Study Notes on Stockholders' Equity
Learning Objective 11.1: Role of Stock in Financing a Corporation
Corporate Ownership
The primary advantage of corporate structure:
Facilitates capital-raising from both large and small investors
A corporation is a separate legal entity and can:
Own assets.
Incur liabilities.
Expand and contract in size.
Sue and be sued.
Enter into contracts.
Stockholder Benefits
Stockholder Benefits
Voting Rights: Stockholders have the right to vote on corporate matters.
Dividends: Payment of profits to shareholders.
Residual Claim: Rights to company assets after other claims are paid.
Preemptive Rights: Rights to maintain ownership percentage by purchasing additional shares before new shares are issued.
Equity Versus Debt Financing
Advantages of Equity Financing:
No obligation to repay principal.
Dividends are optional and not legally required, giving more flexibility.
Advantages of Debt Financing:
Interest on debt is tax-deductible, reducing taxable income.
Does not dilute ownership or control of the company.
Learning Objective 11.2: Common Stock Transactions
Stockholders' Equity
Composed of:
Contributed Capital
Preferences: Preferred stock (e.g., 2.5%, $1 par)
Common Stock: Basic voting rights (e.g., $0.01 par value).
Outstanding shares: Shares owned by stockholders.
Treasury shares: Reacquired by the corporation.
Authorization, Issuance, and Repurchase of Stock
Authorized Shares: Maximum number of shares a corporation can issue, e.g. 200 million.
Issued Shares: Shares that have been distributed, e.g., 101.7 million.
Treasury Shares: Shares reacquired by the corporation, e.g., 8.4 million shares.
Par Value and Market Price
Par Value:
A nominal value assigned to each share of stock, e.g., $0.01.
No-Par Value Stock: Some states allow stock issuance without par value.
Stock Issuance
Initial Public Offering (IPO): First-time stock issuance to the public.
Subsequent Issue: New stock issues after IPO.
Typical transactions are cash transactions.
Example: National Beverage issued 100,000 shares at $20 each.
Accounting Entry:
Cash: +$2,000,000
Common Stock: +$1,000
Additional Paid-In Capital: +$1,999,000
Stock Exchange Between Investors
Purchases between two investors have no effect on corporate accounting records.
Employee Compensation with Stock Options
Employee salaries may include options to buy stock in the future at pre-determined prices.
Implication: If corporate goals are met, employees can benefit from selling stocks at a profit.
Repurchase of Stock
Corporations repurchase stock to:
Signal confidence in the company’s future.
Reissue shares for acquisitions.
Provide shares for employee compensation plans.
Reduce outstanding shares and increase per-share metrics (EPS, stock value).
Accounting for Repurchased Shares: Treasury stock recorded at cost.
Example: National Beverage repurchased 50,000 shares at $25 each.
Cash: -$1,250,000.
Treasury Stock: -$1,250,000.
Reissuance of Treasury Stock
When reissuing, if shares are sold at a price higher or lower than the purchase price, the entries vary.
Example 1: Reissuing shares at $28 previously acquired at $25.
Cash: +$140,000
Treasury Stock: -$125,000
Additional Paid-In Capital: +$15,000
Example 2: Selling shares at $23.
Cash: +$115,000
Treasury Stock: -$125,000
Additional Paid-In Capital: -$10,000.
Learning Objective 11.3: Cash Dividends and Stock Transactions
Cash Dividends on Common Stock:
Declared by the board, creating a liability upon declaration.
Requires sufficient retained earnings and cash.
Dividend Dates:
Declaration Date
Date of Record
Date of Payment
Dividend Example
National Beverage declared a cash dividend of $280 million:
Analyze: Dividends Payable +$280 million
Record: Dividends: -$280 million
Stock Dividends
Corporations may issue stock dividends to:
Lower stock price per share.
Show commitment while conserving cash.
Indicate expected future earnings.
Stock Splits
Stock splits increase the number of shares while decreasing par value with no effect on total equity.
Example: 1,000,000 at $0.01 par before a 2-for-1 split results in 2,000,000 at $0.005 par, with total equity unchanged.
Learning Objective 11.4: Preferred Stock Transactions
Preferred Stock Issuance: National Beverage issued 400,000 shares of $1 par value for $19.7 million.
Analyze: Cash +$19,704,000; Preferred Stock +$400,000; Additional Paid-In Capital +$19,304,000
Preferred Stock Redemption: Redeemed 120,000 shares for $6,000,000.
Analyze: Cash -$6,000,000; Preferred Stock -$120,000; Additional Paid-In Capital -$5,880,000.
Preferred Dividends: Must be paid before common stock dividends.
Current Preference: Preferred dividends must be current.
Cumulative Preference: Missed payments accumulate and must be addressed prior to common dividends.
Retained Earnings
Cumulative representation of net income minus net losses and dividends declared over time.
Learning Objective 11.5: EPS, ROE, and P/E Ratios
Earnings Per Share (EPS): Key financial ratio measuring profit allocated per share of common stock.
Return on Equity (ROE): Measures profitability for each dollar invested by common stockholders.
Price/Earnings (P/E) Ratio: Indicator of market valuation based on earnings per share.
Earnings Analysis Table
Analysis provides detailed EPS, P/E, and ROE ratios for specific years against competitor benchmarks.
Recording Stock Dividends
Large Stock Dividends: Example involves a $76,000 adjustment moving from retained earnings to common stock.
Small Stock Dividends: Adjustments based on market price, accounting for market value rather than par value.
Exercises**
Exercises analyze common stock issuance, dividends, and stockholder equity calculations with detailed journal entries to enforce learning of concepts.
Record Keeping for Sole Proprietorships and Partnerships
Sole Proprietorship: Uses capital accounts for owner investments and withdrawals.
Partnerships: Separate capital and drawings accounts maintained for each partner.
Limited Liability Entities: Different business forms ensure protection against debts while maintaining operational flexibility.