Intermediate accounting 19th by stice stice chapter 13

Par or Stated Value of StocksThe journal entry to record the issuance of common stock in exchange for cash frequently looks something like this:... Cumulative and Noncumulative Preferr

Intermediate

Accounting

James D Stice Earl K Stice

Equity Financing

Chapter 13

19 th

Edition

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 stock certificates evidencing ownership interests.

• Stockholders elect a board of directors

whose members oversee the strategic

and long-run planning of the corporation.

Common and Preferred Stock

usually issued.

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 of Stocks

The journal entry to record the issuance of

common stock in exchange for cash

frequently looks something like this:

Par or Stated Value of Stocks

• 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 at all.

• No-par stock sometimes has a stated

value that for financial reporting purposes acts like a par value.

(continued)

Preferred Stock

misleading because it gives the impression that preferred stock is better than common stock.

rights of ownership in exchange for some

of the protection enjoyed by creditors.

(continued)

• Sharing in success The cash dividends

received by preferred stockholders are usually fixed in amount Therefore, if the company

does exceptionally well, preferred stockholders

do not get to share in the success

Preferred Stock

• Cash dividend preference Preferred

stockholders are entitled to receive the full

cash dividend before any cash dividends are

paid to common stockholders

• Liquidation preferences If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid, in full, before

common stockholders receive anything

The protections enjoyed by preferred stockholders, relative to common stockholders, are:

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

• 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

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.

stock more like common stock.

relatively rare.

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.

• In some instances, preferred stock may

be converted into bonds.

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.

like a loan in that the issuing corporation may be forced to repay the stock

proceeds.

Current Development in The

Accounting for Preferred Stock

• In the Preliminary Views document, the

FASB recommends the “basic ownership

approach” to identifying equity

• This approach hinges on the idea that equity claims are those that remain when all other

claims have been satisfied

• The basic ownership approach would be very restrictive In fact, all preferred stock, whether redeemable or not, would be reported as a

liability under this approach

Current Development in The

Accounting for Preferred Stock

• Users prefer a “perpetual approach,” which

describes an equity instrument as one for

which there is no requirement to repay the

invested funds, and the holder of the

instrument is entitled to some assets if the

company is liquidated

• Both the FASB and IASB are leaning toward the “perpetual approach.”

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 an

additional paid-in capital account.

(continued)

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

Par Value Stock

Capital Stock Issued for Cash

(continued)

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 41,000

2011

Stated Value Stock

Stated Value Stock

Capital Stock Issued for Cash

(continued)

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

$45,000 cash.

Common Stock 45,000

Capital Stock Sold on Subscription

• A subscription is a legally binding contract between the subscriber (purchaser of stock)

and the corporation (issuer of stock)

• The contract states the number of shares

subscribed, the subscription price, the terms of payment, and other conditions of the

transaction

• Ordinarily, stock certificates are not issued

until the full subscription price has been

received by the corporation

Subscription Defaults

If a subscriber defaults on a subscription, a

corporation may:

1) return to the subscriber the amount paid,

2) return to the subscriber the amount paid less

any reduction in price or expense incurred on the resale of the stock,

3) declare the amount paid by the subscriber as

forfeited, or

4) issue to the subscriber shares equal to the

number paid for in full

Reasons Companies Repurchase Stock

and employee savings plans.

holders of convertible securities.

amount of debt.

in order to protect against a hostile takeover.

(continued)

6 Improve per-share earnings by reducing the

number of shares outstanding and returning inefficiently used assets to shareholders.

currently undervalued by the market.

Reasons Companies Repurchase Stock

Treasury Stock

• Treasury stock is stock issued by a corporation and subsequently reacquired by the corporation and held for possible future reissuance or

retirement

• Treasury stock should not be viewed as an

asset; report as a reduction in owner’s equity

• There is no income or loss on the reacquisition, reissuance, or retirement of treasury stock

• Retained Earnings can be decreased by

treasury stock transactions but never increased

2012—Newly organized corporation issued 10,000

shares of common stock, $1 par, at $15:

2013—Reacquired 1,000 shares of common

stock at $40 per share:

Cash

40,000

Cost Method of Accounting

for Treasury Stock

(continued)

2013—Sold 200 shares of treasury stock at $50

2,000 Note: No gain is recorded on the

sale The excess is credited

to Paid-in Capital from Treasury Stock.

Note: No gain is recorded on the

sale The excess is credited

to Paid-in Capital from Treasury Stock.

Cost Method of Accounting

for Treasury Stock

2013—Sold 500 shares of treasury stock at $34

Cost Method of Accounting

for Treasury Stock

(continued)

The difference is debited to Retained Earnings.

Note: No loss is recorded on the sale

The difference is debited to Retained Earnings.

2013—Retired remaining 300 shares of

treasury (3% of original issue of 10,000 shares):

Cost Method of Accounting

for Treasury Stock

Alternatively, the entire $11,700 difference between Common Stock and the cost to acquire the treasury stock may be debited to Retained Earnings.

Par (or Stated) Value Method of

Accounting for Treasury Stock

Paid-In Capital in Excess of Par 14,000 Retained Earnings [1,000 x ($40 – $15)] 25,000 Cash

40,000

Same entry as the cost method (Slide 13-46).

Same entry as the cost method (Slide 13-46).

2013—Reacquired 1,000 shares of common

stock at $40 per share:

2012—Newly organized corporation issued

10,000 shares of common stock, $1 par,

at $15:

(continued)

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

2013—Sold 200 shares of treasury stock at $50

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

2013—Retired remaining 300 shares of

treasury stock:

Treasury Stock

300

Stock Rights, Warrants,

• 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

additional shares of stock, the directors of

a corporation specify a date on which the rights will be issued.

are entitled to the rights Thus, between

the announcement date and the issue date,

(continued)

• After the rights are issued, the stock sells

ex-rights , and the rights may be sold

separately by those receiving them from

the corporation.

the rights are announced, and rights not

exercised by this date are worthless.

Stock Rights

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.

(continued)

Stock Warrants

The value assigned to the warrants is

determined by the relative fair value method which is illustrated in the following equation:

Value

assigned to

warrants

Total issue price

Market value of warrants

Market value

of security without warrants

Market value of warrants +

x

=

Stock Option Compensation Expense

a “hot potato” issue in accounting.

stock option accounting only to find that

there were strong feelings against

expensing the cost of stock options.

expense would reduce reported earnings.

(continued)

Stock Option Compensation Expense

requires the expensing of the fair value of stock options granted as compensation.

Topic 718

Accounting for Performance-Based Plans

well the individual performs after the date the options are granted or how well the

company performs during the vesting

period.

Mandatorily Redeemable

Preferred Shares

not include mandatorily redeemable

preferred stock under the Stockholders’

Equity heading.

redeemable preferred shares to be

reported as liabilities in the balance sheet.

(continued)

Mandatorily Redeemable

Preferred Shares

On January 1, 2011, Tarazi Company issued mandatorily redeemable preferred shares in exchange for $100 cash The shares must be redeemed on January 1, 2012, for $110 The interest rate implicit in this agreement is 10%.

Mandatorily Redeemable Preferred Shares (liability) 100

2011

Dec 31 Interest Expense ($100 x 0.10) 10

Mandatorily Redeemable Preferred Shares (liability) 10

Mandatorily Redeemable

Preferred Shares

Jan 1 Mandatorily Redeemable

Preferred Shares (liability) 100 Cash

100

2012

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.

share, the issuing corporation pays nothing.

put options as part of equity The FASB now instructs companies to record the fair value

of the obligation as a liability.

Obligation to Issue Shares

of a Certain Dollar Value

their obligations by delivering shares of their own stock rather than by paying cash.

trying to conserve their limited cash supply.

this promise to deliver shares of one’s stock

to satisfy the obligation can be recorded as equity or as a liability.

Obligation to Issue Shares

of a Certain Dollar Value

Example 1: On October 1, 2011, Lily Company experienced trouble with its office air conditioning system The repair bill is $5,000 Lily agrees to

deliver 200 shares of no-par common stock to the repairperson on February 1, 2012 On October 1,

2011, Lily’s shares have a market value of $25

Oct 1 Maintenance Expense (200 x

Obligation to Issue Shares

of a Certain Dollar Value

Example 2: On October 1, 2011, Lily Company received air conditioning repair services costing

$5,000 Lily agrees to deliver shares of Lily’s par common stock with a market value of $5,000

no-to the repairperson on February 1, 2012 On

October 1, 2011, Lily’s shares have a market

value of $25, and on February 1, 2012, the

shares have a market value of $20

Feb 1 Common Stock Issuance

Obligation (equity) 5,000 Common Stock

5,000

2012

Obligation to Issue Shares

of a Certain Dollar Value

Feb 1 Common Stock Issuance

Obligation (liability) 5,000 Common Stock (250 x $20)

5,000

2012

Oct 1 Maintenance Expense 5,000

Common Stock Issuance Obligation (liability)

5,000

2011

Noncontrolling Interest

investment made by outside shareholders to consolidated subsidiaries that are not 100% owned by the parent.

interest to replace “minority interest” in the consolidated balance sheet.

Stock Conversions

On December 31, 2013, 1,000 shares of

preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $1)

Case 1: One Preferred for Four Common ($1)

Case 1: One Preferred for Four Common ($1)

Dec 31 Preferred Stock, $50 par 50,000

Paid-In Capital in Excess of Par—

On December 31, 2011, 1,000 shares of

preferred stock (par $50) are exchanged for

4,000 shares of common stock (par $20)

Dec 31 Preferred Stock, $50 par 50,000

Paid-In Capital in Excess of Par—

Case 2: One Preferred for Four Common ($20)

Case 2: One Preferred for Four Common ($20)

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

Prior-Period Adjustments

In some situations, errors made in past years

are discovered and corrected in the current year

by an adjustment to Retained Earnings, referred

to as a prior-period adjustment:

• Mathematical mistakes

• Failure to apply appropriate accounting procedures

• Misstatement or omission of certain information

• Change from a non-GAAP principle to a GAAP

principle

Appropriated Retained Earnings

• Retained Earnings may be restricted at the

discretion of the board of directors

 Example: Expansion of plant facilities

• The restricted portion may be designed as

appropriated retained earnings and the

unrestricted portion as unappropriated (or free) retained earnings

• The main idea behind this restriction is to

notify stockholders that some of the assets

may not be available for dividends