CONTENTS

1. Introduction
1.1. Accounting equatuion
1.2. Corporations and Stockholders’ Equity
1.3. Issuing Stock For Cash
2. Abstract
FINANCIAL 3. References

ACCOUNTING
TARGETS
After reading this chapter you should be able to:

SHAREHOLDER’S EQUITY  Understand accounting equatuion

• Identify equity
 Understand issuingstock for cash

Prof. Dr. Bener Güngör

Shareholder’s Equity Financial Accounting / 14. Unit

1. INTRODUCTION
Accounting may be difined as the process of analyzing, classifying, recording
summarizing, and interpreting business transactions. One of the key aspects of
the process is keeping “running totals” of “things.” Examples of items a business
might keep track of include the amount of cash the business currently has, what
a company has paid for utilities for the month, the amount of money it owes, its
income for the entire year, and the total cost of all the equipment it has
purchased. You want to always have these running totals up to date so they are
readily available to you when you need the information. It is similar to checking
what your cash balance in the bank is when deciding if you have enough money
to make a purchase with your debit card.

1.1. Accountİng Equation

The accounting equation is the basis for all transactions in accounting. It
must be in balance at all times. It involves the three types of accounts that
appear on the balance sheet.
The accounting equation is Assets = Liabilities + Stockholders’ Equity.
The corporation has assets, and it must pay for these assets. It can do so in
two ways. The corporation can use its own money or it can borrow and use
other people’s money, incurring liabilities, or debts.
Indirectly, revenue and expense accounts are part of this accounting equation
since they impact the value of stockholders’ equity through closing entries,
which move revenue and expense account balances into Retained Earnings.

Retained earnings is a company’s accumulated profit since it began

operations
minus any dividends distributed over that time.
Stockholders’ equity (account category) is the amount of a business’s total
assets that is owned by the stockholders. Two accounts that you know so far fall
in this category: stockholders’ equity is the total of the balances in the Common
Stock and Retained Earnings accounts.
Common Stock (account) is the ownership value in the business that comes
from outside the company - investors put their own money into the business.
Retained Earnings (account) is the ownership value in the business that
comes from inside the company - the business makes a profit that is shared by
its stockholders.
Dividends (account) are distributions of profits from Retained Earnings to
stockholders.
Any change in the Common Stock, Retained Earnings, or Dividends accounts

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affects total stockholders’ equity.

Stockholders’ Equity can increase in two ways:
1. Stock is issued and Common Stock increases and/or
2. Business makes a profit and Retained Earnings increases
Stockholders’ Equity can decrease in two ways:
1. Dividends are distributed and Retained Earnings decreases and/or
2. Business takes a loss and Retained Earnings decreases

1.2. Corporations and Stockholders’ Equity

A corporation is a form of business organization that is a separate legal
entity; it is distinct from the people who own it. The corporation can own
property, enter into contracts, borrow money, conduct business, earn profit, pay
taxes, and make investments similar to the way individuals can.
The owners of a corporation are called stockholders. These are people
who have invested cash or contributed other assets to the business. In return,
they receive shares of stock, which are transferable units of ownership in a
corporation. Stock can also be thought of as a receipt to acknowledge ownership
in the company. The value of the stock that a stockholder receives equals the
value of the asset(s) that were contributed.
A corporation may be owned by one stockholder or by millions. Very small
companies can incorporate by filing articles of incorporation with a state in the
U.S. and being granted corporate status.
Corporations are ongoing. Stockholders can buy and sell their shares of stock
without interrupting the operation of the company. Another characteristic of a
corporation is limited liability. Stockholders can lose no more than the amount
they invested in the corporation. If the corporation fails, the individuals who
own it do not personally have to cover the corporation’s liabilities.
Up to this point, the stockholders’ equity section of the balance sheet has
included two accounts: Common Stock and Retained Earnings. Common Stock
is value that the owners have in the business because they have contributed
their own personal assets. Retained earnings is value the owners have in the
Corporation because the business has been operating – doing what it was set up
to do - and as a result it has generated a profit that the owners share. It is
preferable, of course, for stockholder wealth to increase due to net income over
time. That earnings potential is, in fact, what attracts stockholders to invest their
own money into a business in the first place.
The following Accounts Summary Table summarizes the accounts relevant to
issuing stock.

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We will be using the accounts above in numerous journal entries. The point
of these journal entries is to ultimately arrive at one number: total stockholders’
equity. Owners of a business are very interested in knowing what they are
worth, and that final result is the answer to that question.
The new material we will cover next involves the stockholders’ equity section
of the balance sheet. The generic Common Stock account will no longer be the
only account used for owner investments: six new accounts will be added that
describe a corporation’s equity in more specific detail. In addition, a second type
of dividends will be covered: Stock Dividends.
The income statement is not affected by these new accounts. The retained
earnings and balance sheet are. The statements on the left show account names
in blue that you learned previously. The statements on the right show account
names in blue that will replace those on the left as we take a more detailed look
at stockholders’ equity.

6.3. Issuing Stock For Cash

A corporation may issue stock to raise money. “Issue” means to sell the
shares of stock for the first time. If the company issues only one type of stock, it
is common stock. The investors become owners of the company and are called
stockholders.
A journal entry must be recorded when a corporation issues stock.

Par value is an amount assigned to each share of stock when it is authorized.

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Notice in this case the par value equals the issue price per share.
▲▲ Cash is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.

Here the issue price is greater than the par value. The Common Stock
account
can only be credited in multiples of the par value per share. The other $2 per
share
is credited to the Paid-in Capital in Excess of Par - Common Stock account.
▲▲ Cash is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.
▲▲ Paid-in Capital in Excess of Par - Common Stock is a stockholders’ equity
account
that is increasing.
Besides common stock, a corporation may also issue preferred stock. This
type of stock has a more predictable dividend payment, which will be covered
later.

The journal entry for issuing preferred stock is very similar to the one for
common stock. This time Preferred Stock and Paid-in Capital in Excess of Par -
Preferred Stock are credited instead of the accounts for common stock.
▲▲ Cash is an asset account that is increasing.
▲▲ Preferred Stock is a stockholders’ equity account that is increasing.
▲▲ Paid-in Capital in Excess of Par - Preferred Stock is a stockholders’
equity account that is increasing.
Information about preferred stock might also be presented in one of the
following two ways:
Example 1: A corporation issues 1,000 shares of $1 preferred, $100 par stock
for $105 per share.
Example 2: A corporation issues 1,000 shares of 1% preferred, $100 par stock
for $105 per share.
The extra dollar or percentage information given relates to the cash dividend
amount per share on the preferred stock. It may be stated directly as a dollar

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amount, such as $1. It may also be stated as a percentage, such as 1% of the

par value of $100, which also results in $1 per share. This $1 or 1% is not a
factor in the journal entry for issuing the preferred stock.

1.4. Issuing Stock For Non-Cash Assets

Stock may be issued for assets other than cash, such as services rendered,
land, equipment, vehicles, accounts receivable, and inventory. This is more
common in small corporations than in larger ones. The journal entries are
similar to those for issuing stock for cash. In this case, the value of either the
stock or the asset must be known. The assumption is that both the asset and
the stock have the same value.

When issuing stock for non-cash assets, it is assumed the value of the asset
(land) and the value of the stock are equal. Notice that the par value equals
the issue price per share. The value of the stock can be calculated and the
value of the land is set equal to that same amount.
▲▲ Land is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.

The value of the stock ($25 per share) is given; the value of the land
equals that of the stock. Remember, the Common Stock account can only be
credited for the par value per share. The Paid-in Capital in Excess of Par -
Common Stock account is used for the difference between the value of the
land and the stock’s total par value.
▲▲ Land is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.
▲▲ Paid-in Capital in Excess of Par - Common Stock is a stockholders’ equity
account that is increasing.

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The value of the land is given; the value of the stock equals that of the
land. Remember, the Common Stock account can only be credited for the par
value per share. The Paid-in Capital in Excess of Par - Common Stock account
is used for the difference between the value of the land and the stock’s total
par value.
▲▲ Land is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.
▲▲ Paid-in Capital in Excess of Par - Common Stock is a stockholders’ equity
account that is increasing.

Organization Costs are expenses incurred to start a business, such as legal

fees.
This is an asset account. Sometimes the service providers are given stock
rather than cash for their services. When issuing stock for non-cash assets, it
is assumed the value of the asset (organization costs) and the value of the
stock that is issued are equal. Notice that the par value equals the issue price
per share.
▲▲ Organization Costs is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.

The market value per share of the stock, $12, is given. Therefore, the value of
the organization costs can be calculated by multiplying the $12 times the
number of shares issued. Remember, the Common Stock account can only be
credited for the par value of $10 per share, so the Paid-in Capital in Excess of
Par – Common Stock account is used for the $2 per share difference.
▲▲ Organization Costs is an asset account that is increasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.
▲▲ Paid-in Capital in Excess of Par - Common Stock is a stockholders’ equity
account that is increasing.

1.5. Treasury Stock

Treasury stock is stock that is repurchased by the same corporation that

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issued it. The corporation is buying back its own stock from the stockholders.
Since treasury stock shares are no longer owned by stockholders, but by the
Corporation itself, total stockholders’ equity decreases.
Shares outstanding equals the number of shares issued (sold for the first
time) minus the number of shares of treasury stock a corporation has
reacquired.
When treasury stock is purchased, the number of shares issued remains
unchanged, but the number of shares outstanding decreases.
When treasury stock is purchased, the Treasury Stock account is debited for
the number of shares purchased times the purchase price per share. Treasury
Stock is a contra stockholders’ equity account and increases by debiting. It is
not an asset account.
Treasury stock may be resold to stockholders at the same, a higher, or a
lower price than it was purchased for. When sold, the Treasury Stock account
can only be credited in multiples of its original purchase price per share. Use
the Paid-in Capital from Sale of Treasury Stock account for differences
between purchase and selling prices. Paid-in Capital from Sale of Treasury
Stock is credited for any amount above the original purchase price (similar to
a gain) and is debited for any amount below the original purchase price
(similar to a loss). The sale of treasury stock increases the number of shares
outstanding and increases total stockholders’ equity.
The par value of the stock is not a factor in the purchase or sale of treasury
stock.
EXAMPLE
Assume there were 10,000 shares of common stock issued before any
treasury stock transaction. That would mean there were also 10,000
shares outstanding.

Buying treasury stock reduces the number of shares outstanding (the

number of shares stockholders own). Prior to purchasing the 1,000 shares of
treasury stock there were 10,000 shares of common stock outstanding. After
purchasing the treasury stock, there are 9,000 shares outstanding.
▲▲ Treasury Stock is a contra stockholders’ equity account that is
increasing.
▼▼ Cash is an asset account that is decreasing.
NOTE: Another way this same transaction could be stated is as follows:
Purchased 1,000 shares of treasury stock for $45,000.
To determine the purchase price per share, divide $45,000 by 1,000 shares to
get $45 per share.

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Treasury stock may be resold to stockholders for more than its purchase
price per share.

Notice that the treasury stock is sold for $60, MORE than it was purchased
for per share ($45). The $15 per share difference is recorded as a credit to
the Paid-in Capital from Sale of Treasury Stock account.
Selling treasury stock increases the number of shares outstanding (the
number of shares stockholders own). Prior to selling these 200 shares of
treasury stock there were 9,000 shares of common stock outstanding (see
#1). After selling these shares of treasury stock, there are 9,200 shares
outstanding.
▲▲ Cash is an asset account that is increasing.
▲▲ Paid-in Capital from Sale of Treasury Stock is a stockholders’ equity
account that is increasing.
▼▼ Treasury Stock is a contra stockholders’ equity account that is
decreasing.
Treasury stock may be resold to stockholders for less than its purchase price
pershare.

Notice that the treasury stock is sold for $40, LESS than it was purchased for
per share ($45). The $5 per share difference is recorded as a debit to the
Paid-in Capital from Sale of Treasury Stock account.
Selling treasury stock increases the number of shares outstanding (the
number of shares stockholders own). Prior to selling these additional 200
shares of treasury stock there were 9,200 shares of common stock
outstanding (see #2). After selling
these additional shares of treasury stock, there are 9,400 shares outstanding.
▲▲ Cash is an asset account that is increasing.
▼▼ Paid-in Capital from Sale of Treasury Stock is a stockholders’ equity
account that is decreasing.
▼▼ Treasury Stock is a contra stockholders’ equity account that is
decreasing.

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1.6. Cash Dividends

Cash dividends are corporate earnings that are paid out to stockholders.
They are pay payouts of retained earnings, which is accumulated profit.
Therefore, cash dividends reduce both the Retained Earnings and Cash
account balances.
Cash Dividends is a contra stockholders’ equity account that temporarily
substitutes for a debit to the Retained Earnings account. At the end of the
accounting period, Cash Dividends is closed to Retained Earnings.
There are three prerequisites to paying a cash dividend: a decision by the
Board of Directions, sufficient cash, and sufficient retained earnings.
Cash dividends are only paid on shares outstanding. No dividends are paid on
treasury stock, or the corporation would essentially be paying itself.
Three dates are associated with a cash dividend. The date of declaration is
the date the corporation commits to paying the stockholders. On that date, a
liability is incurred and the Cash Dividends Payable is used to record the
amount owed to the stockholders until the cash is actually paid. The date of
record is the date on which ownership is determined. Since shares of stock
may be traded, the corporation names a specific date, and whoever owns the
shares on that date will receive the dividend. There is no journal entry on the
date of record. Finally, the date of payment is the date the cash is actually
paid out to stockholders.
1. Date of Declaration
Declared a cash dividend of $32,000. OR
Declared a cash dividend of $2 per share on 10,000 shares of preferred stock
outstanding (total $20,000) and $.50 per share on 24,000 shares of common
stock outstanding (total $12,000). NOTE: The $20,000 for preferred and
$12,000 for common dividends can be combined into one journal entry.

▲▲ Cash Dividends is a contra stockholders’ equity account that is

increasing.
▲▲ Cash Dividends Payable is a liability account that is increasing.
2. Date of Record - no journal entry
3. Date of Payment
Paid the amount that had been declared. The Cash Dividends Payable
account balance is set to zero.

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NOTE: Many times the challenge with dividend declarations is to first

determine the number of shares outstanding.
For example, if a company issued 30,000 shares of common stock, reacquired
10,000 as treasury stock, and then sold 1,000 shares of the Treasury Stock,
there would be 21,000 shares outstanding (30,000 - 10,000 + 1,000). If a cash
dividend of $2 per share were declared, the total cash dividends would be
$42,000 (21,000x $2).

1.7. Stock Dividends

Stock dividends are corporate earnings that are distributed to stockholders.
They are distributions of retained earnings, which is accumulated profit. With
a stock dividend, stockholders receive additional shares of stock instead of
cash.
Stock dividends transfer value from Retained Earnings to the Common Stock
and Paid-in Capital in Excess of Par – Common Stock accounts, which
increases total paid-in capital.
Stock Dividends is a contra stockholders’ equity account that temporarily
substitutes for a debit to the Retained Earnings account. At the end of the
accounting period, Stock Dividends is closed to Retained Earnings.
Stock dividends are only declared on shares outstanding, not on treasury
stock shares.
Three dates are associated with a stock dividend. The date of declaration is
the date the corporation commits to distributing additional shares to
stockholders.
On that date, the stockholders’ equity account Stock Dividends Distributable
is used to record the value of the shares due to the stockholders until the
shares are distributed. The date of record is the date on which ownership is
determined.
Since shares of stock may be traded, the corporation names a specific date,
and whoever owns the shares on that date will receive the dividend. There is
no journal entry on the date of record. Finally, the date of distribution is the
date the shares are actually distributed to stockholders.

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▼▼ Stock Dividends Distributable is a stockholders’ equity account that is

decreasing.
▲▲ Common Stock is a stockholders’ equity account that is increasing.
Stock Dividends Distributable is debited (zeroed out) when dividends are
distributed and Common Stock is credited.
NOTE: Many times the challenge with stock dividend declarations is to first
determine the number of shares outstanding.
For example, if a company issued 30,000 share of common stock, reacquired
10,000 as Treasury Stock, and then sold 1,000 shares of the Treasury Stock,
there would be 21,000 shares outstanding (30,000 - 10,000 + 1,000). If a 2%
stock dividend is declared, there would be 420 additional shares issued
(21,000 x 2%).

1.8. Stockholders’ Equity Section of The Balance Sheet

The equation for the balance sheet is Assets = Liabilities + Stockholders’
Equity.
The stockholders’ equity section of the balance sheet reports the worth of

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the stockholders. It has two subsections: Paid-in capital (from stockholder

investments) and Retained earnings (profits generated by the corporation.)

Total paid-in capital is the sum of the first five accounts above and equals
Preferred Stock plus Paid-in Capital in Excess of Par - Preferred plus Common
Stock plus Paid-in Capital in Excess of Par - Common plus Paid-in Capital from
Sale of Treasury Stock.
Common stock includes all shares issued, including those reacquired as
treasury stock. Since treasury stock is not currently owned by stockholders, it
should not be included as part of their worth. Therefore, the value of
treasury stock shares is subtracted out to arrive at total stockholders’ equity.
In summary, total stockholders’ equity equals total paid-in capital plus
retained earnings minus treasury stock.
Cash Dividends and Stock Dividends are not reported on the balance sheet.

1.9. Stock Splits

A stock split is when a corporation reduces the par value of each share of
stock outstanding and issues a proportionate number of additional shares.
This does affect the number of shares outstanding and, therefore, the
number of shares dividends will be paid on. It also may affect the par value
and market price per share, reducing them proportionately. However, the
total dollar value of the shares outstanding does not change. No journal entry
is required for a stock split.
EXAMPLE
A company has 10,000 shares outstanding. The par value is $16 per share.
The fair market value per share is $20. The total capitalization (value of the
shares outstanding) is $200,000 (10,000 x $20).
The company declares a 4-for-1 stock split. Multiply the number of shares by
4: there are 40,000 shares outstanding after the split. Divide the par value by
4: each share has a par value of $4 after the split. Also divide the market
value per share by 4, resulting in $5 per share. The total capitalization (value
of the shares outstanding) is still $200,000 (40,000 x $5).

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1.10. Cash Dividends Calculations

Preferred stockholders are paid a designated dollar amount per share
before common stockholders receive any cash dividends. However, it is
possible that the dividend declared is not enough to pay the entire amount
per preferred share that is guaranteed before common stockholders receive
dividends. In that case the amount declared is divided by the number of
preferred shares. Common stockholders would then receive no dividend
payment.
Preferred stock may be cumulative or non-cumulative. This determines
whether preferred shares will receive dividends in arrears, which is payment
for dividends missed in the past due to inadequate amount of dividends
declared in prior periods. If preferred stock is non-cumulative, preferred
shares never receive payments for past dividends that were missed. If
preferred stock is cumulative, any past dividends that were missed are paid
before any payments are applied to the current period.

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ABSTRACT
There is no single authoritative and generally accepted definition of
financial accounting, or of accounting in general. It began as a practical
activity in response to perceived needs, and for most of its development it has
progressed in the same way, adapting to meet changes in the demands made
on it. Where the needs differed in different countries or environments,
accounting tended to develop in different ways as a response to a particular
environment, essentially on the Darwinian principle: useful accounting
survived. Because accounting developed in different ways, it is likely that
definitions suggested in different contextual surroundings will vary.
At a general level it is at least safe to say that accounting exists to provide a
service. In the box below there are three definitions. These have all been
taken from the same economic and cultural source (the United States)
because that country has the longest history of attempting explicit definitions
of this type.
Note that each suggested definition seems broader than the previous one,
and the third one, from 1970, does not restrict accounting to financially
quantifiableinformation at all.

REFERENCES

Jonick Chiristine (2017). Principles of Financial Accounting, University of

North Georgia Press

SUGGESTED REFERENCES
David Alexander And Christopher Nobes (2004), Financial Accounting An
International Introduction, Prentice Hall.

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