Financial Accounting Fifth Edition
Stockholders’ Equity
10
CHAPTER BUSF-SHU250
Jing Dai
10-1
Accounting Equation and Components of
Stockholders’ Equity
Assets = Liabilities + Stockholders’ Equity
(resources) (creditors’ claims) (owners’ claims)
Primary Components of Stockholders' Equity
1. Paid-in capital is the amount stockholders have invested in the
company.
2. Retained earnings is the amount of earnings the company has kept
or retained—that is, the earnings not distributed in dividends to
stockholders over the life of the company.
3. Treasury stock is a company’s own issued stock that it has
repurchased.
10-2
Part A
INVESTED CAPITAL
10-3
Organization Chart
Ultimately, a corporation’s
The articles of Stockholders stockholders control the
incorporation describe company.
(a) the nature of the
firm’s business
The board of directors
activities, (b) the Board of appoints the CEO.
shares of stock to be Directors
issued, and (c) the
initial board of
directors. Chief Executive The Chief Executive
Officer Officer (CEO) runs the
(CEO) company.
Vice President Vice President Chief Financial Legal Vice President
Management Marketing Officer Counsel Human
(CFO) Resources
10-4
Stages of Equity Financing
The progression
leading to a public
offering might
include some or all
of these steps.
10-5
Public or Private Corporation
Public Private
• Allows public investment • No public investment
• More stockholders • Fewer stockholders
• Regulated by the SEC • Not regulated by the SEC
• Examples: Wal-Mart, • Examples: Cargill
Microsoft, Intel (agricultural commodities)
Koch Industries (oil and
gas), Mars (food and
candy)
10-6
Stockholder Rights
10-7
Advantages and Disadvantages of
a Corporation
10-8
Concept Check 10–1
Which of the following is a primary advantage of
forming a corporation?
a. Reduced taxes
b. Increased personal liability of the owners
c. Increased ability to raise capital and transfer
ownership
d. Fewer state and federal reporting requirements
10-9
Authorized, Issued, Outstanding, and Treasury Stock
Why don’t firms
issue all authorized
stock?
10-10
Par Value
• Legal capital per share of stock that’s assigned
when the corporation is first established
• Most new corporations, and even some
established corporations such as Nike or Procter
& Gamble, issue no-par value common stock.
Par Value(Stated Value)= GARBAGE #
Market Value=Real # (what stock sells for)
10-11
Accounting for Common Stock
Assume Canadian Falcon issues 1,000 shares of no-par common stock at
$30 per share.
Debit Credit
Cash (= 1,000 shares × $30) …………………………… 30,000
Common Stock …………………………………………. 30,000
(Issue no-par value common stock)
Assume American Falcon issues 1,000 shares of $0.01 par value
common stock at $30 per share.
Debit Credit
Cash (= 1,000 shares × $30) ……………………………… 30,000
Common Stock (= 1,000 shares × $0.01) ……… 10
Additional Paid-in Capital (difference) ………... 29,990
(Issue common stock above par)
Both Common Stock and Additional Paid-In Capital are stockholders’
equity accounts.
10-12
Accounting for Common Stock
Occasionally, a company will issue shares of stock in exchange for
noncash goods or services. For example, what if 1,000 shares of
common stock were issued to an attorney in payment for $30,000 in
legal services?
Debit Credit
Legal Fees Expense …………...…………………………… 30,000
Common Stock …………………………………………. 30,000
(Issue no-par value common stock)
10-13
Concept Check 10–2
Company A issues 20,000 shares of $5 par common
stock at $12.50 per share. The entry to record the
issuance would include which of the following?
a. Debit to cash of $100,000
b. Credit to Common Stock of $250,000
c. Credit to Additional Paid-in Capital of $150,000
d. Credit to Additional Paid-in Capital of $250,000
10-14
Preferred Stock
• Issued in addition to common stock to attract wider investment
• Preferred stockholders have:
q First rights to a specified amount of dividends (% of Par Value)
q First rights to distribution if the firm dies
q Most preferred stock does not have voting rights
About 20% of the largest U.S. companies have preferred stock
outstanding
Convertible: shares can be exchanged for common stock
Redeemable: shares can be returned to the corporation at a fixed price
Cumulative: shares receive priority for future dividends if dividends are
not paid in a given year
Dividends in arrears - unpaid dividends
10-15
Cumulative Preferred Stock
Cumulative:If the specified dividend is not paid in a given year, unpaid
dividends (dividends in arrears) accumulate, and the firm must pay them in a
later year before paying any dividends on common stock.
Assume a company issues 1,000 shares of 8%, $30 par value preferred stock
and 1,000 shares of $1 par value common stock at the beginning of 2019.
If the preferred stock is cumulative, the company owes a dividend on the
preferred stock of $2,400 each year (= 1,000 shares ×8% ×$30 par value).
If the dividend is not paid in 2019 or 2020, dividends in arrears for the two years
will total $4,800.
Now, let's say the company declares a total dividend of $10,000 in 2021. How
will the total dividend of $10,000 be allocated between preferred stockholders
and common stockholders?
10-16
Accounting for Preferred Stock
Issues
Assume Canadian Falcon issues 1,000 shares
of $30 par value preferred stock at $40 per
share.
Debit Credit
Cash (= 1,000 shares × $40) ……………………………… 40,000
Preferred Stock(= 1,000 shares × $30) ……… 30,000
Additional Paid-in Capital (difference) ………... 10,000
(Issue preferred stock above par)
10-17
Concept Check 10–3
Which of the following is a primary advantage of
owning preferred stock?
a. Preferential voting rights in most cases
b. Tax deductibility of payments
c. Preference over common stockholders in the
distribution of assets in the event of dissolution
d. Higher risk to investors than owning common stock
10-18
Key Point
• Preferred stock has preference over common
stock in receiving dividends and in the distribution
of assets in the event the corporation is dissolved.
• We record the issuance of preferred stock similar
to the way we did for the issuance of common
stock.
• Some preferred stock is cumulative, meaning any
dividends not declared in a given year accumulate
to be paid in a later year.
10-19
Treasury Stock
Companies buy back their own stock
If a company buys another firm’s stock: Dr Investment
Cr Cash
Why firms repurchase their stock?
To boost underpriced stock by decreasing the supply of stock in the
market. An announcement by Johnson & Johnson that it planned to
buy up to $5 billion of its outstanding shares triggered a public buying
spree that pushed the stock price up by more than 3%.
To distribute surplus cash without paying dividends
To boost earnings per share(EPS = Earnings/# of shares outstanding)
To satisfy employee stock ownership plans. Microsoft repurchased
shares of its common stock to offset the increase in shares from stock
option and stock purchase plans.
10-20
Purchase of Treasury Stock
• Record treasury stock at the cost to purchase the
shares in the market .
Canadian Falcon repurchases 100 shares of its own $0.01 par
value common stock at $30 per share.
10-21
Selling Treasury Stock
Reissues the $3000 Treasure Stock for $3,500 (above cost)
Reissues the $3000 Treasure Stock for $2,500 (below cost)
Rule: No Gains or Losses when fooling around with our own
stock.
10-22
Stockholders’ Equity before and
after Sale of Treasury Stock (above
cost)
CANADIAN FALCON
Balance Sheet (partial)
Stockholders’ equity: Before After
Preferred stock, $30 par value; 100,000 shares authorized;
1,000 shares issued and outstanding(market price $40) $ 30,000 $30,000
Common stock, $0.01 par value; 1 million shares authorized;
1,000 shares issued and 900 shares outstanding ($30) 10 10
Additional paid-in capital 39,990 40,490
Total paid-in capital 70,000 70,500
Retained earnings 30,000 30,000
Treasury stock, 100 shares (3,000) 0
Total stockholders’ equity $97,000 $100,500
SE= TPIC+RE-TS
TPIC=PS+CS+APIC 10-23
Concept Check 10–4
Treasury Stock:
a. Has a normal credit balance
b. Decreases stockholders’ equity
c. Is recorded as an investment
d. Increases stockholders’ equity
10-24
Part B
EARNED CAPITAL
10-25
Retained Earnings
• Earnings retained in the corporation and not
paid out as dividends
• Equals all net income less all dividends, since
the company began operations
q Retained Earnings = All net income since the company
began − All dividends since the company began
• Has a normal credit balance
10-26
Retained Earnings Over a
Four-Year Period
Net Income Balance in
(Net Loss) Dividends Retained Earnings
Year 1 $(1,000) $ 0 $(1,000)
Year 2 3,000 0 2,000
Year 3 4,000 1,000 5,000
Year 4 10,000 3,000 12,000
• The balance of Retained Earnings equals all net income
minus all dividends to date over the life of the company.
• In Year 1, the company shows an accumulated deficit.
10-27
Cash Dividends
10-28
Recording Cash Dividends
On March 15, Canadian Falcon declares a $0.25 per share
dividend on its 2,000 outstanding shares.
Declaration date: date on which board of directors declares
the cash dividend to be paid
March 15 (declaration date) Debit Credit
Dividends (= 2,000 shares × $0.25) ……………… 500
Dividends Payable …………………………………… 500
(Declare cash dividends)
Record date: specific date on which the company will determine
who will receive the dividend (registered owners of stock)
Payment date: date of the actual cash distribution
April 15 (payment date) Debit Credit
Dividends Payable (= 2,000 shares × $0.25) …… 500
Cash …………………………………………………………… 500
(Pay cash dividends)
10-29
Key Point
The declaration of cash dividends decreases
Retained Earnings and increases Dividends
Payable. The payment of cash dividends
decreases Dividends Payable and decreases
Cash. The net effect, then, is a reduction in
both Retained Earnings and Cash.
10-30
Concept Check 10–5
On which date would a company record a debit to
Dividends and a credit to Dividends Payable?
a. Date of declaration
b. Date of record
c. Date of payment
d. Settlement date
10-31
Stock Dividends and Stock Splits
• Stock dividends: additional shares of a company’s
own stock given to stockholders as dividends
• Stock split: a large stock dividend that includes a
reduction in the par or stated value per share
You own 100 shares
You will receive:
and assume a:
10% stock dividend 10 additional shares
20% stock dividend 20 additional shares
100% stock dividend 100 additional shares
Large stock dividend Small stock
or stock split (2-for-1) dividend
10-32
Why Stock dividend?
• The primary reason of large stock dividends and stock splits is to lower the
trading price of the stock to a more acceptable trading range, making it
attractive to a larger number of potential investors.
Market price Number of shares
Total value
per share you have
Before the 100% stock dividend $40 100 $4,000
After the 100% stock dividend ?=$20 200 $4,000
Since stock dividend or stock splits won’t
change the value of the company, each share
of stock is now worth one-half what it was
worth before the stock dividend.
33
Accounting for Stock Dividends
• Stock split: Reduces par value per share and increases shares
outstanding; No Entry
• Large stock dividends(25%+): recorded at par value
• Small stock dividends (25%-): recorded at market value
Assumes no material impact on share price
As if issued shares for cash And then paid a cash dividend
Dr. Cash 3000 Dr. Dividends 3,000
Cr. Common stock 1 Cr. Cash 3,000
APIC 2,999
10-34
Effects of a Stock Split and a Stock
Dividend
Stock Split Stock Dividend
Total stockholders’ equity No change No change
Common stock No change Increase
Retained earnings No change Decrease
Par value per share Decrease No change
10-35
Stock split: Having the par value per share change is expensive. All
records, printed or electronic, that refer to the previous amount must
be changed to reflect the new amount. To avoid changing the
par value per share, most companies report stock
splits in the same way as a large stock dividend.
Stockholders’ Equity before and after a 2-for-1 Stock Split Accounted
for as a 100% Stock Dividend
36
Concept Check 10–6
A company has 1,000 shares of $20 par stock
outstanding and issues a 2-for-1 split. How many
shares are outstanding after the split?
a. 1,000
b. 2,000
c. 3,000
d. 500
10-37
Part C
REPORTING STOCKHOLDERS’ EQUITY
10-38
Statement of Stockholders’
Equity—Canadian Falcon
CANADIAN FALCON
Statement of Stockholders’ Equity
For the year ended December 31, 2021
Additional Total
Preferred Common Paid-in Retained Treasury Stockholders’
Stock Stock Capital Earnings Stock Equity
Balance, January 1 $ –0– $ –0– $ –0– $ –0– $ –0– $ –0–
Issue common stock 10 29,990 30,000
Issue preferred stock 30,000 10,000 40,000
Repurchase treasury stock (3,000) (3,000)
Resell treasury stock 500 3,000 3,500
Cash dividends (500) (500)
100% stock dividend 10 (10) –0–
Net income 30,000 30,000
Balance, December 31 $30,000 $ 20 $40,490 $29,490 $ –0– $100,000
10-39
Stockholders’ Equity Section—
Canadian Falcon
CANADIAN FALCON
Balance Sheet (partial)
December 31, 2021
Stockholders’ equity:
Preferred stock, $30 par value; 100,000 shares authorized;
1,000 shares issued and outstanding $ 30,000
Common stock, $0.01 par value; 1 million shares authorized;
2,000 shares issued and outstanding 20
Additional paid-in capital 40,490
Total paid-in capital 70,510
Retained earnings 29,490
Treasury stock –0–
Total stockholders’ equity $100,000
10-40
Key Point
The stockholders’ equity section of the balance
sheet presents the balance of each equity
account at a point in time. The statement of
stockholders’ equity shows the change in each
equity account balance over time.
10-41
Concept Check 10–7
How does the stockholders’ equity section of the
balance sheet differ from the statement of stockholders'
equity?
a. The stockholders' equity section shows the balances
at a point in time and the statement of stockholders'
equity shows activity over time.
b. The stockholders' equity section shows the activity
over time and the statement of stockholders' equity
shows the balances at a point in time.
c. There are no differences.
d. The stockholders' equity section is more detailed.
10-42
Learning Objective 8
LO10–8 Evaluate company performance using
information on stockholders’ equity.
10-43
Return on Equity
• Measures the ability of company management
to generate earnings from the resources that
owners provide
Net income
Return on equity =
Average stockholders’ equity
10-44
Dividend Yield
• Measures how much a company pays out in
dividends relative to its share price
Dividends per share
Dividend yield =
Stock price
10-45
Illustration 10–21
Selected Financial Data for
Facebook and IBM
($ in millions except share data) Facebook IBM
Net sales $27,638 $79,919
Net income $10,217 $11,872
Total liabilities $ 5,767 $99,078
Stockholders' equity, beginning $44,218 $14,424
Stockholders' equity, ending $59,194 $18,392
Stock price, ending $ 115.05 $165.99
Dividends per share $ 0.00 $ 5.50
Average shares outstanding 2,863 million 955 million
10-46
Illustration 10–22
Return on Equity for Facebook
and IBM
Net* Average* Return on
Income ÷ Stockholders’ Equity = Equity
Facebook $10,217 ÷ ($44,218 + $59,194)/2 = 19.8%
IBM $11,872 ÷ ($14,424 + $18,392)/2 = 72.4%
(* = $ in millions)
10-47
Illustration 10–23
Dividend Yield for Facebook and
IBM
Dividends
Per Share ÷ Stock Price = Dividend Yield
Facebook $0.00 ÷ $115.05 = 0.0%
IBM $5.50 ÷ $165.99 = 3.3%
10-48
Earnings per Share
• Measures net income earned per share of
common stock
Net income – Dividends on preferred stock
Earnings per share =
Average shares of common stock outstanding
10-49
Price-Earnings Ratio (PE ratio)
• Indicates how the stock is trading relative to
current earnings
Stock price
Price-earnings ratio =
Earnings per share
10-50
Illustration 10–24
Price-Earnings Ratios for
Facebook and IBM
Stock Earnings per Price-Earnings
Price ÷ Share = Ratio
Facebook $115.05 ÷ $10,217 / 2,863 = 32.2
IBM $165.99 ÷ $11,872 / 955 = 13.4
10-51
Key Point
The return on equity measures the ability to
generate earnings from the owners’ investment.
It is calculated as net income divided by average
stockholders’ equity. The dividend yield
measures how much a company pays out in
dividends in relation to its stock price. Earnings
per share measures the net income per share of
common stock. The price-earnings ratio
indicates how the stock is trading relative to
current earnings.
10-52
Concept Check 10–8
The PE ratio:
a. Typically is more than 100
b. Equals the stock price divided by net income
c. Typically is less than 1
d. Indicates how a stock is trading relative to its
current earnings
10-53
End of Chapter 10
10-54
