Common Stock & Split Stock Lecture 10/27/2025

Accounting for Common Stock

• Equipment Transactions

  • Equipment is recorded by debiting the equipment account and crediting the common stock account.

  • Sometimes, services are provided in lieu of cash, for example, a lawyer may set up your corporation in exchange for company shares.

  • In such scenarios, the corporation might not yet be operational, representing a risk for the lawyer involved.

Preferred Stock

• Overview

  • Preferred stock is a class of stock that has specific contractual provisions giving it a preference over common stock.

  • Key attributes include:

  • Preference in dividend payments

  • Preference in liquidation events

• Dividend Preferences

  • Preferred stockholders receive dividends before common stockholders.

  • The board of directors must declare dividends.

  • Example:

  • A credit union informs its members that dividends will be distributed based on ownership.

• Additional Characteristics

  • Preferred stock may have terms that include:

  • Receiving missed dividends in arrears if previous years' dividends were not paid.

  • In a liquidation situation, preferred stockholders are repaid first, before common shareholders.

• Voting Rights

  • Common stockholders typically have voting rights proportional to their shares, while preferred stockholders generally do not have such rights.

Treasury Stock

• Definition

  • Treasury stock refers to a corporation's own shares that have been reacquired from shareholders but not retired.

• Reasons for Repurchasing Treasury Stock

  • Corporations may buy back their shares to:

  • Reissue them for stock compensation plans

  • Increase trading activity by reducing shares available on the market

  • Utilize the stock as currency for mergers or acquisitions

• Impact on Financial Ratios

  • The earnings per share (EPS) ratio can increase with fewer shares outstanding, potentially indicating increased profitability.

• Example of a Leveraged Buyout

  • An investor offers $150 per share for a company when the shares are trading at $100, incentivizing shareholders to sell their stock.

Dividends

• Cash Dividends

  • Declaring a cash dividend creates a liability until the payment is made.

  • Example Scenario:

    • Declare a cash dividend of $1 per share with 7,000 shares outstanding results in a $7,000 liability on declaration.

    • When paid, cash decreases, and the liability is eliminated.

• Stock Dividends

  • Stock dividends are distributions of additional shares to existing shareholders and do not decrease total assets or stockholders' equity.

  • They do not materially change ownership percentage or company value but can be perceived positively.

• Assessing Dividends

  • Dividends can be declared in either cash or stock.

  • The effects of declaring and distributing cash and stock dividends differ in that cash dividends increase liabilities while stock dividends do not.

Stock Splits

• Definition

  • A stock split is the issuance of additional shares to stockholders according to their percentage of ownership.

  • It aims to lower the market price per share, increasing marketability.

• Example Scenario

  • Holding shares at $10 each, a 2-for-1 stock split results in two shares at $5 each, thus improving trading activity.

Summary of Accounting Entries for Dividends

• Cash Dividends:

  • Increase liability upon declaration.

  • Decrease cash upon payment.

• Stock Dividends:

  • No changes to total equity.

  • Just reallocates amounts within equity on the balance sheet without altering total ownership percentages.

• Stock Splits:

  • No change in equity, only reallocation.

  • Does not affect the overall value of investments for shareholders.

Homework Exercise Reference

• Examples were provided for practice exercises in declaring and paying dividends, both cash and stock, demonstrating their impacts on liabilities and equity on the balance sheet.