Stockholders’ Equity

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Characteristics of a Corporation

 Separate legal entity

 Exists separately from owners
 Can enter in contracts, sue or be sued
 Continuous life
 Change of ownership does not end Corporate life
 Ownership can be transferred
 Limited liability
 Only Corporate debts
 No personal obligation for corporate liabilities

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Characteristics of a Corporation
 Separation of ownership and management
 Stockholders own the corporation
○ Elect Board of Directors
○ Sets Policies and appoints officers
 Elect Chairperson (CEO)
 Elect President (COO)
- In charge of day-to-day operations
 Corporate taxation
 Franchise Tax (some states)
 Corporate Taxes on Income
○ Double Taxation
 Corporation is Taxed on Earnings
 Individuals are taxed on dividends from earnings
 Government regulation
 Disclosure of Information for Stakeholders (Investors, Creditors, Taxing
Authorities, etc.) to make informed decisions
 Accounting

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Advantages of a Corporation
1. Can raise more capital than a
proprietorship or partnership can
2. Continuous life
3. Ease of transferring ownership
4. Limited liability of stockholders

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Disadvantages of a Corporation
1. Separation of ownership
2. Corporate taxation
3. Government regulation

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Authority Structure of a
Corporation
Stockholders

Board of Directors

Chairperson of the Board

President

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Stockholders’ Rights

Vote

Dividends

Liquidation

Preemption

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Stockholders Rights
 Unless Withheld by Agreement
 Voting
○ One Vote for each share owned
 Dividends
○ Right to Receive proportionate share
 Liquidation
○ Right to Receive proportionate share of Net
Assets
 Preemption
○ Right to Maintain one’s proportionate
ownership
 Usually withheld from stockholders

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Stockholder’s Equity Section of the Balance Sheet

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Stockholders’ Equity
Two main components:
 Paid-in capital (contributed capital)
 Amount contributed by stockholders
○ Stock (At Par)
○ Additional Paid in Capital
 Retained earnings
 Equity Earned but not paid in
Dividends

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What is Par Value
 The par value of a stock was  Most common stocks
the share price upon initial issued today do not
offering; the issuing company
promised not to issue further
have par values; those
shares below par value, so that do (usually only in
investors could be confident that jurisdictions where par
no one else was receiving a values are required by
more favorable issue price. This law) have extremely low
was far more important in
unregulated equity markets than
par values, for example
in the regulated markets that a penny par value on a
exist today. stock issue at
 Quoted from Wikipedia at USDPhp25/share.
http://en.wikipedia.org/wiki/Par_
value

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Capital Stock
 Authorized shares
 Total # of Shares available for sale
 Outstanding shares
 Total # of Shares actually sold
 Represents 100% ownership
 Often Less than shares authorized

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Types of Capital Stock
 Common Stock
 Residual Equity Holder
○ Paid Dividends after Preferred Stockholders
○ After Creditors & Preferred Stockholders are
satisfied, Common stockholder receives
liquidation
○ Dividends are not subject to Limit
 Voting Rights (controls the corporation)

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Types of Capital Stock
 Preferred Stock
 Rights and Privileges
○ Current Dividend Preference
 May be in Arrears
- Though in Arrears is not a liability
○ Dividends are still discretionary

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Dividend Example
Case Dividend Declared Non-Cumulative Pfd Common
A 1000 1000 0
B 7000 6000 1000
C 13000 6000 7000
D 19000 6000 13000

Cumulative Pfd Common Arrears

A 1000 1000 0 17000
B 7000 7000 0 11000
C 13000 13000 0 5000
D 19000 18000 1000

Assumptions: Preferred Stock is 6%, Php100 par value, two years in arrears,
1000 Shares outstanding; common stock is Php10 par, 1000 shares outstanding

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Accounting for Issuance of Common Stock and Re-
purchase of Treasury Stock

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 Common Stock at Par
Suppose IHOP’s common stock has a par value of
Php10 per share. The company issues 6,200
shares of common stock at par. What is the entry?

General Journal
Date Accounts and Explanations PR Debit Credit
Jan 8 Cash (6,200 x Php10) 62,000
Common Stock 62,000
To record issuance of stock
 Common Stock above Par
Suppose IHOP’s common stock has a par value of
Php0.01 per share. The company issues 6,200
shares of common stock for Php10 per share.
What is the entry?

General Journal
Date Accounts and Explanations PR Debit Credit
Jul 23 Cash (6,200 x Php10) 62,000
Common Stock 62
Paid-in Capital in Excess of Par 61,938
To record issuance of stock
 Balance Sheet
Common Stock Above Par
Stockholders’ Equity
Common Stock, Php.01 par;
40,000 shares authorized,
6,200 shares issued Php 62
Paid-in capital n excess of par 61,938
Total paid-in capital Php 62,000
Retained earnings 194,000
Total stockholders’ equity Php256,000
 Common Stock at Par
Suppose IHOP’s common stock is no par value stock.
The company issues 6,200 shares of common
stock for Php20 per share. What is the entry?

General Journal
Date Accounts and Explanations PR Debit Credit
Jul 23 Cash (6,200 x Php20) 124,000
Common Stock 124,000
To record issuance of stock
Preferred Stock
 Accounting for preferred stock follows
the pattern illustrated for common stock.

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Treasury Stock Transactions
 Shares that a company has issued
and later reacquired.
 Shares needed for Employee Stock Plan
Distribution
 Increase net assets
○ Buy Low, Sell High
 Avoidance of a takeover
 Contra Stockholder Equity

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IHOP Corp. Before Purchase
of Treasury Stock
Stockholder’s Equity at December 31, 2005
(if no treasury stock purchased)
Common Stock Php 203
Paid-in capital in excess of par 69,655
Retained earnings 193,632
Total equity Php263,490

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 IHOP Corp. Purchase
of Treasury Stock
During 2005, IHOP paid Php5,170 to purchase
288 shares of its common stock as treasury
stock.

General Journal
Date Accounts and Explanations PR Debit Credit
Nov 1 Treasury Stock 5,170
Cash 5,170
Purchased treasury stock
IHOP Corp. After Purchase
of Treasury Stock
Stockholder’s Equity at December 31, 2005
(with treasury stock purchased)
Common Stock Php 203
Paid-in capital in excess of par 69,655
Retained earnings 193,632
Less: Treasury stock
(288 shares at cost) (5,170)
Total equity Php258,320
 Sale of Treasury Stock
Assume that on July 22, 2006, the shares of
treasury stock are sold for Php5,300.

General Journal
Date Accounts and Explanations PR Debit Credit
Jul 22 Cash 5,300
Treasury Stock 5,170
Paid-in Capital from Treasury
Stock Transactions 130
Sold treasury stock
(Loss would require debit of retained earnings)
IHOP Corp. After Sale of Treasury
Stock
Stockholder’s Equity at December 31, 2006

Common Stock Php 203

Paid-in capital in excess of par 69,785
Retained earnings 193,632
Total equity Php263,620
Equity before purchase of
treasury stocks 263,490
Increase in stockholders’ equity Php 130
Retirement of Stock
 Decreases the outstanding stock of the corporation
 Retired shares cannot be reissued
 There is no gain or loss on retirement
General Journal
Date Accounts and Explanations PR Debit Credit
Common Stock 100
Additional Paid in Capital 10,900
Cash 11,000

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 Equity Transactions on the Cash
Flow Statement
During 2003, IHOP issued stock,
repurchased stock, but paid no dividends.

Cash flows from financing activities:

Proceeds from issuance of common stockPhp172,000
Purchase of treasury stock (5,170,000)
Net cash used by financing activities Php(4,998,000)

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Retained Earnings and Dividends

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Retained Earnings
 Is Not Cash
 Is Not a Reserve held for Dividends
 Is the account used to Record
 Cash Dividends
 Stock Dividends
 Is Profits Reinvested into Corporation
 Credit Balance = Earnings > Losses +
Dividends
 Debit Balance (Deficit) = Earnings < Losses
+ Dividends
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Dividends and Splits
 Dividend - corporation’s return to its
stockholders of some of the benefits of
earnings
 Cash or Stock
 Stock split - increase in the number of
authorized, issued, and outstanding
shares

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Dividend Dates
 Declaration date
 BOD announces dividend
 Date of record
 Stockholders who own stock by this date will receive dividend
 Payment date
 When dividend is paid

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Preferred Stock Dividends
The preferred stock of Pinecraft is cumulative. Suppose the
company passed the 20x6 preferred dividend of Php150,000.
In 20x7, the company declares a Php500,000 dividend.

General Journal
Date Accounts and Explanations PR Debit Credit
Retained Earnings 500,000
Dividends Payable-Preferred 300,000*
Dividends Payable-Common 200,000
Declared a cash dividend
*Php150,000 x 2 years
Stock Dividend
IHOP declared a 10% stock dividend in
2006. Assume IHOP had 20,000.00
shares of common stock outstanding.
The stock is trading for Php15 per
share. How would this stock dividend be
recorded?

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Stock Dividend
General Journal In thousands
Date Accounts and Explanations PR Debit Credit
Retained Earnings
(20,000.00 X 10% X Php15) 30,000
Common Stock
(20,000.00 X 10% X Php0.01) 20
Paid-in Capital in Excess of Par
Common 29,980
Distributed a 10% stock dividend
Stock Splits
 Corporations like stock prices within a specific
trading range
 Higher prices might discourage small investors
 The more widely held a stock (small and large investors) the
less volatile the market pricing may be
 Thus, stock splits are used to reduce the market price by
 Increasing the number of authorized, issued, and
outstanding shares of stock
 Proportionate reduction in stock’s par value
 Decreasing market price

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Stock Split Example

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Stock Valuations

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Stock Values
 Market value
 Market Price
 Redemption value
 Set price for Preferred stock
○ Not Equity but a liability
 Liquidation value
 Amount paid to Preferred stockholders in case
the company liquidates
 Book value
 Amount of Stockholders Equity per outstanding share

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Book Value Per Share
 Preferred stock =

 Common stock =

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 Book Value
Stockholders’ Equity
Preferred stock, 6%, Php100 par, 5,000 shares
authorized, 400 shares issued,
redemption value Php130 per share Php 40,000
Additional paid-in capital in excess of par –
preferred 4,000
Common stock, Php10 par, 20,000 shares
authorized, 5,500 shares issued 55,000
Additional paid-in capital in excess of par –
common 72,000
Retained earnings 85,000
Treasury stock – common, 500 shares at cost ( 15,000)
Total stockholders’ equity Php241,000
Book Value Common Stock
Suppose that four years’ (including the
current year) cumulative preferred
dividends are in arrears and that
preferred stock has a redemption value
of Php130 per share.

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Book Value – Preferred Stock
Preferred equity:
Redemption value (400 shares × 130) Php 52,000
Cumulative dividends (Php40,000 × Php0.06 × 4 yrs) 9,600
Preferred equity Php 61,600

61,600 / 400 =
Php154.00

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 Book Value Common Stock
Preferred equity:
Redemption value (400 shares × 130) Php 52,000
Cumulative dividends (Php40,000 × Php0.06 × 4 yrs) 9,600
Preferred equity Php 61,600

Common equity:
Total stockholders’ equity Php241,000
Less preferred equity – 61,600
Common equity Php179,400
Book value per share: Php179,400 ÷ 5,000 shares* Php 5.88

*5,500 shares issued minus 500 treasury shares

Ratios: Return on Assets and Return on Equity

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Ratio Definitions
 Return on Assets
 Measure of a company’s ability to generate profits
from the use of its assets
 (Net income + Interest expense) ÷ Average total
assets
 Return on Equity
 Measure of income earned from common
stockholders’ investment in the company
 (Net income – Preferred dividends) ÷ Average
common stockholders’ equity

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