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Stockholders Equity

I. Background Information
A. Types of Corporations
1. Public Sector Owned by governmental unit
Example: FDIC
2. Private Sector
a. Nonstock - Nonprofit entities
No stock issued
Examples: Church, Charity
b. Stock -

For profit entities


Stock is issued
Examples: General Motors, IBM

i. Private enterprise Stock not available


for public purchase
ii. Public enterprise Stock is available
for public purchase

II.B. Legal Basis for Operations


1. State law in state of incorporation
2. Articles of Incorporation approved by state

C. Usual Features Associated with Common Stock


1. Share proportionately in profits
2. Elect directors who select management
3. Share proportionately in corporate assets
upon liquidation after all other claims on
assets are satisfied
4. Share proportionately in new issues of same
stock (i.e., preemptive right )
Note: Legal documents set forth the rights of
common shareholders for a particular
issue of common stock.
Sometimes these documents omit one or
more of the above rights. It is very
common that when a corporation has
multiple classes of common stock only
one of the classes has voting privileges.
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I. D. Usual Features Associated with Preferred Stock


1. Preference as to dividends - Normally receives a
fixed divided based on stock par value
which must be paid before common
shareholders can receive a dividend
cumulative vs. non-cumulative
participating vs. non-participating
2. Preference as to assets in liquidation - Share in
corporate assets before common
shareholders upon liquidation
3. Voting privileges - Normally no voting privileges
4. Callable - Normally callable at the discretion of
the company
The stock indenture agreement will specify
if the stock can be called and the price the
company must pay
5. Sometimes convertible into common stock
Note: PS with a fixed redemption date or PS
which is redeemable at the option of the
holder is not treated as equity. It is
reported as debt per FAS # 150.
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I. E. Some Benefits of Corporate Form


1. Limited liability of Stockholders a. Loss limited to investment for stock purchased
at par or above
b. May be liable for losses beyond investment if
stock purchased below par (discount)
2. Access to large amounts of capital via issuance
of stock
3. Corporate form encourages risk taking which
generally leads to higher wealth creation over
longer time periods

II. Nature of Capital (Stockholders Equity)


A. Components
1. + Capital Stock Common and Preferred issued
2. + Paid-In Capital (PIC) Amounts received from
various sources including the issuance
of options and warrants
3. Retained Earnings Earnings less dividends
4. - Treasury Stock Own stock purchased
5. + Subscribed Stock Stock contracted to be
issued but not yet issued
6. - Stock Subscriptions A type of account
receivable representing money owed to
company for subscribed stock
7. Other Comprehensive Income Accumulated
gains and losses that GAAP requires be
booked directly to Stockholders Equity
Question: Why book gains/losses directly to SE?
Answer: Political pressure from firms.

II.B. Events Affecting Stockholders Equity


1. Stockholder investments Creates stock and PIC
2. Retirement of stock Reduces stock and PIC
3. Issuance of options and warrants Creates PIC
4. Net Income ( Loss ) Increases ( reduces )
retained earnings
5. Dividends Reduce retained earnings
6. Treasury stock transactions Buying (selling)
own stock creates (reduces) TS bal.
7. Conversion of certain securities to stock
Creates stock and PIC
8. Contracts to issue stock Gives rise to
subscribed stock and stock
subscriptions A/R
9. Error corrections and certain Prior Period Adj.
10. Recognition of Other Comprehensive Income
Certain gains/losses are booked directly to
Stockholders Equity rather than to income.
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III. Accounting for Original Issuance of Stock


A. Par or Stated Value Stock
1. Issue at or above Par (or Stated Value)Cash
XX
Common Stock
XX
PIC
XX

(shares x sales price)


(shares x par/SV)
(plug)

2. Issue below Par (or Stated Value)


Cash
XX
Common Stock
XX
PIC
XX

(shares x sales price)


(shares x par/SV)
(plug)

or if insufficient PIC
Cash
XX
Common Stock
XX
Discount on CS XX

(shares x sales price)


(shares x par/SV)
(plug)

Note: same basic entries for preferred stock (PS)

III.
B. No Par Stock
1. Issue
Cash
XX
(shares x sales price)
Common Stock
XX (shares x sales price)

Note: same basic entry for preferred stock.

IV. Subscribed Stock


A. Concept Individuals sign a contract in which
they agree to purchase stock.
The stock is issued once the stock has
been paid for.
B. Entries
1. At date contract is signed
Subscriptions A/R
XX
(shares x price)
Common Stk. Subscribed
XX (shares x par)
PIC CS
XX (plug)
2. When cash is collected
Cash
Subscriptions A/R

XX
(cash collected)
XX

3. When final payment is received and stock is


issued
Cash
Subscriptions A/R

XX
(cash collected)
XX

Common Stk. Subscribed XX


(shares x par)
Common Stock
XX (shares x par)
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IV.B.
4. If some individuals default
(cannot complete contract)
Accounting can vary depending on state law.
If company is allowed to retain partial payment
made by the defaulted subscriber the entry is:
Recording strategy Remove existing balances
from the Balance Sheet and record
the net of the existing balances
(this will be a cr. ) as PIC

Common Stock Sub.


PIC CS
Subscriptions A/R

XX
XX

PIC Defaulted Stk. Sub.

(shares x par)
(prior PIC booked)
XX (unpaid A/R)
XX (prior cash
collected)

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V. Stock Issued with Other Securities


A. Description Two or more securities are sold for
one total lump sum price
B. Problem How to allocate total sales price to
each security
C. Example Sell 2 shares of sec. A (par = $1) and
5 shares of sec. B (par = $2)
for a total price of $48
D. If market value of each security is known
Use Proportional Method
Calculate total market value of all securities
Allocate lump sum sales price based on
relative market values of each security
If sec. A = $10 market value each (2x10=$20)
sec. B = $8 market value each (5x8=$40)
Total market = $60
Allocate Total Unit Sales Price:
sec. A = 20/60 x 48 = $16
sec. B = 40/60 x 48 = $32
Then use normal accounting rules to journalize.
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V. D. (continued)
Cash

48

(total unit sales price)

Sec. A.
PIC - A

2
14

(2 A-shares x $1 par)
(plug)

$16

Sec. B
PIC - B

10
22

(5 B-shares x $2 par)
(plug)

$32

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V. E. If market value is known for only one security


Use Incremental Method
Use known market for one security
Use difference in lump sum sales price and
known market for security to value the
other security
If sec. A = $10 market value each (2x10=$20)
sec. B = market unknown
Allocate:
sec. A = $20 (known market)
sec. B = $28 (lump sum price sec. A market)
(
$48
$20
)
Then use normal accounting rules to journalize.
Cash

48

(total unit sales price)

Sec. A
PIC- A

2
18

(2 A-shares x $1 par)
(plug)

$20

Sec. B
PIC - B

10
18

(5 B-shares x $2 par)
(plug)

$28

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VI. Stock Issued in a Noncash Transaction


A. Description Sell stock and receive property
(land, building, patent, inventory, etc.)
B. Problem - How to value transaction?
Property
??
Stock
PIC Stock

XX
YY

Total = ??

C. Answer Use the fair value of the stock or the


property whichever is more clearly
determinable
VII. Cost of Issuing Stock
A. Description When stock is issued the company
normally incurs (pays) a variety of fees.
Examples: Attorneys fees
Accountants fees
Underwriters fees
SEC filing expenses
Mailing costs
B. Accounting Record as a reduction of PIC
(not expense)

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VIII. Treasury Stock Transactions


A. Description Company buys its own stock and
holds for some future use.
Note: Treasury Stock is a contra-equity account
(not an asset)
B. Two Accounting Methods
1. Cost method Vast majority of companies use
Record TS at cost
Record PIC TS when sell stock for a profit
2. Par value method Few companies use
Record TS at par value
Record PIC TS when TS is purchased for
less than average amount received
on original issue of stock
Note: Given the heavy usage of the Cost Method
this is the method we will focus on.

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VIII.C. Cost Method Entries


1. Buy Treasury Stock (TS)
TS
Cash

XX

(total price paid)


XX

2. Sell TS for more than originally paid


Cash
TS
PIC TS

XX

(sales price)
XX (cost of TS)
XX (gain booked as PIC)

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VIII.C.
3. Sell TS for less than originally paid
Cash
TS

XX

PIC-TS

XX

(sales price)
XX (cost of TS)
(loss booked as PIC reduction
but do not reduce
PIC-TS below 0)

If loss on sale exceeds preexisting PIC-TS


Cash
TS

XX

PIC-TS

XX

(reduce PIC-TS to 0)

R.E.

XX

(record remainder of loss


as reduction of retained
earnings)

XX

(sales price)
(cost of TS)

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IX. Accounting for Stock Retirement


A. Description - Company stock is purchased in the
open market and then retired
Note: No gains or losses are recorded.
B. Entry Depends On Two Factors
1. How purchased stock is reflected in G/L
a. Stock held as treasury stock and later retired
(entries made to treasury stock account)
b. Stock purchased and immediately retired
(no entries made to treasury stock account)

2. Comparison of price paid versus amount


received when the stock was originally issued
a. Paid more for stock than original issue price
i. Implies a type of loss
ii. Will cause a reduction in PIC and/or RE

b. Paid less for stock than original issue price


i. Implies a type of gain
ii. Will create additional PIC
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IX. C. Stock to be Retired is Held as Treasury Stock


1. Accounting Strategy Remove Stock and PIC balances created when
stock was originally issued
Remove TS balances
Then Balancing cr. (gain) is additional PIC
Balancing dr. (loss) reduces PIC and/or RE

Note: See FASB Codification


505-30-30-8

2. If paid more for TS than average issue price of


original stock book loss as reduction of:
1st choice: PIC-TS and/or
2nd choice: RE

CS
XX
PIC-CS XX
TS
XX

(shares x par)
(shares x average PIC-CS)
(cost of TS)

PIC-TS
RE

(reduce PIC-TS if available)


(reduce RE if needed)

XX
XX

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IX. C.
3. If paid less for TS than average issue price of
original stock - book gain as additional
PIC - Retirement of TS

CS
XX
PIC-CS XX
TS
PIC-Retirement
of TS

XX

XX

(shares x par)
(shares x avg PIC-CS)
(cost of TS)

(gain on retirement
booked as PIC)

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IX. D. Stock Purchased and Retired Immediately


(Not Held as Treasury Stock)
1. Accounting Strategy Remove Stock and PIC balances created when
stock was originally issued
Record cash paid out
Then Balancing cr. (gain) is additional
PIC -Share Repurchase (PIC-SR)
Balancing dr. (loss) reduces PIC and/or RE

2. If paid more for stock than average issue price of


original stock book loss as reduction of:
1st choice: PIC-Share Repurchase and/or
2nd choice: RE
CS
XX
PIC-CS XX
Cash
XX

(shares x par)
(shares x average PIC-CS)
(cost of stock)

PIC-SR XX
RE
XX

(reduce PIC-SR if available)


(reduce RE if needed)

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IX. D.
3. If paid less for stock than average issue price of
original stock - book gain as additional
PIC - Share Repurchase (PIC-SR)

CS
XX
PIC-CS XX
Cash
PIC-SR

XX
XX

(shares x par)
(shares x avg PIC-CS)
(cost of stock)
(gain on retirement
booked as PIC arising
from Share Repurchase)

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X. Accounting for Dividends


A. Cash Dividends Paid on outstanding shares
Not paid on treasury stock
Date of Declaration:
Retained Earnings
Dividends Payable

XX

(outstanding shares x
dividend rate)
XX

Note: Dividends Payable is normally a current


liability
Date of Record:
No entry in general ledger
Date of Payment:
Dividends Payable XX
Cash
XX

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X.B. Property Dividends


1. Description Company distributes property
instead of cash
2. Accounting First book entry to restate property
to FMV at date of declaration and
recognize gain or loss
Then book normal entries with
minor changes in account titles
3. Entries
Date of Declaration:
If property has appreciated in value
Property account1
Gain

XX
XX

Retained Earnings
XX
Property Dividends Payable XX

1- the actual entry will use the title of the property


to be distributed (i.e., inventory, securities, etc.)

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X.B.3. Entries
Date of Record:
No entry in general ledger

Date of Distribution:
Property Dividends Payable XX
XX
Property Account1

1- the actual entry will use the title of the property


to be distributed (i.e., inventory, securities, etc.)

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X.C. Liquidating Dividends


1. Description - Some portion of dividend paid from
contributed capital (PIC) rather than
retained earnings.
2. Accounting - Recorded as a return of capital
(reduction of PIC)
3. Entries
Assume a cash dividend, a portion being return
of capital (not paid from RE)
Date of Declaration:
Retained Earnings XX
Paid In Capital
XX
Dividends Payable
XX

(amt. paid from RE)


(amt. paid from PIC)
(total dividend)

Note: Dividends Payable is normally a current


liability
Date of Record: No entry in general ledger
Date of Payment:
Dividends Payable XX
Cash
XX
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X.D. Stock Dividends


1. Description Company distributes additional
shares of stock rather than cash
or property
Depending on state law a stock
dividend may or may not be paid
on treasury stock.
2. Accounting Creation of additional stock
balances results in a similar
reduction in retained earnings.
So no change in total SE
Value small dividends at market price at
date of declaration
(small = less than 20-25% of
outstanding stock at date of
declaration)
Value large dividends at par value
(large = more than 20-25% of
outstanding stock at date of
declaration)

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X.D.3. Entries for Small Stock Dividend


Date of Declaration:
Retained Earnings
XX
(shares x mkt.)
Common Stk. Div.
Distributable
XX (shares x par)
Paid In Capital - CS
XX (plug)
Note: Common Stock Dividend Distributable is an
equity account (part of contributed capital)

Date of Record:
No entry in general ledger

Date of Distribution:
Common Stk. Div. Distributable XX
Common Stock
XX

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X.D.4. Entries for Large Stock Dividend


Date of Declaration:
Retained Earnings
Common Stk. Div.
Distributable

XX

(shares x par)
XX (shares x par)

Date of Record:
No entry in general ledger

Date of Distribution:
Common Stk. Div. Distributable XX
Common Stock
XX

Note: A large stock dividend is often called


Stock split-up effected in the form of a dividend

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XI. Stock Splits


A. Description Often to manage the market price
of its stock a company may split or
reverse split its stock.
This has the effect of changing the
number of shares outstanding and
the market price of those shares
Examples: 2 for 1 split is where the company
issues 2 new shares for each 1 (old)
share surrendered.
(Reduces stock price.)
1 for 2 split is where the company
issues 1 new shares for each 2 (old)
shares surrendered.
(Increases stock price.)
B. Accounting No formal entries to general ledger
but the par or stated value is altered
to maintain the same total recorded
value of the stock.
Example: In a 2 for 1 split the number of
shares doubles and the par is
reduced to its former value.

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XII. Presentation of Stockholders Equity


A. Required by GAAP
1. Show components of SE in balance sheet
2. Disclose: Rights and privileges of various
securities
Dividend and liquidation preferences
Call prices, dates, conversion
privileges
Contracts for additional shares
Changes in each SE account

B. Optional under GAAP


Separate statement of changes in SE
Separate statement of changes in RE

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XIII. Common Book Value Per Share


A. Description Stockholders equity available to
common in liquidation after claims of
other equity holders are satisfied.
B. Computation
CS book value = Common stockholders equity
Outstanding common shares

Common Stockholders equity =


+ Total SE
- Claims of Preferred stock (if any)
- Claims of other equity holders (if any)
Common stockholders equity

Note: Claims of Preferred stock (PS) include


PS Dividends in arrears
PS Current year dividend
PS Dividend participation (if any)
Liquidation value of PS
(may be different than par value)

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