Reporting and Analyzing Equity: © The Mcgraw-Hill Companies, Inc., 2010 Mcgraw-Hill/Irwin

Chapter 11
Reporting and Analyzing Equity
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2010
Conceptual Learning Objectives

C1: Identify characteristics of
corporations and their organization
C2: Describe the components of
stockholders equity
C3: Explain characteristics of common
and preferred stock
C4: Explain the items reported in
retained earnings
McGraw-Hill/Irwin
Analytical Learning Objectives

A1: Compute earnings per share and
describe its use
A2: Compute price-earnings ratio and
describe its use in analysis
A3: Compute dividend yield and explain
its use in analysis
A4: Compute book value and explain its
use in analysis
McGraw-Hill/Irwin
Procedural Learning Objectives

P1: Record the issuance of corporate stock
P2: Record transactions involving cash
dividends
P3: Account for stock dividends and stock
splits
P4: Distribute dividends between common
stock and preferred stock
P5: Record purchases and sales of treasury
stock and the retirement of stock
McGraw-Hill/Irwin
C1
Corporate Form of Organization

An
An entity
entity
created
created by
by law
law
Existence
Existence is
is
separate
separate from
from
owners
owners
Has
Has rights
rights and
and
privileges
privileges
McGraw-Hill/Irwin
Ownership
can be
Privately Held
Publicly Held
C1
Characteristics of Corporations
McGraw-Hill/Irwin
Advantages
Advantages
Separate
Separate legal
legal entity
entity
Limited
Limited liability
liability of
of stockholders
stockholders
Transferable
Transferable ownership
ownership rights
rights
Continuous
Continuous life
life
Lack
Lack of
of mutual
mutual agency
agency for
for stockholders
stockholders
Ease
Ease of
of capital
capital accumulation
accumulation
Disadvantages
Disadvantages
Governmental
Governmental regulation
regulation
Corporate
Corporate taxation
taxation
C1
Organizing and Managing

a Corporation
Stockholders
Board of Directors
President, Vice-President,
and Other Officers
Employees of the Corporation

McGraw-Hill/Irwin
Organizing and Managing

a Corporation
C1
C o r p o r a t e O r g a n iz a t io n C h a r t
Ultimate
Ultimate
control.
control.
S to c k h o ld e r s
Selected
Selected by
by aa
vote
vote of
of the
the
stockholders.
stockholders.
B o a r d o f D ir e c to r s
Stockholders
Stockholders
usually
usually meet
meet
once
once aa year.
year.
Overall
Overall
responsibility
responsibility
for
for managing
managing
the
the company.
company.
P r e s id e n t
S e c re ta ry
McGraw-Hill/Irwin
V ic e P r e s id e n t
F in a n c e
P r o d u c tio n
M a r k e tin g
C1
Rights of Stockholders
McGraw-Hill/Irwin
Vote
Vote at
at stockholders
stockholders meetings
meetings
Sell
Sell stock
stock
Purchase
Purchase additional
additional shares
shares of
of stock
stock
Receive
Receive dividends,
dividends, ifif any
any
Share
Share equally
equally in
in any
any assets
assets remaining
remaining
after
after creditors
creditors are
are paid
paid in
in aa liquidation
liquidation
C1
Stock Certificates and Transfer
Each
Each unit
unit of
of
ownership
ownership is
is
called
called aa share
share of
of
stock.
stock.
A
A stock
stock certificate
certificate
serves
serves as
as proof
proof
that
that aa stockholder
stockholder
has
has purchased
purchased
shares.
shares.
When
When the
the stock
stock is
is sold,
sold, the
the stockholder
stockholder signs
signs aa transfer
transfer
endorsement
endorsement on
on the
the back
back of
of the
the stock
stock certificate.
certificate.
McGraw-Hill/Irwin
C2
Basics of Capital Stock

Total
Total amount
amount of
of stock
stock that
that aa
corporations
corporations charter
charter authorizes
authorizes itit to
to sell.
sell.
Note: Another name for common stock is ordinary share
McGraw-Hill/Irwin
C2
Basics of Capital Stock

Total
Total amount
amount of
of stock
stock that
that has
has been
been
issued
issued or
or sold
sold to
to stockholders.
stockholders.
McGraw-Hill/Irwin
C2
Selling (Issuing) Stock
Par
Par value
value is
is an
an
arbitrary
arbitrary amount
amount
assigned
assigned to
to each
each
share
share of
of stock
stock when
when
itit is
is authorized.
authorized.
McGraw-Hill/Irwin
Market
Market price
price is
is the
the
amount
amount that
that each
each
share
share of
of stock
stock will
will
sell
sell for
for in
in the
the market.
market.
C2
Classes of Stock
Par Value
No-Par Value
Stated Value
McGraw-Hill/Irwin
P1
Issuing Par Value Stock

Par
Par Value
Value Stock
Stock
On
On September
September 1,
1, Matrix,
Matrix, Inc.
Inc. issued
issued 100,000
100,000
shares
shares of
of $2
$2 par
par value
value stock
stock for
for $25
$25 per
per share.
share.
Lets
Lets record
record this
this transaction.
transaction.
Record:
Record:
1.
1. The
The cash
cash received.
received.
2.
2. The
The number
number of
of shares
shares issued
issued the
the par
par value
value
per
per share
share in
in the
the Common
Common Stock
Stock account.
account.
3.
3. The
The remainder
remainder is
is assigned
assigned to
to Paid-In
Paid-In Capital
Capital
in
in Excess
Excess of
of Par
Par Value,
Value, Common
Common Stock.
Stock.
McGraw-Hill/Irwin
P1

Par
Par Value
Value Stock
Stock
On
On September
September 1,
1, Matrix,
Matrix, Inc.
Inc. issued
issued 100,000
100,000
shares
shares of
of $2
$2 par
par value
value stock
stock for
for $25
$25 per
per share.
share.
Lets
Lets record
record this
this transaction.
transaction.
McGraw-Hill/Irwin
P1
McGraw-Hill/Irwin
P1
Issuing Stock for Noncash Assets

Par
Par Value
Value Stock
Stock
On
On September
September 1,
1, Matrix,
Matrix, Inc.
Inc. issued
issued 100,000
100,000
shares
shares of
of $2
$2 par
par value
value stock
stock for
for land
land valued
valued at
at
$2,500,000.
$2,500,000. Lets
Lets record
record this
this transaction.
transaction.
Record:
Record:
1.
1. The
The asset
asset received
received at
at its
its market
market value.
value.
2.
2. The
The number
number of
of shares
shares issued
issued the
the par
par value
value
per
per share
share in
in the
the Common
Common Stock
Stock account.
account.
3.
3. The
The remainder
remainder is
is assigned
assigned to
to Paid-In
Paid-In Capital
Capital
in
in Excess
Excess of
of Par,
Par, Common
Common Stock.
Stock.
McGraw-Hill/Irwin
P1
Issuing Stock for Noncash Assets

Par
Par Value
Value Stock
Stock
On
On September
September 1,
1, Matrix,
Matrix, Inc.
Inc. issued
issued 100,000
100,000
shares
shares of
of $2
$2 par
par value
value stock
stock for
for land
land valued
valued at
at
$2,500,000.
$2,500,000. Lets
Lets record
record this
this transaction.
transaction.
McGraw-Hill/Irwin
C3
Preferred Stock
A
A separate
separate class
class of
of stock,
stock, typically
typically having
having
priority
priority over
over common
common shares
shares in
in .. .. ..
Dividend
Dividend distributions
distributions
Distribution
Distribution of
of assets
assets in
in case
case of
of liquidation
liquidation
Usually
Usually has
has aa stated
stated
dividend
dividend rate
rate
Normally
Normally has
has no
no
voting
voting rights
rights
Note: Another name for preferred stock is preference share
McGraw-Hill/Irwin
Cumulative or Noncumulative
Dividend
P4
Cumulative
Dividends
Dividends in
in arrears
arrears
must
must be
be paid
paid before
before
dividends
dividends may
may be
be
paid
paid on
on common
common
stock.
stock.
Vs.
Noncumulative
Undeclared
Undeclared dividends
dividends
from
from current
current and
and
prior
prior years
years do
do not
not have
have
to
to be
be paid
paid in
in future
future
years.
years.
Most preferred stock

is cumulative.
McGraw-Hill/Irwin
Dividend
P4
Example: Consider the following Stockholders

Equity Section of the Balance Sheet
The Board of Directors did not declare or pay

dividends in 2009. In 2010, the Board of Directors
declare and pay cash dividends of $42,000.
McGraw-Hill/Irwin
P4
McGraw-Hill/Irwin
Dividend
P4
Participating or Nonparticipating
Dividend
Participating
Dividends
Dividends may
may exceed
exceed
aa stated
stated amount
amount once
once
common
common stockholders
stockholders
receive
receive aa dividend
dividend
equal
equal to
to the
the preferred
preferred
stated
stated rate.
rate.
Vs. Nonparticipating
Dividends
Dividends are
are limited
limited to
to
aa maximum
maximum amount
amount each
each
year.
year. The
The maximum
maximum is
is
usually
usually the
the stated
stated
dividend
dividend rate.
rate.
Most preferred
stock is
nonparticipating.
McGraw-Hill/Irwin
P4
Reasons for Issuing Preferred Stock
To
To raise
raise capital
capital without
without sacrificing
sacrificing
control
control
To
To boost
boost the
the return
return earned
earned by
by common
common
stockholders
stockholders through
through financial
financial leverage
leverage
To
To appeal
appeal to
to investors
investors who
who may
may believe
believe
the
the common
common stock
stock is
is too
too risky
risky or
or that
that
the
the expected
expected return
return on
on common
common stock
stock is
is
too
too low
low
McGraw-Hill/Irwin
P2
Cash Dividends
To pay a cash dividend the corporation

must have:
1.
2.
A sufficient balance in retained earnings and

The cash necessary to pay the dividend.
McGraw-Hill/Irwin
P2
Cash Dividends
Regular cash dividends provide a return to investors
and almost always affect the stocks market value.
June
30
Stockholders
Corporation
McGraw-Hill/Irwin
Dividends
P2
Entries for Cash Dividends
Three important dates

ds
n
e
id
Div
Date of Declaration
Date of Record
Date of Payment
Record liability
for dividend.
No entry
required.
Record payment of
cash to stockholders.
McGraw-Hill/Irwin
P2
ds
n
e
id
Di v
On January 19, a $1 per share cash dividend

is declared on Dana, Inc.s 10,000 common
shares outstanding. The dividend will be paid
on March 19 to stockholders of record on
February 19.
Date of Declaration
Record liability
for dividend.
McGraw-Hill/Irwin
P2

On January 19, a $1 per share cash
dividend is declared on Dana, Inc.s
10,000 common shares
outstanding. The dividend will be
paid on March 19 to stockholders of
record on February 19.
Date of Record
No entry required on
February 19.
No entry
required.
McGraw-Hill/Irwin
P2

On January 19, a $1 per share cash
dividend is declared on Dana, Inc.s
10,000 common shares outstanding.
The dividend will be paid on March 19
to stockholders of record on February
19.
Date of Payment
Record payment of
cash to stockholders.
McGraw-Hill/Irwin
P2
Deficits and Cash Dividends

Created when a company incurs cumulative losses or pays
dividends greater than total profits earned in other years.
McGraw-Hill/Irwin
P3
Stock Dividends
The
The corporation
corporation distributes
distributes additional
additional shares
shares
of
of its
its own
own stock
stock to
to its
its stockholders
stockholders without
without
receiving
receiving any
any payment
payment in
in return.
return.
Why
Why aa stock
stock dividend?
dividend?
100 shares
HotAir, Inc.
Common Stock
$1 par
Can
Can be
be used
used to
to keep
keep the
the market
market
price
price on
on the
the stock
stock affordable.
affordable.
Can
Can provide
provide evidence
evidence of
of
managements
managements confidence
confidence that
that
the
the company
company is
is doing
doing well.
well.
McGraw-Hill/Irwin
P3
Stock Dividends
Small
Small Stock
Stock Dividend
Dividend
Distribution
Distribution is
is 25%
25%of
of the
the previously
previously
outstanding
outstanding shares.
shares.
Capitalize
Capitalize retained
retained earnings
earnings for
for the
the market
market value
value
of
of the
the shares
shares to
to be
be distributed.
distributed.
Large
Large Stock
Stock Dividend
Dividend
Distribution
Distribution is
is >> 25%
25% of
of the
the previously
previously
outstanding
outstanding shares.
shares.
Capitalize
Capitalize retained
retained earnings
earnings for
for the
the minimum
minimum
amount
amount required
required by
by state
state law,
law, usually
usually par
par or
or
stated
stated value
value of
of the
the shares.
shares.
McGraw-Hill/Irwin
P3
Recording a Small Stock Dividend

Here
Here is
is the
the stockholders
stockholders equity
equity section
section of
of
Quests
Quests balance
balance sheet
sheet prior
prior to
to the
the declaration
declaration
of
of aa small
small stock
stock dividend.
dividend.
McGraw-Hill/Irwin
P3
Recording a Small Stock Dividend

On
On December
December 31,
31, 2010,
2010, Quest
Quest declared
declared aa 2%
2% stock
stock
dividend,
dividend, when
when the
the stock
stock was
was selling
selling for
for $10
$10 per
per
share.
share. The
The stock
stock will
will be
be distributed
distributed to
to stockholders
stockholders
on
on January
January 20,
20, 2011.
2011. Lets
Lets make
make the
the December
December 31
31
entry.
entry.
100,000
100,000 2%
2% == 2,000
2,000 $10
$10 == $20,000
$20,000
2,000
2,000 $1
$1 par
par == $2,000
$2,000
McGraw-Hill/Irwin
P3
Before the
stock
dividend.
After the
stock
dividend.
McGraw-Hill/Irwin
P3
Recording a Large Stock Dividend

Router,
Router, Inc.
Inc. shows
shows the
the following
following stockholders
stockholders
equity
equity section
section just
just prior
prior to
to issuing
issuing aa large
large
stock
stock dividend.
dividend.
McGraw-Hill/Irwin
P3
Recording a Large Stock Dividend

On
On December
December 31,
31, 2010,
2010, Router
Router declared
declared aa
40%
40% stock
stock dividend,
dividend, when
when the
the stock
stock was
was
selling
selling for
for $8
$8 per
per share.
share. ItIt is
is often
often required
required
by
by law
law that
that large
large stock
stock dividends
dividends be
be
capitalized
capitalized at
at par
par value
value per
per share.
share.
50,000
50,000 40%
40% == 20,000
20,000 shares
shares $1
$1 par
par value
value == $20,000
$20,000
McGraw-Hill/Irwin
P3
Stock Splits
A distribution of additional shares of stock to
stockholders according to their percent
ownership.
$10 par value
Common Stock
Old
Shares
100 shares
$5 par value
New
Shares
Common Stock
200 shares
McGraw-Hill/Irwin
P3
Stock Splits
After
After the
the 2-for-1
2-for-1 split
split the
the stockholders
stockholders equity
equity
section
section of
of the
the balance
balance sheet
sheet looks
looks like
like this:
this:
No accounting
entry is made.
McGraw-Hill/Irwin
P5
Purchasing Treasury Stock

On
On May
May 8,
8, Whitt,
Whitt, Inc.
Inc. purchased
purchased 2,000
2,000 of
of its
its own
own
shares
shares of
of stock
stock in
in the
the open
open market
market for
for $8,000.
$8,000.
Treasury stock is shown as a reduction in total

stockholders equity on the balance sheet.
McGraw-Hill/Irwin
P5
Selling Treasury Stock at Cost

On
On June
June 30,
30, Whitt
Whitt sold
sold 100
100 shares
shares of
of its
its
treasury
treasury stock
stock for
for $4
$4 per
per share.
share.
$8,000 2,000 shares = $4 cost per treasury share
McGraw-Hill/Irwin
P5
Selling Treasury Stock Above

Cost
On
On July
July 19,
19, Whitt,
Whitt, Inc.
Inc. sold
sold an
an additional
additional 500
500
shares
shares of
of its
its treasury
treasury stock
stock for
for $8
$8 per
per share.
share.
McGraw-Hill/Irwin
Selling Treasury Stock

Below Cost
P5
On
On August
August 27,
27, Whitt
Whitt sold
sold an
an additional
additional 400
400 shares
shares
of
of its
its treasury
treasury stock
stock for
for $1.50
$1.50 per
per share.
share.
McGraw-Hill/Irwin
P5
Stock Options
The right to purchase common stock at a fixed
price over a specified period of time. As the
stocks price rises above the fixed option
price, the value of the option increases.
Option
purchase
price $30
per share.
McGraw-Hill/Irwin
Market
price of
stock $75
per share.
P5
Stock Options
Options are given to key employees to motivate
them to:
focus on company performance,
take a long-run perspective, and
remain with the company.
McGraw-Hill/Irwin
C4
Statement of Retained Earnings

Total cumulative amount of reported net
income less any net losses and dividends
declared since the company started operating.
McGraw-Hill/Irwin
C4
Restricted Retained Earnings
Legal
Contractual
Most
Most states
states restrict
restrict
the
the amount
amount of
of
treasury
treasury stock
stock
purchases
purchases to
to the
the
amount
amount of
of retained
retained
earnings.
earnings.
Loan
Loan agreements
agreements
can
can include
include
restrictions
restrictions on
on
paying
paying
dividends
dividends below
below aa
certain
certain amount
amount of
of
retained
retained earnings.
earnings.
McGraw-Hill/Irwin
C4
Appropriated Retained Earnings

A corporations directors can voluntarily limit
dividends because of a special need for cash
such as the purchase of new facilities.
McGraw-Hill/Irwin
Prior Period Adjustments
C4
Correction of material errors in past years financial

statements. If an amount is incorrectly expensed,
add amount to Retained Earnings.
McGraw-Hill/Irwin
C4
Statement of Stockholders Equity
This is a more inclusive statement than the statement of

retained earnings.
McGraw-Hill/Irwin
A1
Earnings Per Share

Earnings per share is one of the most widely
cited items of accounting information.
Basic
Net income - Preferred dividends
earnings =
Weighted-average common shares outstanding
per share
McGraw-Hill/Irwin
A2
Price Earnings
This ratio reveals information about the stock
markets expectations for a companys future growth
in earnings, dividends, and opportunities.
PriceMarket value per share

=
Earnings
Earnings per share
If earnings go up,
will the market price
of my stock follow?
McGraw-Hill/Irwin
A3
Dividend Yield
Tells us the annual amount of cash
dividends distributed to common
stockholders relative to the stocks
market price.
Dividend
=
Yield
McGraw-Hill/Irwin
Annual cash dividends per share

Market value per share
A4
Book Value per ShareCommon

Records amount of stockholders equity
applicable to common shares on a per
share basis.
Stockholders equity applicable
Book value per
to common shares
=
common share
Number of common shares
outstanding
McGraw-Hill/Irwin
A4
Book Value per SharePreferred

Records amount of stockholders equity
applicable to preferred shares on a per
share basis.
Stockholders equity applicable

Book value per
to preferred shares
=
preferred share
Number of preferred shares
outstanding
McGraw-Hill/Irwin
End of Chapter 11
McGraw-Hill/Irwin

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Chapter 11

Reporting and Analyzing Equity

The McGraw-Hill Companies, Inc., 2010

Conceptual Learning Objectives

The McGraw-Hill Companies, Inc., 2010

Analytical Learning Objectives

The McGraw-Hill Companies, Inc., 2010

Procedural Learning Objectives

The McGraw-Hill Companies, Inc., 2010

Corporate Form of Organization

The McGraw-Hill Companies, Inc., 2010

Organizing and Managing

Employees of the Corporation

The McGraw-Hill Companies, Inc., 2010

Organizing and Managing

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

Stock Certificates and Transfer

The McGraw-Hill Companies, Inc., 2010

Basics of Capital Stock

Note: Another name for common stock is ordinary share

The McGraw-Hill Companies, Inc., 2010

Basics of Capital Stock

The McGraw-Hill Companies, Inc., 2010

Selling (Issuing) Stock

The McGraw-Hill Companies, Inc., 2010

Issuing Par Value Stock

The McGraw-Hill Companies, Inc., 2010

Issuing Par Value Stock

The McGraw-Hill Companies, Inc., 2010

Issuing Par Value Stock

The McGraw-Hill Companies, Inc., 2010

Issuing Stock for Noncash Assets

The McGraw-Hill Companies, Inc., 2010

Issuing Stock for Noncash Assets

The McGraw-Hill Companies, Inc., 2010

Note: Another name for preferred stock is preference share

The McGraw-Hill Companies, Inc., 2010

Most preferred stock

The McGraw-Hill Companies, Inc., 2010

Example: Consider the following Stockholders

The Board of Directors did not declare or pay

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

Reasons for Issuing Preferred Stock

The McGraw-Hill Companies, Inc., 2010

To pay a cash dividend the corporation

A sufficient balance in retained earnings and

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

Entries for Cash Dividends

Three important dates

The McGraw-Hill Companies, Inc., 2010

Entries for Cash Dividends

On January 19, a $1 per share cash dividend

The McGraw-Hill Companies, Inc., 2010

Entries for Cash Dividends

The McGraw-Hill Companies, Inc., 2010

Entries for Cash Dividends

The McGraw-Hill Companies, Inc., 2010

Deficits and Cash Dividends

The McGraw-Hill Companies, Inc., 2010