chapter 18 outline 7e

7/26/2019 Chapter 18 Outline 7e

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Chapter

18Shareholders EquityLEARNINGOBJECTIES

After studying this chapter, you should be able to:

LO18!1 Describe the components of shareholders equity and explain how they are reported in astatement of shareholders' equity.

LO18!" Describe comprehensive income and its components.

LO18!# nderstand the corporate form of organi!ation and the nature of stoc".

LO18!$ #ecord the issuance of shares when sold for cash and noncash consideration.

LO18!% Distinguish between accounting for retired shares and treasury shares.

LO18!& Describe retained earnings and distinguish it from paid$in capital.

LO18!' %xplain the basis of corporate dividends, including the similarities and differencesbetween cash and property dividends.

LO18!8 %xplain stoc" dividends and stoc" splits and we account for them.

LO18!( Discuss the primary differences between .&. AA( and )*#& with respect toaccounting for shareholders equity.

C)A*TER)IG)LIG)TS

*ART A+ T)E NAT,RE O- S)ARE)OL.ERS E/,IT0

+usinesses raise money externally to fund operations in two ways debt financing and equityfinancing. Debt financing ta"es the form of notes, bonds, leases, and other liabilities. -hese createcreditors interest in the assets of the business. %quity financing creates ownership interests in theassets of the business. wners of a corporation are its shareholders. &hareholders equity is aresidual amount. -hat is, its the amount that remains after creditor claims have been subtracted

from assets /net assets0. #emember, net assets equal shareholders equity:

Assets Lia2ilities 3 Shareholders equity

Net Assets

The McGraw-Hill Companies, Inc., 2013

Student Study Guide 18-


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Shareholders Equity

Shareholders Equity i4 -i4a45ial State6e4ts

&hareholders equity arises primarily from /a0 amounts invested by shareholders and /b0 amountsearned by the firm on behalf of its shareholders. -hese two amounts are reported in two categorieson a balance sheet: paid$in capital and retained earnings.

-he balance sheet reports balances of shareholders equity accounts. )n addition, companies alsodisclose the reasons forchangesin those accounts. -he statement of shareholders equity serves thatpurpose. )t reports the transactions that cause changes in shareholders equity account balances.

Illustratio4

ariety Bra4ds Corporatio4

State6e4ts o7 Shareholders Equity

*or the 1ears %nded Dec. 23, 4532, 4536, 4537 /)n millions0

Additional8ommon (aid$in #etained -reasury &hareholders

&toc" 8apital %arnings &toc" %quityBala45e Ja49 1 ":1# 925 9655 9475 9/350 9755;et income 65 658ash dividends /470 /4708ommon shares sold 7


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Shareholders Equity

*ART B+ *AI.!IN CA*ITAL

-u4da6e4tal Share Ri;hts

Co66o4 Sto5


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Shareholders Equity

noncash consideration, whichever seems more clearly evident. -his is consistent with the generalrule for accounting for any noncash transaction.

Share Issue Costs

&hare issue costs refer to the costs of obtaining the legal, promotional, and accounting servicesnecessary to effect the sale of shares. -he costs reduce the net cash proceeds from selling the sharesand thus paid$in capital excess of par, and are not recorded separately.

Rea5quired Shares

8ompanies sometimes reacquire shares previously sold. -here is a variety of reasons why, but themost common motivation is to support the mar"et price of the shares. Although, all sharerepurchases are functionally the same, accounting treatment depends on whether the company statesthat it is formally retiring the shares or purchasing treasury shares.

Shares -or6ally Retired

hen a corporation retires previously issued shares, those shares assume the same status asauthori!ed but unissued shares Bust the same as if they never had been issued. (ayments made toretire shares are viewed as a distribution of corporate assets to shareholders. e reduce precisely thesame accounts that previously were increased when the shares were sold namely, common /orpreferred0 stoc" and paid$in capital excess of par.

Illustratio4

At the time it retired 3 million common shares, eneral #etailers balance sheet included thefollowing:

/9 in millions0

8ommon stoc", 355 million shares at 93 par, ................................. 9 355(aid$in capital excess of par.......................................................... 755

I7 shares are 2ou;ht 2a5< i4 ":1# at =$ per share+

8ommon stoc" /3 million shares at 93 par0.................................................... 3(aid$in capital excess of par /3 million shares at 97 per share0..................... 7

(aid$in capital share repurchase /difference0...................................... 48ash /cost0............................................................................................ 6

I7 a4other 1 6illio4 shares are 2ou;ht 2a5< i4 ":1% at =( per share+

8ommon stoc" /3 million shares at 93 par0.................................................... 3(aid$in capital excess of par /3 million shares at 97 per share0..................... 7(aid$in capital share repurchase /account balance0................................... 4#etained earnings /remaining difference0...................................................... 3

8ash /cost0............................................................................................ >


St!ent St!" Gi!e 1#-$


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Shareholders Equity

e treat the difference between the cash paid to buy the shares and the amount the shares originallysold for differently depending on whether that difference is positive /credit0 or negative /debit0:

a. )f a cre!it difference is created as in the first entry, we credit paid in capital sharerepurchase.

b. )f a !e%itdifference is created, we debit retained earnings unless a credit balance alreadyexists in paid$in capital share repurchase, as in the second entry.

Shares Treated as Treasury Sto5


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Shareholders Equity

*ART C+ RETAINE. EARNINGS

)n general, retained earnings represents a corporation's accumulated, undistributed or reinvested netincome /or net loss0. Distributions of earned assets are dividends.

.i>ide4dsCost corporate dividends are paid in cash. At the declaration date, retained earnings is reduced anda liability is recorded. #egistered owners of shares on the date of record are entitled to receive thedividend.

Illustratio4

-he board of directors of Carlin (roperties declared a cash dividend of 9.75 per share on its 75million shares on Carch 3. -he dividend was payable to shareholders of record Carch 37, to bepaid Carch 25:

?ar5h 1 de5laratio4 date /9 in millions0

#etained earnings..................................................................................... 478ash dividends payable/75 million shares at 9.75share0.............................. 47

?ar5h 1% date o7 re5ord

no entry

?ar5h #: pay6e4t date

8ash dividends payable ........................................................................... 478ash .................................................................................................... 47

*roperty .i>ide4ds

ccasionally, a noncash asset is distributed. )n that case it is referred to as a property dividend. -hefair mar"et value of the assets to be distributed is the amount recorded for a property dividend.+efore recording the property dividend, the asset may need to be written up or down to fair mar"etvalue. -his would create a gain or loss.

Sto5< .i>ide4ds

)n a stoc" dividend additional shares of stoc" are distributed to current shareholders. )ts important tonote that a stoc" dividend affects neither the assets nor the liabilities of the firm. And, because eachshareholder receives the samepercentageincrease in shares, a shareholders percentage ownership

of the firm remains unchanged.

*or a EsmallE stoc" dividend /less than 47F0, the fair value of the additional shares distributed istransferred from retained earnings to paid$in capital.




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Shareholders Equity

#etained earnings /mar"et value of new shares0................................................. xxx8ommon stoc" /par value of new shares0..................................................... xxx(aid$in capital excess of par/remainder0.............................................. xxx




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Shareholders Equity

Sto5< Splits

A stoc" distribution of 47F or higher is a stoc" split. )f referred to as a Estoc" split effected in theform of a stoc" dividend,E the par value of the additional shares is reclassified within shareholdersequity:

(aid$in capital excess of par................................................................ xxx8ommon stoc" /par value of new shares0..................................................... xxx

)f referred to merely as a stoc" split, no Bournal entry is recorded.

.e5isio4!?ae

-he "ey to a company's long run survival is profitability. -he return on shareholders' equity is asummary measure of profitability popular among investors, common shareholders in particular.-his ratio is calculated by dividing net income by average shareholders' equity and measures theability of company management to generate net income from the resources that owners provide.

-o supplement the return on shareholders equity ratio, analysts frequently use the earnings$priceratio to relate earnings to the mar"et value of equity rather than the boo" value of equity. -his ratiois calculated as the earnings per share divided by the mar"et price per share. A popular variation isthe inverse the price$earnings ratio.

-he return to shareholders can be significantly affected by decisions that managers ma"e withregard to shareholders equity transactions. hen a corporation buys bac" shares of its own stoc",for instance, the return on shareholders equity goes up. Gowever, the buy bac" of shares usesassets, which reduces the resources available to earn net income in the future.

Dividend decisions should be evaluated in light of prevailing circumstances. hen cash isavailable, management must decide whether shareholders are better off receiving cash dividends orhaving funds reinvested in the firm.

I4ter4atio4al -i4a45ial Reporti4; Sta4dards

.&. AA( and )*#& are generally compatible with respect to accounting for shareholders' equity.&ome differences exist in presentation format and terminology and in choices regarding reportingcomprehensive income. &hareholders equity is classified under )*#& into two categories: &hare

capital and ?reserves.@ -he term reserves is considered misleading and thus is discouraged under.&. AA(.

nder .&. AA(, preferred stoc" normally is reported as equity, but is reported as debt with thedividends reported in the income statement as interest expense if it is ?manditorily redeemable@preferred stoc". nder )*#&, most non$mandatorily redeemable preferred stoc" /preference shares0also is reported as debt as well as some preference shares that arent redeemable. nder )*#&, the




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Shareholders Equity

critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash /oranother financial instrument0 to the holder.

ith regard to the presentation of comprehensive income, both sets of standards permit either /30single statement of comprehensive income or /40 two statements: a separate Hincome statement and

Hstatement of comprehensive income. .&. AA( permits a third alternative: /20 include in thestatement of shareholders equity.

Appe4di@ 18+ /uasi!Reor;a4iatio4s

hen a company undergoes financial difficulties, but has favorable future prospects, it may ma"euse of a quasi$reorgani!ation. -he firm writes down inflated asset values and eliminates theaccumulated deficit /debit balance in retained earnings0 following these procedures:3. Assets and perhaps liabilities are revalued /up or down0 to reflect fair mar"et values with

corresponding credits or debits to retained earnings. -he deficit usually is temporarilyincreased by this step.

4. -hen the debit balance in retained earnings /deficit0 is eliminated against additional paid$in

capital. )f additional paid$in capital is not sufficient to absorb the entire deficit, a reduction incapital stoc" may be necessary /with an appropriate restating of the par amount per share0.

2. *or several years, retained earnings is ?dated@ to indicate the date the deficit was eliminated andwhen the new accumulation of earnings began.

SEL-!ST,.0 /,ESTIONSAN.EERCISES

Co45ept Re>ie

3. -he two primary sources of shareholders equity are amounts invested by shareholders in the

corporation and amounts earned by the corporation on behalf of its shareholders. )nvestedcapital is reported as and earned capital is reported as .

4. -he statement of reports the transactions that cause changes in itsshareholders equity account balances.

2. -ypical reasons for changes in shareholders equity are the sale of additional shares of stoc", theacquisition of , , and the declaration of .

6. )n the eyes of the law, a is a separate legal entity separate and distinct from its

owners.

7. Iimited is perhaps the single most important advantage of corporateorgani!ation over a proprietorship or a partnership.


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Shareholders Equity

=. 8orporations are formed in accordance with the corporation laws of individual .

. -he typical rights of preferred shares usually include a preference to a predesignated amount ofJJJJJJJJJJJJJJ and a preference over shareholders in thedistribution of assets

in the event the corporation is dissolved.

>. )f preferred shares are , when the specified dividend is not paid in a given yearthe unpaid dividends must be made up in a later dividend year before any dividends are paid oncommon shares.

35. was defined by early corporation laws as the amount of net assets notavailable for distribution to shareholders as dividends or otherwise.

33. )n a noncash issuance of shares, the measurement obBective is that the transaction should berecorded at .

34. costs reduce the net cash proceeds from selling the shares and thus paid$incapital excess of par.

32. hen shares are retired, common /or preferred0 stoc" and are reduced by the same amounts they were increased by whenthe shares were originally sold.

36. *or a stoc" dividend of less than F, the fair mar"et value of the additional shares distributedis transferred from retained earnings to paid$in capital

37. -he effect and maybe the motivation for a 4 for 3 stoc" split is to reduce the per share mar"etprice /by half0. -his will li"ely increase the stoc"s .

3


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Shareholders Equity

REIEDEERCISES

E@er5ise 1

#etained earnings is affected by a variety of accounting transactions. *or each of the transactions

listed below, indicate by letter whether retained earnings is increased IF, decreased .F, or notaffected NF. At the time of each transaction, assume the shareholders equity of the transactingcompany includes only common stoc", paid$in capital excess of par, and retained earnings.

Tra4sa5tio4s

3. ;et income for the year 4. A net loss for the year 2. Declaration of a cash dividend 6. (ayment of a previously declared cash dividend 7. Declaration of a property dividend


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Shareholders Equity

E@er5ise "

American Cineral 8ompany provides mineral additives to bottled water companies. Americanscorporate charter authori!ed the issuance of 46 million, 93 par common shares. During 4532, itsfirst year of operations, American transacted the following:

Kanuary 7 &old 3< million new common shares at 927 per shareApril 33 #epurchased 3 million shares at 965 per shareDecember 4 &old 3 million shares at 964 per share

Required+

(repare Bournal entries to record each of the three transactions under each of two assumptions: /30American formally retires the shares it buys bac" and /40 American views share buybac"s as treasuryshares.

19 Retire6e4t

Ja4uary % /9 in millions0

April 11

.e5e62er "

"9 Treasury Sto55 million shares0 9 >5(aid$in capital excess of par 765

#etained earnings 45 -otal shareholders equity 9>35

n Kanuary 7, 4536, Golmes purchased 3 million treasury shares for 9> million)mmediately after the purchase of the shares, the balances in the paid$in capital excessof par and retained earnings accounts are:

*aid!i4 5apital Retai4ed

e@5ess o7 par ear4i4;s

a. 9765 945b. 9765 94=4

c. 9726 94=d. 9724 945




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Shareholders Equity

35. &anderson &ofas, a family$owned corporation, issued


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Shareholders Equity

36. -he following data were reported in the shareholders equity section of the Ketson8ompanys comparative balance sheets for the years ended December 23:

/9 in millions0

":1# ":1"

8ommon stoc", 93 par per share 925< 9255(aid$in capital excess of par 3=6 375#etained earnings 236 255

During 4532, Ketson declared and paid cash dividends of 967 million. -he company alsodeclared and issued a stoc" dividend. ;o other changes occurred in shares outstandingduring 4532. hat was Ketsons net income for 4532Na. 936 millionb. 97> millionc. 9 million

37. -he corporate charter of (haraoh -ent 8o. authori!ed the issuance of < million, 93 par

common shares. During 4532, its first year of operations, (haraoh had the followingtransactions:

*ebruary 6 sold 6 million shares at 937 per sharectober 34 retired 3 million shares at 93 per shareDecember 25 sold the 3 million shares at 945 per share

hat amount should (haraoh report as additional paid$in capital in its December 234532, balance sheetNa. 92= millionb. 97< million

c. 97 milliond. 9


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Shareholders Equity

3=. At the beginning of 4532, (riester Dental &upplies had outstanding 6 million shares of9355 par, F cumulative, non$participating preferred stoc" and 45 million shares of 93par common stoc". During 4532, (riester declared and paid cash dividends of 9355million. ;o dividends had been declared or paid during 4534. n Kanuary 34, (riester

issued a 7F common stoc" dividend when the quoted mar"et price the common stoc"was 945 per share. hat amount of cash did (riester distribute to common shareholdersNa. 92< millionb. 97< millionc. 9


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Shareholders Equity

45. *ancy )mports applies )nternational *inancial #eporting &tandards. -he company issued

shares of the companys 8lass + stoc". *ancy )mports should report the stoc" in the

companys statement of financial position

a. as equity unless the shares are redeemable at the option of the issuer.

b. as equity unless the shares are manditorily redeemable.c. among liabilities if the shares are manditorily redeemable or redeemable at the option

of the shareholder.

d. among liabilities unless the shares are manditorily redeemable.

&nswers'3. b. . a

7. d. 35. c. 37. d. 45. c

C*A E@a6 /uestio4s3. 29 -he entries to record the stoc" issuance and subsequent acquisition andretirement /per share0 are as follows:Issua45e

8ash ............................................................................... 478ommon stoc" ......................................................... 35(aid$in capitalOexcess of par ................................. 37

Retire6e4t

8ommon stoc" ............................................................... 35(aid$in capitalOexcess of par ....................................... 37

(aid$in capitalOshare repurchase ............................ 78ash .......................................................................... 45

-he net result is a decrease in (aid$in capitalOexcess of par /additional paid$incapital0 of 935 per share retired.

"9 59 A treasury stoc" account is created when a company reacquires its own stoc"as treasury stoc". -he full purchase price /cost0 is debited to -reasury &toc".

hen treasury stoc" is sold, the -reasury &toc" account is credited for thecost per share, with an additional credit to (aid$in 8apital, -reasury &toc"/or (aid$in 8apital O#epurchased &hares0, if the sale price exceeds thereacquisition price. -he 4534 repurchase is accounted for with a debit to-reasury &toc" for 9355,555. hen half of the treasury stoc" is resold,975,555 is credited to -reasury &toc" and 925,555 is credited to (aid$)n8apital, -reasury &toc". -he balance in the -reasury &toc" account is 975,555.




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Shareholders Equity

2. 29 (roperty dividends are recorded at the fair value of the property distributedas of the date of declaration, with any gain or loss being recogni!ed in thecurrent period.*air mar"et value of property dividend94.75 x 355,555 shares 9475,5558arrying value94.55 x 355,555 shares 455,555ain on disposal of investment 9 75,555

6. 59 -he number of shares issued is less than 45O47F. -herefore, the transactionis considered a small stoc" dividend and retained earnings should be debitedfor the *P at date of declaration.


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Shareholders Equity

C?A E@a6 /uestio4s3. 29 (ar value represents a stoc"s legal capital. )t is an arbitrary value assignedto stoc" before it is issued. (ar value represents a shareholders liabilityceiling because, as long as the par value has been paid in to the corporation,

the shareholders obtain the benefits of limited liability.

4. 59 8ommon shareholders usually have preemptive rights, which means theyhave the right to purchase any new issues of stoc" in proportion to theircurrent ownership percentages. -he purpose of a preemptive right is toallow shareholders to maintain their current percentages of ownership.iven that &mith had 4,555,555 shares outstanding /935,555,555 R 970, aninvestor with 45,555 shares has a 3F ownership. Gence, this investor must

be allowed to purchase 6,555 /3F x 655,555 shares0 of the additional shares.

2. 29 A stoc" dividend is a transfer of equity from retained earnings to paid$incapital. -he debit is to retained earnings, and the credits are to commonstoc" and additional paid$in capital. Core shares are outstanding followingthe stoc" dividend, but every shareholder maintains the same percentage ofownership. )n effect, a stoc" dividend divides the pie /the corporation0 intomore pieces, but the pie is still the same si!e. Gence, a corporation will havea lower %(& and a lower carrying amount per share following a stoc"dividend, but every shareholder will be Bust as well off as previously.



chapter 18 outline 7e

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