LEARNING OUTCOMES 1, Define and explain capital stock; and 2. Know the book value per share. Not infrequently, shares of stocks are used as collaterals to secure loans from the banks and other financing institutions. An investor who acquires shares of stock in a corporation is issued a certificate of stock as evidence of the shares purchased. Usually, only one certificate is issued for each block of shares purchased. Capital Stock Ownership in a corporation is represented by its capital stock. The capital stock is divided into fractional units for convenience in transferring ownership and distributing profits in the form of dividends. Each of the proportionate units of capital stock is referred to as a share of stock. A stockholder acquires an interest in a corporation by buying shares of stock. His proportionate interest in the assets and profits of the corporation is determined by the number of shares of stock which he owns. In order to attract kinds of investors, a corporation’s capital stock may be divided into two or more classes with different rights, voting powers, preferences, and restrictions. Each class of stock in turn, is divided into shares. Within each class of stock, each share has the same rights and privileges as every other share. The classes of stock, and the rights and privileges of each class are described in the articles of incorporation. The two principal classes of capital stock are: common and preferred. Stock Certificates A stock certificate customarily has all of the following on its face:‘CREDIT A COLLECTION. a, Name of the company; b.. State of incorporation; c. "Par value”, if par value stock; oF “no-par value” if no-par stock; ad. Statement that the stock is “fully paid and non-assessable; , Serial number; f, Number of shares; gg Name of the owner; and h, Names of officers and others authorized to sign for the company. On the back of the certificate there will be provisions for transfer of title to the certificate with spaces for dates, name of transferee and signature of the owner. Ifa company has issued several classes of stock the stock certificate of each class may summarize the rights and privileges pertaining to it, but more often these provision will be in the articles of incorporation and/or by-laws of the corporation. Ownership Evidenced by Transferable Shares The use of freely transferable shares permits a stockholder to buy, sell, or dispose of his interest in a corporation without approval of other stockholders or of the corporation. This feature of transferable ownership is an important factor in raising large capital funds because many individuals are willing to make only temporary investments in a company. ‘There are few exceptions to the general rule that stockholders may be free to dispose of their interest in a corporation without the approval of the corporation, In some cases, employees may acquire stock under an employee ownership plan that requires them to sell the stock back to the corporation if and when they cease being employees; in other cases, a stockholder may be required to keep the stock acquired under an “incentive plan” for a specified number of years. Common Stock Common stock, which represents the owner's equity investment in corporate businesses, is the basis and largest source of permanent financing. ‘The outstanding characteristic of common stock is its complete claim to the profits of the business that remain after the holders of all other classes of debt and equity instruments have received their stipulated returns, Also, it is generally the voting privilege of the common stockholders that governs the selection of the board of directors of a corporation; the board of directors, in turn, exercises general control 182‘CREDIT & COLLECTION of the enterprise. For these reasons, the holders of common stock may be regarded as the basic owners of the corporation. The favorable position of the common stockholders with respect to dividends and control of the corporation is offset by the fact that during periods when profits from operations are low, the claims of others may completely absorb available funds, leaving little or nothing for the common stockholders. Just as the common stockholders receive dividends only after all other classes of security holders has received their specified return, so they have low priority when a business venture is liquidated. Common stockholders generally receive little, if anything, from liquidation proceedings. The common stockholders, therefore, suffer the brunt of business failure just as they enjoy the primary benefits of business success, Common. stocks may be divided into special groups, generally Class and Class B, in order to permit the acquisition of additional capital without diluting the control of the business. Preferred Stock Preferred stock, in contrast with common stock, generally carries a limited dividend, specified either as a percentage of par value or as a fixed number of pesos per year. Preferred stock is a stock which entitles the holder to some preference over some other class or classes of stockholders. The preferences may be given to preferred stock are: a. Priority in the distribution of dividends, and/or b. Priority in the distribution of corporate assets in case of liquidation. Stock preferred as to dividends are entitled to be paid dividends at a certain specified rate before any dividends are given to common stockholders. The dividends preference may be on a cumulative or non-cumulative basis, and/or on a __ participating basis. Cumulative preferred stock is entitled to receive any dividends that may not ~ have been paid in previous years, in addition to the current year’s dividends, before any payment can be made to common stockholders. Non-cumulative preferred stock is entitled to the current year’s dividends only, and no longer to dividends which have been passed in previous years. Participating preferred stock entitles the holder to participate pro-rata in the excess of the profits set aside for dividends equal in rate to that already given the preferred shares.CREDIT COLLECTION Non«participating preferred stock does not share in any remaining dividends after it has received its preferred rate. ILLUSTRATION ‘The XYZ Corporation has the following classes of stock outstanding: Common Stock (par value) P300,000.00 6% Preferred Stock (par value) 100,000.00 Total 400,000.00 Retained earnings of P48,000 is to be distributed as dividends. Dividends have not been paid on preferred stock for the preceding two years. The dividendsis tobe given to each class of stock under different assumptions with respect to the preferred shares, are computed below: 1. PREFERRED STOCK IS NON-CUMULATIVE AND NON-PARTICIPATING Preferred Common Total Current Year's Dividends 6% of P100,000 6,000.00 6,000.00 Balance to Common P42,000.00 42,000.00 Total P6,000.00 P 42,000.00 P48,000.00 2. PREFERRED STOCK IS CUMULATIVE AND NON-PARTICIPATING Preferred Common Total Dividends in Arrears: 6% of P100,000 x 2 years 12,000.00 12,000.00 Current Year's Dividends 6% of P100,000 6,000.00 6,000.00 Balance to Common. 30,000.00 30,000.00 Total 6,000.00 30,000.00 P48,000.00(CREDIT & COLLECTION 3. PREFERRED STOCK IS NON-CUMULATIVE AND FULLY PARTICIPATING Preferred Common Current Year's Dividends: To Preferred stock: 6% x P100,000 6,000.00 ‘To Common Stock (same rate as preferred) 6% x 300,000 P18,000.00 Balance of P24,000 allocated on the basis of total par value as follows: To Preferred Stock: ¥ of 24,000 6,000.00 To Common Stock: %4 of 24,000 18,000.00 Total P12,000,00 __P36,000.00 Total 6,000.00 18,000.00 6,000.00 18,000.00 P48,000.00 4. PREFERRED STOCK IS CUMULATIVE AND FULLY PARTICIPATING Preferred. Common Dividends in Arrears: 6% P100,000 x 2 years 12,000.00 Current Year Dividends 6,000.00 P18,000.00 Balance of P12,000 allocated as follows: To Preferred Stock: 4 of 12,000 3,000.00 To Common Stock: % of P12,000 9,000.00 Total 21,000.00 P27,000.00 Preference as to Assets in Liquidation Total 12,000.00 24,000.00 3,000.00 9,000.00 P48,000.00 Stock which is preferred as to assets have a prior claim over common stock in the distribution of corporate assets in case of liquidation, Stock which is preferred as to dividends is not necessarily preferred as to assets in liquidation. The rights incorporation. and privileges of preferred shares must be specifically stated in the articles ofCREDIT & COLLECTION, Preference as to assets in liquidation usually includes a right to cumulative dividends in arrears before assets are distributed to common stockholders. It has ‘been generally held that such preference is valid whether or not there have been accumulated earnings available for dividends. Redeemable Preferred Stock Redeemable preferred stock is stock which may be called or redeemed by the corporation, usually in an amount exceeding par of original issuance price. Convertible Preferred Stock Convertible preferred stock may be exchanged for some other security of the corporation at the option of the holder. Par vs. No-Par Value Stock Both preferred and common stock may be par value or no-par value stock, except that if the stock is preferred as to assets in liquidating, it must have a par value, Par Value Capital Stock It is a stock which has an assigned nominal value per share appearing on the certificate of stock. The par value establishes the minimum amount that must be paid by each stockholder for the share of stock. If stock is acquired below its par value, the original purchasers become contingently liable to creditors of the corporation for the amount of the discount in the event of insolvency, or involuntary dissolution of the corporation. The par value of a share of stock should not be confused with its market value. Market value is the price at which each share will sell in the open market. The par value of a share of stock is fixed. Its market value fluctuates. A share of stock may sell at an amount equal to above, or below its par value. No par value stock has no assigned nominal value per share appearing in the certificate of stock. Our corporation law provides that no-par value shares may not be issued for a consideration less than five pesos per share. No par value shares may be sold at any amount above this legal minimum without a discount liability. No par value shares were introduced to overcome some of the disadvantages of, and abuses committed in connection with par value stock. For example, non- cash assets contributed by stockholders were sometimes overvalued in order to avoi9d the discount liability on par value shares. The use of no-par shares removed one of the reasons for inflating asset values. No par value shares have also forced investors to consider such factors as earnings, dividends fair value of assets, etc, in determining the true worth of a share of stock. teense(CREDIT & COLLECTION No par value shares may be assigned a stated value in the articles of incorporation, by the board of directors if authorized or by a majority of the stockholders at a meeting called for that purpose. The assignment of a stated value negates the purpose for which no-par value shares are issued. True no-par value shares do not have a stated value. BOOK VALUE PER SHARE Book Value Defined The term “book value per share of stock” refers to the amount of stockholders equity applicable to each share of outstanding capital stock, as reflected in the accounting records or related financial statements of the date such value is determined. Underlying Assumptions The computation of book value per share is based on the assumption that the business is liquidated on the date book value is determined, and the assets are realized at the amounts appearing in the accounting records (or financial statements) on that date without any loss or gain to the corporation. Thus, while book value is based on assumed liquidation, the values employed in the computation are “going concern” rather than actual “liquidation” values. Book value, since it is based on going concern values is not synonymous with, nor necessarily equal to par, declared, appraised, liquidation or market values. Uses of Book Value per Share 1. To guide an investor in comparing the value of one stock against another in establishing the trend of market values of stock. 2. If the stock is not quoted in the open market, to serve as an index of the value of the stock. 3. To indicate increases or decreases in stockholder equity per share of stock over a period of time. : 4. When an interest in a closed corporation, or in a corporation not listed in the stock exchange is to be bought or sold; to serve as one of the bases for setting a sales price satisfactory to both buyer and seller.CREDIT COLLECTION Computation - One Class of Stock Where there is only one class of stock, the book value per share is determined by dividing the total stockholders’ equity by the number of shares outstanding, The formula is: Total Stockholders’ Equity _ Book Value per Share No. of Shares Outstanding Computation - Two or More Classes of Stock Where two or more classes of stock are outstanding, the rights of each class of stock in corporate surplus must be determined. The applicable stockholders’ equity assigned dividend by the corresponding number of outstanding shares of stock to obtain the book value per share of each class of capital stock. ILLUSTRATIVE PROBLEM Assume the following data pertaining to the XYZ Corporation. 6% Preferred stock par 100, 1000 shares authorized issued and outstanding 100,000.00 Common Stock, par P100, authorized 5,000 shares, issued and outstanding 3,000 300,000.00 shares Additional, contributed capital P18,000.00 Retained Earnings: Appropriated P10,000.00 Unappropriated 20,000.00 30,000.00 Total Surplus 48,000.00 Total stockholders’ equity 448,000.00 Dividends for the last two years are in arrears: the preferred stock is cumulative and non-participating, Compute the book value per share of common and preferred stock.(CREDIT & COLLECTION Surplus Preferred Common Total Capital Stock 100,000.00 300,000.00 P400,000.00 Surplus: ‘To preferred P12,000.00 12,000.00 P12,000.00 Stock PASSED DIVIDENDS: 6% x 100,000 x 2 years CURRENT Year's 6,000.00 6,000.00 6,000.00 Dividends 6% x 100,000 BALANCE TO 30,000.00 30,000.00 30,000.00 COMMON TOTAL 4g,000.00__P118,000.00__P330,000.00 _P448,000.00 Outstanding Shares 1,000.00 3,000.00. Book Value per Share 71800___110.00 Surplus Available for Dividends In computing book value per share, itis assumed that the corporation will liquidate, Therefore, all surplus, whether earned, contributed, or appraisal, and whether appropriated or unappropriated, are to be available for dividends. The requirement that only retained earings are available for dividends applies to a going concern, not to one that is liquidating. ‘SPECIAL PROBLEMS Special problems may arise in computing book value per share. The following should serve as guidelines in dealing with these problems: Intangible Assets Intangible assets are sometimes excluded from book value computations in order to obtain a more conservative figure. Unless otherwise required, the computation of book value should include all assets, whether tangible or intangible. ‘Subscribed Stock In computing book value per share, outstanding shares should include subscribed shares of stock.CREDIT & COLLECTION Subscription Receivable iptions receivable may be presented either as an asset, or as deduction ‘bed capital stock. In most cases, it appears desirable to treat subscription receivable as an asset for the purpose of book value computation. Liquidation Value of Stock Liquidation value is the amount which will be paid to preferred shareholders from dissolution of a corporation, in accordance with the provisions of the stock issue. Where a liquidation value is assigned to preferred stock. This amount should be substituted for par, value for the purpose of determining book value per share. Redemption Value or “Call Price” The redemption value or call price of preferred stocks is the amount at which, in accordance with provisions of the stock issue, the corporation may at its option redeem the preferred shares. Redemption value may be equal to or higher than par value. In computing book value, call price is sometimes substituted for par value. This practice has been criticized by some accountants on the grounds that the option would presumably be exercised by the corporation before, not upon, liquidation and retirement of all shares. Call price may be issued where it appears from the facts that the corporation may exercise the redemption privilege i.e., where it appears advantageous for the corporation to call in the preferred shares.