Accounting For Stocks

Learning unit 90

Stockholders’ Equity

The balance sheet equation takes you back to the beginning of when you studied Financial Accounting.

In days gone by, it was written as what you have = what you owe + what you own. More recently, it is

written as Assets = Liabilities plus Stockholders’ Equity. Assets are what you have, liabilities are what

you owe, and stockholders’ equity is what you own. Rewriting the equation, you get Assets minus

liabilities equals stockholders’ equity.

In previous chapters, you studied in detail about assets and Liabilities. This chapter is a detailed study of

the elements of stockholders’ equity.

The word equity means ownership, so stockholders’ equity represents the part of what you have that

belongs to the owners.

Stockholders’ equity arises primarily from two sources. 1. Paid in capital and 2. Retained Earnings. Paid

in capital represents amounts invested by the shareholders. Retained Earnings represents accumulated

net income not paid out in dividends.

However, in some cases, a corporation may report two additional classifications of stockholders’ equity.

This would include Treasury stock and accumulated Other Comprehensive income. Treasury stock

represents stock purchased by the issuing corporation. Accumulated other comprehensive income

represents items not included in the calculation of net income.

PAID-IN CAPITAL: Investments by shareholders when they buy shares of stock; may result when a

company buys back some of their shares; from share-based compensation activities.

RETAINED EARNINGS: When a company generates net income, they have two choices. They can give it

to stockholders in dividends or they can keep it. The part of net income that is kept (retained) goes into

Retained Earnings.

TREASURY STOCK: This may seem a bit odd at first, but this is a situation where shares of stock

previously sold to stockholders is bought back by the issuing corporation.

ACCUMULATED OTHER COMPREHENSIVE INCOME: Four types of gains and losses not included in the

income statement. 1. Net holding gains or losses on available for sale investment in debt securities; 2.

Gains or losses from amendments to postretirement benefit plans; 3. Deferred gains and losses from

derivatives; and 4. Adjustments from foreign currency translations. The focus is on all changes in equity

other than those from transactions with stockholders.

The statement of comprehensive income starts with net income adjusts for the four types of gains and

losses not included in the income statement (noted above) and ends with comprehensive income. May

be reported as an expanded version of the income statement or a separate statement following the

income statement. The accumulated other comprehensive income over the current and past periods is

reported on the balance sheet.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

LEARNING UNIT 91

THE CORPORATE FORM OF BUSINESS

If you decided to start your own business, you have three ways to organize your company. Your choices

are a sole proprietorship, a partnership, or a corporation. In a sole proprietorship, you and you alone

bear all the risk and reward. A partnership is where two or more individuals combine their talents and

share the risk and reward.

A corporation is a business entity separate and distinct from the owners of the business. Many people

organize as a corporation because of what is termed LIMITED LIABILITY. Limited liability means the

owners are not personally liable for debts of the corporation and the stockholders liability is limited to

the amounts they invest into the company.

Another advantage of the corporate form of business is the ease of raising capital. Corporations sell

stock in the company, get the cash from the sale, and ownership rights are easily transferred.

However, the corporate form of business is not without some disadvantages. State and federal

government agencies impose rather extensive reporting requirements. The paper trail is required to

provide for adequate disclosure of information investors and creditors want. Another disadvantage is

called DOUBLE TAXATION. Double taxation happens when a corporation pays tax on the earnings of the

company and then the earnings of a company are distributed as dividends to individual shareholders

and since the dividends to the shareholders are taxable, the income is taxes twice: once as net income

for the corporation and again as a dividend to the shareholder getting the dividend.

If you choose to start your business as a corporation, you must decide on the type of corporation you

want to have. The type of corporation you will ultimately choose depends on the nature of your

business.

If you are going into business to make money, you would sell your stock, record the stock transactions,

and then pay taxes on your net income. However, some corporations do not sell stock and are not

organized for profit. These are called Not-for-profit corporations. ASU is a good example of a not-for-

profit corporation. Churches and charities are also examples of not-for-profit corporations.

Publicly held corporations have stock available for purchase by the general public. Privately held

corporations have stock owned by only a few individuals and are not available to the general public.

S-Corporation. The S is for small. This is a corporation with only a few owners that has the advantages

of the corporate form of business but where the income flows thru to the owners and thus avoids

double taxation.

Limited Liability Company (LLC). Owners are not liable for debts of the business except to the extent of

their own investment; all can participate in managing company without losing liability protection; no

double taxation; no limit on the number of owners. Limited Liability Partnership (LLP). Similar to a LLC

except it doesn’t offer all the liability protection available in the LLC. Partners are liable for their own

actions but not entirely liable for the actions of other partners.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 92

Common and Preferred shares of stock.

A corporation raises money by selling stock in the company. A share of stock is a piece of paper

representing some level of ownership in the issuing company. If a company has only one class of stock,

the stock is called common stock.

Rights of Common stockholders. If you buy the common stock of a corporation, you have some

fundamental rights that go with the shares. These rights include: The right to vote for the board of

directors and other matters that may come before the shareholders; the right to share in profits when

dividends are declared; the right to share in the distribution of assets if the company goes belly up; and

the Preemptive right. The preemptive right gives each stockholder the right to maintain their share of

ownership when new shares are issued.

If a company has more than one class of stock, in addition to common stock, they may have what is

called Preferred stock. Preferred stock typically carries a stated return, such as 8% preferred stock.

Though the 8% appears to be an interest rate, when part of preferred stock, this rate has nothing to do

with interest but rather represents a dividend payout rate. The rate applies to the par value of the

preferred stock.

Typically, the rights of preferred shareholders include the right to receive dividends before any

dividends are paid to common shareholders and/or the right to have a preference over common

stockholders in the distribution of assets if the corporation goes bankrupt.

In addition, Preferred stockholders may have the Right of Conversion. The Right of conversion allows

preferred shareholders to exchange shares of preferred stock for common stock at a specified ratio.

Preferred Shareholders may also have the right of redemption privilege. Under certain conditions, this

right allows the preferred shareholders to return their shares for a predetermined redemption price.

Cumulative Preferred stock: Dividends in arrears accumulate and must be paid in later years before

common gets anything.

Non-Cumulative Preferred stock: Dividends in arrears DO NOT accumulate for payment in future years.

Participating Preferred stock: Allows Preferred stockholders to get dividends in excess of the stated rate

or amount.

Non-participating preferred stock: Preferred shareholders will not get an amount in excess of the stated

rate.

Preferred stock is reported on the balance sheet as part of stockholder’s equity because dividends on

preferred stock are not considered a liability.

However, if the shares are noted as mandatorily redeemable preferred shares, the shares must be

reported on the balance sheet as a liability.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 93

How to account for the issuance of stock

When stock is sold, the corporation will receive cash or other assets and the investor will get some

shares of stock. Stock may be Par-value stock or No Par value stock. Par value is an arbitrary amount

set for the stock and has nothing to do with the market value of the stock. When selling par value stock,

credit the stock at par (this credit to stock at par is called the stated value) and credit Paid-in-capital in

excess of par for the difference between the cash received and the par value.

When shares are issued for a non-cash consideration (perhaps some land), the stock goes on the books

at the grant-date fair value of what was given (the stock). This is because a quoted market price is the

best evidence of the fair value of the transaction.

When more than one type security is issued for a single price, the cash received is usually the sum of the

separate market values of the two securities. However, if only one security’s value is known, record the

transaction at the value of the stock price known and balance the transaction with the second security.

Share issue costs, such as legal, promotional, and accounting services necessary for the sale, are not

recorded as a separate item. Share issue costs reduce the net proceeds from selling the shares. Since

the net proceeds are reduced by the share issue costs, the paid-in-capital in excess will also be reduced

by enough to balance the transaction.

Consider

The stockholder’s equity section of the balance sheet for ABC on December 21, 2019 is

STOCKHOLDERS EQUITY

Paid in Capital:

Common stock (120 million shares at $1 par value) $120 million

Paid in capital in excess of par $836 million

Retained Earnings $2449 million

Total Stockholders’ Equity $3.405 million

2020 Transactions

March 11: issued 10 million of its 9.2% preferred shares, $1 par, for $44 per share.

November 22, issued 1 million common shares, $1 par per share, for eight machines. ABC common

stock was listed at $10 per share on that day.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

On November 23, 1 million common shares and 1 million preferred shares sold for $60 million dollars.

The preferred stock has not traded since March and the market value is uncertain.

Prepare the journal entries for the above transactions.

On March 11

Cash 440

Preferred stock 10

Paid-in capital in excess of par, preferred 430

Machinery (at fair value of shares) 10

Common stock (at par) 1

Paid in capital in excess of par, common (to balance) 9

Cash 60

Common stock (1 million shares at $1 par each) 1

Paid-in Capital in excess of par, common (to balance) 9

Preferred stock (at par) 1

Paid-in capital in excess of par—preferred (to balance) 49

On transaction three, since only the market value of the common is known, record common at the going

rate and balance the transaction by recording the 1 million preferred shares.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 94

Accounting for share repurchases

When companies sell stock, they give up some ownership in the company and get some cash.

Sometimes a company will go into the marketplace and buy back some of their own shares. They pay

out the cash and get back the shares of stock.

A stock repurchase is viewed as a way to distribute company profits without paying a dividend; a way to

decrease the supply of shares in the market and support the price of those shares remaining available in

the marketplace; a way to buy shares in their own company that does not create an asset; and a way to

offset the increase in shares issued in compensation plans.

Three reasons to buy back your own stock: distribute a stock dividend; part of a proposed merger; a

defense against a hostile takeover. Two ways to account for the stock repurchase: Retire the shares or

hold the shares as Treasury Stock.

CONSIDER THE FOLLOWING STOCKHOLDERS EQUITY IN MILLIONS

COMMON STOCK, 100 MILLION SHARES AT $1 PAR 100

PAID IN CAPITAL IN EXCESS OF PAR 900

PAID IN CAPITAL- SHARE REPURCHASE 2

RETAINED EARNINGS 2,000

TRANSACTION: BOUGHT BACK 1 MILLION SHARES at $7 per share.

The Treasury stock method is the EASY method. Debit treasury stock for 7 and credit cash for 7.

The retirement method is a bit more complex: debit common stock for 1, debit paid in capital for 9,

credit cash for 7 and balance the transaction with a credit to paid in capital share repurchase for 3

TRANSACTION: BOUGHT BACK 1 MILLION SHARES AT $13 PER SHARE

The Treasury stock method is still the easy one. Debit Treasury stock for 13 and credit cash for 13

The retirement method: debit common stock for 1, debit paid in capital in excess of par for 9, and debit

paid in capital-share repurchase for 2 (to zero out the account); the credit for cash of 13 and balance the

transaction with a debit to retained earnings for 1

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 95

Accounting for Treasury Stock and stock retirement resale

Additional examples related to share repurchases

Treasury stock: Outstanding stock reacquired by the issuing Corporation. Does not create an asset but

rather is viewed as a temporary reduction of stockholder’s equity. Treasury shares are part of issued

shares but not part of outstanding shares. The purchase and later resale is considered a single

transaction. This single transaction approach is call the cost method.

If the shares are retired and later taken from retirement and resold, the transaction is recorded exactly

like any sale of shares. Resale of stock held as Treasury shares is viewed as the end of the single

transaction started when the shares were purchased as Treasury shares. When Treasury shares are sold

the cost of the Treasury shares must be allocated.

COMMON STOCK, 100 MILLION SHARES AT $1 PAR 100

PAID IN CAPITAL IN EXCESS OF PAR 900

PAID IN CAPITAL- SHARE REPURCHASE 2

RETAINED EARNINGS 2,000

TRANSACTION: American bought 1 million of their own $1 par shares at $13 per share. Later they sold

the shares for $14 per share.

Treasury stock method: debit cash for 14, credit treasury stock for 13 (to reduce balance to zero), and

credit paid-in capital—share repurchase for 1

Retirement method: debit cash for 14, credit stock at par for 1, credit paid in capital in excess of par for

However, if the shares sold at $10 per share:

Under the treasury stock method: debit cash for 10, credit Treasury stock for 13 (to reduce balance to

zero), debit paid in capital –share repurchase for 2 (to reduce balance to zero) and debit retained

earnings for 1 to balance the transaction.

Retirement method: debit cash for $10, credit common stock (at par) 1, and credit paid in capital in

excess of par for 9.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 96

Accounting for Retained Earnings and dividends.

Retained Earnings represents accumulated net income not paid out in dividends. When a company has

net income, they can keep it or distribute it as dividends. If they keep it, it goes into the account called

Retained Earnings. The normal balance is a credit balance.

A net loss reduces retained earnings. A debit balance in Retained earnings is called a deficit.

A company might have 1 million in cash and 5 dollars in retained earnings. And on the other side, a

company may have $5 in cash and 1 million in retained earnings. Retained earnings is not a fund, it is

merely an account showing that portion of accumulated net income not paid out in dividends.

DIVIDEND: A distribution of assets the company has earned.

LIQUIDATING DIVIDEND: This is where the amount of the dividend exceeds the balance in retained

earnings. A liquidating dividend nor representing a distribution of earnings should be debited to

additional-paid in capital.

Restricted Retained earnings represents any portion of retained earnings unavailable for dividends.

Most often noted in the Disclosure notes. Sometimes a company may journalize the transaction as a

debit to Retained Earnings and a credit to Appropriated Retained Earnings.

CASH DIVIDENDS: Where the company distributes cash to the stockholders based on the stockholder’s

level of ownership in the stock for which dividends are being distributed.

Three Events for a cash dividend: DATE OF DECLARATION: Debit retained earnings and Credit a liability;

DATE OF RECORD: The day when the list of the stockholders to receive the cash dividend is prepared;

and DATE OF PAYMENT: Debit the liability and credit cash.

Registered owners must purchase the stock before the Ex-Dividend date, which is usually one business

day before the date of record.

PROPERTY DIVIDEND: This is the distribution of a non-cash asset as a dividend. This is sometimes called

a dividend in kind. A property dividend should be recorded at the fair value of the asset distributed. This

means the asset distributed must be revalued at the time of the distribution and any gain or loss is

recognized for the difference between book value and fair value.

STOCK DIVIDEND: A stock dividend is the distribution of additional shares of stock to the current

stockholders. Has no impact on assets or liabilities. Each shareholders proportional interest in the

company is maintained. It is a way to give stockholders something when a company does not have cash

or other assets to distribute as a dividend. The stock market price will decline in proportion to the

additional shares issued. The total market value will remain the same.

Small stock dividend, less than 25%, use the fair value of the stock to reclassify retained earnings. For

Large stock dividends, use the par value to reclassify retained earnings.

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 97

Dividend Transactions

On June 1, About company declared a cash dividend of $2 per share on its 100 million shares, payable to

shareholders of record June 15, to be paid July 1. Prepare the Journal entry.

June 1: date of declaration: debit retained earnings for 200 million and credit cash dividends payable

for 200 million; June 14, Ex-Dividends date, no entry; June 15, Date of Record, No entry; July 1, date of

payment: debit cash dividends payable for 200 million and credit cash for 200 million.

The stockholder’s equity section of Caleb has the following items shown below. The board declared

dividends of $360,000; $500,000, and $700,000 in the first three years of operations, 2020, 2021, and

20220. Preferred shareholders are entitled to $480,000 of dividends (8% of 6,000,000)

Common stock $3,000,000

Paid in capital in excess of par, common 9,800,000

Preferred stock, 8% 6,000,000

Paid in capital in excess of par, preferred 780,000

How much is paid to Preferred and Common if Preferred is cumulative and non-participating?

In 2020, Preferred gets $360,000 and common gets zero because preferred gets the first $480,000

In 2021, Preferred gets $500,000 (480,000 for this year and 20,000 carried forward from last year) and

common gets zero

In 2022, Preferred gets $580,000 (480,000 for this year, and $100,000 carried forward from 2020) and

common gets the balance of $120,000 (700,000-580,000)

On October 1, the board of craft company declared a property dividend of 2 million shares of Beamon

preferred stock. Beamon preferred stock has a book value of 9 million and a fair value of 10 million. The

property dividend is payable to shareholders of record October 15 to be distributed November 1.

October 1, date of declaration: First, record fair value of asset to be distributed: debit investment in

equity securities and credit gain on investments. Second, record the payable: debit retained earnings

10 and credit property dividends payable 10.

October 15, date of record: no entry

November 1, date of distribution of property dividend: debit property dividends payable and credit

investment in equity securities

Craft company declares and distributes a 10% stock dividend (10 million shares) when the market value

of the $1 par commons stock is $12 per share. Prepare the journal entry to record the stock dividend.

Since the stock dividend is a small stock dividend, the fair value of the stock is used to journalize the

transaction.

The journal entry is: debit retained earnings for 120M (10M shares at ‘$12 per share, credit stock at par

for 10m, and credit paid in capital in excess of par for 110m (the remainder).

Success is a journey, not a destination. It requires constant effort, vigilance, and reevaluation. Mark

Twain. Success in Intermediate II: Study guides, study groups, study time journalized. Terry Dancer

Learning unit 98

Stock Splits

A stock split results in the distribution of additional shares of the company stock and a decline in the per

share market price of the stock. A 2 for 1 stock split means the number of shares outstanding will

double because shareholders will get one new share for each share they currently own.

Wanting to lower the price of your stock may seem counter-intuitive because we think in terms of

companies wanting to increase the price of their stock. But sometimes, companies want to lower the

price of their stock. A classic example is Sam Walton. While Sam was alive, he told his accountants to

split the stock every time the stock got above $50. Splitting the stock when it got above $50 would

lower the price below $25. Sam believed this lower price would give small investors a better

opportunity to buy into Wal-Mart.

A stock dividend of 25% or more can be accounted for in one of two ways: 1. Treat as a large stock

dividend and prepare a journal entry to decrease the paid in capital account and increase the common

stock account or 2) Treat as a stock split in which case no journal entry is needed, but rather the event is

disclosed in the notes to the financial statements.

With a stock split, though no journal entry is needed, in a 2 for 1 split, the par value if reduced by half

and the number of shares is doubled.

Example: Crouch declares and distributes a 2 for 1 stock split effected in the form of a 100% stock

dividend (100 million shares) when the market value of the $1 par common stock is $12 per share.

Prepare any needed journal entry.

Since the stock split is effected in the form of a stock dividend, a journal entry is needed.

Debit retained earnings 100M (recorded at par and not fair value); and credit common stock for 100M. If

the stock split is not effected as a stock dividend, no journal entry is needed but a detailed disclosure

note is needed in the notes to the financial statements.

REVERSE STOCK SPLITS: You may omit from your studies because it will not be on the test

FRACTIONAL SHARES: You may also omit.

QUASI REORGANIZATION: You may also omit.