Shareholders' Equity - Lecture Notes

Shareholders' Equity

Mini Case 3

• Mini Case 3 Quiz due Tuesday, May 6 at 10 PM.
• The quiz is based on case materials.
• There are five multiple-choice questions.
• The quiz duration is 20 minutes, and only one attempt is allowed.
• Referring to the case materials while answering questions is permitted.

Mid-term Exam #3

• Mid-term exam #3 is on May 13 (Tuesday).
• The exam duration is 75 minutes.
• It is a closed book and closed notes exam.
• The exam covers topics from Session 17 (working capital analysis) to Session 28 (Introduction to FSA).
• There will be 5 long questions: Working capital analysis, PP&E, Intangibles, Investments (MS), and SE.
• Miscellaneous short questions may cover any topic from sessions 17 to 28.
• Practice questions will be posted on Canvas later this week.
• Submit ADS requests ASAP.
• All make-up exams must be completed by May 16.
• There is no final exam.

Sources of Financing

• A company finances its assets from three sources:
  1. Borrowing funds from creditors.
  2. Obtaining funds from shareholders.
  3. Reinvesting profits.
• Shareholders’ Equity (SE)

Pfizer’s Balance Sheet: SE

• Shareholders' Equity consists of:

  1. Contributed capital
  2. Earned capital

• Contributed capital: Reports the proceeds from the original stock issuances.

• Earned capital: Consists of retained earnings (RE) and accumulated other comprehensive income (AOCI).

Contributed Capital

• Common stock
  • Represents the most common class of stock in a corporation.
  • Typically comes with voting rights.
  • Can have different classes (e.g., Class A vs. Class B) with varying voting rights.
• Preferred stock
  • Has liquidation and dividend preference relative to common stock.
  • A hybrid between common stock and bonds.
  • Usually without voting power.
• Companies must issue common stock and may issue preferred stock.
• Less: Treasury stock (a contra-SE account)
  • Occurs when a company repurchases its shares and holds them.

Par Value

• Par value is an arbitrary amount set by company organizers at the time of formation.
• It has little economic meaning.
• It specifies the allocation of proceeds from stock issuances between par value (common stock) and additional paid-in capital.

Additional Paid-in Capital

• Additional Paid-in Capital (APIC) is paid-in capital in excess of par.
• It reflects the difference between the amount provided by shareholders and the par value of the issued shares.

Exercise: Par Value and APIC

• Davis Company issues 10,000 shares of $1 par value common stock at a market price of $43 cash per share.

• Total cash proceeds = 43 \times 10,000 = $430k

• Total par value (recorded as common stock) = 1 \times 10,000 = $10k

• Additional paid-in capital = Total cash proceeds – common stock = 430k - $10k = $420k

• Journal Entry

  • Cash (+A) 430,000
  • Common Stock (+SE) 10,000
  • Additional Paid-in Capital (+SE) 420,000

Accounting for Contributed Capital

• Contributed capital is accounted for at historical cost.
• Fluctuations in the stock price after IPO do not directly affect the financial statements of the issuing company.
• There is never any gain or loss reported on the purchase and sale of the company’s own stock or the payment of dividends.
  • Increase or decrease in the contributed capital

Pfizer’s Balance Sheet: Common Stock Example

• Par value per share: $0.05
• Number of shares issued: 9,562 million
• Common stock: 0.05 \times 9,562m = $478m
• Common stock + Additional paid-in capital = Total proceeds from stock issuance
• 478m + $92,613m = $93,091m

Pfizer's Consolidated Balance Sheets Example

• Preferred stock: no par value, at stated value; 27 shares authorized; no shares issued or outstanding as of December 31, 2023, and December 31, 2022.
• Common stock: $0.05 par value; 12,000 shares authorized; issued: 2023—9,562; 2022-9,519
• Treasury stock, shares at cost: 2023-3,916; 2022-3,903

Number of Shares

• Shares authorized
  • The maximum number of shares that the corporation can issue.
  • This number is established in the articles of incorporation.
• Shares issued
  • Actual number of shares that have been sold to shareholders.
• Shares outstanding
  • The number of shares issued less the number of shares repurchased as treasury stock.

Shares : Authorized \geq Shares : Issued \geq Shares : Outstanding
Shares : Issued = Treasury : Shares + Shares : Outstanding

Example 1: Pfizer’s SE

• Dec 31, 2023
  • Shares Authorized: 12,000
  • Shares Issued: 9,562
  • Shares Unissued: 2,438 (12,000-9,562)
  • Treasury Shares: 3,916
  • Shares Outstanding: 5,646 (9,562-3,916)

Example 2: Apple’s SE

• Questions
  • Does Apple have any preferred stocks?
  • Does Apple have any treasury stocks?
  • What is the number of shares authorized, issued, and outstanding for common stock?

Apple’s SE

• For Apple: # of shares issued = # of shares outstanding => No treasury stock!

Apple’s SE Data (Sept 28, 2024)

• Shares Authorized: 50.4m
• Shares Issued: 15,116,786
• Shares Outstanding: 15,116,786
• Treasury Shares: 0
• Shares Unissued: 35,283,214

Apple’s SE Data (Sept 30, 2023)

• Shares Authorized: 50.4m
• Shares Issued: 15,550,061
• Shares Outstanding: 15,550,061
• Treasury Shares: 0
• Shares Unissued: 34,849,939

Apple’s Footnote 10: Shareholders’ Equity

• Stock Repurchases (Stock Buybacks):
  • Buy back their own common stock
    • Retire the shares, or
    • Keep them as treasury stocks: contra-SE account

Accounting for Stock Repurchases

• When a company purchases its own shares, it reduces equity and assets (cash).
  • Retire the shares
  • Keep them as treasury stocks: contra-SE account (XSE).

Treasury : Stock : (+XSE, -SE)

Accounting for Stock Repurchases

• Retire the shares:
  • Common stock (-SE) XX
  • Cash (-A) XX
• Keep them as treasury stocks: contra-SE account (XSE)
  • Treasury stock (+XSE,-SE) XX
  • Cash (-A) XX

Exercise: Stock Repurchase

• Assume that 3,000 common shares of Davis Company stock previously issued for $43 are later repurchased for $40.
• Journal Entry for treasury stock:
  • Treasury stock (+XSE, -SE) 120,000
  • Cash (-A) 120,000
• Journal Entry for retired stock:
  • Common stock (-SE) 120,000
  • Cash (-A) 120,000