Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 11
Reporting and Analyzing
Equity
11-2
Conceptual Learning Objectives
C1: Identify characteristics of
corporations and their organization.
C2: Explain characteristics of, and
distribute dividends between, common
and preferred stock.
C3: Explain the items reported in retained
earnings.
11-3
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.
11-4
Procedural Learning Objectives
P1: Record the issuance of corporate stock.
P2: Record transactions involving cash
dividends, stock dividends, and stock splits.
P3: Record purchases and sales of treasury
stock and the retirement of stock.
11-5
C1
Characteristics of Corporations
Advantages
n Separate legal entity
n Limited liability of stockholders
n Transferable ownership rights
n Continuous life
n Lack of mutual agency for stockholders
n Ease of capital accumulation
Disadvantages
n Governmental regulation
n Corporate taxation
11-6
C1 Organizing and Managing
a Corporation
Corporate Organization Chart
Stockholders
Ultimate
Stockholders usually meet
control
once a year
Selected by a
Board of Directors Overall
vote of the
responsibility
stockholders
for managing
President the company
Secretary Vice President Vice President Vice President
Finance Production Marketing
11-7
C2
Basics of Capital Stock
Total amount of stock that a
corporation’s charter authorizes it to sell
Stockholders' Equity 2011 2010
Common stock, par value $.01;
authorized 250,000,000 shares; issued
92,556,295 shares in 2011; 111,015,133
shares in 2010 $925,563 $1,110,151
Total amount of stock that has been issued or
sold to stockholders
11-8
C2
Classes of Stock
Par value
No-par value
Stated value
11-9
P1
Issuing Par Value Stock
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Record:
1. The cash received.
2. The number of shares issued × the par value
per share in the Common Stock account.
3. The remainder is assigned to Paid-In Capital
in Excess of Par Value, Common Stock.
11-10
P1
Issuing Par Value Stock
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Dr Cr
Sept. 1 Cash 2,500,000
Common stock, $2 par value 200,000
Paid-In Capital in
Excess of Par Value, Common Stock 2,300,000
Sold and issued 100,000 shares of common stock
11-11
P1
Issuing Par Value Stock
Stockholders' Equity with Common Stock
Stockholders' Equity
Common Stock - $2 par value; 500,000 shares
authorized; 100,000 shares issued and
outstanding $ 200,000
Paid-In Capital in Excess of Par 2,300,000
Retained earnings 650,000
Total stockholders' equity $ 3,150,000
11-12
P1
Issuing Stock for Noncash Assets
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Record:
1. The asset received at its market value.
2. The number of shares issued × the par value
per share in the Common Stock account.
3. The remainder is assigned to Paid-In Capital
in Excess of Par, Common Stock.
11-13
P1
Issuing Stock for Noncash Assets
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Sept. 1 Land 2,500,000
Common stock, $2 par value 200,000
Paid-In Capital in
Excess of Par Value, 2,300,000
Common Stock
Exchanged 100,000 common shares for land
11-14
P2
Cash Dividends
To pay a cash
dividend the
corporation Cas h Dividend T ypes and F requency
must have: 100%
75%
80%
1. A sufficient
balance in 60%
retained earnings 40%
22%
and 20%
2. The cash 0%
necessary to pay Common P referred
the dividend.
11-15
P2
Cash Dividends
Three important dates
ends
id
Div
Date of Declaration Date of Record Date of Payment
Record liability No entry Record payment of
for dividend. required. cash to stockholders.
11-16
P2
Entries for Cash Dividends
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
ivid
ends to stockholders of record on February
D
19.
Dr Cr
Jan. 19 Retained Earnings 10,000
Common Dividend Payable 10,000
Declared $1 per share cash dividend
Date of Declaration
Record liability
for dividend.
11-17
P2
Entries for Cash Dividends
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.
No entry required on
Date of Record
February 19.
No entry
required.
11-18
P2
Entries for Cash Dividends
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.
Dr Cr
Mar. 19 Common Dividend Payable 10,000
Cash 10,000
Paid $1 per share cash dividend
Date of Payment
Record payment of
cash to stockholders.
11-19
P2
Stock Dividends
The corporation distributes additional shares
of its own stock to its stockholders without
receiving any payment in return.
Why a stock dividend?
100 shares
HotAir, Inc. •Can be used to keep the market
Common Stock price on the stock affordable.
$1 par
•Can provide evidence of
management’s confidence that
the company is doing well.
11-20
P2
Stock Dividends
Small Stock Dividend
l Distribution is £ 25% of the previously
outstanding shares.
l Capitalize retained earnings for the market
value of the shares to be distributed.
Large Stock Dividend
l Distribution is > 25% of the previously
outstanding shares.
l Capitalize retained earnings for the minimum
amount required by state law, usually par or
stated value of the shares.
11-21
P2
Recording a Small Stock Dividend
Here is the stockholders’ equity section of
Quest’s balance sheet prior to the
declaration of a small stock dividend.
Quest, Inc.
Stockholders' Equity
December 31, 2011
Common stock - $1 par value,
250,000 shares authorized,
100,000 shares issued and outstanding $ 100,000
Paid-In capital in excess of par value 8,000
Total paid-in capital $ 108,000
Retained earnings 35,000
Total stockholders' equity $ 143,000
11-22
P2
Recording a Small Stock Dividend
On December 31, 2011, Quest declared a 2% stock
dividend, when the stock was selling for $10 per
share. The stock will be distributed to
stockholders on January 20, 2012. Let’s make the
December 31 entry.
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 2,000
Paid-In Capital in Excess
of Par Value 18,000
Declared a 2,000 share (2%) stock dividend
100,000 × 2% = 2,000 × $10 = $20,000
2,000 × $1 par = $2,000
11-23
P2
Before the
Quest, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2011
stock Common stock - $1 par value,
250,000 shares authorized,
dividend. 100,000 shares issued and outstanding
Paid-in capital in excess of par value
$ 100,000
8,000
Total paid-in capital $ 108,000
Retained earnings 35,000
Total stockholders' equity $ 143,000
Quest, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2011
Com m on stock - $1 par value,
250,000 shares authorized,
After the
100,000 shares issued and outstanding $ 100,000 stock
Com m on stock dividend distributable, 2,000 shares 2,000
Total com m on stock issued and to be issued $ 102,000 dividend.
Paid-in capital in excess of par value 26,000
Total Paid-in capital $ 128,000
Retained earnings 15,000
Total stockholders' equity $ 143,000
11-24
P2
Recording a Large Stock Dividend
Router, Inc. shows the following stockholders’
equity section just prior to issuing a large
stock dividend.
Router, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2011
Common stock - $1 par value,
200,000 shares authorized,
50,000 shares issued and outstanding $ 50,000
Paid-in capital in excess of par value 75,000
Retained earnings 100,000
Total stockholders' equity $ 225,000
11-25
P2
Recording a Large Stock Dividend
On December 31, 2011, Router declared a
40% stock dividend, when the stock was
selling for $8 per share. State law requires
that large stock dividends be capitalized at
par value per share.
Dr Cr
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 20,000
Declared a 20,000 share (40%) stock dividend
50,000 × 40% = 20,000 shares × $1 par value = $20,000
11-26
P2
Stock Splits
A distribution of additional shares of stock to
stockholders according to their percent
ownership.
$10 par value
Old
Common Stock
Shares
100 shares
$5 par value
New
Shares Common Stock
200 shares
11-27
P2
Stock Splits
After the 2-for-1 split the stockholders’ equity
section of the balance sheet looks like this .
Thomas, Inc.
Stockholders' Equity No accounting
June 30, 2011 entry is made.
Common stock - $5 par value,
100,000 shares authorized,
50,000 shares issued and outstanding $ 250,000
Paid-In capital in excess of par value 300,000
Total paid-in capital 550,000
Retained earnings 775,000
Total stockholders' equity $ 1,325,000
11-28
C2
Preferred Stock
A separate class of stock, typically having
priority over common shares in . . .
l Dividend distributions
l Distribution of assets in case of liquidation
Usually has a stated Normally has no
dividend rate voting rights
Corporations
73% with no
Preferred Stock
Corporations
with Preferred
Stock
27% 11-29
P2 Cumulative or Noncumulative
Dividend
Cumulative Vs. Noncumulative
Dividends in arrears Undeclared dividends
must be paid before from current and
dividends may be prior years do not have
paid on common to be paid in future
stock. years.
Most preferred stock
is cumulative.
11-30
P2 Cumulative or Noncumulative
Dividend
Example: Consider the following stockholders’
equity section of the balance sheet
Common stock, $5 par value; 40,000 shares
authorized, issued and outstanding $ 200,000
Preferred stock, 9%, $100 par value; 1,000
shares authorized, issued and outstanding 100,000
Total Paid-In capital $ 300,000
The board of directors did not declare or pay
dividends in 2011. In 2012, the board of directors
declare and pay cash dividends of $42,000.
11-31
P2 Cumulative or Noncumulative
Dividend
If Preferred Stock is Noncumulative: Preferred Common
Year 2011: No dividends paid. $ - $ -
Year 2012:
1. Pay 2012 preferred dividend. $ 9,000
2. Remainder goes to common. $ 33,000
If Preferred Stock is Cumulative: Preferred Common
Year 2011: No dividends paid. $ - $ -
Year 2012:
1. Pay 2011 preferred dividend in arrears. $ 9,000
2. Pay 2012 preferred dividend. 9,000
3. Remainder goes to common. $ 24,000
Totals $ 18,000 $ 24,000
11-32
P2
Reasons for Issuing Preferred Stock
n To raise capital without sacrificing
control
n To boost the return earned by common
stockholders through financial leverage
n To appeal to investors who may believe
the common stock is too risky or that
the expected return on common stock is
too low
11-33
P3
Purchasing Treasury Stock
On May 8, Whitt, Inc. purchased 2,000 of its
own shares of stock in the open market for
$8,000.
Dr Cr
May 8 Treasury Stock, Common 8,000
Cash 8,000
Purchase 2,000 treasury shares
at $4 per share
Treasury stock is shown as a reduction in total
stockholders’ equity on the balance sheet.
11-34
P3
Selling Treasury Stock at Cost
On June 30, Whitt sold 100 shares of its
treasury stock for $4 per share.
Dr Cr
June 30 Cash 400
Treasury Stock, Common 400
Sold 100 shares of treasury
$8,000 ÷ 2,000 shares
for $4= per
$4 cost per treasury share
share
11-35
P3 Selling Treasury Stock Above
Cost
On July 19, Whitt, Inc. sold an additional 500
shares of its treasury stock for $8 per share.
Dr Cr
July 19 Cash 4,000
Treasury Stock, Common 2,000
Paid-In Capital, Treasury Stock 2,000
Sold 500 treasury shares for $8 per share
Shares per Share Total
Sale 500 $ 8.00 $ 4,000
Cost 500 4.00 2,000
Paid-In Capital $ 2,000
11-36
P3 Selling Treasury Stock
Below Cost
On August 27, Whitt sold an additional 400 shares
of its treasury stock for $1.50 per share.
Dr Cr
Aug. 27 Cash 600
Paid-in Captial, Treasury Stock 1,000
Treasury Stock, Common 1,600
Sold 500 treasury shares for $1.50 per share
Shares per Share Total
Cost 400 $ 4.00 $ 1,600
Sale 400 1.50 600
Difference $ 1,000
11-37
C3
Statement of Retained Earnings
Total cumulative amount of reported net
income less any net losses and dividends
declared since the company started operating.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2011
Retained earnings, 1/1/11 $ 875,000
Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/11 $ 950,600
11-38
C3
Restricted Retained Earnings
Legal Contractual
Loan agreements
Most states restrict
can include
the amount of
restrictions on
treasury stock
paying
purchases to the
dividends below a
amount of retained
certain amount of
earnings.
retained earnings.
11-39
C3
Appropriated Retained Earnings
A corporation’s directors can voluntarily limit
dividends because of a special need for cash
such as the purchase of new facilities.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2011
Retained earnings, 1/1/11 $ 875,000
Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/11 $ 950,600
Appropriated retained earnings (450,000)
Unappropriated retained earnings $ 500,600
11-40
Prior Period Adjustments
C3
Correction of material errors in past years’ financial
statements. If an amount is incorrectly expensed,
add amount to retained earnings.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2011
Retained earnings, 12/31/10, as previously reported $ 875,000
Prior period adjustment: Cost of equipment
incorrectly expensed (net of $28,000 income taxes) 72,000
Retained earnings, 12/31/10, as adjusted 947,000
Plus: net income for 2011 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/11 $ 1,022,600
11-41
C3
Statement of Stockholders’ Equity
Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2011
Common Stock and
(In millions) Capital in Excess of Par Retained
Shares Amount Earnings Total
Balance at January 1, 2011 821 $ 2,500 $ 9,500 $ 12,000
Stock sales 17 500 500
Stock repurchases and retirement (17) (260) (925) (1,185)
Cash dividends declared (150) (150)
Other, net 70 70
Net income 5,100 5,100
Balance at December 31, 2011 821 $ 2,740 $ 13,595 $ 16,335
This is a more inclusive statement than the statement of
retained earnings.
11-42
C3
Stock Options
Options are given to key employees to motivate
them to:
l focus on company performance;
l take a long-run perspective; and
l remain with the company.
11-43
A1
Earnings per Share
Earnings per share is one of the most widely
cited items of accounting information.
Basic
earnings = Net income - Preferred dividends
per share Weighted-average common shares outstanding
11-44
A2
Price-Earnings
This ratio reveals information about the stock
market’s expectations for a company’s future growth
in earnings, dividends, and opportunities.
Price- Market value per share
=
earnings Earnings per share
ratio
If earnings go up,
will the market price
of my stock follow?
11-45
A3
Dividend Yield
Tells us the annual amount of cash
dividends distributed to common
stockholders relative to the stock’s
market price.
Dividend Annual cash dividends per share
=
yield Market value per share
11-46
A4
Book Value per Share—Common
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
11-47
A4
Book Value per Share—Preferred
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
11-48
End of Chapter 11
11-49
