Stockholders' Equity

Overview and Capital

Stock (Legal Capital):
Part 1

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 Stockholders' Equity Overview
• The owners' claim to the net assets of a corporation.

Assets – Liabilities = Residual interest

• Also called:
o shareholders' equity; or
o owners' equity.
• Generally presented on the statement of financial position
(balance sheet) as the last major section (following liabilities).
• The various elements constituting stockholders' equity must be
clearly classified according to source.

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 Stockholders' Equity Overview
Capital Corp.
Consolidated Shareholders' Equity—December 31, Year 1
Capital Stock (capital equal to par or stated value)
Preferred stock, noncumulative, $100 par value, authorized 1,000 shares
$ 50,000
issued and outstanding 500 shares
Common stock, $10 par value, authorized 50,000 shares, issued 30,000
300,000
shares of which 5,000 are held in the treasury
350,000
Additional Paid-in Capital (capital in excess of par or stated value)
Excess of issue price over par value of common/preferred stock sold $ 29,000
Excess of sales price over cost of treasury shares sold 15,000
Excess of FMV over par of stock issued as stock dividend 20,000
Defaulted stock subscriptions 10,000
FMV of common shares contributed by shareholders to corporation 75,000
FMV of fixed assets contributed by local government 60,000 209,000
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 Stockholders' Equity Overview
Retained Earnings
Appropriated (reserved) for general contingencies 50,000
Appropriated (reserved) for possible future inventory decline 20,000
Appropriated (reserved) for plant expansion 40,000
Appropriated (reserved) for higher replacement cost of fixed assets 60,000
Unappropriated (unreserved) $200,000 370,000
929,000
Accumulated other comprehensive income 10,000
Less: Cost of shares in treasury (85,000)
Total Capital Corp. shareholders' equity 854,000
Noncontrolling interest 25,000
Total equity $879,000

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 Capital Stock (Legal Capital)
• The amount of capital that must be retained by the corporation
for the protection of creditors.
• The par or stated value of both preferred and common stock:
o is legal capital; and
o is frequently referred to as "capital" stock.

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 Capital Stock (Legal Capital)
Par Value
• Generally, preferred stock is issued with a par value; but
• common stock may be issued with or without a par value.
• No-par common stock may be issued as:
o true no-par stock; or
o no-par stock with a stated value.
• Any excess of the actual amount received over the par or
stated value of the stock is accounted for as additional
paid-in capital.

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 Capital Stock (Legal Capital)
Authorized, Issued, and Outstanding
• A corporation's charter contains the amounts of each class of
stock that it may legally issue, and this is called "authorized"
capital stock.
• When part or all of the authorized capital stock is issued, it is
called "issued" capital stock.
• Because a corporation may own issued capital stock in the form
of treasury stock, the amount of issued capital stock in the hands
of shareholders is called "outstanding" capital stock.

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 Capital Stock (Legal Capital)
Authorized, Issued, and Outstanding
• In summary, capital stock may be:
o authorized;
o authorized and issued; or
o authorized, issued, and outstanding.
• The number of shares of each class of stock authorized, issued,
and outstanding must be disclosed.

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 Capital Stock (Legal Capital)
Common Stock
• The basic ownership interest in a corporation.
• Common shareholders:
o bear the ultimate risk of loss;
o receive the ultimate benefits of success;
o are not guaranteed dividends or assets upon dissolution; and
o generally control management.

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 Capital Stock (Legal Capital)
Common Stock
• Common shareholders have:
o the right to vote;
o the right to share in earnings of the corporation; and

Net income – Preferred dividends

= EPS
Weighted average common shares outstanding

o the right to share in assets upon liquidation after the claims

of creditors and preferred shareholders are satisfied.

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 Capital Stock (Legal Capital)
Allows shareholder to maintain voting strength
Pass Key
Common shareholders may have preemptive rights to a proportionate share of
any additional common stock issued if granted in the articles of incorporation.

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 Capital Stock (Legal Capital)
Common Stock
• Book Value per Common Share
o Measures the amount that common shareholders would receive
for each share if all assets were sold at their book (carrying)
values and all creditors were paid.
o Can be determined as follows:

Assets – Liabilities – Preferred equity – Dividends in arrears

Common shareholders' equity

Book value per share =
Common shares outstanding

Number of shares issued – Number of shares repurchased

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 Capital Stock (Legal Capital)
Common Stock
• Common Stockholders' Equity Formula

Total shareholders' equity

– Preferred stock outstanding (at greater of call price or par value)
– Cumulative preferred dividends in arrears
= Common shareholders' equity

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 Stockholders' Equity
Overview and Capital
Stock (Legal Capital):
Part 2

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 Capital Stock (Legal Capital)
Preferred Stock
• An equity security with preferences and features not associated
with common stock.
• May include a preference relating to dividends, which may be:
o cumulative or noncumulative; and
o participating or nonparticipating.
• May also include a preference relating to liquidation. Assume less risk than common stock
• Usually, preferred stock does not have voting rights.

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 Capital Stock (Legal Capital)
Preferred Stock
• Cumulative Preferred Stock
o The cumulative feature provides that all or part of the preferred
dividend not paid in any year accumulates and must be paid in
the future before dividends can be paid to common shareholders.
o The accumulated amount is referred to as dividends in arrears.
o The amount of dividends in arrears is not a legal liability, but it
must be disclosed in total and on a per-share basis either:
o parenthetically on the balance sheet; or
o in the footnotes.

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 Capital Stock (Legal Capital)
Preferred Stock
• Noncumulative Preferred Stock
o Dividends not paid in any year do not accumulate.
o The preferred shareholders lose the right to receive
dividends that are not declared.

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 Capital Stock (Legal Capital)
Preferred Stock
• Participating Preferred Stock
o The participating feature provides that preferred shareholders
share (participate) with common shareholders in dividends in
excess of a specific amount.
o The participation may be:
o full; or
o partial.

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 Capital Stock (Legal Capital)
Preferred Stock
• Participating Preferred Stock
o Fully participating means that preferred shareholders participate
in excess dividends without limit.
o Generally, preferred shareholders receive their preference
dividend first, and then additional dividends are shared between
common and preferred shareholders.
o Partially participating means preferred shareholders participate in
excess dividends, but to a limited extent (e.g., a percentage limit).

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 Capital Stock (Legal Capital)
Preferred Stock
• Non-participating Preferred Stock Less valuable Fixed returns only
o Preferred shareholders are:
o limited to the dividends provided by their preference; and
o do not share in excess dividends.

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 Capital Stock (Legal Capital)
Preferred Stock
• Preference Upon Liquidation
o Preferred stock may include a preference to assets upon
liquidation of the entity.
o If the liquidation preference is significantly greater than the par
or stated value, the liquidation preference must be disclosed.
o The disclosure of the liquidation preference must be in the
equity section of the balance sheet, not in the notes to the
financial statements.

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 Capital Stock (Legal Capital)
Preferred Stock
• Convertible Preferred Stock
o May be exchanged for common stock (at the option of the
stockholder) at a specified conversion rate.
• Callable (Redeemable) Preferred Stock
o May be called (repurchased) at a specified price (at the option
of the issuing corporation).
o The aggregate or the per-share amount at which the preferred
stock is callable must be disclosed either on the balance sheet
or in the footnotes.

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 Capital Stock (Legal Capital)
Preferred Stock
• Mandatorily Redeemable Preferred Stock (Liability)
o Issued with a maturity date.
o Similar to debt, mandatorily redeemable preferred stock
must be bought back by the company on the maturity date.
o Must be classified as a liability, unless the redemption is
required to occur only upon the liquidation or termination of
the reporting entity.

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 Capital Stock (Legal Capital)
Example: Distribution of Dividends to Participating
Preferred Stockholders
Facts: On January 1, Year 1, Samuel Co. issued 100,000 shares
of $5 par common stock and 25,000 shares of $10 par fully
participating 8 percent cumulative preferred stock. No dividends
were paid in Year 1. Cash dividends of $101,000 were declared
and paid in Year 2.

Year 1 dividend in arrears: 25,000 × $10 × 8% = $20,000

Required: Determine the dividend to be paid on the preferred
and common stock.

Common stock 100,000 shares × $5 = $500,000 par

Calculation of pro rata share of
Preferred stock 25,000 shares x $10 = $250,000 par excess dividends:
Common: 500,000/750,000 = 2/3
Total legal capital = $750,000
Preferred: 250,000/750,000 = 1/3
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 Capital Stock (Legal Capital)
Preferred
Solution:Stock
•Schedule
Convertible Preferred Remaining
1: Dividends Stock for Distribution
o May
Cash be exchanged for common stock (at the option of the
dividends $101,000
stockholder) at a specified conversion rate.
Year 1 preferred dividends in arrears [(25,000 × $10) × 0.08] (20,000)
• Callable (Redeemable) Preferred Stock
Preferred dividends accumulated in Year 2 (20,000)
o May be called (repurchased) at a specified price (at the option
of the issuing corporation). 61,000
o The aggregate
Common or the per-share
stock [(100,000 amount at which the preferred
× $5) × 0.08]* (40,000)
stock is callable must be disclosed either on the balance sheet C/S 2/3
or in thefor
Remaining footnotes.
proration between preferred and common stock $ 21,000
P/S 1/3
* The principle applied here is that, with participating cumulative preferred stock, before any proration
of dividends may exist, the common shareholders must receive an equal dividend as the preferred
shareholders. In this case, preferred shareholders receive an 8 percent dividend first; common
shareholders receive an 8 percent dividend second; and the balance ($21,000) is shared pro rata.

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 Capital Stock (Legal Capital)
Solution:

Schedule 2: Proration of Remaining Dividends According to Par Values

Preferred stock

250,000
× $21,000 = $7,000
750,000

Common stock

500,000
× $21,000 = $14,000
750,000

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 Capital Stock (Legal Capital)
Solution:

Schedule 3: Total Dividends Paid on Preferred and Common Stock

Preferred stock $7,000 + $20,000 + $20,000 = $ 47,000

Common stock $14,000 + $40,000 = 54,000
Total cash dividends distributed $101,000

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 Additional Paid-in Capital,
Retained Earnings, and
Accumulated OCI

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 Additional Paid-in Capital

Number of shares issued × (Contributed capital – Par value)

• Generally contributed capital in excess of par or stated value.

• Can also arise from many other different types of transactions.
• May be aggregated and shown as one amount on the balance sheet.
• Examples include:
o Sale of treasury stock at a gain
o Liquidating dividends
o Conversion of bonds
o Small stock dividends

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 Retained Earnings

Most revenues, expenses, gains, and losses flow through

the income statement and then to Retained Earnings/Equity.

• Accumulated earnings (or losses) during the life of the corporation that have
not been paid out as dividends.
• The amount of accumulated retained earnings is reduced by:
o distributions to stockholders; and
o transfers to additional paid-in capital for stock dividends.
• Retained earnings does not include:
o treasury stock; or
o accumulated other comprehensive income.
• If the retained earnings account has a negative balance, it is called a deficit.

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 Retained Earnings
Formula

Net income/loss

– Dividends (cash, property, and stock) declared

± Prior period adjustments

± Accounting changes reported retrospectively

Retained earnings

Current year change in retained earnings

+ Beginning retained earnings

Ending retained earnings

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 Retained Earnings
Classification of Retained Earnings (Appropriations)
• May be classified as either appropriated or unappropriated.
• The purpose of appropriating retained earnings is to disclose to the
shareholders (usually the common shareholders) that some of the
retained earnings are not available to pay dividends because they
have been restricted:
E.g., debt covenants, protect credit
o for legal or contractual reasons; or
rating, maintain financial ratios, etc.
o as a discretionary act of management for specific contingency purposes.

When dividend is declared: A = L + E

D
E = Risk

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 Retained Earnings
Classification of Retained Earnings (Appropriations)
• An appropriation of retained earnings:
o may not be used to absorb costs or losses; and
o may not be transferred to income.
• The following entry should be recorded when an appropriation is to be
made (and should be reversed when the purpose of the appropriation
has occurred):

DR Retained earnings (unappropriated) $XXX

CR Retained earnings appropriated for [purpose] $XXX

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 Accumulated Other Comprehensive Income
• Components of accumulated other comprehensive income include:
o pension adjustments;
o unrealized gains and losses on available-for-sale debt securities
and hedges; and
o foreign currency translation adjustments.

Similar to statement of retained earnings:

Beginning AOCI

± Current year OCI G/L and reclassification

Ending AOCI (part of stockholder's equity; earned capital)

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 Accumulated Other Comprehensive Income
• These components of other comprehensive income are not included in
determining net income and, therefore, do not enter into retained earnings.
• Rather, they:
o are recognized in the period in which they occur; and
o are combined with net income to determine comprehensive income.
• Total accumulated other comprehensive income must be shown in the
shareholders' equity section separate from capital stock, additional paid-in
capital, and retained earnings.

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 Treasury Stock: Part 1

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 Treasury Stock
• A corporation's own stock that has been issued to shareholders
and subsequently reacquired (but not retired). Financing outflow

• Treasury stockholders are not entitled to any of the rights of

ownership given to common shareholders, such as the right:
o to vote; or
o receive dividends.

Shares issued – Shares repurchased = Shares outstanding

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 Methods of Accounting for Treasury Stock
• Two methods of accounting for treasury stock are permitted:

Cost method Legal (or par/state value) method

• Gain or loss calculated upon reissue • Gain or loss calculated immediately

upon repurchase

• The primary difference between the two methods is the timing of the recognition of "gain or loss" on
treasury stock transactions.

Gain: Equity , Loss: Equity

• Under both methods:

o the "gains and losses" are recorded as a direct adjustment to stockholders' equity and are not included
in the determination of net income; and
o shares held as treasury stock are not considered to be outstanding shares.

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 Methods of Accounting for Treasury Stock
Cost Method (Used by Entities Approximately 95 Percent of the Time)
The treasury shares are recorded and carried at their reacquisition cost.
• A gain or loss will be determined when:
o treasury stock is reissued or retired; and
o the original issue price and book value of the stock do not enter into the accounting.
Equity Equity

• The account "additional paid-in capital from treasury stock" is credited for gains and debited for losses when
treasury stock is reissued at prices that differ from the reacquisition cost.
o Excess losses reduce retained earnings.
o Treasury stock gains and losses never affect the income statement (regardless of which method is used).

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 Methods of Accounting for Treasury Stock
Cost Method (Used by Entities Approximately 95 Percent of the Time)

Gain or loss = Reissue price – Repurchase cost

• Losses: Paid-in capital treasury stock , Excess retained earnings
• Gain: Paid-in capital treasury stock

• Losses may also decrease retained earnings if the additional paid-in capital from treasury
stock account does not have a balance large enough to absorb the loss.
• Net income or retained earnings will never be increased through treasury stock transactions.

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 Methods of Accounting for Treasury Stock
Cost Method:
• Carried at cost upon repurchase and reissue
• Calculate gain or loss upon reissue
Illustration: Cost Method
Original issue
10,000 shares $10 par value common stock sold for $15 per share.
DR Cash $150,000 Assets
CR Common stock (10,000 × $10 par) $100,000
Equity
CR Additional paid-in capital – C/S 50,000

Buy back above issue price

200 shares were repurchased for $20 per share.
DR Treasury stock (200 × $20) $4,000 Equity
CR Cash Financing outflow $4,000 Assets

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 Methods of Accounting for Treasury Stock
Illustration: Cost Method
Reissue above cost
100 shares × ($22 – $20) = $200 (Gain)
100 shares repurchased for $20 were resold for $22.
DR Cash (100 × $22) $2,200 Assets Paid-in capital treasury stock
CR Treasury stock (100 × $20) $2,000 100 shares × ($13 – $20) = $700 (Loss)
Equity
CR Additional paid-in capital – T/S 200 Paid-in capital treasury stock : $200

The following journal entry was made after the preceding entry: Retained earnings : $500
Reissue below cost
100 shares repurchased for $20 were resold for $13.

DR Cash (100 × $13) $1,300 Assets

DR Additional paid-in capital – T/S 200 Net change to equity
Equity
DR Retained earnings Excess loss 500 $1,300

CR Treasury stock (100 × $20) $2,000 Equity

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 Treasury Stock: Part 2

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 Methods of Accounting for Treasury Stock
Legal (or Par/Stated Value) Method (Used by Entities Approximately 5 Percent of the Time)

Calculate gains or losses immediately upon repurchase

• The treasury shares are recorded by reducing the amounts of par (or stated) value and additional
paid-in capital received at the time of the original sale.

Reverse original entry for shares repurchased

• Treasury stock is debited for its par (or stated) value.

• APIC — Common Stock is debited (reduced) for the pro rata share of the original issue price
attributable to the reacquired shares.
• Additional paid-in capital from treasury stock is credited for gains and debited for losses when
treasury stock is repurchased at prices that differ from the original selling price.

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 Methods of Accounting for Treasury Stock
Legal (or Par/Stated Value) Method (Used by Entities Approximately 5 Percent of the Time)

Step 1 Calculate gain or loss: Original selling price – Repurchase price

Step 2 Reverse original entry for shares repurchased: Debit treasury stock at par

Step 3 Credit cash price paid

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 Methods of Accounting for Treasury Stock
Legal (or Par/Stated Value) Method (Used by Entities Approximately
5 Percent of the Time)
• Losses may also decrease retained earnings if the "additional
paid-in capital from treasury stock" account does not have a
balance large enough to absorb the loss.
• The sources of capital associated with the original issue
are maintained.

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 Methods of Accounting for Treasury Stock
Calculate gains or losses
Illustration: Par Value Method
immediately upon repurchase
Original issue: Debit treasury stock at par
10,000 shares $10 par value common stock sold for $15 per share. Debit paid-in capital — C/S for the
original surplus in excess of par
DR Cash $150,000
CR Common stock (10,000 × $10 par) $100,000
CR Additional paid-in capital — C/S 50,000
Buy back above issue price:
200 shares were repurchased for $20 per share.

DR Treasury stock (200 × $10 par) $2,000 Step 1: ($15 – $20) × 200 shares
= $1,000 Loss
DR Additional paid-in capital — C/S 1,000
DR Retained earnings* 1,000 Step 2: Reverse original entry for
200 shares repurchased.
CR Cash $4,000
*This entry should be made to retained earnings if there is no balance in the additional
paid-in capital-T/S account.

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 Methods of Accounting for Treasury Stock
Illustration: Par Value Method
Buy back below issue price:
200 shares repurchased for $12 per share.

DR Treasury stock (200 × $10 par) $2,000

DR Additional paid-in capital — C/S (200 × $5) 1,000 Step 1:

CR Cash (200 × $12) $2,400 ($15 – $12) × 200 shares

= $600 Gain
CR Additional paid-in capital — T/S 600
Step 2:
Reissue shares: Reverse original entry for
200 shares repurchased.
100 shares repurchased for $20 were resold for $22.

DR Cash (100 × $22) $2,200

CR Treasury stock (100 × $10 par) $1,000
CR Additional paid-in capital — C/S 1,200

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 Methods of Accounting for Treasury Stock
Illustration: Par Value Method
Reissue shares:
100 shares repurchased for $20 were resold for $13.

DR Cash (100 × $13) $1,300

CR Treasury stock (100 × $10 par) $1,000
CR Additional paid-in capital — C/S 300

Cost Method: Calculate gains or losses upon reissuance of shares.

Gains or Losses = Reissue price – Repurchase price (cost)

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 Methods of Accounting for Treasury Stock
Illustration: Effect of Cost and Par Value Methods on Balance Sheet Presentation

The equity sections of the cost balance sheet and par value balance sheet would appear as follows, assuming
that the treasury shares were repurchased for $20 per share:

Cost Method Par Value Method

Common stock (par value) $100,000 Common stock (par value) $100,000
Additional paid-in capital 50,000 Less: Treasury stock at par (2,000)
Total paid-in capital 150,000 Common stock o/s at par 98,000
Retained earnings 75,000 Additional paid-in capital 49,000
225,000 147,000
Less: Treasury stock at cost (4,000) Retained earnings 74,000
Total stockholders' equity $221,000 Total stockholders' equity $221,000

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 Retirement of Treasury Stock
• When treasury stock is acquired with the intent of retiring the stock
(regardless of whether it is accomplished) and the price paid is in
excess of the par or stated value, that excess may be charged
against either:
o all paid-in capital arising from past transactions in the same
class of stock; or
o retained earnings.
• When the price paid for the acquired treasury stock is less than par
or stated value, the difference must be credited to paid-in capital.

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 Retirement of Treasury Stock
• The retirement of treasury stock would be accomplished with the following journal entries under the cost
method and the par value method:

Illustration: Retirement of Treasury Stock

If all 200 treasury shares reacquired for $20 were retired rather than reissued, the following entry
would be made:
Retirement of Shares (Cost Method) Original Sale
200 shares of $10 par common stock originally sold for $15 and Debit cash: 200 × $15 = $3,000
reacquired for $20 are retired.
Credit common stock:
DR Common stock (200 × $10) $2,000 200 × $10 = $2,000
DR Additional paid-in capital — C/S (200 × $5) 1,000 Credit paid-in capital:
200 × $5 = $1,000
DR Retained earnings 1,000 Repurchase
CR Treasury stock (200 × $20) $4,000 Debit treasury stock:
200 × $20 = $4,000
Credit cash: $4,000

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 Retirement of Treasury Stock
• The retirement of treasury stock would be accomplished with the following journal entries under the cost
method and the par value method:

Illustration: Retirement of Treasury Stock

To retire treasury stock under the par value method, debit common stock at par and credit treasury
stock at par.
Retirement of Shares (Par Value Method)

DR Common stock (200 × $10 par) $2,000

CR Treasury stock (200 × $10 par) $2,000

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 Donated Stock
• A company's own stock received as a donation from a shareholder.
• There is no change in total shareholders' equity as a result of the
donation, but the number of shares outstanding decreases,
resulting in higher book value per common share.
• The company should record donated stock at fair market value,
as follows:

DR Donated treasury stock (at FMV) $XXX

CR Additional paid-in capital (at FMV) $XXX

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 Donated Stock
• If the donated stock is sold, the journal entry would be:
DR Cash (at sales price) $XXX
DR Additional paid-in capital (if SP < original FMV) XXX
CR Additional paid-in capital (if SP > original FMV) $XXX
CR Donated treasury stock (at book value, or original FMV) XXX

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