Reporting and Analyzing Stockholders’ Equity

Reporting and Analyzing Stockholders’ Equity

 CHAPTER PREVIEW 

Corporations like Facebook and Google have substantial resources at their disposal. In fact, the corporation is the dominant form of business organization in the United States in terms of sales, earnings, and number of employees. All of the 500 largest U.S. companies are corporations. In this chapter, we look at the essential features of a corporation and explain the accounting for a corporation’s capital stock transactions.

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Oh Well, I Guess I’ll Get Rich

Suppose you started one of the fastest-growing companies in the history of business. Now suppose that by “going public”—issuing stock of your company to outside investors who are foaming at the mouth for the chance to buy its shares—you would instantly become one of the richest people in the world. Would you hesitate?

That is exactly what Mark Zuckerberg, the founder of Facebook, did. Many people who start high-tech companies go public as soon as possible to cash in on their riches. But Zuckerberg was reluctant to do so. To understand why, you need to understand the advantages and disadvantages of being a public company.

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. But why not go public anyway, so the company would have some extra cash on hand—and so you personally get rich? As head of a closely held, nonpublic company, Zuckerberg was subject to far fewer regulations than a public company. Prior to going public, Zuckerberg could basically run the company however he wanted to.

For example, early in 2012, Facebook shocked the investment community by purchasing the photo- sharing service Instagram. The purchase was startling both for its speed (over a weekend) and price ($1 billion). Zuckerberg basically didn’t seek anyone’s approval. He thought it was a good idea, so he just did it. The structured decision-making process of a public company would make it very dif�icult for a public company to move that fast.

Speed is useful, but it is likely that Facebook will make even bigger acquisitions in the future. To survive among the likes of Microsoft, Google, and Apple, it needs lots of cash. To raise that amount of money, the company really needed to go public. So in 2012, Mark Zuckerberg reluctantly made Facebook a public company, thus becoming one of the richest people in the world.

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LEARNING OBJECTIVE 1

Discuss the major characteristics of a corporation. 

A corporation is created by law. As a legal entity, a corporation has most of the rights and privileges of a person. The major exceptions relate to privileges that can be exercised only by a living person, such as the right to vote or to hold public of�ice. Similarly, a corporation is subject to the same duties and responsibilities as a person. For example, it must abide by the law and it must pay taxes.

We can classify corporations in a variety of ways. Two common classi�ications are by purpose and by ownership. A corporation may be organized for the purpose of making a pro�it (such as Facebook or General Motors), or it may be a nonpro�it charitable, medical, or educational corporation (such as the Salvation Army or the American Cancer Society).

Classi�ication by ownership differentiates publicly held and privately held corporations. A publicly held corporation may have thousands of stockholders, and its stock is traded on a national securities market such as the New York Stock Exchange. Examples are IBM, Caterpillar, and General Electric. In contrast, a privately held corporation, often referred to as a closely held corporation, usually has only a few stockholders and does not offer its stock for sale to the general public. Privately held companies are generally much smaller than publicly held companies although some notable exceptions exist. Before going public, Facebook was one example. Also, Cargill Inc., a private corporation that trades in grain and other commodities, is one of the largest companies in the United States. This chapter deals primarily with issues related to publicly held companies.

DECISION TOOLS

Understanding the costs and bene�its of different types of business organizations helps managers determine if incorporating is in the best interest of the company.

CHARACTERISTICS OF A CORPORATION Many businesses start as partnerships or sole proprietorships but eventually convert to the corporate form. For example, Nike’s founders formed their original organization as a partnership. In 1968, they reorganized the company as a corporation. A number of characteristics distinguish a corporation from sole proprietorships and partnerships. The most important of these characteristics are explained below.

Separate Legal Existence

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As an entity separate and distinct from its owners, the corporation acts under its own name rather than in the name of its stockholders. Facebook, for example, buys, owns, and sells property; borrows money; and enters into legally binding contracts in its own name. It may also sue or be sued. It pays taxes as a separate entity.

In a partnership, the acts of the owners (partners) bind the partnership. In contrast, the acts of corporate owners (stockholders) do not bind the corporation unless such owners are agents of the corporation. For example, if you own shares of Facebook stock, you do not have the right to purchase inventory for the company unless you are also designated as an agent of the corporation.

Limited Liability of Stockholders

Since a corporation is a separate legal entity, creditors ordinarily have recourse only to corporate assets to satisfy their claims. The liability of stockholders is normally limited to their investment in the corporation. Creditors have no legal claim on the personal assets of the stockholders unless fraud has occurred. Thus, even in the event of bankruptcy of the corporation, stockholders’ losses are generally limited to the amount of capital they have invested in the corporation.

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Transferable Ownership Rights

Ownership of a corporation is held in shares of capital stock, which are transferable units. Stockholders may dispose of part or all of their interest in a corporation simply by selling their stock. The transfer of an ownership interest in a partnership requires the consent of each partner. In contrast, the transfer of stock is entirely at the discretion of the stockholder. It does not require the approval of either the corporation or other stockholders.

The transfer of ownership rights among stockholders normally has no effect on the operating activities of the corporation. Nor does it affect the corporation’s assets, liabilities, and total stockholders’ equity. The transfer of ownership rights is a transaction between individual owners. The company does not participate in the transfer of these ownership rights after the original sale of the capital stock.

Ability to Acquire Capital

It is relatively easy for a corporation to obtain capital through the issuance of stock. Buying stock in a corporation is often attractive to an investor because a stockholder has limited liability and shares of stock are readily transferable. Also, numerous individuals can become stockholders by investing small amounts of money.

Continuous Life

The life of a corporation is stated in its charter. The life may be perpetual or it may be limited to a speci�ic number of years. If it is limited, the company extends the period of existence through renewal of the charter. Since a corporation is a separate legal entity, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or of�icer. As a result, a successful corporation can have a continuous and perpetual life.

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Corporation Management

Although stockholders legally own the corporation, they manage it indirectly through a board of directors they elect. Mark Zuckerberg is the chairman of Facebook’s board of directors. The board, in turn, formulates the operating policies for the company. The board also selects of�icers, such as a president and one or more vice presidents, to execute policy and to perform daily management functions. As a result of the Sarbanes-Oxley Act, the board is required to monitor management’s actions closely. Many feel that the failures at Enron, WorldCom, and more recently MF Global could have been avoided by more diligent boards.

Illustration 11-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo1#c11-�ig-0001) presents a typical organization chart showing the delegation of responsibility.

ILLUSTRATION 11-1 Corporation organization chart

The chief executive of�icer (CEO) has overall responsibility for managing the business. As the organization chart shows, the CEO delegates responsibility to other of�icers. The chief accounting of�icer is the controller. The controller (1) maintains the accounting records, (2) ensures an adequate system of internal control, and (3) prepares �inancial statements, tax returns, and internal reports. The treasurer has custody of the corporation’s funds and oversees the company’s cash position.

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The organizational structure of a corporation enables a company to hire professional managers to run the business. On the other hand, the separation of ownership and management often reduces an owner’s ability to actively manage the company.

ETHICS NOTE

Managers who are not owners are often compensated based on the performance of the company. They thus may be tempted to exaggerate company performance by in�lating income �igures.

Government Regulations

A corporation is subject to numerous state and federal regulations. For example, state laws usually prescribe the requirements for issuing stock, the distributions of earnings permitted to stockholders, and acceptable methods for buying back and retiring stock. Federal securities laws govern the sale of capital stock to the general public. Also, publicly held corporations must disclose their �inancial affairs to the Securities and Exchange Commission (SEC) through quarterly and annual reports (Forms 10Q and 10K). The Sarbanes-Oxley Act increased the company’s responsibility for the accuracy of these reports. In addition, when a corporate stock is listed and traded on organized securities exchanges, the corporation must comply with the reporting requirements of these exchanges.

PEOPLE, PLANET, AND PROFIT INSIGHT The Impact of Corporate Social Responsibility

A survey conducted by Institutional Shareholder Services, a proxy advisory �irm, shows that 83% of investors now believe environmental and social factors can signi�icantly impact shareholder value over the long term. This belief is clearly visible in the rising level of support for shareholder proposals requesting action related to social and environmental issues.

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The following table shows that the number of corporate social responsibility (CSR) related shareholder proposals rose from 150 in 2000 to 191 in 2010. Moreover, those proposals received average voting support of 18.4% of votes cast versus just 7.5% a decade earlier.

Trends in Shareholder Proposals on Corporate Responsibility 2000 2005 2010 Number of proposals voted 150 155 191 Average voting support 7.5% 9.9% 18.4% Percent proposals receiving >10% support 16.7% 31.2% 52.1%

Source: Investor Responsibility Research Center, Ernst & Young, Seven Questions CEOs and Boards Should Ask About: “Triple Bottom Line” Reporting.

Why are CSR-related shareholder proposals increasing? (Go to WileyPLUS for this answer and additional questions.)

Additional Taxes

Owners of proprietorships and partnerships report their share of earnings on their personal income tax returns. The individual owner then pays taxes on this amount. Corporations, on the other hand, must pay federal and state income taxes as a separate legal entity. These taxes can be substantial. They can amount to as much as 40% of taxable income.

In addition, stockholders are required to pay taxes on cash dividends. Thus, many argue that corporate income is taxed twice (double taxation)—once at the corporate level and again at the individual level.

Illustration 11-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo1#c11-�ig-0002) shows the advantages and disadvantages of a corporation compared to a sole proprietorship and partnership.

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ILLUSTRATION 11-2 Advantages and disadvantages of a corporation

Other Forms of Business Organization

A variety of “hybrid” organizational forms—forms that combine different attributes of partnerships and corporations—now exist. For example, one type of corporate form, called an S corporation, allows for legal treatment as a corporation but tax treatment as a partnership—that is, no double taxation. Because of changes to the S corporation’s rules, more small- and medium-sized businesses now may choose S corporation treatment. One of the primary criteria is that the company cannot have more than 100 shareholders. Other forms of organization include limited partnerships, limited liability partnerships (LLPs), and limited liability companies (LLCs).

FORMING A CORPORATION A corporation is formed by grant of a state charter. The charter is a document that describes the name and purpose of the corporation, the types and number of shares of stock that are authorized to be issued, the names of the individuals that formed the company, and the number of shares that these individuals agreed to purchase. Regardless of the number of states in which a corporation has operating divisions, it is incorporated in only one state. It is to the company’s advantage to incorporate in a state whose laws are favorable to the corporate form of business organization. For example, although Facebook has its headquarters in California, it is incorporated in Delaware. In fact, more and more corporations have been incorporating in states with rules that favor existing management. For example, Gulf Oil changed its state of incorporation to Delaware to thwart possible unfriendly takeovers. There, certain defensive tactics against takeovers can be approved by the board of directors alone, without a vote by shareholders.

Upon receipt of its charter from the state of incorporation, the corporation establishes by-laws. The by- laws establish the internal rules and procedures for conducting the affairs of the corporation. Corporations engaged in interstate commerce must also obtain a license from each state in which they do business. The license subjects the corporation’s operating activities to the general corporation laws of the state.

STOCKHOLDER RIGHTS When chartered, the corporation begins selling shares of stock. When a corporation has only one class of stock, it is identi�ied as common stock. Each share of common stock gives the stockholder the ownership rights pictured in Illustration 11-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo1#c11-�ig-0003) (page 542). The articles of incorporation or the by-laws state the ownership rights of a share of stock.

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Proof of stock ownership is evidenced by a printed or engraved form known as a stock certi�icate. As shown in Illustration 11-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo1#c11-�ig-0004) (page 542), the face of the certi�icate shows the name of the corporation, the stockholder’s name, the class and special features of the stock, the number of shares owned, and the signatures of authorized corporate of�icials. Certi�icates are prenumbered to ensure proper control over their use; they may be issued for any quantity of shares.

ILLUSTRATION 11-3 Ownership rights of stockholders

ILLUSTRATION 11-4 A stock certi�icate

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STOCK ISSUE CONSIDERATIONS Although Facebook incorporated in 2004, it did not sell stock to the public until 2012. At that time, Facebook evidently decided it would bene�it from the infusion of cash that a public sale of its shares would bring. When a corporation decides to issue stock, it must resolve a number of basic questions: How many shares should it authorize for sale? How should it issue the stock? What value should it assign to the stock? We address these questions in the following sections.

Authorized Stock

Authorized stock is the amount of stock that a corporation is authorized to sell as indicated in its charter. If the corporation has sold all of its authorized stock, then it must obtain permission from the state to change its charter before it can issue additional shares.

The authorization of common stock does not result in a formal accounting entry. The reason is that the event has no immediate effect on either corporate assets or stockholders’ equity. However, the corporation discloses in the stockholders’ equity section of the balance sheet the number of shares authorized. Facebook, for example, has approximately 9 billion authorized shares.

Issuance of Stock

A corporation can issue common stock directly to investors. Alternatively, it can issue common stock indirectly through an investment banking �irm that specializes in bringing securities to the attention of prospective investors. Direct issue is typical in closely held companies. Indirect issue is customary for a publicly held corporation.

New issues of stock may be offered for sale to the public through various organized U.S. or foreign securities exchanges. Five of the largest exchanges by value of shares traded are the New York Stock Exchange, Nasdaq stock market, London Stock Exchange, Tokyo Stock Exchange, and Euronext.

ANATOMY OF A FRAUD

The president, chief operating of�icer, and chief �inancial of�icer 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 pro�it from exercising the options to $90 per share.

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Total take: $1.7 million

THE MISSING CONTROL

Independent internal veri�ication. The company’s board of directors should have ensured that the awards were properly administered. For example, the date on the minutes from the board meeting should be compared to the dates that were recorded for the awards. In addition, the dates should again be con�irmed upon exercise.

INTERNATIONAL NOTE U.S. and U.K. corporations raise most of their capital through millions of outside shareholders and bondholders. In contrast, companies in Germany, France, and Japan acquire �inancing mostly from large banks or other �inancial institutions. Consequently, in the latter environment, shareholders are somewhat less important.

Par and No-Par Value Stocks

Par value stock is capital stock that has been assigned a value per share in the corporate charter. Years ago, par value determined the legal capital that must be retained in the business for the protection of corporate creditors. That amount is not available for withdrawal by stockholders. Thus, in the past, most states required the corporation to sell its shares at par or above.

However, the usefulness of par value as a device to protect creditors was limited because par value was often immaterial relative to the value of the company’s stock in the securities markets—even at the time of issue. For example, Facebook’s par value is $0.000006 per share, yet its market price recently was $84. Thus, par has no relationship with market price. In the vast majority of cases, it is an immaterial amount. As a consequence, today many states do not require a par value. Instead, they use other means to protect creditors.

No-par value stock is capital stock that has not been assigned a value in the corporate charter. No-par value stock is fairly common today. For example, Nike and Procter & Gamble both have no-par stock. In many states, the board of directors assigns a stated value to the no-par shares.

CORPORATE CAPITAL Owners’ equity is identi�ied by various names: stockholders’ equity, shareholders’ equity, or corporate capital. The stockholders’ equity section of a corporation’s balance sheet consists of two parts: (1) paid-in (contributed) capital and (2) retained earnings (earned capital).

The distinction between paid-in capital and retained earnings is important from both a legal and a �inancial point of view. Legally, corporations can make distributions of earnings (declare dividends) out of

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retained earnings in all states. However, in many states they cannot declare dividends out of paid-in capital. Management, stockholders, and others often look to retained earnings for the continued existence and growth of the corporation.

Paid-in Capital

Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock. As noted earlier, when a corporation has only one class of stock, it is common stock.

Retained Earnings

Retained earnings is net income that a corporation retains in the business. Net income is recorded in Retained Earnings by a closing entry that debits Income Summary and credits Retained Earnings. Similarly, the Retained Earnings account is reduced by dividends (both cash dividends and stock dividends) by a closing entry that debits Retained Earnings and credits Dividends.

DO IT! 1

Corporate Organization

Indicate whether each of the following statements is true or false. If false, indicate how to correct the statement.

__ 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.

Action Plan ✓ Review the characteristics of a corporation and understand

which are advantages and which are disadvantages.

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✓ Understand that corporations raise capital through the issuance of stock, which can be par or no-par.

SOLUTION

1. False. The liability of stockholders is normally limited to their investment in the corporation.
2. True.
3. False. The separation of ownership and management is a disadvantage of the corporate form of business.
4. False. The authorization of capital stock does not result in a formal accounting entry.
5. False. Many states do not require a par value.

Related exercise material: BE11-1 and DO IT! 11-1.

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LEARNING OBJECTIVE 2

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

ACCOUNTING FOR COMMON STOCK Let’s now look at how to account for new issues of common stock. The primary objectives in accounting for the issuance of common stock are (1) to identify the speci�ic sources of paid-in capital and (2) to maintain the distinction between paid-in capital and retained earnings. As shown below, the issuance of common stock affects only paid-in capital accounts.

▼ HELPFUL HINT

Stock is sometimes issued in exchange for services (payment to attorneys or consultants, for example) or for noncash assets (land or buildings). The value recorded for the shares issued is determined by either the market price of the shares or the value of the good or service received, depending upon which amount the company can more readily determine.

Issuing Par Value Common Stock for Cash

As discussed earlier, par value does not indicate a stock’s market price. The cash proceeds from issuing par value stock may be equal to, greater than, or less than par value. When a company records the issuance of common stock for cash, it credits the par value of the shares to Common Stock and records in a separate paid-in capital account the portion of the proceeds that is above or below par value.

To illustrate, assume that Hydro-Slide, Inc. issues 1,000 shares of $1 par value common stock at par for cash. The entry to record this transaction is as follows.

Now assume Hydro-Slide, Inc. issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share. The amount received above the par value, in this case $4 ($5−$1), would be credited to Paid-in Capital in Excess of Par Value. The entry is as follows.

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The total paid-in capital from these two transactions is $6,000. If Hydro-Slide, Inc. has retained earnings of $27,000, the stockholders’ equity section of the balance sheet is as shown in Illustration 11-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo2#c11-�ig-0005) .

ILLUSTRATION 11-5 Stockholders’ equity—paid-in capital in excess of par value

Some companies issue no-par stock with a stated value. For accounting purposes, companies treat the stated value in the same way as the par value. For example, if in our Hydro-Slide example the stock was no-par stock with a stated value of $1, the entries would be the same as those presented for the par stock except the term “Par Value” would be replaced with “Stated Value.” If a company issues no-par stock that does not have a stated value, then it credits to the Common Stock account the full amount received. In such a case, there is no need for the Paid-in Capital in Excess of Stated Value account.

ACCOUNTING FOR PREFERRED STOCK To appeal to a larger segment of potential investors, a corporation may issue an additional class of stock, called preferred stock. Preferred stock has contractual provisions that give it preference or priority over common stock in certain areas. Typically, preferred stockholders have a priority in relation to (1) dividends and (2) assets in the event of liquidation. However, they sometimes do not have voting rights. Facebook had 543 million preferred shares held by investors at the end of 2011, prior to going public. Approximately 6% of U.S. companies have one or more classes of preferred stock.

Like common stock, companies issue preferred stock for cash or for noncash consideration. The entries for these transactions are similar to the entries for common stock. When a corporation has more than one class of stock, each paid-in capital account title should identify the stock to which it relates (e.g., Preferred Stock, Common Stock, Paid-in Capital in Excess of Par Value—Preferred Stock, and Paid-in Capital in Excess of Par Value—Common Stock).

Assume that Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. The entry to record the issuance is as follows.

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Preferred stock has either a par value or no-par value. In the stockholders’ equity section of the balance sheet, companies show preferred stock �irst because of its dividend and liquidation preferences over common stock.

INVESTOR INSIGHT  

Facebook

How to Read Stock Quotes

Organized exchanges trade the stock of publicly held companies at dollar prices per share established by the interaction between buyers and sellers. For each listed security, the �inancial press reports the high and low prices of the stock during the year, the total volume of stock traded on a given day, the high and low prices for the day, and the closing market price, with the net change for the day. Facebook is listed on the Nasdaq exchange. Here is a recent listing for Facebook:

These numbers indicate the following. The high and low market prices for the last 52 weeks have been $86.07 and $54.66. The trading volume for the day was 54,156,600 shares. The high, low, and closing prices for that date were $85.59, $83.11, and $84.63, respectively. The net change for the day was a decrease of $0.629 per share.

For stocks traded on organized exchanges, how are the dollar prices per share established? What factors might in�luence the price of shares in the marketplace? (Go to WileyPLUS for this answer and additional questions.)

DO IT! 2a

Issuance of Stock

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Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 28, Cayman issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares.

Action Plan ✓ In issuing shares for cash, credit Common Stock for par value

per share.

✓ Credit any additional proceeds in excess of par to a separate paid-in capital account.

✓ For the cash equivalent price, use either the fair value of what is given up or the fair value of what is received, whichever is more clearly determinable.

Related exercise material: BE11-2, BE11-3, BE11-4, DO IT! 11-2a, E11-2, and E11-5.

TREASURY STOCK Treasury stock is a corporation’s own stock that has been reacquired by the corporation and is being held for future use. A corporation may acquire treasury stock for various reasons:

1. To reissue the shares to of�icers and employees under bonus and stock compensation plans.
2. To increase trading of the company’s stock in the securities market. Companies expect that buying their own stock will signal that management believes the stock is underpriced, which they hope will enhance its market price.
3. To have additional shares available for use in acquiring other companies.
4. To reduce the number of shares outstanding and thereby increase earnings per share.

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A less frequent reason for purchasing treasury shares is to eliminate hostile shareholders by buying them out.

Many corporations have treasury stock. For example, in the United States approximately 65% of companies have treasury stock. During one quarter, companies in the Standard & Poor’s 500-stock index spent a record of about $118 billion to buy treasury stock. In a recent year, Nike purchased more than 6 million treasury shares. At one point, stock repurchases were so substantial that a study by two Federal Reserve economists suggested that a sharp reduction in corporate purchases of treasury shares might result in a sharp drop in the value of the U.S. stock market.

Purchase of Treasury Stock

The purchase of treasury stock is generally accounted for by the cost method. This method derives its name from the fact that the Treasury Stock account is maintained at the cost of shares purchased. Under the cost method, companies increase (debit) Treasury Stock by the price paid to reacquire the shares. Treasury Stock decreases by the same amount when the company later sells the shares.

To illustrate, assume that on January 1, 2017, the stockholders’ equity section for Mead, Inc. has 100,000 shares of $5 par value common stock outstanding (all issued at par value) and retained earnings of $200,000. Illustration 11-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo2#c11-�ig-0006) shows the stockholders’ equity section of the balance sheet before purchase of treasury stock.

ILLUSTRATION 11-6 Stockholders’ equity with no treasury stock

On February 1, 2017, Mead acquires 4,000 shares of its stock at $8 per share. The entry is as follows.

The Treasury Stock account would increase by the cost of the shares purchased ($32,000). The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change.

Companies show treasury stock as a deduction from total paid-in capital and retained earnings in the stockholders’ equity section of the balance sheet. Illustration 11-7

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(http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo2#c11-�ig-0007) shows this presentation for Mead, Inc. Thus, the acquisition of treasury stock reduces stockholders’ equity.

ILLUSTRATION 11-7 Stockholders’ equity with treasury stock

Company balance sheets disclose both the number of shares issued (100,000) and the number in the treasury (4,000). The difference is the number of shares of stock outstanding (96,000). The term outstanding stock means the number of shares of issued stock that are being held by stockholders.

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 signi�icant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed that the 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 repurchased the shares to make it less likely that the company would be acquired by another company (in which case Reebok’s top managers would likely lose their jobs). Acquiring companies like to purchase companies with large cash reserves so they can pay off debt used in the acquisition. By depleting its cash through the purchase of treasury shares, Reebok became a less likely acquisition target.

DO IT! 2b

Treasury Stock

Santa Anita Inc. purchases 3,000 shares of its $50 par value common stock for $180,000 cash on July 1. It expects to hold the shares in the treasury until resold. Journalize the treasury stock transaction.

Action Plan ✓ Record the purchase of treasury stock at cost.

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✓ Report treasury stock as a deduction from stockholders’ equity (contra account) at the bottom of the stockholders’ equity section.

Related exercise material: DO IT! 11-2b, E11-2, and E11-5.

▼ HELPFUL HINT

Treasury Stock is a contra stockholders’ equity account.

ETHICS NOTE

The purchase of treasury stock reduces the cushion for creditors. To protect creditors, many states require that a portion of retained earnings equal to the cost of the treasury stock purchased be restricted from being paid as dividends.

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LEARNING OBJECTIVE 3

Explain how to account for cash dividends and describe the effect of stock dividends and stock splits. 

As noted earlier, a dividend is a distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis. Pro rata means that if you own, say, 10% of the common shares, you will receive 10% of the dividend. Dividends can take four forms: cash, property, scrip (promissory note to pay cash), or stock. Cash dividends predominate in practice, although companies also declare stock dividends with some frequency.

Investors are very interested in a company’s dividend practices. In the �inancial press, dividends are generally reported quarterly as a dollar amount per share. (Sometimes they are reported on an annual basis.) For example, the recent quarterly dividend rate was 24 cents per share for Nike, 22 cents per share for GE, and 25 cents per share for ConAgra Foods. Facebook does not pay dividends.

CASH DIVIDENDS A cash dividend is a pro rata (proportional to ownership) distribution of cash to stockholders. Cash dividends are not paid on treasury shares. For a corporation to pay a cash dividend, it must have the following:

1. Retained earnings. Payment of dividends from retained earnings is legal in all states. In addition, loan agreements frequently constrain companies to pay dividends only from retained earnings. Many states prohibit payment of dividends from legal capital. However, payment of dividends from paid-in capital in excess of par value is legal in some states.
2. Adequate cash. Recently, Facebook had a balance in retained earnings of $6,099 million but a cash balance of only $4,315 million. If it had wanted to pay a dividend equal to its retained earnings, Facebook would have had to raise $1,784 million more in cash. It would have been unlikely to do this because it would not be able to pay this much in dividends in future years. In addition, such a dividend would completely deplete Facebook’s balance in retained earnings, so it would not be able to pay a dividend in the next year unless it had positive net income.
3. Declared dividends. The board of directors has full authority to determine the amount of income to distribute in the form of dividends. Dividends are not a liability until they are declared.

The amount and timing of a dividend are important issues for management to consider. The payment of a large cash dividend could lead to liquidity problems for the company. Conversely, a small dividend or a missed dividend may cause unhappiness among stockholders who expect to receive a reasonable cash payment from the company on a periodic basis. Many companies declare and pay cash dividends quarterly. On the other hand, a number of high-growth companies pay no dividends, preferring to conserve cash to �inance future capital expenditures.

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Investors monitor a company’s dividend practices. For example, regular dividend boosts in the face of irregular earnings can be a warning signal. Companies with high dividends and rising debt may be borrowing money to pay shareholders. On the other hand, low dividends may not be a negative sign because it may mean the company is reinvesting in itself, which may result in high returns through increases in the stock price. Presumably, investors seeking regular dividends buy stock in companies that pay periodic dividends, and those seeking growth in the stock price (capital gains) buy stock in companies that retain their earnings rather than pay dividends.

Entries for Cash Dividends

Three dates are important in connection with dividends: (1) the declaration date, (2) the record date, and (3) the payment date. Companies make accounting entries on the declaration date and the payment date.

On the declaration date, the board of directors formally authorizes the cash dividend and announces it to stockholders. The declaration of a cash dividend commits the corporation to a binding legal obligation. Thus, the company must make an entry to recognize the increase in Cash Dividends and the increase in the liability Dividends Payable.

To illustrate, assume that on December 1, 2017, the directors of Media General declare a $0.50 per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000×$0.50). The entry to record the declaration is as follows.

In Chapter 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) , we used an account called Dividends to record a cash dividend. Here, we use the more speci�ic title Cash Dividends to differentiate from other types of dividends, such as stock dividends. (For homework problems, you should use the Cash Dividends account for recording dividend declarations). Dividends Payable is a current liability. It will normally be paid within the next several months.

At the record date, the company determines ownership of the outstanding shares for dividend purposes. The stockholders’ records maintained by the corporation supply this information.

For Media General, the record date is December 22. No entry is required on the record date.

On the payment date, the company makes cash dividend payments to the stockholders on record as of December 22. It also records the payment of the dividend. If January 20 is the payment date for Media General, the entry on that date is as follows.

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Note that payment of the dividend on the payment date reduces both current assets and current liabilities, but it has no effect on stockholders’ equity. Cash Dividends is closed to Retained Earnings at the end of the accounting period. Thus, the cumulative effect of the declaration and payment of a cash dividend on a company’s �inancial statements is to decrease both stockholders’ equity and total assets.

 ACCOUNTING ACROSS THE ORGANIZATION 

Up, Down, and ??

The decision whether to pay a dividend, and how much to pay, is a very important management decision. As the chart below shows, from 2002 to 2007, many companies substantially increased their dividends, and total dividends paid by U.S. companies hit record levels. One reason for the increase is that Congress lowered, from 39% to 15%, the tax rate paid by investors on dividends received, making dividends more attractive to investors.

Then the �inancial crisis of 2008 occurred. As result, in 2009, 804 companies cut their dividends (see chart below), the highest level since Standard & Poor’s started collecting data in 1995. In 2010, more companies started to increase their dividends. However, potential higher taxes on dividends coming in the future and the possibility of a low-growth economy may stall any signi�icant increase.

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Source: Matt Phillips and Jay Miller, “Last Year’s Dividend Slash Was $58 Billion,” Wall Street Journal (January 8, 2010), p. C5.

What factors must management consider in deciding how large a dividend to pay? (Go to WileyPLUS for this answer and additional questions.)

▼ HELPFUL HINT

The record date is important in determining the dividend to be paid to each stockholder.

DIVIDEND PREFERENCES Preferred stockholders have the right to share in the distribution of corporate income before common stockholders. For example, if the dividend rate on preferred stock is $5 per share, common shareholders cannot receive any dividends in the current year until preferred stockholders have received $5 per share. The �irst claim to dividends does not, however, guarantee dividends. Dividends depend on many factors, such as adequate retained earnings and availability of cash.

For preferred stock, companies state the per share dividend amount as a percentage of the par value of the stock or as a speci�ied amount. For example, EarthLink speci�ies a 3% dividend.

Most preferred stocks have a preference on corporate assets if the corporation fails. This feature provides security for the preferred stockholder. The preference to assets may be for the par value of the shares or for a speci�ied liquidating value. For example, Commonwealth Edison issued preferred stock that entitled the holders to receive $31.80 per share, plus accrued and unpaid dividends, in the event of involuntary liquidation. The liquidation preference is used in litigation pertaining to bankruptcy lawsuits involving the respective claims of creditors and preferred stockholders.

Cumulative Dividend

Preferred stock contracts often contain a cumulative dividend feature. This feature stipulates that preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders are paid dividends. When preferred stock is cumulative, preferred dividends not declared that were supposed to be declared in a given period are called dividends in arrears.

To illustrate, assume that Scienti�ic Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. Each $100 share pays a $7 dividend (.07×$100). The annual dividend is $35,000 (5,000×$7 per share). If dividends are two years in arrears, preferred stockholders are entitled to receive in the current year the dividends as shown in Illustration 11-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo3#c11-�ig-0008) .

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ILLUSTRATION 11-8 Computation of total dividends to preferred stock

No distribution can be made to common stockholders until Scienti�ic Leasing pays this entire preferred dividend. In other words, companies cannot pay dividends to common stockholders while any preferred stock dividend is in arrears.

Dividends in arrears are not considered a liability. No obligation exists until the board of directors formally “declares” that the corporation will pay a dividend. However, companies should disclose in the notes to the �inancial statements the amount of dividends in arrears. Doing so enables investors to assess the impact of this potential obligation on the corporation’s �inancial position.

The investment community does not look favorably upon companies that are unable to meet their dividend obligations. As a �inancial of�icer noted in discussing one company’s failure to pay its cumulative preferred dividend for a period of time, “Not meeting your obligations on something like that is a major black mark on your record.”

DO IT! 3a

Preferred Stock Dividends

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.
2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years.
3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years.

Action Plan ✓ Determine dividends on preferred shares by multiplying the

dividend rate times the par value of the stock times the

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number of preferred shares.

✓ Understand the cumulative feature: If preferred stock is cumulative, then any missed dividends (dividends in arrears) and the current year’s dividend must be paid to preferred stockholders before dividends are paid to common stockholders.

SOLUTION

1. The company has not missed past dividends and the preferred stock is noncumulative. Thus, the preferred stockholders are paid only this year’s dividends. The dividend paid to preferred stockholders would be $12,000 (2,000×$.06×$100). The dividend paid to common stockholders would be $48,000 ($60,000−$12,000).
2. The preferred stock is noncumulative. Thus, past unpaid dividends do not have to be paid. The dividend paid to preferred stockholders would be $12,000 (2,000×.06×$100). The dividend paid to common stockholders would be $48,000 ($60,000−$12,000).
3. The preferred stock is cumulative. Thus, dividends that have been missed (dividends in arrears) must be paid. The dividend paid to preferred stockholders would be $36,000 (3×2,000×.06×$100). Of the $36,000, $24,000 relates to dividends in arrears and $12,000 relates to the current dividend on preferred stock. The dividend paid to common stockholders would be $24,000 ($60,000−$36,000).

Related exercise material: DO IT! 11-3a.

STOCK DIVIDENDS A stock dividend is a pro rata (proportional to ownership) distribution of the corporation’s own stock to stockholders. Whereas a cash dividend is paid in cash, a stock dividend is paid in stock. A stock dividend results in a decrease in retained earnings and an increase in paid-in capital. Unlike a cash dividend, a stock dividend does not decrease total stockholders’ equity or total assets.

Because a stock dividend does not result in a distribution of assets, some view it as nothing more than a publicity gesture. Stock dividends are often issued by companies that do not have adequate cash to issue a cash dividend. Such companies may not want to announce that they are not going to issue a cash dividend at their expected time. By issuing a stock dividend, they “save face” by giving the appearance of distributing a dividend. Note that since a stock dividend neither increases nor decreases the assets in the

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company, investors are not receiving anything they didn’t already own. In a sense, it is like asking for two pieces of pie and having your host take one piece of pie and cut it into two smaller pieces. You are not better off, but you got your two pieces of pie.

To illustrate a stock dividend, assume that you have a 2% ownership interest in Cetus Inc.; you own 20 of its 1,000 shares of common stock. If Cetus declares a 10% stock dividend, it issues 100 shares (1,000×10%) of stock. You receive two shares (2%×100), but your ownership interest remains at 2% (22÷1,100). You now own more shares of stock, but your ownership interest has not changed. Moreover, the company disburses no cash and assumes no liabilities.

What, then, are the purposes and bene�its of a stock dividend? Corporations generally issue stock dividends for one of the following reasons:

1. To satisfy stockholders’ dividend expectations without spending cash.
2. To increase the marketability of the stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes it easier for smaller investors to purchase the shares.
3. To emphasize that the company has permanently reinvested in the business a portion of stockholders’ equity, which therefore is unavailable for cash dividends.

When the dividend is declared, the board of directors determines the size of the stock dividend and the value per share to use to record the transaction. In order to meet legal requirements, the per share amount must be at least equal to the par or stated value.

The accounting profession distinguishes between a small stock dividend (less than 20%–25% of the corporation’s issued stock) and a large stock dividend (greater than 20%–25%). It recommends that the company use the fair value per share to record small stock dividends. The recommendation is based on the assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding. Thus, many stockholders consider small stock dividends to be distributions of earnings equal to the fair value of the shares distributed. The accounting profession does not specify the value to use to record a large stock dividend. However, companies normally use par or stated value per share. Small stock dividends predominate in practice. In Appendix 11A at the end of the chapter, we illustrate the journal entries for small stock dividends.

Effects of Stock Dividends

How do stock dividends affect stockholders’ equity? They change the composition of stockholders’ equity because they result in a transfer of a portion of retained earnings to paid-in capital. However, total stockholders’ equity remains the same. Stock dividends also have no effect on the par or stated value per share, but the number of shares outstanding increases.

Illustration 11-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo3#c11-�ig-0009) shows the effects that result when Medland Corp. declares a 10% stock dividend on its $10 par common stock when 50,000 shares were outstanding. The market price was $15 per share.

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ILLUSTRATION 11-9 Stock dividend effects

In this example, total paid-in capital increased by $75,000 (50,000 shares×10%×$15), and retained earnings decreased by the same amount. Note also that total stockholders’ equity remains unchanged at $800,000. The number of shares increases by 5,000 (50,000×10%).

▼ HELPFUL HINT

Because of its effects, a stock dividend is also referred to as capitalizing retained earnings.

STOCK SPLITS A stock split, like a stock dividend, involves the issuance of additional shares of stock to stockholders according to their percentage ownership. However, a stock split results in a reduction in the par or stated value per share. The purpose of a stock split is to increase the marketability of the stock by lowering its market price per share. This, in turn, makes it easier for the corporation to issue additional stock. After hitting a peak of 114 stock splits in 1986, the number of splits in the United States has fallen to about 30 per year. Google announced a 2-for-1 split recently when its stock was selling for $650 per share.

Like a stock dividend, a stock split increases the number of shares owned by a shareholder, but it does not change the percentage of the total company that the shareholder owns. The effects of a 4-for-1 split are shown in Illustration 11-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo3#c11-�ig-0010) .

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ILLUSTRATION 11-10 Effect of stock split for stockholders

The effect of a split on market price is generally inversely proportional to the size of the split. For example, after a recent 2-for-1 stock split, the market price of Nike’s stock fell from $111 to approximately $55.

INVESTOR INSIGHT  

Berkshire Hathaway

A No-Split Philosophy

Warren Buffett’s company, Berkshire Hathaway, has two classes of shares. Until recently, the company had never split either class of stock. As a result, the class A stock had a market price of $97,000 and the class B sold for about $3,200 per share. Because the price per share is so high, the stock does not trade as frequently as the stock of other companies. Buffett has always opposed stock splits because he feels that a lower stock price attracts short-term investors. He appears to be correct. For example, while more than 6 million shares of IBM are exchanged on the average day, only about 1,000 class A shares of Berkshire are traded. Despite Buffett’s aversion to splits, in order to accomplish a recent acquisition, Berkshire decided to split its class B shares 50 to 1.

Source: Scott Patterson, “Berkshire Nears Smaller Baby B’s,” Wall Street Journal Online (January 19, 2010).

Why does Warren Buffett usually oppose stock splits? (Go to WileyPLUS for this answer and additional questions.)

In a stock split, the company increases the number of shares in the same proportion that it decreases the par or stated value per share. For example, in a 2-for-1 split, the company exchanges one share of $10 par

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value stock for two shares of $5 par value stock. A stock split does not have any effect on paid-in capital, retained earnings, and total stockholders’ equity. However, the number of shares outstanding increases. The effects of a 2-for-1 stock split of Medland Corporation’s common stock are shown in Illustration 11-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo3#c11-�ig- 0011) .

ILLUSTRATION 11-11 Stock split effects

Because a stock split does not affect the balances in any stockholders’ equity accounts, a company does not need to journalize a stock split. However, a memorandum entry explaining the effect of the split is typically made.

Illustration 11-12 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo3#c11-�ig- 0012) compares the effects of stock dividends and stock splits.

ILLUSTRATION 11-12 Effects of stock splits and stock dividends differentiated

DO IT! 3b

Stock Dividends; Stock Splits

Due to �ive years of record earnings at Sing CD Corporation, the market price of its 500,000 shares of $2 par value common stock tripled from $15 per share to $45. During this period, paid-in capital remained the same at $2,000,000. Retained earnings increased

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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 (a) retained earnings, (b) total stockholders’ equity, and (c) par value per share.

Action Plan ✓ Calculate the stock dividend’s effect on retained earnings by

multiplying the number of new shares times the market price of the stock (or par value for a large stock dividend).

✓ Recall that a stock dividend increases the number of shares without affecting total equity.

✓ Recall that a stock split only increases the number of shares outstanding and decreases the par value per share without affecting total equity.

SOLUTION

The stock dividend amount is $2,250,000 [(500,000×10%)×$45]. The new balance in retained earnings is $7,750,000 ($10,000,000−$2,250,000). The retained earnings balance after the stock split is the same as it was before the split: $10,000,000. The effects on the stockholders’ equity accounts are as follows.

Related exercise material: BE11-6, BE11-7, DO IT! 11-3b, and E11-7.

▼ HELPFUL HINT

A stock split changes the par value per share but does not affect any balances in stockholders’ equity.

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LEARNING OBJECTIVE 4

Discuss how stockholders’ equity is reported and analyzed. 

RETAINED EARNINGS Retained earnings is net income that a company retains in the business. The balance in retained earnings is part of the stockholders’ claim on the total assets of the corporation. It does not, however, represent a claim on any speci�ic asset. Nor can the amount of retained earnings be associated with the balance of any asset account. For example, a $100,000 balance in retained earnings does not mean that there should be $100,000 in cash. The reason is that the company may have used the cash resulting from the excess of revenues over expenses to purchase buildings, equipment, and other assets. Illustration 11-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0013) shows recent amounts of retained earnings and cash in selected companies.

ILLUSTRATION 11-13 Retained earnings and cash balances

When expenses exceed revenues, a net loss results. In contrast to net income, a net loss decreases retained earnings. In closing entries, a company debits a net loss to the Retained Earnings account. It does not debit net losses to paid-in capital accounts. To do so would destroy the distinction between paid-in and earned capital. If cumulative losses and dividends exceed cumulative income over a company’s life, a debit balance in Retained Earnings results. A debit balance in Retained Earnings, such as that of Groupon, Inc. in a recent year, is a de�icit. A company reports a de�icit as a deduction in the stockholders’ equity section of the balance sheet, as shown in Illustration 11-14 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0014) .

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ILLUSTRATION 11-14 Stockholders’ equity with de�icit

RETAINED EARNINGS RESTRICTIONS The balance in retained earnings is generally available for dividend declarations. Some companies state this fact. In some circumstances, however, there may be retained earnings restrictions. These make a portion of the balance currently unavailable for dividends. Restrictions result from one or more of these causes: legal, contractual, or voluntary.

Companies generally disclose retained earnings restrictions in the notes to the �inancial statements. For example, as shown in Illustration 11-15 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0015) , Tektronix Inc., a manufacturer of electronic measurement devices, recently had total retained earnings of $774 million, but the unrestricted portion was only $223.8 million.

ILLUSTRATION 11-15 Disclosure of unrestricted retained earnings

BALANCE SHEET PRESENTATION OF STOCKHOLDERS’ EQUITY In the stockholders’ equity section of the balance sheet, companies report paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock. Within paid-in capital, two classi�ications are recognized:

1. Capital stock, which consists of preferred and common stock. Companies show preferred stock before common stock because of its preferential rights. They report information about the par value, shares authorized, shares issued, and shares outstanding for each class of stock.
2. Additional paid-in capital, which includes the excess of amounts paid in over par or stated value.

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As discussed in Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , in some instances unrealized gains and losses are not included in net income. Instead, these excluded items, referred to as other comprehensive income items, are reported as part of a more inclusive earnings measure called comprehensive income. Examples of other comprehensive income items include certain adjustments to pension plan assets, types of foreign currency gains and losses, and some gains and losses on investments. The items reported as other comprehensive income are closed each year to the Accumulated Other Comprehensive Income account. Thus, this account includes the cumulative amount of all previous items reported as other comprehensive income. This account can have either a debit or credit balance depending on whether or not accumulated gains exceed accumulated losses over the years. If accumulated losses exceed gains, then the company reports accumulated other comprehensive loss.

Illustration 11-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig- 0016) presents the stockholders’ equity section of the balance sheet of Graber Inc. The company discloses a retained earnings restriction in the notes. The stockholders’ equity section for Graber Inc. includes most of the accounts discussed in this chapter. The disclosures pertaining to Graber’s common stock indicate that 400,000 shares are issued, 100,000 shares are unissued (500,000 authorized less 400,000 issued), and 390,000 shares are outstanding (400,000 issued less 10,000 shares in treasury).

ILLUSTRATION 11-16 Stockholders’ equity section of balance sheet

KEEPING AN EYE ON CASH The balance sheet presents the balances of a company’s stockholders’ equity accounts at a point in time. Companies report in the Financing Activities section of the statement of cash �lows information regarding cash in�lows and out�lows during the year that resulted from equity transactions. The excerpt below presents the cash �lows from �inancing activities

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from the statement of cash �lows of Sara Lee Corporation in a recent year. From this information, we learn that the company’s purchases of treasury stock during the period far exceeded its issuances of new common stock, and its �inancing activities resulted in a net reduction in its cash balance.

DO IT! 4a

Stockholders’ Equity Section

Jennifer Corporation has issued 300,000 shares of $3 par value common stock. It is authorized to issue 600,000 shares. The paid-in capital in excess of par value on the common stock is $380,000. The corporation has reacquired 15,000 shares at a cost of $50,000 and is currently holding those shares. It also had a cumulative other comprehensive loss of $82,000.

The corporation also has 4,000 shares issued and outstanding of 8%, $100 par value preferred stock. It is authorized to issue 10,000 shares. The paid-in capital in excess of par value on the preferred stock is $97,000. Retained earnings is $610,000.

Prepare the stockholders’ equity section of the balance sheet.

Action Plan ✓ Present capital stock �irst; list preferred stock before common

stock.

✓ Present additional paid-in capital after capital stock.

✓ Report retained earnings after capital stock and additional paid-in capital.

✓ Deduct treasury stock from total paid-in capital and retained earnings.

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Related exercise material: BE11-8, DO IT! 11-4a, E11-8, E11-9, and E11-10.

INTERNATIONAL NOTE Like GAAP, under IFRS companies typically disclose separate categories of capital on the balance sheet. However, because of varying accounting treatments of certain transactions (such as treasury stock or asset revaluations), some categories used under IFRS vary from those under GAAP.

ANALYSIS OF STOCKHOLDERS’ EQUITY Investors are interested in both a company’s dividend record and its earnings performance. Although those two measures are often parallel, that is not always the case. Thus, investors should investigate each one separately.

Dividend Record

One way that companies reward stock investors for their investment is to pay them dividends. The payout ratio measures the percentage of earnings a company distributes in the form of cash dividends to common stockholders. It is computed by dividing total cash dividends declared to common shareholders by net income. Using the information shown below, the payout ratio for Nike in 2014 and 2013 is calculated in Illustration 11-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0017) .

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2014 2013 2014 2013

Dividends (in millions) $  821 $  727 Net income (in millions) 2,693 2,472

ILLUSTRATION 11-17 Nike’s payout ratio

Nike’s payout ratio was relatively constant at approximately 30%. Companies attempt to set their dividend rate at a level that will be sustainable.

Companies that have high growth rates are characterized by low payout ratios because they reinvest most of their net income in the business. Thus, a low payout ratio is not necessarily bad news. Companies that believe they have many good opportunities for growth, such as Facebook, will reinvest those funds in the company rather than pay dividends. However, low dividend payments, or a cut in dividend payments, might signal that a company has liquidity or solvency problems and is trying to conserve cash by not paying dividends. Thus, investors and analysts should investigate the reason for low dividend payments.

Illustration 11-18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig- 0018) lists recent payout ratios of four well-known companies.

ILLUSTRATION 11-18 Payout ratios of companies

DECISION TOOLS

The payout ratio helps users determine the portion of a company’s earnings that its pays out in dividends.

Earnings Performance

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Another way to measure corporate performance is through pro�itability. A widely used ratio that measures pro�itability from the common stockholders’ viewpoint is return on common stockholders’ equity (ROE). This ratio shows how many dollars of net income a company earned for each dollar of common stockholders’ equity. It is computed by dividing net income available to common stockholders (Net income−Preferred dividends) by average common stockholders’ equity. Common stockholders’ equity is equal to total stockholders’ equity minus any equity from preferred stock.

Using the information on the previous page and the additional information presented below, Illustration 11-19 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0019) shows Nike’s return on common stockholders’ equity.

ILLUSTRATION 11-19 Nike’s return on common stockholders’ equity

From 2013 to 2014, Nike’s return on common shareholders’ equity increased. As a company grows larger, it becomes increasingly hard to sustain a high return. In Nike’s case, since many believe the U.S. market for expensive sports shoes is saturated, it will need to grow either along new product lines, such as hiking shoes and golf equipment, or in new markets, such as Europe and Asia.

DECISION TOOLS

Return on common stockholders’ equity helps users determine a company’s return on its common stockholders’ investment.

DEBT VERSUS EQUITY DECISION When obtaining long-term capital, corporate managers must decide whether to issue bonds or to sell common stock. Bonds have three primary advantages relative to common stock, as shown in Illustration 11-20 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0020) .

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ILLUSTRATION 11-20 Advantages of bond �inancing over common stock

How does the debt versus equity decision affect the return on common stockholders’ equity? Illustration 11-21 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig-0021) shows that the return on common stockholders’ equity is affected by the return on assets and the amount of leverage a company uses—that is, by the company’s reliance on debt (often measured by the debt to assets ratio). If a company wants to increase its return on common stockholders’ equity, it can either increase its return on assets or increase its reliance on debt �inancing.

ILLUSTRATION 11-21 Components of the return on common stockholders’ equity

To illustrate the potential effect of debt �inancing on the return on common stockholders’ equity, assume that Microsystems Inc. currently has 100,000 shares of common stock outstanding issued at $25 per share and no debt. It is considering two alternatives for raising an additional $5 million. Plan A involves issuing 200,000 shares of common stock at the current market price of $25 per share. Plan B involves issuing $5 million of 12% bonds at face value. Income before interest and taxes will be $1.5 million; income taxes are expected to be 30%. The alternative effects on the return on common stockholders’ equity are shown in Illustration 11-22 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo4#c11-�ig- 0022) .

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ILLUSTRATION 11-22 Effects on return on common stockholders’ equity of issuing debt

Note that with long-term debt �inancing (bonds), net income is $420,000 ($1,050,000−$630,000) less. However, the return on common stockholders’ equity increases from 14% to 25.2% with the use of debt �inancing because net income is spread over a smaller amount of common stockholders’ equity. In general, as long as the return on assets rate exceeds the rate paid on debt, a company will increase the return on common stockholders’ equity by the use of debt.

After seeing this illustration, you might ask, why don’t companies rely almost exclusively on debt �inancing rather than equity? Debt has one major disadvantage: Debt reduces solvency. The company locks in �ixed payments that it must make in good times and bad. The company must pay interest on a periodic basis and must pay the principal (face value) of the bonds at maturity. A company with �luctuating earnings and a relatively weak cash position may experience great dif�iculty in meeting interest requirements in periods of low earnings. In the extreme, this can result in bankruptcy. With common stock �inancing, on the other hand, the company can decide to pay low (or no) dividends if earnings are low.

DO IT! 4b

Analyzing Stockholders’ Equity

On January 1, 2017, Siena Corporation purchased 2,000 shares of treasury stock. Other information regarding Siena Corporation is provided below.

2017 2016 Net income $110,000  $110,000 Dividends on preferred stock $10,000  $10,000 Dividends on common stock $1,600  $2,000 Common stockholders’ equity, beginning of year $400,000* $500,000 Common stockholders’ equity, end of year $400,000  $500,000

*Adjusted for purchase of treasury stock.

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Compute (a) return on common stockholders’ equity for each year, and (b) discuss its change from 2016 to 2017.

Action Plan ✓ Determine return on common stockholders’ equity by

dividing net income available to common stockholders by average common stockholders’ equity.

SOLUTION

(a)

(b) Between 2016 and 2017, return on common stockholders’ equity improved from 20% to 25%. While this would appear to be good news for the company’s common stockholders, this increase should be carefully evaluated. It is important to note that net income did not change during this period. The increase in the ratio was due to the purchase of treasury shares, which reduced the denominator of the ratio. As the company repurchases its own shares, it becomes more reliant on debt and thus increases its risk.

Related exercise material: BE11-10, DO IT! 11-4b, E11-11, E11-12, and E11-13.

USING DECISION TOOLS—ADIDAS adidas is one of Nike’s competitors. In such a competitive and rapidly changing environment, one wrong step can spell �inancial disaster.

INSTRUCTIONS

The following facts are available from adidas’s annual report. As a German company, adidas reports under International Financial Reporting Standards (IFRS). Using this information, evaluate its (1) payout ratio and (2) earnings per share and return on

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common stockholders’ equity (ROE). (3) Compare the payout ratio and ROE with those for Nike for 2014 and 2013.

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LEARNING OBJECTIVE *5

APPENDIX 11A: Prepare entries for stock dividends. 

To illustrate the accounting for stock dividends, assume that Medland Corporation has a balance of $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair value of its stock is $15 per share. The number of shares to be issued is 5,000 (10%×50,000), and the total amount to be debited to Stock Dividends is $75,000 (5,000×$15). The entry to record this transaction at the declaration date is as follows:

At the declaration date, Medland increases (debits) Stock Dividends for the fair value of the stock issued, increases (credits) Common Stock Dividends Distributable for the par value of the dividend shares (5,000×$10), and increases (credits) the excess over par (5,000×$5) to an additional paid-in capital account.

Stock Dividends is closed to Retained Earnings at the end of the accounting period. Common Stock Dividends Distributable is a stockholders’ equity account. It is not a liability because assets will not be used to pay the dividend. If Medland prepares a balance sheet before it issues the dividend shares, it reports the distributable account in paid-in capital as an addition to common stock issued, as shown in Illustration 11A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11lo5#c11-�ig- 0023) .

ILLUSTRATION 11A-1 Statement presentation of common stock dividends distributable

When Medland issues the dividend shares, it decreases Common Stock Dividends Distributable and increases Common Stock as follows.

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▼ HELPFUL HINT

Note that the dividend account title is distributable, not payable.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW 1. Discuss the major characteristics of a corporation. The major characteristics

of a corporation are separate legal existence, limited liability of stockholders, transferable ownership rights, ability to acquire capital, continuous life, corporation management, government regulations, and additional taxes.

1. Explain how to account for the issuance of common and preferred stock, and the purchase of treasury stock. When a company records issuance of common stock for cash, it credits the par value of the shares to Common Stock. It records in a separate paid-in capital account the portion of the proceeds that is above par value. When no-par common stock has a stated value, the entries are similar to those for par value stock. When no-par common stock does not have a stated value, the entire proceeds from the issue are credited to Common Stock.

Companies generally use the cost method in accounting for treasury stock. Under this approach, a company debits Treasury Stock at the price paid to reacquire the shares.

1. Explain how to account for cash dividends and describe the effect of stock dividends and stock splits. Companies make entries for dividends at the declaration date and the payment date. At the declaration date, the entries for a cash dividend are debit Cash Dividends and credit Dividends Payable.

Preferred stock has contractual provisions that give it priority over common stock in certain areas. Typically, preferred stockholders have a preference as to (1) dividends and (2) assets in the event of liquidation. However, they sometimes do not have voting rights.

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The effects of stock dividends and splits are as follows. Small stock dividends transfer an amount equal to the fair value of the shares issued from retained earnings to the paid-in capital accounts. Stock splits reduce the par value per share of the common stock while increasing the number of shares so that the balance in the Common Stock account remains the same.

1. Discuss how stockholders’ equity is reported and analyzed. Additions to retained earnings consist of net income. Deductions consist of net loss and cash and stock dividends. In some instances, portions of retained earnings are restricted, making that portion unavailable for the payment of dividends.

In the stockholders’ equity section of the balance sheet, companies report paid-in capital and retained earnings and identify speci�ic sources of paid-in capital. Within paid-in capital, companies show two classi�ications: capital stock and additional paid-in capital. If a corporation has treasury stock, it deducts the cost of treasury stock from total paid-in capital and retained earnings to determine total stockholders’ equity.

A company’s dividend record can be evaluated by looking at what percentage of net income it chooses to pay out in dividends, as measured by the payout ratio (dividends divided by net income). Earnings performance is measured with the return on common stockholders’ equity (income available to common stockholders divided by average common stockholders’ equity).

1. Prepare entries for stock dividends. To record the declaration of a small stock dividend (less than 20%), debit Stock Dividends for an amount equal to the fair value of the shares issued. Record a credit to a temporary stockholders’ equity account—Common Stock Dividends Distributable—for the par value of the shares, and credit the balance to Paid-in Capital in Excess of Par Value. When the shares are issued, debit Common Stock Dividends Distributable and credit Common Stock.

DECISION TOOLS REVIEW

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GLOSSARY REVIEW Accumulated Other Comprehensive Income This account includes the cumulative

amount of all previous items reported as other comprehensive income.

Authorized stock The amount of stock that a corporation is authorized to sell as indicated in its charter.

Cash dividend A pro rata (proportional to ownership) distribution of cash to stockholders.

Charter A document that describes a corporation’s name and purpose, types of stock and number of shares authorized, names of individuals involved in the formation, and number of shares each individual has agreed to purchase.

Corporation A company organized as a separate legal entity, with most of the rights and privileges of a person.

Cumulative dividend A feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

Declaration date The date the board of directors formally authorizes the dividend and announces it to stockholders.

De�icit A debit balance in Retained Earnings.

Dividend A distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis.

Dividends in arrears Preferred dividends that were supposed to be declared but were not declared during a given period.

Legal capital The amount of capital that must be retained in the business for the protection of corporate creditors.

No-par value stock Capital stock that has not been assigned a value in the corporate charter.

Outstanding stock Capital stock that has been issued and is being held by stockholders.

Paid-in capital The amount stockholders paid in to the corporation in exchange for shares of ownership.

Par value stock Capital stock that has been assigned a value per share in the corporate charter.

Payment date The date cash dividend payments are made to stockholders.

Payout ratio A measure of the percentage of earnings a company distributes in the form of cash dividends to common stockholders.

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Preferred stock Capital stock that has contractual preferences over common stock in certain areas.

Privately held corporation A corporation that has only a few stockholders and whose stock is not available for sale to the general public.

Publicly held corporation A corporation that may have thousands of stockholders and whose stock is traded on a national securities market.

Record date The date when the company determines ownership of outstanding shares for dividend purposes.

Retained earnings restrictions Circumstances that make a portion of retained earnings currently unavailable for dividends.

Retained earnings Net income that a company retains in the business.

Return on common stockholders’ equity (ROE) A measure of pro�itability from the stockholders’ point of view; computed by dividing net income minus preferred dividends by average common stockholders’ equity.

Stated value The amount per share assigned by the board of directors to no-par stock.

Stock dividend A pro rata (proportional to ownership) distribution of the corporation’s own stock to stockholders.

Stock split The issuance of additional shares of stock to stockholders accompanied by a reduction in the par or stated value per share.

Treasury stock A corporation’s own stock that has been reacquired by the corporation and is being held for future use.

PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)

1. Which of these is not a major advantage of a corporation?

(a) Separate legal existence.

(b) Continuous life.

(c) Government regulations.

(d) Transferable ownership rights.

(LO 1)

1. A major disadvantage of a corporation is:

(a) limited liability of stockholders.

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(b) additional taxes.

(c) transferable ownership rights.

(d) None of the above.

(LO 1)

1. 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 2)

1. ABC Corp. issues 1,000 shares of $10 par value common stock at $12 per share. When the transaction is recorded, credits are made to:

(a) Common Stock $10,000 and Paid-in Capital in Excess of Stated Value $2,000.

(b) Common Stock $12,000.

(c) Common Stock $10,000 and Paid-in Capital in Excess of Par Value $2,000.

(d) Common Stock $10,000 and Retained Earnings $2,000.

(LO 2)

1. Treasury stock may be repurchased:

(a) to reissue the shares to of�icers and employees under bonus and stock compensation plans.

(b) to signal to the stock market that management believes the stock is underpriced.

(c) to have additional shares available for use in the acquisition of other companies.

(d) More than one of the above.

(LO 3)

1. Preferred stock may have priority over common stock except in:

(a) dividend preference.

(b) preference to assets in the event of liquidation.

(c) cumulative dividends.

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(d) voting.

(LO 3)

1. U-Bet Corporation has 10,000 shares of 8%, $100 par value, cumulative preferred stock outstanding at December 31, 2017. No dividends were declared in 2015 or 2016. If U-Bet wants to pay $375,000 of dividends in 2017, common stockholders will receive:

(a) $0.

(b) $295,000.

(c) $215,000.

(d) $135,000.

(LO 3)

1. Entries for cash dividends are required on the:

(a) declaration date and the record date.

(b) record date and the payment date.

(c) declaration date, record date, and payment date.

(d) declaration date and the payment date.

(LO 3)

1. Which of these statements about stock dividends is true?

(a) Stock dividends reduce a company’s cash balance.

(b) A stock dividend has no effect on total stockholders’ equity.

(c) A stock dividend decreases total stockholders’ equity.

(d) A stock dividend ordinarily will increase total stockholders’ equity.

(LO 3)

1. Zealot Inc. has retained earnings of $500,000 and total stockholders’ equity of $2,000,000. It has 100,000 shares of $8 par value common stock outstanding, which is currently selling for $30 per share. If Zealot declares a 10% stock dividend on its common stock:

(a) net income will decrease by $80,000.

(b) retained earnings will decrease by $80,000 and total stockholders’ equity will increase by $80,000.

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(c) retained earnings will decrease by $300,000 and total stockholders’ equity will increase by $300,000.

(d) retained earnings will decrease by $300,000 and total paid-in capital will increase by $300,000.

(LO 4)

1. In the stockholders’ equity section of the balance sheet, common stock:

(a) is listed before preferred stock.

(b) is added to total capital stock.

(c) is part of paid-in capital.

(d) is part of additional paid-in capital.

(LO 4)

1. In the stockholders’ equity section, the cost of treasury stock is deducted from:

(a) total paid-in capital and retained earnings.

(b) retained earnings.

(c) total stockholders’ equity.

(d) common stock in paid-in capital.

(LO 4)

1. The return on common stockholders’ equity is usually increased by all of the following, except:

(a) an increase in the return on assets ratio.

(b) an increase in the use of debt �inancing.

(c) an increase in the company’s stock price.

(d) an increase in the company’s net income.

(LO 4)

1. Thomas is nearing retirement and would like to invest in a stock that will provide a good steady income. Thomas should choose a stock with a:

(a) high current ratio.

(b) high dividend payout.

(c) high earnings per share.

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(d) high price-earnings ratio.

(LO 4)

1. Jackson Inc. reported net income of $186,000 during 2017 and paid dividends of $26,000 on common stock. It also paid dividends on its 10,000 shares of 6%, $100 par value, noncumulative preferred stock. Common stockholders’ equity was $1,200,000 on January 1, 2017, and $1,600,000 on December 31, 2017. The company’s return on common stockholders’ equity for 2017 is:

(a) 10.0%.

(b) 9.0%.

(c) 7.1%.

(d) 13.3%.

(LO 4)

1. If everything else is held constant, earnings per share is increased by:

(a) the payment of a cash dividend to common shareholders.

(b) the payment of a cash dividend to preferred shareholders.

(c) the issuance of new shares of common stock.

(d) the purchase of treasury stock.

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SOLUTIONS

1. (c) Government regulations are a disadvantage of a corporation. The other choices are advantages of a corporation.
2. (b) Additional taxes are a disadvantage of a corporation. The other choices are advantages of a corporation.
3. (d) Legal capital is intended to protect creditors, not stockholders. The other choices are true statements.
4. (c) Common Stock should be credited for $10,000 and Paid-in Capital in Excess of Par Value should be credited for $2,000. The stock is par value stock, not stated value stock, and this excess is contributed, not earned, capital. The other choices are therefore incorrect.
5. (d) Treasury stock may be repurchased to reissue the shares as part of bonus and stock compensation plans, to signal to the stock market that the stock is underpriced, and to have additional shares available for use in the acquisition of other companies. Choice (a), (b), (c) are all correct, but (d) is the best answer.
6. (d) Preferred stock usually does not have voting rights and therefore does not have priority over common stock on this issue. The other choices are true statements.
7. (d) The preferred stockholders will receive a total of $240,000 of dividends [dividends in arrears ($80,000×2 years)+current-year dividends($80,000)]. If U-Bet wants to pay a total of $375,000 in 2017, then common stockholders will receive $135,000 ($375,000−$240,000), not (a) $0, (b) $295,000, or (c) $215,000.
8. (d) Entries are required for dividends on the declaration date and the payment date, but not the record date. The other choices are therefore incorrect.
9. (b) A stock dividend moves amounts from retained earnings to paid-in capital and has no effect on stockholders’ equity or cash. The other choices are therefore incorrect.
10. (d) A 10% stock dividend on the company’s common stock will increase the number of shares issued by 10,000 (100,000×10%). At a market price of $30 per share, total paid-in capital will increase by $300,000 (10,000 shares×$30/share) and retained earnings will decrease by that same amount. The other choices are therefore incorrect.
11. (c) Common stock is part of paid-in capital. The other choices are incorrect because common stock (a) is listed after preferred stock, (b) is not added

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to total capital stock but is part of capital stock, and (d) is part of capital stock, not additional paid-in capital.

1. (a) The cost of treasury stock is deducted from total paid-in capital and retained earnings. The other choices are therefore incorrect.
2. (c) An increase in the company’s stock price has no effect on the return on common stockholders’ equity. The other choices are incorrect because (a) an increase in a �irm’s return on assets, (b) an increase in a �irm’s use of debt �inancing, and (c) an increase in a �irm’s net income will all increase the return on common stockholders’ equity.
3. (b) Thomas should focus on a high dividend payout. The other choices are incorrect because a stock with a (a) high current ratio, (c) high earnings per share, or (d) high price-earnings ratio may or may not pay dividends on a consistent basis.
4. (b) Return on common stockholders’ equity is net income available to common stockholders divided by average common stockholders’ equity. Net income available to common stockholders is net income less preferred dividends=$126,000 [$186,000−(10,000×.06×$100)]. The company’s return on common stockholders’ equity for the year is therefore 9.0% [$126,000/($1,200,000+$1,600,000)/2)], not (a) 10.0%, (c) 7.1%, or (d) 13.3%.
5. (d) The purchase of treasury stock reduces the number of shares outstanding, which is the denominator of earnings per share (EPS). With a smaller denominator, EPS is larger. The other choices are incorrect because (a) the payment of a cash dividend to common stockholders does not affect the earnings or the number of outstanding shares, so EPS will stay the same; (b) the payment of a cash dividend to preferred stockholders will reduce the amount of earnings available to the common stockholders, thus reducing EPS; and (c) the issuance of new shares of common stock would not affect earnings but will increase the number of outstanding shares, thereby reducing EPS.

PRACTICE EXERCISES

Journalize issuance of common and preferred stock and purchase of treasury stock.

(LO 2)

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1. Maci Co. had the following transactions during the current period.

June 12 Issued 60,000 shares of $5 par value common stock for cash of $370,000. July  11

Issued 1,000 shares of $100 par value preferred stock for cash at $112 per share.

Nov. 28 Purchased 2,000 shares of treasury stock for $70,000.

INSTRUCTIONS

Journalize the transactions.

Journalize cash dividends; indicate statement presentation..

(LO 3, 4)

1. On January 1, Chong Corporation had 95,000 shares of no-par common stock issued and outstanding. The stock has a stated value of $5 per share. During the year, the following occurred.

Apr.  1

Issued 25,000 additional shares of common stock for $17 per share.

June 15

Declared a cash dividend of $1 per share to stockholders of record on June 30.

July 10

Paid the $1 cash dividend.

Dec.  1

Issued 2,000 additional shares of common stock for $19 per share.

15 Declared a cash dividend on outstanding shares of $1.20 per share to stockholders of record on December 31.

INSTRUCTIONS (a) Prepare the entries, if any, on each of the three dividend dates.

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(b) How are dividends and dividends payable reported in the �inancial statements prepared at December 31?

PRACTICE PROBLEM

Journalize transactions and prepare stockholders’ equity section.

(LO 2, 3, 4)

Rolman Corporation is authorized to issue 1,000,000 shares of $5 par value common stock. In its �irst year, the company has the following stock transactions.

Jan.  10 Issued 400,000 shares of stock at $8 per share. Sept. 21 Purchased 10,000 shares of common stock for the treasury at $9 per share. Dec.  24 Declared a cash dividend of 10 cents per share on common stock outstanding.

INSTRUCTIONS (a) Journalize the transactions.

(b) Prepare the stockholders’ equity section of the balance sheet, assuming the company had retained earnings of $150,600 at December 31 and an accumulated other comprehensive loss of $105,000.

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WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

QUESTIONS 1. Joe, a student, asks your help in understanding some characteristics of a corporation. Explain each

of these to Joe. (a) Separate legal existence.

(b) Limited liability of stockholders.

(c) Transferable ownership rights.

1. (a) Your friend G. C. Jones cannot understand how the characteristic of corporate management is both an advantage and a disadvantage. Clarify this problem for G. C.

(b) Identify and explain two other disadvantages of a corporation.

1. Nona Jaymes believes a corporation must be incorporated in the state in which its headquarters of�ice is located. Is Nona correct? Explain.

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1. What are the basic ownership rights of common stockholders in the absence of restrictive provisions?
2. A corporation has been de�ined as an entity separate and distinct from its owners. In what ways is a corporation a separate legal entity?
3. What are the two principal components of stockholders’ equity?
4. The corporate charter of Gage Corporation allows the issuance of a maximum of 100,000 shares of common stock. During its �irst 2 years of operation, Gage sold 70,000 shares to shareholders and reacquired 4,000 of these shares. After these transactions, how many shares are authorized, issued, and outstanding?
5. Which is the better investment—common stock with a par value of $5 per share or common stock with a par value of $20 per share?
6. For what reasons might a company like IBM repurchase some of its stock (treasury stock)?
7. Monet, Inc. purchases 1,000 shares of its own previously issued $5 par common stock for $11,000. Assuming the shares are held in the treasury, what effect does this transaction have on (a) net income, (b) total assets, (c) total paid-in capital, and (d) total stockholders’ equity?
8. (a) What are the principal differences between common stock and preferred stock?

(b) Preferred stock may be cumulative. Discuss this feature.

(c) How are dividends in arrears presented in the �inancial statements?

1. Identify the events that result in credits and debits to retained earnings.
2. Indicate how each of these accounts should be classi�ied in the stockholders’ equity section of the balance sheet. (a) Common Stock.

(b) Paid-in Capital in Excess of Par Value.

(c) Retained Earnings.

(d) Treasury Stock.

(e) Paid-in Capital in Excess of Stated Value.

(f) Preferred Stock.

1. What three conditions must be met before a cash dividend is paid?
2. Three dates associated with Petrie Company’s cash dividend are May 1, May 15, and May 31. Discuss the signi�icance of each date and give the entry at each date.
3. Contrast the effects of a cash dividend and a stock dividend on a corporation’s balance sheet.

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1. Doris Angel asks, “Since stock dividends don’t change anything, why declare them?” What is your answer to Doris?
2. Jayne Corporation has 10,000 shares of $15 par value common stock outstanding when it announces a 3-for-1 split. Before the split, the stock had a market price of $120 per share. After the split, how many shares of stock will be outstanding, and what will be the approximate market price per share?
3. The board of directors is considering a stock split or a stock dividend. They understand that total stockholders’ equity will remain the same under either action. However, they are not sure of the different effects of the two actions on other aspects of stockholders’ equity. Explain the differences to the directors.
4. What was the total cost of Apple’s treasury stock at September 27, 2014? What was the amount of the 2014 cash dividend? What was the size of the 2014 stock split?
5. (a) What is the purpose of a retained earnings restriction?

(b) Identify the possible causes of retained earnings restrictions.

1. Thom Inc.’s common stock has a par value of $1 and a current market price of $15. Explain why these amounts are different.
2. What is the formula for the payout ratio? What does it indicate?
3. Explain the circumstances under which debt �inancing will increase the return on common stockholders’ equity.
4. Under what circumstances will the return on assets and the return on common stockholders’ equity be equal?
5. Sauer Corp. has a return on assets of 12%. It plans to issue bonds at 8% and use the cash to repurchase stock. What effect will this have on its debt to assets ratio and on its return on common stockholders’ equity?

BRIEF EXERCISES

Cite advantages and disadvantages of a corporation.

(LO 1), K

BE11-1 Hana Ascot is planning to start a business. Identify for Hana the advantages and disadvantages of the corporate form of business organization.

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Journalize issuance of par value common stock.

(LO 2), AP

BE11-2 On May 10, Pilar Corporation issues 2,500 shares of $5 par value common stock for cash at $13 per share. Journalize the issuance of the stock.

Journalize issuance of no-par common stock.

(LO 2), AP

BE11-3 On June 1, Forrest Inc. issues 3,000 shares of no-par common stock at a cash price of $7 per share. Journalize the issuance of the shares.

Journalize issuance of preferred stock.

(LO 2), AP

BE11-4 Layes Inc. issues 8,000 shares of $100 par value preferred stock for cash at $106 per share. Journalize the issuance of the preferred stock.

Prepare entries for a cash dividend.

(LO 3), AP

BE11-5 Basse Corporation has 7,000 shares of common stock outstanding. It declares a $1 per share cash dividend on November 1 to stockholders of record on December 1. The dividend is paid on December 31. Prepare the entries on the appropriate dates to record the declaration and payment of the cash dividend.

Show before-and-after effects of a stock dividend.

(LO 3), AP

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BE11-6 The stockholders’ equity section of Mabry Corporation’s balance sheet consists of common stock ($8 par) $1,000,000 and retained earnings $300,000. A 10% stock dividend (12,500 shares) is declared when the market price per share is $19. Show the before-and-after effects of the dividend on (a) the components of stockholders’ equity and (b) the shares outstanding.

Compare impact of cash dividend, stock dividend, and stock split.

(LO 3), K

BE11-7 Indicate whether each of the following transactions would increase (+), decrease (−), or not affect (N/A) total assets, total liabilities, and total stockholders’ equity.

Prepare a stockholders’ equity section.

(LO 4), AP

BE11-8 Sudz Corporation has these accounts at December 31: Common Stock, $10 par, 5,000 shares issued, $50,000; Paid-in Capital in Excess of Par Value $22,000; Retained Earnings $42,000; and Treasury Stock, 500 shares, $11,000. Prepare the stockholders’ equity section of the balance sheet.

Evaluate a company’s dividend record.

(LO 4), C

BE11-9 Hans Miken, president of Miken Corporation, believes that it is a good practice for a company to maintain a constant payout of dividends relative to its earnings. Last year, net income was $600,000, and the corporation paid $120,000 in dividends. This year, due to some unusual circumstances, the corporation had income of $1,600,000. Hans expects next year’s net income to be about $700,000. What

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was Miken Corporation’s payout ratio last year? If it is to maintain the same payout ratio, what amount of dividends would it pay this year? Is this necessarily a good idea—that is, what are the pros and cons of maintaining a constant payout ratio in this scenario?

Calculate the return on stockholders’ equity.

(LO 4), AP

BE11-10 SUPERVALU, one of the largest grocery retailers in the United States, is headquartered in Minneapolis. Suppose the following �inancial information (in millions) was taken from the company’s 2017 annual report: net sales $44,597, net income $393, beginning stockholders’ equity $2,581, and ending stockholders’ equity $2,887. There were no dividends paid on preferred stock. Compute the return on common stockholders’ equity. Provide a brief interpretation of your �indings.

Compare bond �inancing to stock �inancing.

(LO 4), AP

BE11-11 Emron Inc. is considering these two alternatives to �inance its construction of a new $2 million plant:

1. Issuance of 200,000 shares of common stock at the market price of $10 per share.
2. Issuance of $2 million, 6% bonds at face value.

Complete the table and indicate which alternative is preferable.

Prepare entries for a stock dividend.

(LO 5), AP

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*BE11-12 Stossel Corporation has 200,000 shares of $10 par value common stock outstanding. It declares a 12% stock dividend on December 1 when the market price per share is $17. The dividend shares are issued on December 31. Prepare the entries for the declaration and distribution of the stock dividend.

DO IT! EXERCISES

Analyze statements about corporate organization.

(LO 1), C

DO IT! 11-1 Indicate whether each of the following statements is true or false.

__ 1. The corporation is an entity separate and distinct from its owners.

__ 2. The liability of stockholders is normally limited to their investment in the corporation.

__ 3. The relative lack of government regulation is an advantage of the corporate form of business.

__ 4. There is no journal entry to record the authorization of capital stock.

__ 5. No-par value stock is quite rare today.

Journalize issuance of stock.

(LO 2), AP

DO IT! 11-2a Beauty Island Corporation began operations on April 1 by issuing 55,000 shares of $5 par value common stock for cash at $13 per share. In addition, Beauty Island issued 1,000 shares of $1 par value preferred stock for $6 per share. Journalize the issuance of the common and preferred shares.

Journalize treasury stock transaction.

(LO 2), AP

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DO IT! 11-2b Dinosso Corporation purchased 2,000 shares of its $10 par value common stock for $76,000 on August 1. It will hold these in the treasury until resold. Journalize the treasury stock transaction.

Determine dividends paid to preferred and common stockholders.

(LO 3), AP

DO IT! 11-3a Sparks Corporation has 3,000 shares of 8%, $100 par value preferred stock outstanding at December 31, 2017. At December 31, 2017, the company declared a $105,000 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.
2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years.
3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years.

Determine effects of stock dividend and stock split.

(LO 3), AP

DO IT! 11-3b Spears Company has had 4 years of record earnings. Due to this success, the market price of its 400,000 shares of $2 par value common stock has increased from $6 per share to $50. During this period, paid-in capital remained the same at $2,400,000. Retained earnings increased from $1,800,000 to $12,000,000. CEO Don Ames is considering either (1) a 15% stock dividend or (2) a 2-for-1 stock split. He asks you to show the before-and-after effects of each option on (a) retained earnings, (b) total stockholders’ equity, and (c) par value per share.

Prepare stockholders’ equity section.

(LO 4), AP

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DO IT! 11-4a Hoyle Corporation has issued 100,000 shares of $5 par value common stock. It was authorized 500,000 shares. The paid-in capital in excess of par value on the common stock is $263,000. The corporation has reacquired 7,000 shares at a cost of $46,000 and is currently holding those shares. It also had accumulated other comprehensive income of $67,000.

The corporation also has 2,000 shares issued and outstanding of 9%, $100 par value preferred stock. It was authorized 10,000 shares. The paid-in capital in excess of par value on the preferred stock is $23,000. Retained earnings is $372,000. Prepare the stockholders’ equity section of the balance sheet.

Compute return on stock-holders’ equity and discuss changes.

(LO 4), AP

DO IT! 11-4b On January 1, 2017, Vahsholtz Corporation purchased 5,000 shares of treasury stock. Other information regarding Vahsholtz Corporation is provided as follows.

2016 2017 Net income $100,000 $110,000 Dividends on preferred stock $ 30,000 $ 30,000 Dividends on common stock $ 20,000 $ 25,000 Weighted-average number of common shares outstanding 50,000 45,000 Common stockholders’ equity beginning of year $600,000 $750,000 Common stockholders’ equity end of year $750,000 $830,000

Compute (a) return on common stockholders’ equity for each year, and (b) discuss the changes in each.

EXERCISES

Journalize issuance of common stock.

(LO 2), AP

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E11-1 During its �irst year of operations, Mona Corporation had these transactions pertaining to its common stock.

Jan. 10 Issued 30,000 shares for cash at $5 per share. July  1 Issued 60,000 shares for cash at $7 per share.

Instructions (a) Journalize the transactions, assuming that the common stock has a par value of $5 per share.

(b) Journalize the transactions, assuming that the common stock is no-par with a stated value of $1 per share.

Journalize issuance of common stock and preferred stock and purchase of treasury stock.

(LO 2), AP

E11-2 Sagan Co. had these transactions during the current period.

June 12 Issued 80,000 shares of $1 par value common stock for cash of $300,000. July  11 Issued 3,000 shares of $100 par value preferred stock for cash at $106 per share. Nov. 28 Purchased 2,000 shares of treasury stock for $9,000.

Instructions

Prepare the journal entries for the Sagan Co. transactions.

Journalize preferred stock transactions and indicate statement presentation.

(LO 2, 4), AP

E11-3 Penland Corporation is authorized to issue both preferred and common stock. The par value of the preferred is $50. During the �irst year of operations, the company had the following events and transactions pertaining to its preferred stock.

Feb. 1 Issued 40,000 shares for cash at $51 per share. July 1 Issued 60,000 shares for cash at $56 per share.

Instructions (a) Journalize the transactions.

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(b) Post to the stockholders’ equity accounts. (Use T-accounts.)

(c) Discuss the statement presentation of the accounts.

Answer questions about stockholders’ equity section.

(LO 2, 4), C

E11-4 The stockholders’ equity section of Lachlin Corporation’s balance sheet at December 31 is presented here.

Instructions

From a review of the stockholders’ equity section, answer the following questions.

(a) How many shares of common stock are outstanding?

(b) Assuming there is a stated value, what is the stated value of the common stock?

(c) What is the par value of the preferred stock?

(d) If the annual dividend on preferred stock is $36,000, what is the dividend rate on preferred stock?

(e) If dividends of $72,000 were in arrears on preferred stock, what would be the balance reported for retained earnings?

Prepare correct entries for capital stock transactions.

(LO 2), AN

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E11-5 Mesa Corporation recently hired a new accountant with extensive experience in accounting for partnerships. Because of the pressure of the new job, the accountant was unable to review what he had learned earlier about corporation accounting. During the �irst month, he made the following entries for the corporation’s capital stock.

Instructions

On the basis of the explanation for each entry, prepare the entries that should have been made for the capital stock transactions.

Journalize cash dividends and indicate statement presentation.

(LO 3), AP

E11-6 On January 1, Graves Corporation had 60,000 shares of no-par common stock issued and outstanding. The stock has a stated value of $4 per share. During the year, the following transactions occurred.

Apr.   1

Issued 9,000 additional shares of common stock for $11 per share.

June  15

Declared a cash dividend of $1.50 per share to stockholders of record on June 30.

July   10

Paid the $1.50 cash dividend.

Dec.   1

Issued 4,000 additional shares of common stock for $12 per share.

15 Declared a cash dividend on outstanding shares of $1.60 per share to stockholders of record on December 31.

Instructions (a) Prepare the entries, if any, on each of the three dates that involved dividends.

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(b) How are dividends and dividends payable reported in the �inancial statements prepared at December 31?

Compare effects of a stock dividend and a stock split.

(LO 3), AP

E11-7 On October 31, the stockholders’ equity section of Manolo Company’s balance sheet consists of common stock $648,000 and retained earnings $400,000. Manolo is considering the following two courses of action: (1) declaring a 5% stock dividend on the 81,000 $8 par value shares outstanding or (2) effecting a 2-for-1 stock split that will reduce par value to $4 per share. The current market price is $17 per share.

Instructions

Prepare a tabular summary of the effects of the alternative actions on the company’s stockholders’ equity and outstanding shares. Use these column headings: Before Action, After Stock Dividend, and After Stock Split.

Prepare a stockholders’ equity section.

(LO 4), AP

E11-8 Wells Fargo & Company, headquartered in San Francisco, is one of the nation’s largest �inancial institutions. Suppose it reported the following selected accounts (in millions) as of December 31, 2017.

Retained earnings $41,563  Preferred stock 8,485  Common stock—$123; par value, authorized 6,000,000,000 shares; issued 5,245,971,422 shares

8,743 

Treasury stock—67,346,829 common shares (2,450) Paid-in capital in excess of par value—common stock 52,878  Accumulated Other Comprehensive Income 8,327 

Instructions

Prepare the stockholders’ equity section of the balance sheet for Wells Fargo as of December 31, 2017.

Prepare a stockholders’ equity section.

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(LO 4), AP

E11-9 The following stockholders’ equity accounts, arranged alphabetically, are in the ledger of Ryder Corporation at December 31, 2017.

Common Stock ($2 stated value) $1,600,000 Paid-in Capital in Excess of Par Value—Preferred Stock 45,000 Paid-in Capital in Excess of Stated Value—Common Stock 1,050,000 Preferred Stock (8%, $100 par, noncumulative) 600,000 Retained Earnings 1,334,000 Treasury Stock (12,000 common shares) 72,000

Instructions

Prepare the stockholders’ equity section of the balance sheet at December 31, 2017.

Prepare a stockholders’ equity section.

(LO 4), AP

E11-10 The following accounts appear in the ledger of Paisan Inc. after the books are closed at December 31, 2017.

Common Stock (no-par, $1 stated value, 400,000 shares authorized, 250,000 shares issued) $ 250,000 Paid-in Capital in Excess of Stated Value—Common Stock 1,200,000 Preferred Stock ($50 par value, 8%, 40,000 shares authorized, 14,000 shares issued) 700,000 Retained Earnings 920,000 Treasury Stock (9,000 common shares) 64,000 Paid-in Capital in Excess of Par Value—Preferred Stock 24,000 Accumulated Other Comprehensive Loss 31,000

Instructions

Prepare the stockholders’ equity section at December 31, assuming $100,000 of retained earnings is restricted for plant expansion. (Use Note R.)

Calculate ratios to evaluate dividend and earnings performance.

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(LO 4), AP

E11-11 The following �inancial information is available for Flintlock Corporation.

(in millions) 2017 2016 Average common stockholders’ equity $2,532 $2,591 Dividends declared for common stockholders 298 611 Dividends declared for preferred stockholders 40 40 Net income 504 555

Instructions

Calculate the payout ratio and return on common stockholders’ equity for 2017 and 2016. Comment on your �indings.

Calculate ratios to evaluate dividend and earnings performance.

(LO 4), AP

E11-12 Suppose the following �inancial information is available for Walgreen Company.

(in millions)  2017  2016 Average common stockholders’ equity $13,622.5 $11,986.5 Dividends declared for common stockholders 471 394 Dividends declared for preferred stockholders 0 0 Net income 2,006 2,157

Instructions

Calculate the payout ratio and return on common stockholders’ equity for 2017 and 2016. Comment on your �indings.

Calculate ratios to evaluate pro�itability and solvency.

(LO 4), AN

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E11-13 Kojak Corporation decided to issue common stock and used the $300,000 proceeds to redeem all of its outstanding bonds on January 1, 2017. The following information is available for the company for 2017 and 2016.

2017 2016 Net income $ 182,000 $ 150,000 Dividends declared for preferred stockholders 8,000 8,000 Average common stockholders’ equity 1,000,000 700,000 Total assets 1,200,000 1,200,000 Current liabilities 100,000 100,000 Total liabilities 200,000 500,000

Instructions (a) Compute the return on common stockholders’ equity for both years.

(b) Explain how it is possible that net income increased but the return on common stockholders’ equity decreased.

(c) Compute the debt to assets ratio for both years, and comment on the implications of this change in the company’s solvency.

Compare issuance of stock �inancing to issuance of bond �inancing.

(LO 4), AN

E11-14 Baja Airlines is considering these two alternatives for �inancing the purchase of a �leet of airplanes:

1. Issue 50,000 shares of common stock at $40 per share. (Cash dividends have not been paid nor is the payment of any contemplated.)
2. Issue 12%, 10-year bonds at face value for $2,000,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90,000 shares of common stock outstanding prior to the new �inancing.

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Instructions

Determine the effect on net income and earnings per share for (a) issuing stock and (b) issuing bonds. Assume the new shares or new bonds will be outstanding for the entire year.

Compute ratios and interpret.

(LO 4), AN

E11-15 Cabo Company has $1,000,000 in assets and $1,000,000 in stockholders’ equity, with 40,000 shares outstanding the entire year. It has a return on assets of 10%. During 2016, it had net income of $100,000. On January 1, 2017, it issued $400,000 in debt at 4% and immediately repurchased 20,000 shares for $400,000. Management expected that, had it not issued the debt, it would have had net income of $100,000 in 2017.

Instructions (a) Determine the company’s net income and earnings per share for 2016 and 2017. (Ignore taxes in your

computations.)

(b) Compute the company’s return on common stockholders’ equity for 2016 and 2017.

(c) Compute the company’s debt to assets ratio for 2016 and 2017.

(d) Discuss the impact that the borrowing had on the company’s pro�itability and solvency. Was it a good idea to borrow the money to buy the treasury stock?

Journalize stock dividends.

(LO 5), AP

*E11-16 On January 1, 2017, Lenne Corporation had $1,200,000 of common stock outstanding that was issued at par and retained earnings of $750,000. The company issued 30,000 shares of common stock at par on July 1 and earned net income of $400,000 for the year.

Instructions

Journalize the declaration of a 15% stock dividend on December 10, 2017, for the following two independent assumptions.

(a) Par value is $10 and market price is $15.

(b) Par value is $5 and market price is $8.

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EXERCISES: SET B AND CHALLENGE EXERCISES Visit the book’s companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.

PROBLEMS: SET A

Journalize stock transactions, post, and prepare paid-in capital section.

(LO 2, 4), AP

P11-1A Tidal Corporation was organized on January 1, 2017. It is authorized to issue 20,000 shares of 6%, $50 par value preferred stock and 500,000 shares of no-par common stock with a stated value of $1 per share. The following stock transactions were completed during the �irst year.

Jan.  10 Issued 70,000 shares of common stock for cash at $4 per share. Mar.   1 Issued 12,000 shares of preferred stock for cash at $53 per share. May   1 Issued 120,000 shares of common stock for cash at $6 per share. Sept.  1 Issued 5,000 shares of common stock for cash at $5 per share. Nov.   1 Issued 3,000 shares of preferred stock for cash at $56 per share.

Instructions (a) Journalize the transactions.

(b) Post to the stockholders’ equity accounts. (Use T-accounts.)

(c) Prepare the paid-in capital portion of the stockholders’ equity section at December 31, 2017.

(c) Tot. paid-in capital $1,829,000

Journalize transactions, post, and prepare a stockholders’ equity section; calculate ratios.

(LO 2, 3, 4), AP

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P11-2A The stockholders’ equity accounts of Cyrus Corporation on January 1, 2017, were as follows.

Preferred Stock (7%, $100 par noncumulative, 5,000 shares authorized) $ 300,000 Common Stock ($4 stated value, 300,000 shares authorized) 1,000,000 Paid-in Capital in Excess of Par Value—Preferred Stock 15,000 Paid-in Capital in Excess of Stated Value—Common Stock 480,000 Retained Earnings 688,000 Treasury Stock (5,000 common shares) 40,000

During 2017, the corporation had the following transactions and events pertaining to its stockholders’ equity.

Feb.   1

Issued 5,000 shares of common stock for $30,000.

Mar.   20

Purchased 1,000 additional shares of common treasury stock at $7 per share.

Oct.   1

Declared a 7% cash dividend on preferred stock, payable November 1.

Nov.   1

Paid the dividend declared on October 1.

Dec.   1

Declared a $0.50 per share cash dividend to common stockholders of record on December 15, payable December 31, 2017.

31 Determined that net income for the year was $280,000. Paid the dividend declared on December 1.

Instructions (a) Journalize the transactions. (Include entries to close net income and dividends to Retained Earnings.)

(b) Enter the beginning balances in the accounts and post the journal entries to the stockholders’ equity accounts. (Use T-accounts.)

(c) Prepare the stockholders’ equity section of the balance sheet at December 31, 2017.

(d) Calculate the payout ratio, earnings per share, and return on common stockholders’ equity. (Note: Use the common shares outstanding on January 1 and December 31 to determine the average shares outstanding.)

(c) Tot. paid-in capital $1,825,000

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Prepare a stockholders’ equity section.

(LO 2, 3, 4), AP

P11-3A On December 31, 2016, Jons Company had 1,300,000 shares of $5 par common stock issued and outstanding. At December 31, 2016, stockholders’ equity had the amounts listed here.

Common Stock $6,500,000 Additional Paid-in Capital 1,800,000 Retained Earnings 1,200,000

Transactions during 2017 and other information related to stockholders’ equity accounts were as follows.

1. On January 10, 2017, issued at $107 per share 120,000 shares of $100 par value, 9% cumulative preferred stock.
2. On February 8, 2017, reacquired 15,000 shares of its common stock for $11 per share.
3. On May 9, 2017, declared the yearly cash dividend on preferred stock, payable June 10, 2017, to stockholders of record on May 31, 2017.
4. On June 8, 2017, declared a cash dividend of $1.20 per share on the common stock outstanding, payable on July 10, 2017, to stockholders of record on July 1, 2017.
5. Net income for the year was $3,600,000.

Instructions

Prepare the stockholders’ equity section of Jons’ balance sheet at December 31, 2017.

Tot. stockholders’ equity $23,153,000

Reproduce Retained Earnings account, and prepare a stockholders’ equity section.

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(LO 3, 4), AP

P11-4A The ledger of Waite Corporation at December 31, 2017, after the books have been closed, contains the following stockholders’ equity accounts.

Preferred Stock (10,000 shares issued) $1,000,000 Common Stock (300,000 shares issued) 1,500,000 Paid-in Capital in Excess of Par Value—Preferred Stock 200,000 Paid-in Capital in Excess of Stated Value—Common Stock 1,600,000 Retained Earnings 2,860,000

A review of the accounting records reveals this information:

1. Preferred stock is 8%, $100 par value, noncumulative. Since January 1, 2016, 10,000 shares have been outstanding; 20,000 shares are authorized.
2. Common stock is no-par with a stated value of $5 per share; 600,000 shares are authorized.
3. The January 1, 2017, balance in Retained Earnings was $2,380,000.
4. On October 1, 60,000 shares of common stock were sold for cash at $9 per share.
5. A cash dividend of $400,000 was declared and properly allocated to preferred and common stock on November 1. No dividends were paid to preferred stockholders in 2016.
6. Net income for the year was $880,000.
7. On December 31, 2017, the directors authorized disclosure of a $160,000 restriction of retained earnings for plant expansion. (Use Note A.)

Instructions (a) Reproduce the Retained Earnings account (T-account) for the year.

(b) Prepare the stockholders’ equity section of the balance sheet at December 31.

(b) Tot. paid-in capital $4,300,000

Prepare entries for stock transactions, and prepare a stockholders’ equity section.

(LO 2, 4), AP

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P11-5A Layes Corporation has been authorized to issue 20,000 shares of $100 par value, 7%, noncumulative preferred stock and 1,000,000 shares of no-par common stock. The corporation assigned a $5 stated value to the common stock. At December 31, 2017, the ledger contained the following balances pertaining to stockholders’ equity.

Preferred Stock $  150,000 Paid-in Capital in Excess of Par Value—Preferred Stock 20,000 Common Stock 2,000,000 Paid-in Capital in Excess of Stated Value—Common Stock 1,520,000 Treasury Stock (4,000 common shares) 36,000 Retained Earnings 82,000 Accumulated Other Comprehensive Income 51,000

The preferred stock was issued for $170,000 cash. All common stock issued was for cash. In November 4,000 shares of common stock were purchased for the treasury at a per share cost of $9. No dividends were declared in 2017.

Instructions (a) Prepare the journal entries for the following.

1. Issuance of preferred stock for cash.
2. Issuance of common stock for cash.
3. Purchase of common treasury stock for cash.

(b) Prepare the stockholders’ equity section of the balance sheet at December 31, 2017.

(b) Tot. stockholders’ equity $3,787,000

Prepare a stockholders’ equity section.

(LO 2, 3, 4), AP

P11-6A On January 1, 2017, Kimbel Inc. had these stockholders’ equity balances.

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Common Stock, $1 par (2,000,000 shares authorized, 600,000 shares issued and outstanding)

$ 600,000

Paid-in Capital in Excess of Par Value 1,500,000 Retained Earnings 700,000 Accumulated Other Comprehensive Income 60,000

During 2017, the following transactions and events occurred.

1. Issued 50,000 shares of $1 par value common stock for $3 per share.
2. Issued 60,000 shares of common stock for cash at $4 per share.
3. Purchased 20,000 shares of common stock for the treasury at $3.80 per share.
4. Declared and paid a cash dividend of $207,000.
5. Earned net income of $410,000.
6. Had other comprehensive income of $17,000.

Instructions

Prepare the stockholders’ equity section of the balance sheet at December 31, 2017.

Tot. stockholders’ equity $3,394,000

Evaluate a company’s pro�itability and solvency.

(LO 4), AP

P11-7A Spahn Company manufactures backpacks. During 2017, Spahn issued bonds at 10% interest and used the cash proceeds to purchase treasury stock. The following �inancial information is available for Spahn Company for the years 2017 and 2016.

2017 2016 Sales revenue $ 9,000,000 $ 9,000,000 Net income 2,240,000  2,500,000  Interest expense 500,000 140,000

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2017 2016 Tax expense 670,000 750,000 Dividends paid on common stock 890,000 1,026,000 Dividends paid on preferred stock 300,000 300,000 Total assets (year-end) 14,500,000 16,875,000 Average total assets 15,687,500 17,763,000 Total liabilities (year-end) 6,000,000 3,000,000 Avg. total common stockholders’ equity 9,400,000 14,100,000

Instructions (a) Use the information above to calculate the following ratios for both years: (1) return on assets, (2)

return on common stockholders’ equity, (3) payout ratio, (4) debt to assets ratio, and (5) times interest earned.

(b) Referring to your �indings in part (a), discuss the changes in the company’s pro�itability from 2016 to 2017.

(c) Referring to your �indings in part (a), discuss the changes in the company’s solvency from 2016 to 2017.

(d) Based on your �indings in (b), was the decision to issue debt to purchase common stock a wise one?

Prepare dividend entries, prepare a stockholders’ equity section, and calculate ratios.

(LO 3, 4, 5), AP

*P11-8A On January 1, 2017, Tacoma Corporation had these stockholders’ equity accounts.

Common Stock ($10 par value, 70,000 shares issued and outstanding) $700,000 Paid-in Capital in Excess of Par Value 500,000 Retained Earnings 620,000

During the year, the following transactions occurred.

Jan. 15

Declared a $0.50 cash dividend per share to stockholders of record on January 31, payable February 15.

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Feb. 15

Paid the dividend declared in January.

Apr. 15

Declared a 10% stock dividend to stockholders of record on April 30, distributable May 15. On April 15, the market price of the stock was $14 per share.

May 15

Issued the shares for the stock dividend.

Dec. 1

Declared a $0.60 per share cash dividend to stockholders of record on December 15, payable January 10, 2018.

31 Determined that net income for the year was $400,000.

Instructions (a) Journalize the transactions. (Include entries to close net income and dividends to Retained Earnings.)

(b) Enter the beginning balances and post the entries to the stockholders’ equity T-accounts. (Note: Open additional stockholders’ equity accounts as needed.)

(c) Prepare the stockholders’ equity section of the balance sheet at December 31.

(d) Calculate the payout ratio and return on common stockholders’ equity.

(c) Tot. stockholders’ equity $2,138,800

PROBLEMS: SET B AND SET C Visit the book’s companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEM Cookie Creations

(Note: This is a continuation of the Cookie Creations problem from Chapters 1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01#ch01) through 10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch10#ch10) .)

CC11 Part 1 Because Natalie has been so successful with Cookie Creations and her friend Curtis Lesperance has been just as successful with his coffee shop, they conclude that they could bene�it from each other’s business expertise. Curtis and Natalie next evaluate the different types of business organization. Because of the advantage of limited personal liability, they decide to form a corporation.

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Natalie and Curtis are very excited about this new business venture. They come to you with information they have gathered about their companies and with a number of questions.

Part 2 After establishing their company’s �iscal year to be October 31, Natalie and Curtis began operating Cookie & Coffee Creations Inc. on November 1, 2017. On that date, they issued both preferred and common stock. Natalie and Curtis now want to prepare �inancial information for the �irst year of operations.

Go to the book’s companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , to �ind the completion of this problem.

COMPREHENSIVE ACCOUNTING CYCLE | REVIEW

Journalize transactions and prepare �inancial statements.

(LO 2, 3, 4), AP

ACR11-1 Hawkeye Corporation’s balance sheet at December 31, 2016, is presented below.

During 2017, the following transactions occurred.

1. On January 1, 2017, Hawkeye issued 1,200 shares of $40 par, 7% preferred stock for $49,200.
2. On January 1, 2017, Hawkeye also issued 900 shares of the $10 par value common stock for $21,000.
3. Hawkeye performed services for $320,000 on account.
4. On April 1, 2017, Hawkeye collected fees of $36,000 in advance for services to be performed from April 1, 2017, to March 31, 2018.
5. Hawkeye collected $276,000 from customers on account.

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1. Hawkeye bought $35,100 of supplies on account.
2. Hawkeye paid $32,200 on accounts payable.
3. Hawkeye reacquired 400 shares of its common stock on June 1, 2017, for $28 per share.
4. Paid other operating expenses of $188,200.
5. On December 31, 2017, Hawkeye declared the annual preferred stock dividend and a $1.20 per share dividend on the outstanding common stock, all payable on January 15, 2018.
6. An account receivable of $1,700 which originated in 2016 is written off as uncollectible.

Adjustment data:

1. A count of supplies indicates that $5,900 of supplies remain unused at year-end.
2. Recorded revenue from item 4 above.
3. The allowance for doubtful accounts should have a balance of $3,500 at year end.
4. Depreciation is recorded on the building on a straight-line basis based on a 30-year life and a salvage value of $10,000.
5. The income tax rate is 30%. (Hint: Prepare the income statement up to income before taxes and multiply by 30% to compute the amount.)

Instructions

(You may want to set up T-accounts to determine ending balances.)

(a) Prepare journal entries for the transactions listed above and adjusting entries.

(b) Prepare an adjusted trial balance at December 31, 2017.

(c) Prepare an income statement and a retained earnings statement for the year ending December 31, 2017, and a classi�ied balance sheet as of December 31, 2017.

(b) Totals $740,690 (c) Net income $81,970 Tot. assets $421,000

Journalize transactions and prepare �inancial statements.

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(LO 2, 3, 4), AP

ACR11-2 Karen Noonan opened Clean Sweep Inc. on February 1, 2017. During February, the following transactions were completed.

Feb.   1

Issued 5,000 shares of Clean Sweep common stock for $13,000. Each share has a $1.50 par.

1 Borrowed $8,000 on a 2-year, 6% note payable. 1 Paid $9,020 to purchase used �loor and window cleaning equipment from a company

going out of business ($4,820 was for the �loor equipment and $4,200 for the window equipment).

1 Paid $220 for February Internet and phone services. 3 Purchased cleaning supplies for $980 on account. 4 Hired 4 employees. Each will be paid $480 per 5-day work week (Monday–Friday).

Employees will begin working Monday, February 9. 5 Obtained insurance coverage for $9,840 per year. Coverage runs from February 1,

2017, through January 31, 2018. Karen paid $2,460 cash for the �irst quarter of coverage.

5 Discussions with the insurance agent indicated that providing outside window cleaning services would cost too much to insure. Karen sold the window cleaning equipment for $3,950 cash.

16 Billed customers $3,900 for cleaning services performed through February 13, 2017. 17 Received $540 from a customer for 4 weeks of cleaning services to begin February 21,

1. (By paying in advance, this customer received 10% off the normal weekly fee of $150.)

18 Paid $300 on amount owed on cleaning supplies. 20 Paid $3 per share to buy 300 shares of Clean Sweep common stock from a shareholder

who disagreed with management goals. The shares will be held as treasury shares. 23 Billed customers $4,300 for cleaning services performed through February 20. 24 Paid cash for employees’ wages for 2 weeks (February 9–13 and 16–20). 25 Collected $2,500 cash from customers billed on February 16. 27 Paid $220 for Internet and phone services for March. 28 Declared and paid a cash dividend of $0.20 per share.

Instructions (a) Journalize the February transactions. (You do not need to include an explanation for each

journal entry.)

(b) Post to the ledger accounts (Use T-accounts.)

(c) Prepare a trial balance at February 28, 2017.

(d) Journalize the following adjustments. (Round all amounts to whole dollars.)

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(c) Totals $30,420

(1) Services performed for customers through February 27, 2017, but unbilled and uncollected were $3,800.

(2) Received notice that a customer who was billed $200 for services performed February 10 has �iled for bankruptcy. Clean Sweep does not expect to collect any portion of this outstanding receivable.

(3) Clean Sweep uses the allowance method to estimate bad debts. Clean Sweep estimates that 3% of its month-end receivables will not be collected.

(4) Record 1 month of depreciation for the �loor equipment. Use the straight-line method, an estimated life of 4 years, and $500 salvage value.

(5) Record 1 month of insurance expense.

(6) An inventory count shows $400 of supplies on hand at February 28.

(7) One week of services were performed for the customer who paid in advance on February 17.

(8) Accrue for wages owed through February 28, 2017.

(9) Accrue for interest expense for 1 month.

(10) Karen estimates a 20% income tax rate. (Hint: Prepare an income statement up to “income before taxes” to help with the income tax calculation.)

(e) Post adjusting entries to the T-accounts.

(f) Prepare an adjusted trial balance.

(g) Prepare a multiple-step income statement, a retained earnings statement, and a properly classi�ied balance sheet as of February 28, 2017.

(h) Journalize closing entries.

(q) Net income $3,117 Tot. assets $26,101

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EXPAND YOUR | CRITICAL THINKING

FINANCIAL REPORTING PROBLEM: Apple Inc.

AP

CT11-1 The stockholders’ equity section of Apple Inc.’s balance sheet is shown in the Consolidated Statement of Financial Position in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) . Instructions for accessing and using the company’s complete annual report, including the notes to its �inancial statements, are also provided in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) .

Instructions

Answer the following questions.

(a) What is the par or stated value per share of Apple’s common stock?

(b) What percentage of Apple’s authorized common stock was issued at September 27, 2014? (Round to the nearest full percent.)

(c) How many shares of common stock were outstanding at September 28, 2013, and at September 27, 2014?

(d) Calculate the payout ratio, earnings per share, and return on common stockholders’ equity for 2014.

COMPARATIVE ANALYSIS PROBLEM: Columbia Sportswear Company vs. VF Corporation

AN

CT11-2 The �inancial statements of Columbia Sportswear Company are presented in Appendix B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) . Financial

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statements of VF Corporation are presented in Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) .

Instructions (a) Based on the information in these �inancial statements, compute the 2014 return on

common stockholders’ equity, debt to assets ratio, and return on assets for each company.

(b) What conclusions concerning the companies’ pro�itability can be drawn from these ratios? Which company relies more on debt to boost its return to common shareholders?

(c) Compute the payout ratio for each company. Which pays out a higher percentage of its earnings?

COMPARATIVE ANALYSIS PROBLEM: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.

AN

CT11-3 The �inancial statements of Amazon.com, Inc. are presented in Appendix D (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) . Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) .

Instructions (a) Based on the information in these �inancial statements, compute the 2014 return on

common stockholders’ equity, debt to assets ratio, and return on assets for each company.

(b) What conclusions concerning the companies’ pro�itability can be drawn from these ratios? Which company relies more on debt to boost its return to common shareholders?

(c) Compute the payout ratio for each company. Which pays out a higher percentage of its earnings?

INTERPRETING FINANCIAL STATEMENTS

AN

CT11-4 Marriott Corporation split into two companies: Host Marriott Corporation and Marriott International. Host Marriott retained ownership of the corporation’s vast hotel and other properties, while Marriott International, rather than owning hotels, managed them. The purpose of this split was to free Marriott International from the “baggage” associated with Host Marriott, thus allowing it to be more aggressive in its pursuit of growth. The following information (in millions) is provided for each corporation for their �irst full year operating as independent companies.

Host Marriott Marriott International

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Host Marriott Marriott International Sales revenue $1,501  $8,415 Net income    (25)    200 Total assets  3,822   3,207 Total liabilities  3,112   2,440 Common stockholders’ equity    710     767

Instructions (a) The two companies were split by the issuance of shares of Marriott International to all

shareholders of the previous combined company. Discuss the nature of this transaction.

(b) Calculate the debt to assets ratio for each company.

(c) Calculate the return on assets and return on common stockholders’ equity for each company.

(d) The company’s debtholders were �iercely opposed to the original plan to split the two companies because the original plan had Host Marriott absorbing the majority of the company’s debt. They relented only when Marriott International agreed to absorb a larger share of the debt. Discuss the possible reasons the debtholders were opposed to the plan to split the company.

REAL-WORLD FOCUS

AN

CT11-5 Purpose: Use the stockholders’ equity section of an annual report and identify the major components.

Address: www.annualreports.com (http://www.annualreports.com)

Steps

1. Select a particular company.
2. Search by company name.
3. Follow instructions below.

Instructions

Answer the following questions.

(a) What is the company’s name?

(b) What classes of capital stock has the company issued?

(c) For each class of stock:

http://www.annualreports.com/
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(1) How many shares are authorized, issued, and/or outstanding?

(2) What is the par value?

(d) What are the company’s retained earnings?

(e) Has the company acquired treasury stock? How many shares?

DECISION-MAKING ACROSS THE ORGANIZATION

CT11-6 During a recent period, the fast-food chain Wendy’s International purchased many treasury shares. This caused the number of shares outstanding to fall from 124 million to 105 million. The following information was drawn from the company’s �inancial statements (in millions).

Instructions

Use the information provided to answer the following questions.

(a) Compute earnings per share, return on common stockholders’ equity, and return on assets for both years. Discuss the change in the company’s pro�itability over this period.

(b) Compute the dividend payout ratio. Also compute the average cash dividend paid per share of common stock (dividends paid divided by the average number of common shares outstanding). Discuss any change in these ratios during this period and the implications for the company’s dividend policy.

(c) Compute the debt to assets ratio and times interest earned. Discuss the change in the company’s solvency.

(d) Based on your �indings in (a) and (c), discuss to what extent any change in the return on common stockholders’ equity was the result of increased reliance on debt.

(e) Does it appear that the purchase of treasury stock and the shift toward more reliance on debt were wise strategic moves?

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COMMUNICATION ACTIVITY

C

CT11-7 Earl Kent, your uncle, is an inventor who has decided to incorporate. Uncle Earl knows that you are an accounting major at U.N.O. In a recent letter to you, he ends with the question, “I’m �illing out a state incorporation application. Can you tell me the difference among the following terms: (1) authorized stock, (2) issued stock, (3) outstanding stock, and (4) preferred stock?”

Instructions

In a brief note, differentiate for Uncle Earl the four different stock terms. Write the letter to be friendly, yet professional.

ETHICS CASES

E

CT11-8 The R&D division of Pele Corp. has just developed a chemical for sterilizing the vicious Brazilian “killer bees” which are invading Mexico and the southern United States. The president of Pele is anxious to get the chemical on the market because Pele pro�its need a boost—and his job is in jeopardy because of decreasing sales and pro�its. Pele has an opportunity to sell this chemical in Central American countries, where the laws are much more relaxed than in the United States.

The director of Pele’s R&D division strongly recommends further research in the laboratory to test the side effects of this chemical on other insects, birds, animals, plants, and even humans. He cautions the president, “We could be sued from all sides if the chemical has tragic side effects that we didn’t even test for in the lab.” The president answers, “We can’t wait an additional year for your lab tests. We can avoid losses from such lawsuits by establishing a separate wholly owned corporation to shield Pele Corp. from such lawsuits. We can’t lose any more than our investment in the new corporation, and we’ll invest just the patent covering this chemical. We’ll reap the bene�its if the chemical works and is safe, and avoid the losses from lawsuits if it’s a disaster.” The following week, Pele creates a new wholly owned corporation called Cabo Inc., sells the chemical patent to it for $10, and watches the spraying begin.

Instructions (a) Who are the stakeholders in this situation?

(b) Are the president’s motives and actions ethical?

(c) Can Pele shield itself against losses of Cabo Inc.?

CT11-9 Cooper Corporation has paid 60 consecutive quarterly cash dividends (15 years). The last 6 months have been a real cash drain on the company, however, as pro�it margins have been greatly narrowed by increasing competition. With a cash balance suf�icient to meet only day-to- day operating needs, the president, Sonny Boyd, has decided that a stock dividend instead of a cash dividend should be declared. He tells Cooper’s �inancial vice president, Dana Marks, to issue a press release stating that the company is extending its consecutive dividend record with

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the issuance of a 5% stock dividend. “Write the press release convincing the stockholders that the stock dividend is just as good as a cash dividend,” he orders. “Just watch our stock rise when we announce the stock dividend; it must be a good thing if that happens.”

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Instructions (a) Who are the stakeholders in this situation?

(b) Is there anything unethical about president Boyd’s intentions or actions?

(c) What is the effect of a stock dividend on a corporation’s stockholders’ equity accounts? Which would you rather receive as a stockholder—a cash dividend or a stock dividend? Why?

ALL ABOUT YOU

AN

CT11-10 In response to the Sarbanes-Oxley Act, many companies have implemented formal ethics codes. Many other organizations also have ethics codes.

Instructions

Obtain the ethics code from an organization that you belong to (e.g., student organization, business school, employer, or a volunteer organization). Evaluate the ethics code based on how clearly it identi�ies proper and improper behavior. Discuss its strengths, and how it might be improved.

FASB CODIFICATION ACTIVITY

C

CT11-11 If your school has a subscription to the FASB Codi�ication, go to http://aaahq.org/ascLogin.cfm (http://aaahq.org/ascLogin.cfm) to log in and prepare responses to the following.

(a) What is the stock dividend?

(b) What is a stock split?

(c) At what percentage point does the issuance of additional shares qualify as a stock dividend, as opposed to a stock split?

CONSIDERING PEOPLE, PLANET, AND PROFIT

C

CT11-12 The January 19, 2012, edition of the Wall Street Journal contains an article by Angus Loten entitled “With New Law, Pro�its Take a Back Seat.”

http://aaahq.org/ascLogin.cfm
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Instructions

Read the article and answer the following questions.

(a) Summarize the nature of the new law that is discussed in the article.

(b) What do some proponents of the law say is the “biggest value” of the law? How does the article say that this would have impacted Ben & Jerry’s?

(c) What are some criticisms of the law?

(d) How does incorporation as a bene�it corporation differ from B Corp certi�ication?

(e) What are some of the companies that the article cites as either having adopted bene�it corporation standing or are considering it?

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LEARNING OBJECTIVE 6

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

The accounting for transactions related to stockholders’ equity, such as issuance of shares and purchase of treasury stock, are similar under both IFRS and GAAP. Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of stockholders’ equity information.

KEY POINTS

Following are the key similarities and differences between GAAP and IFRS as related to stockholders’ equity, dividends, retained earnings, and income reporting.

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.

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.

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

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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, �inancial 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.

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

GAAP IFRS

Common stock Share capital—ordinary

Stockholders Shareholders

Par value Nominal or face value

Authorized stock Authorized share capital

Preferred stock Share capital—preference

Paid-in capital Issued/allocated share capital

Paid-in capital in excess of par—common stock Share premium—ordinary

Paid-in capital in excess of par—preferred stock Share premium—preference

Retained earnings Retained earnings or Retained pro�its

Retained earnings de�icit Accumulated losses

Accumulated other comprehensive income General reserve and other reserve accounts

As an example of how similar transactions use different terminology under IFRS, consider the accounting for the issuance of 1,000 shares of $1 par value common stock for $5 per share. Under IFRS, the entry is as follows.

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 pro�its or accumulated pro�it 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 shareholders’ funds.

LOOKING TO THE FUTURE

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The IASB and the FASB are currently working on a project related to �inancial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly de�ined and required to be displayed in the �inancial 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. This convergence will deal with highly technical changes beyond the scope of this textbook.

IFRS Practice IFRS SELF-TEST QUESTIONS

1. Which of the following is true? (a) In the United States, the primary corporate stockholders are �inancial institutions.

(b) Share capital means total assets under IFRS.

(c) The IASB and FASB are presently studying how �inancial statement information should be presented.

(d) The accounting for treasury stock differs extensively between GAAP and IFRS.

1. 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.

1. Which of the following is false? (a) Under GAAP, companies cannot record gains on transactions involving their own shares.

(b) Under IFRS, companies cannot record gains on transactions involving their own shares.

(c) Under IFRS, the statement of stockholders’ equity is a required statement.

(d) Under IFRS, a company records a revaluation surplus when it experiences an increase in the price of its common stock.

1. Which of the following does not represent a pair of GAAP/IFRS-comparable terms? (a) Additional paid-in capital/Share premium.

(b) Treasury stock/Repurchase reserve.

(c) Common stock/Share capital.

(d) Preferred stock/Preference shares.

1. The basic accounting for cash dividends and stock dividends:

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(a) is different under IFRS versus GAAP.

(b) is the same under IFRS and GAAP.

(c) differs only for the accounting for cash dividends between GAAP and IFRS.

(d) differs only for the accounting for stock dividends between GAAP and IFRS.

1. Which item in not considered part of reserves? (a) Unrealized loss on available-for-sale investments.

(b) Revaluation surplus.

(c) Retained earnings.

(d) Issued shares.

1. Under IFRS, a statement of comprehensive income must include: (a) accounts payable.

(b) retained earnings.

(c) income tax expense.

(d) preference stock.

1. Which set of terms can be used to describe total stockholders’ equity under IFRS? (a) Shareholders’ equity, capital and reserves, other comprehensive income.

(b) Capital and reserves, shareholders’ equity, shareholders’ funds.

(c) Capital and reserves, retained earnings, shareholders’ equity.

(d) All of the answer choices are correct.

1. Earnings per share computations related to IFRS and GAAP: (a) are essentially similar.

(b) result in an amount referred to as earnings per share.

(c) must deduct preferred (preference) dividends when computing earnings per share.

(d) All of the answer choices are correct.

IFRS EXERCISES

IFRS11-1 On May 10, Jaurez Corporation issues 1,000 shares of $10 par value ordinary shares for cash at $18 per share. Journalize the issuance of the shares.

IFRS11-2 Meenen Corporation has the following accounts at December 31, 2017 (in euros): Share Capital —Ordinary, €10 par, 5,000 shares issued, €50,000; Share Premium—Ordinary €10,000; Retained

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Earnings €45,000; and Treasury Shares—Ordinary, 500 shares, €11,000. Prepare the equity section of the statement of �inancial position (balance sheet).

IFRS11-3 Overton Co. had the following transactions during the current period.

Mar.  2

Issued 5,000 shares of $1 par value ordinary shares to attorneys in payment of a bill for $30,000 for services performed in helping the company to incorporate.

June  12

Issued 60,000 shares of $1 par value ordinary shares for cash of $375,000.

July  11

Issued 1,000 shares of $100 par value preference shares for cash at $110 per share.

Nov.  28

Purchased 2,000 treasury shares for $80,000.

Instructions

Journalize the above transactions.

INTERNATIONAL FINANCIAL REPORTING PROBLEM: Louis Vuitton

IFRS11-4 The �inancial statements of Louis Vuitton are presented in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) . Instructions for accessing and using the company’s complete annual report, including the notes to its �inancial statements, are also provided in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) .

Instructions

Use the company’s annual report to answer the following questions.

(a) Determine the following amounts at December 31, 2014: (1) total equity, (2) total revaluation reserve, and (3) number of treasury shares.

(b) Examine the equity section of the company’s balance sheet. For each of the following, provide the comparable label that would be used under GAAP: (1) share capital, (2) share premium, and (3) net pro�it, group share.

(c) Did the company declare and pay any dividends for the year ended December 31, 2014?

(d) Compute the company’s return on ordinary shareholders’ equity for the year ended December 31, 2014.

(e) What was Louis Vuitton’s earnings per share for the year ended December 31, 2014?

Answers to IFRS Self-Test Questions

1. c 2. c 3. d 4. b 5. b 6. d 7. c 8. b 9. d

1 A number of companies have eliminated the preemptive right because they believe it places an unnecessary and cumbersome demand on management. For example, IBM, by stockholder approval, has dropped its preemptive right for stockholders.