Shares and Dividends

Outstanding Shares and Market Value

• Issued shares are bought by shareholders, becoming outstanding shares.

• Only outstanding shares are eligible for dividends.

• Market value reflects what buyers and sellers agree upon in the secondary market.

• The focus here is on the original issue of stock by the corporation.

Initial Stock Issuance and Underwriters

• Corporations issue stock initially through underwriters, who ensure proper procedures.

Types of Stock

• Two main types: preferred and common stock, each with distinct rights.

Common Stock

• Holders have the right to residual earnings.

Payment Hierarchy

• Bondholders are paid first, with a contractual right to interest payments.

• Next, preferred stockholders receive a fixed dividend, considered virtually guaranteed and continuing indefinitely.

Preferred Stock vs. Bonds

• Preferred stock differs from bonds because it goes on indefinitely, whereas bonds have a maturity date.

• Both offer fixed payments, but only bonds have a fixed end date.

Common Stock Dividends

• Common stockholders receive what remains after bond and preferred stock payments.

• Common stock dividends are not guaranteed and are considered high risk.

• Boards aim to reward common shareholders for taking on risk.

• Finance instructor's view: the fixed nature of preferred stock makes common stock even more attractive due to potential for high rewards.

Par Value of Stock

• Par value is assigned by the board of directors and is an arbitrary number.

• Par value is intended to protect creditors.

• If stock is issued at par, this amount is locked and unavailable for company use.

Minimum Legal Capital

• Par value represents the minimum legal capital, protecting creditors.

• Creditors could lose more than their investment if the company fails, unlike stockholders.

Stock Issuance

• Stock cannot be issued below par value to preserve minimum legal capital.

• Companies aim to sell stock above par value through underwriters.

• The par value portion is parked in a specific account, while the premium is placed in a separate premium account that can be used more flexibly.

Par Value Significance

• A higher par value provides more protection for creditors.

• Stock can be issued at a nominal par value (e.g., 1p) or no par value, offering minimal or no protection to creditors, respectively.

• Issuing stock at no par requires to label it clearly to ensure truth in lending.

Stockholders' Equity Section

• The stockholders' equity section expands to include various classes of stock.

• Retained earnings, a significant component, accumulates prior years' earnings and decreases when dividends are paid.

Journal Entries for Stock Issuance at Par

• Example: 30,000 shares sold at 10$ par.

• Debit cash for 300,000$, credit common stock at$10$ par for $300,000$. (Rare, but possible)

Stock Issuance at a Premium

• Example: 10$ par stock sold at 12$ a share.

• Debit cash for $360,000$ ($30,000$ shares x $12$).

• Credit common stock at par for $300,000$ ($30,000$ shares x $10$).

• Credit premium on common stock for $60,000$ ($30,000$ shares x $2$).

Stockholders’ Equity Presentation

• The stockholders' equity section includes par value, premium, and retained earnings.

• Premium on stock is also known as paid in capital in excess of par.

Issuing No Par Stock

• It is possible to issue no par stock.

Rule for Stock Issuance

• Separate par from premium by identifying the par value, selling price, and difference between the two.

• Stated value is equivalent to par with legal differences.

Issuing Stock for Non-Cash Assets

• Stock can be issued for non-cash assets like land or services.

• The process is identical: separate par from premium.

Par Value as Minimum Legal Capital

• Par value is an arbitrary number set by the board, establishing minimum legal capital.

Dividends Overview

• Two types of dividends: cash and stock dividends.

Cash Dividends

• Cash dividends are paid on each outstanding share.

• Shareholders can receive cash payments or reinvest the dividends in additional shares.

Important Dates for Cash Dividends

• Three key dates: date of declaration, date of record, and date of payment.

Date of Declaration

• The board declares the dividend.

• A journal entry is made: debit retained earnings for the dividend amount (dividend per share times the number of outstanding shares).

• $Dividend_Amount = Dividend _per _Share \times Number _of _Outstanding _Shares$

Date of Record

• Establishes stock ownership for dividend eligibility.

• Significant trading activity may occur between the declaration and record dates.

Date of Payment

• Checks are cut and mailed to shareholders.

Journal Entry on Date of Record

• No journal entry is required on the date of record.

Stock Dividends

• No cash is paid; instead, additional shares of stock are issued.

• The size of the dividend is expressed as a percentage.

• A stock dividend declared by directors distributes additional shares to stockholders without payment.

Stock Dividends vs. Cash Dividends

• Stock dividends do not reduce assets and equity but transfer equity from retained earnings to contributed capital.

• It is a redistribution within the stockholders' equity section.

• Stockholders receive additional shares, potentially increasing future cash dividends.

Reasons for Stock Dividends

• Keep the market price of the stock affordable by increasing the number of shares, reducing the per-share value.

• Signal management's confidence in the company's future performance.

Accounting for Stock Dividends

• Determine if the dividend is large or small (based on percentage of outstanding shares).

• Small stock dividend: 25% or less of previously outstanding shares.

• Large stock dividend: More than 25%.

• They are valued differently.

Example of Stock Dividends

• Example: 10,000 shares outstanding at 10$ par, 8,000$ premium, 35,000$ retained earnings.

• Total_Equity=100,000+8,000+35,000 = 143,000$</p></li><li><p>Declare a 10$New_Shares = Outstanding _Shares \times Stock _Dividend _Percentage$</p></li><li><p>$10,000 \times 0.10 =1,000$</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Valuation of Stock Dividends</h3><ul><li><p>A small stock dividend is valued at market price on the date of declaration.</p></li><li><p>The journal entry debits retained earnings and credits common stock dividend distributable and premium on common stock.</p></li><li><p>The common stock dividend distributable bucket is created because it has not been distributed yet.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Stock Dividends Example Continued</h3><ul><li><p>The market price of the stock is$15$ a share.

• A small stock dividend is valued at market price on the date of declaration.

• How many new shares do we create? A thousand.

• What value we attach to them? $15$.

• It's gonna be a debit to retained earnings.

• $Retained_Earnings _Decrease = New _Shares \times Market _Price$

• $1,000 \times 15 =15,000$

• The par value of the stock was 10$ a share.

• The stock dividend distributes at par value (10$).</p></li><li><p>$Premium =(Market_Price-Par_Value) \times New Shares$</p></li><li><p>$Premium= ($15-$10) \times1,000 = 5,000$$

Impact on Stockholders' Equity

• Retained earnings decrease by the total amount, redistributing equity within the stockholders' equity section.

• 11,000 shares are outstanding after the dividend.

• A trick question to see if students remember new shares.

Purpose of Stock Dividends

• Corporations do this because it saves cash and rewards existing stockholders.

• Share needs enough money retained earnings

• Increases outstanding shares while maintaining the same pot.

• Potentially increasing market evaluation, although with minor