10 par common stock for $12 per share:

Ball issues 6,000 shares of $10 par common stock for $12 per share:

Cash 72,000Common Stock $10 par 60,000Additional Paid-in Capital on Common Stock 12,000

Treasury Stock

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Reacquisition of 1,000 shares of common stock at $13 per share:


Treasury Stock 13,000Cash 13,000

Treasury Stock

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Reissuance of 600 shares of treasury stock at $15 per share:


Cash 9,000Treasury Stock 7,800Additional Paid-in Capital from Treasury Stock 1,200

Treasury Stock

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Reissuance of another 200 shares of treasury stock at $8 per share:


Cash 1,600Additional Paid-in Capital from Treasury Stock 1,000

Treasury Stock 2,600

Treasury Stock

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Reissuance of another 100 shares of treasury Reissuance of another 100 shares of treasury stock at $10 per share:stock at $10 per share:

Reissuance of another 100 shares of treasury Reissuance of another 100 shares of treasury stock at $10 per share:stock at $10 per share:

Cash 1,000Additional Paid-in Capital from Treasury Stock 200Retained Earnings 100


Treasury Stock

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Contributed Capital:Common stock, $10 par (20,000 shares authorized, 6,000 shares issued , of which 100 are being held in treasury) $ 60,000 Additional paid-in capital on common stock 12,000 Total contributed capital $ 72,000

Retained earnings 39,900 Accumulated other comprehensive income 10,000 Total contributed capital, retained earnings, and $121,900 accumulated other comprehensive income Less: Treasury stock (100 shares at cost) (1,300)Total Stockholders’ Equity $120,600

Treasury Stock

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Par Value MethodPar Value MethodPar Value MethodPar Value Method

Issuance of 6,000 shares of $10 par common stock for $12 per share:

Issuance of 6,000 shares of $10 par common stock for $12 per share:

Cash 72,000Common Stock $10 par 60,000Additional Paid-in Capital on Common Stock 12,000

Treasury Stock

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Treasury Stock 10,000Additional Paid-in Capital on Common Stock 2,000Retained Earnings 1,000

Cash 13,000

Treasury Stock

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Cash 9,000Treasury Stock 6,000Additional Paid-in Capital on Common Stock 3,000

Treasury Stock

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Cash 1,600Additional Paid-in Capital on Common Stock 400


Treasury Stock

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Cash 1,000Treasury Stock 1,000

Par Value MethodPar Value Method

Treasury Stock

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Par Value MethodPar Value Method

Contributed Capital:Common stock, $10 par (20,000 shares authorized, 6,000 shares issued) $ 60,000 Less: Treasury stock (100 shares at par) (1,000)Common stock outstanding (5,900 shares) $ 59,000 Additional paid-in capital on common stock 12,600 Total contributed capital $ 71,600

Retained earnings 39,000 Accumulated other comprehensive income 10,000 Total Stockholders’ Equity $120,600

Treasury Stock

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Conceptual Overview of Treasury Stock

1. Treasury stock is not an asset.2. Treasury stock does not vote, has no

preemptive rights, ordinarily does not share in dividends, or participate in the company’s liquidation assets, but does participate in stock splits.

3. Treasury stock transactions do not result in gains or losses.


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4. Treasury stock transactions may reduce retained earnings, but may never increase it.

5. Retained earnings usually must be restricted regarding dividends when treasury stock is held.

6. Total corporate stockholders’ equity is not affected by whether cost or par value method is used.

Conceptual Overview of Treasury Stock

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Retirement of Treasury Stock

Occasionally, a board of directors may decide to

retire treasury stock and reduce the legal capital

Occasionally, a board of directors may decide to

retire treasury stock and reduce the legal capital

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Retirement of Treasury Stock

Ball Corporation decides to retire the remaining 100 shares of stock.

Ball Corporation decides to retire the remaining 100 shares of stock.

Cost MethodCost MethodCost MethodCost Method


Common Stock, $10 par 1,000Additional Paid-in-Capital($2 per share) 200Retained Earnings (plug) 100


Common Stock, $10 par 1,000Treasury Stock 1,000

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Some preferred stock may either be subject to mandatory redemption at a specified future

date for a specified price, or redeemable at the option of the holder.

Preferred stock, which the company must redeem by transferring its assets at a specified or

determinable date, or upon an event certain to occur, must be reported as a liability. This stock is reported at its fair value, with any

changes in fair value recognized in earnings.

Redeemable Preferred Stock

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A few companies have issued redeemable common stock that require the company to repurchase a fixed number of these shares on a specified date in exchange for cash.

These equity securities are also reported as a liability. Its issuance also has an effect on the calculation of the

company’s basic and diluted earnings per share. FASB Statement No. 150 (par. 25) requires a company to exclude these redeemable common shares from the calculations of

both its basic and diluted earnings per share.Disclosures

A company with redeemable preferred (and common) stock must disclose (par. 26) the nature and terms of this stock, as well as the rights and obligations related to this stock.

Redeemable Common Stock

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Chapter16

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