Intermediate accounting 17e stice skousen cengage chapter 13

Common and Preferred Stock• When a corporation is formed, a single class of stock, known as common stock, usually is issued.. Cumulative and Noncumulative Preferred Stock When a corpora

Intermediate Accounting,17E

Stice | Stice | Skousen

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine

Equity Financing

Nature and Classifications of

Paid-In Capital

• A corporation is a legal artificial entity

separate from its owners

• Individuals contribute capital for which the

corporation issues certificates making them

stockholders

• The board of directors is elected by the

stockholders, and it is in charge of overseeing the long-run plan for the organization

Common and Preferred Stock

• When a corporation is formed, a single class of

stock, known as common stock, usually is

issued

• Corporations may later find that there are

advantages to issuing one or more additional classes of stock with varying rights and

priorities Stock with certain preferences

(rights) over common stock is called preferred stock

Common Stock

Unless restricted by terms of the articles of incorporation, certain basic rights are held by each common stockholder.

1 To vote in the election of directors and in the

determination of certain corporate policies.

2 To maintain one’s proportional interest in the

corporation through purchase of additional common

stock if and when it is issued This right is known as the preemptive right.

Par or Stated Value

• Historically, par value was equal to the market

value of the shares at issuance

• Today, most stocks have a nominal par value

or no par value

• No-par stock sometimes has a stated value that

for financial reporting purposes acts like a par value

Preferred Stock

Rights of ownership given up by preferred

stockholders:

1 Voting— in most cases, preferred stockholders

are not allowed to vote for the board of directors

2 Sharing in success— cash dividends received

by preferred stockholders are usually fixed in amount If the firm does extremely well, their dividend amount is not adjusted

Preferred Stock

Rights enjoyed by preferred stockholders:

1 Cash dividend preference Preferred

stockholders are entitled to receive their full cash dividend before any cash dividends are paid to common stockholders.

2 Liquidation preference In the event of

bankruptcy, preferred stockholders are entitled to have their investments repaid before common

stockholders.

Cumulative and Noncumulative

Preferred Stock

When a corporation fails to declare

dividends on cumulative preferred

stock, such dividends accumulate and

require payment in the future before any

dividends may be paid to common

stockholders

Good Time Corporation has outstanding 100,000

shares of 9% cumulative preferred stock, $10 par

Dividends were last paid in 2008 Total dividends of

$300,000 are declared in 2011.

Cumulative and Noncumulative

Preferred Stock

• Dividends on cumulative preferred stock

that are passed are referred to as dividends

in arrears

• With noncumulative preferred stock, it is

not necessary to provide for passed

dividends

(continues)

Cumulative and Noncumulative

Preferred Stock

• Dividends may be declared on common

stock as long as the noncumulative

preferred stock receives its preferred rate

Cumulative and Noncumulative

Preferred Stock

Participating Preferred Stock

Participating preferred stock issues

provide for additional dividends to be paid

to preferred stockholders after dividends of

a specified amount are paid to the common stockholders A participative provision

makes preferred stock more like common

stock

Convertible Preferred Stock

• Preferred stock is convertible when it

can be exchanged by its owner for some other security of the issuing corporation

• Conversion rights generally provide for

the exchange of preferred stock into common stock

Callable Preferred Stock

• Many preferred issues are callable,

meaning they may be called and canceled

at the option of the corporation

• The call price is usually specified in the

original agreement and provides for

payment of dividends in arrears as part of

the repurchase price

Redeemable Preferred Stock

• Redeemable preferred stock is preferred stock that is redeemable at the option of the

stockholder or upon other conditions not

within the control of the issuer.

• Redeemable preferred stock is somewhat like

a loan in that the issuing corporation may be

forced to repay the stock proceeds.

Capital Stock Issued for Cash

• The issuance of stock for cash is recorded by a

debit to Cash and a credit to Capital Stock for the par value

• When the amount of cash received for the

stock is more than the par value, the excess is recorded as a credit to Paid-In Capital in

Excess of Par

Goode Corporation issued 4,000 shares of

$1 par common stock on April 1, 2011,

for $45,000 cash

Common Stock 4,000

Paid-In Capital in Excess

of Par 41,000

2011

Par Value Stock

Capital Stock Issued for Cash

(continues)

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock with a

$1 stated value

Common Stock 4,000

Paid-In Capital in Excess

of Stated Value

2011

Stated Value Stock

Capital Stock Issued for Cash

(continues)

On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock for

$45,000 cash

Common Stock 45,000

2011

No-Par Stock

Capital Stock Issued for Cash

(continues)

Capital Stock Sold on Subscription

Received subscriptions on November 1 for 5,000 shares of $1 par common stock at $12.50 per share with 50% down, balance due in

60 days The entries for November 1 are as follows:

Common Stock Subscriptions Receivable 62,500

Common Stock Subscribed

Capital Stock Sold on Subscription

On December 31, received balance due on one-half of

subscriptions and issued stock to the fully paid subscribers, 2,500 shares.

Capital Stock Issued for Consideration

Other Than Cash

AC Company issues 200 shares of $0.50 par

value common stock in return for land The

company’s stock is currently selling for $50 per share

Capital Stock Issued for Consideration

Other Than Cash

The land has a readily determinable market

price of $12,000, but AC Company’s common stock has no established fair market value

Reasons Companies Repurchase Stock

1 Provide shares for incentive compensation

and employee savings plans

2 Obtain shares needed to satisfy requests by

holders of convertible securities

3 Reduce the amount of equity relative to the

amount of debt

4 Invest excess cash temporarily

(continues)

Reasons Companies Repurchase Stock

5 Remove some shares from the open market in

order to protect against a hostile takeover.

6 Improve per-share earnings by reducing the

number of shares outstanding and returning

inefficiently used assets to shareholders.

7 Display confidence that the stock is currently

undervalued by the market.

Treasury Stock

subsequently reacquired by the corporation and

held for possible future reissuance or retirement.

• Reported as a contra-equity account, not as an asset.

• Does not create a gain or loss on reacquisition,

reissuance, or retirement.

• May decrease Retained Earnings, but cannot

increase it.

2010—Newly organized corporation issued 10,000 shares of

common stock, $1 par, at $15:

Capital from Treasury Stock

Cost Method of Accounting for

Treasury Stock

(continues)

Note: No gain is recorded on sale

2011—Sold 500 shares of treasury stock at $34 per share:

2011—Retired remaining 300 shares of treasury stock:

Retained Earnings [300 × ($40 – $15)] 7,500

Treasury Stock (300 × $40) 12,000

Because the treasury stock is reissued at a price less than the $40 repurchase price, Retained Earnings is debited for the difference; any paid-in capital from

prior treasury stock transactions may first be debited.

Cost Method of Accounting for

Treasury Stock

Par (or Stated) Value Method of Accounting for Treasury Stock

2010—Newly organized corporation issued 10,000 shares of

common stock, $1 par, at $15:

2011—Sold 500 shares of treasury stock at $34 per share:

Stock Rights, Warrants, and

Options

• Stock rights—issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.

• Stock warrants —sold by the corporation for cash,

generally in conjunction with the issuance of another

security.

• Stock options —granted to officers or employees, usually

as part of a compensation plan.

Stock Rights

• When announcing rights to purchase additional shares of stock, the directors of a corporation specify a date on which the rights will be

issued.

• All stockholders of record are entitled to the

rights Thus, between the announcement date and the issue date, the stock is said to sell

rights-on.

(continues)

Stock Rights

• After the rights are issued, the stock sells

ex-rights, and the rights may be sold separately by those receiving them from the corporation.

Stock Warrants

• Detachable warrants are similar to stock rights because they can be traded separately from the security with which they were originally issued.

• Nondetachable warrants cannot be separated from the security with which they were issued.

Stock Warrants

Stewart Co sells 1,000 shares of $50 par preferred

stock for $58 per share Stewart Co gives the

purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for

$25 per share Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

x Market value of warrants Market value

of security without warrants

+

Market value of warrants

Stock Warrants

The entry on Stewart’s books to record the sale of

the preferred stock with detachable warrants is:

Common Stock Warrants (from Slide

13-38)

2,900

Stock Warrants

If the warrants are exercised:

Common Stock Warrants 2,900

If the warrants expire:

Common Stock Warrants 2,900

Paid-In Capital from Expired Warrants

2,900

The company estimates a grant date value of $10 for

each of the employee stock options The total fair value

of the options granted is $100,000 Compensation

expense is allocated over three years from January 1,

2009 (the grant date) to January 1, 2012 (the vesting

date) The year-end entry is as follows:

$100,000/3

Paid-In Capital from Stock Options

33,333

2009

Share-Based Compensation

On December 31, 2012, all 10,000 of the options are exercised to purchase Neff’s no-par common stock:

If the options are allowed to expire unexercised:

Dec 31 Paid-In Capital from Stock

Paid-In Capital from Expired Options 100,000

2012

Share-Based Compensation

Accounting for Performance-Based

Plans

In a performance-based stock option

plan, the plan terms are dependent on

how well the individual or company

performs after the date the options are

granted

Accounting for Performance-Based

Plans

• On January 1, 2009, the board of directors of Neff

Company authorized the granting of stock options

to supplement the salaries of certain employees.

• Each stock option permits the purchase of one share

of Neff common stock at a price of $50 per share; the market price on January 1, 2009, is also $50 per share.

• Each option is computed to have a value of $10.

(continues)

Accounting for Performance-Based

Plans

• The options vest, or become exercisable, beginning

on January 1, 2012, and only if the employee stays with the company for the entire 3-year period The options expire on December 31, 2012.

• The number of options granted is contingent on

Neff’s level of sales for 2011 If Neff sales are less than $50 million, only 10,000 options will vest.

(continues)

Accounting for Performance-Based

Plans

• If Neff’s 2011 sales are between $50 million and

$80 million, an additional 2,000 options will vest If Neff’s 2011 sales exceed $80 million, a total of

15,000 options will vest.

• Neff’s share price changed as follows over the

3-year vesting period: Jan 1, 2009, $50; Dec 31,

2009, $56; Dec 31, 2010, $57; Dec 31, 2011, $59

Accounting for Performance-Based

Plans

Recognition of compensation of $40,000 for each of the three years [(12,000 options × $10)/3]:

Paid-In Capital from Stock Options

Accounting for Performance-Based

Paid-In Capital from Stock Options 150,000

Common Stock (no par) 900,000

2012

Accounting for Awards That Call for

Cash Settlement

• Assume that Neff Company has decided instead

of granting its employees 10,000 stock options, it will grant an equal number of cash stock

appreciation rights (SARs).

• A cash SAR awards an employee a cash amount

equal to the market value of the issuing firm’s

shares above a specified threshold price.

Neff Company Example

• Neff’s share price:

• As of December 31, 2009, the $56 is used as the best

estimate for the cash SARs The amount of cash

involved will be $60,000 [10,000 × ($56 – $50)].

(continues)

Neff Company Example

Share-Based Compensation Liability

26,667

2010

Neff Company Example

Neff’s stock price is $59 at the end of 2011 Aggregate

compensation expense is $90,000 [10,000 × ($59 – $50)] Of this amount, $46,667 has already been recognized.

Dec 31 Compensation Expense ($90,000 ─

Share-Based Compensation Liability

43,333

2011

(continues)

Neff Company Example

By the end of 2012, the price of Neff’s stock is $61 An entry is required to reflect this increase in stock value [10,000 × ($61 –

$59).

Share-Based Compensation Liability

Mandatorily Redeemable Preferred

Shares

• Historically, the SEC required that firms not

include mandatorily redeemable preferred

stock under the Stockholders’ Equity heading

• Given a “mezzanine” treatment.

• FASB Statement No 150 requires these items

to be reported as liabilities in the balance

sheet

Written Put Options

• A put option is an agreement that allows

investors to sell the issuing corporation shares they hold at set prices on specific dates

• If the stock price stays above a set level per

share, the issuing corporation pays nothing

• Historically recorded as part of equity.

(continues)

Written Put Options

• In Statement No.150, the FASB instructs

companies to record the fair value of the

obligation under written put options on a

company’s own shares as a liability

Obligation to Issue Shares of a Certain

Dollar Value

• Companies occasionally agree to satisfy their

obligations by delivering shares of their own

stock rather than by paying cash.

• This is especially true for startup companies.

• Can be recorded as equity or as a liability,

depending on how the contract is written

Stock Conversions

On December 31, 2011, 1,000 shares of preferred stock (par

$50) are exchanged for 4,000 shares of common stock (par

$1).

Case 1

Paid-In Capital in Excess of Par—

Stock Conversions

On December 31, 2011, 1,000 shares of preferred stock (par

$50) are exchanged for 4,000 shares of common stock (par

$20).

Case 2

Paid-In Capital in Excess of Par—

Factors Affecting Retained Earnings

Net Income and Dividends

• The primary source of retained earnings is the net

income generated by a business.

• When operating losses or other debits to Retained

Earnings produce a debit balance in the account, the debit balance is referred to as a deficit.

• Use of the term dividends without qualification

normally implies the distribution of cash.