Lecture Accounting: What the numbers mean (5/e) - Chapter 8: Accounting for and presentation of owner’ equity

After studying this chapter, you should understand: The characteristics of common stock, and how common stock is presented in the balance sheet; what preferred stock is, what its advantages and disadvantages to the corporation are, and how it is presented in the balance sheet; the accounting for a cash dividend, and the dates involved in dividend transactions;...

CHAPTER 8

ACCOUNTING FOR AND

PRESENTATION OF OWNER’ EQUITY

Learning Objectives

• What are the characteristics of common

stock, and how is common stock presented

in the balance sheet?

• What is preferred stock, what are its

advantages and disadvantages to the

corporation, and how is it presented on the

balance sheet?

• How are cash dividends accounted for, and

what are the dates involved in dividend

transactions?

Learning Objectives

• What are stock dividends and stock

splits, and why are they used?

• What are the components of “other

comprehensive income,” and why do

these items appear in owners’ equity?

• What is treasury stock, why is it

acquired, and how do treasury stock

transactions affect owners’ equity?

• How are owners’ equity transactions

for the year reported in the financial

Learning Objective 1

• What are the characteristics

of common stock, and how

is common stock presented

in the balance sheet?

Owners’ Equity

• The claim of the entity’s owners to the

assets shown in the balance sheet

• Also called net assets

• Owner’s equity for a individual

proprietorship is called proprietor’s capital

• Owners’ equity of a partnerships is called

partners’ capital

• Owners’ equity for a corporation consists

Common Stock

• Also called capital stock

• The ultimate owners of the corporation

• Have claim to all assets after all

liabilities and preferred stock claims

have been satisfied

• Have the right and obligation to elect

members of the corporation’s board of

Value of Common Stock

• Common stock can have par or no-par

• Par value is the nominal value assigned

to the stock when the corporation is

formed

• Usually a stock cannot be issued for a

value less than par

• Stated value stock is essentially the

same as par value

Recording Common Stock

• Par-value common stock sold above par is

recorded as follows:

Cash XX

Common stock XX

Additional paid-in capital XX

• No-par common stock is recorded as follows:

Cash XX

Common stock

Common Stock Disclosures

• Authorized shares of stock represents the

maximum number of shares of stock the

corporation is legally approved to issue

• Issued shares represents the number of

shares of stock that have been transferred from the corporation to shareholders

• Outstanding shares of stock represents

the shares of stock still in the hands of

shareholders

• Treasury stock represents the difference

between issued and outstanding shares

Learning Objective 2

• What is preferred stock, what are

its advantages and disadvantages

to the corporation, and how is it

presented on the balance sheet?

Preferred Stock

• Has several debt-like features and a

limited claim on the assets in the event

of liquidation

• Most preferred stock receives a

quarterly or semiannual dividend

• A dividend is a distribution of earnings

of a corporation to its owners

• The amount of the dividend is usually

stated as a dollar amount or as a

percentage (of par value)

Preferred Stock Dividends

• A cumulative dividend means that a missed

dividend must be paid before dividends are paid

to common shareholders

• A participating dividend means that after

common stockholders have received a specified dividend, further dividends are shared by

common and preferred shareholders

• A liquidating dividend is the preferred stock

claim on assets in the event of liquidation

Types of Preferred Stock

• Callable preferred stock is redeemable at the option of the corporation

• Convertible preferred stock may be

exchanged for common stock of the

corporation at the option of the shareholder

at a stated conversion rate

Additional Paid-In Capital

• The owners’ equity category that reflects the excess of the amount received from

the sale of preferred or common stock

over par value

• Also referred to as capital in excess of

par value or capital surplus

Retained Earnings

• The retained earnings account reflects

the cumulative earnings of the

corporation that have been retained for

use in the business rather than paid out

as dividends

• Retained earnings are not cash

• The main factors affecting retained

earnings are net income (or loss) and

dividends

Learning Objective 3

• How are cash dividends accounted for, and what are the dates involved

in dividend transactions?

Cash Dividends

• To pay a dividend, a corporation must have:

– Sufficient retained earnings

– Sufficient cash to pay the dividend

– A dividend declaration by the board of

Dividend Dates

• Date of declaration is the date the board of

directors declares the dividend

• Date of record is the date used to determine

who receives the dividend – the stockholders

of record as of that date

• Date of payment is the date the dividend

checks are mailed to the shareholders

• Ex-dividend date is three business days

before the date of record – the stock trades

Learning Objective 4

• What are stock dividends and stock splits, and why are they used?

Stock Dividends

• The issuance of additional stock to existing

shareholders in proportion to the number of

shares currently owned

• Used to maintain loyalty of stockholders

when the firm does not have enough cash

for a cash dividend

• Affects only owners’ equity of the firm:

Retained earnings XX

Common stock XX

Stock Split

• Will lower the market price of a firm’s

stock

• Involves issuing additional share of

stock to existing shareholders

• No accounting entry is required

• The par value and the number of

shares issued changes

Learning Objective 6

• What is treasury stock, why is it

acquired, and how do treasury

stock transactions affect owners’

equity?

Treasury Stock

• Shares of a corporation’s own stock that

have been purchased from shareholders

• Is reflected on the balance sheet as a

contra owners’ equity account

• Treasure stock is not an asset

• Recorded as follows:

Treasury stock XX

Sales of Treasury Stock

• When sold above purchase price, treasury stock transactions are recorded as follows:

Additional paid-in capital XX

• Cash dividends are not paid on treasury stock

since the firm would be paying itself a dividend

• Stock dividends and stock splits do affect

treasury stock

Learning Objective 5

• What are the components of

“other comprehensive income,”

and why do these items appear

in owners’ equity?

Other Comprehensive Income

• All items of income (or loss) ultimately affect

owners’ equity

• Comprehensive income consists of:

– Net income (from income statement)

– Cumulative foreign currency translation

adjustment

– Unrealized gains and losses on sale securities (after taxes)

available-for-– Additional minimum pension liability

adjustments (after taxes)

Cumulative Foreign Currency

Translation Adjustment

• Financial statements of a foreign

subsidiary are expressed in the currency

of the country in which it operates

• The financial statements must be

converted into U.S dollars

• Because of fluctuations in exchange

rates, a difference occurs between the

translated assets and liabilities and the

translated owners’ equity

Cumulative Foreign Currency

Translation Adjustment

• The difference may result in a gain or

loss

• The adjustment will fluctuate over time

and will not be realized until the

subsidiary is sold

Learning Objective 7

• How are owners’ equity transactions for the year reported in the financial statements?

Reporting Changes in Owners’ Equity Accounts

• May be reported in the balance sheet,

a separate statement of changes in

owners’ equity, or in the footnotes or

financial review accompanying the

financial statements

• Reports all changes in owners’ equity

for the year

Owners’ Equity for Other Types of Entities

• Proprietorships and partnership do not

issue stock

• No distinction is made between paid-in

capital and retained earnings

• Distributions made to owners are usually recorded in a drawing account – similar

to a dividend account

Owners’ Equity for Other

Types of Entities

• Not-for-profit and governmental entities

do not have owners who have a direct

financial interest in the entity

• Owners’ equity is referred to as fund

balance

• A statement of changes in fund balances takes the place of a statement of owners’