Slide 1
The learning objective of 5.7 is to introduce stockholders’ equity concepts starting with common definitions followed by an overview of the various types of stock and dividends.
Slide 2
Corporations give much thought to the capital structure of their organization. The first question they have to ask themselves is whether to use equity or debt financing when funding capital projects. The main difference between equity and debt financing is with debt financing the creditor receives the repayment of money loaned in full plus interest and with equity financing the investors financial position is tied to the success or failure of the business.
Slide 3
At the time of incorporation, the number of shares that the company can issue to the public is determined. Essentially the company has been given legal authority by the state in which it is incorporated on how many shares of stock the corporation is “AUTHORIZED” to sell to the public. Authorized stock is JUST the number of shares available to sell by the company. Typically the number of authorized shares is listed below or to the side of the stock on the balance sheet.
Along with the information on authorized shares is the number of issued shares. Issued shares are just what the word means...these are the shares that the company has issued to the public since the inception of the company.
Slide 4
Par and No Par value stocks…first this has nothing to do with golf…and its not some Klingon word conjured up by Gene Roddenberry…with that said…par value is a very old concept that was more widely needed decades ago. The need for par is no longer important which is why some states allow “no par” stocks to be issued. Par is like your appendix, we still have it but it no longer performs its intended function.
Par was implemented to prevent shareholders from robbing the coffers of a failing company and leaving the creditors high and dry. The idea was that shareholders could not send the assets to themselves in the form of dividends beyond the par value of the stock.
Now most par values are currently reported on the balance sheets of many corporations are $0.1 or $0.5 so it may seem ridiculous that a $0.1 par or $0.5 par could prevent the raping of a company of its assets. But think, most of these stocks are old they have been around for decades. Back in 1910 when the stock was issued at a $1 par before all the stock splits the dollar was really a significant amount of money. It really did prevent creditors from being left holding the bag.
Slide 5
Next we will go over the basic types of stocks that are listed on the balance sheet and the statement of stockholders’ equity. We have not visited the statement of stockholders’ equity in this class, just a piece of it the statement of retained earnings. Another thing I want you to keep in mind is that how a stock is set up in the incorporation of a company or the authorization by a state for a company to sell certain types of stock is governed by the legal language set up at that time. That legal language can contain many twists and turns in regards to that particular stock, so while most of types of stock have some commonalities to fully understand the your legal rights as a shareholder of a specific stock in a specific company one must look at the legal language associated with the authorization of that particular stock.
Probably the most typical stock type is “common” or “capital” stock. This stock represents the main ownership of the company. Common stock usually has the following basic rights
§ Right to vote in corporate matters
§ Preemptive right or the right of existing stockholders to purchase additional shares of stock to maintain their percent ownership of the company when shares are issued
§ Right to receive cash dividends
§ Right to ownership of all corporate assets in the case of bankruptcy AFTER the obligations of everyone else have been met
Slide 6
Let us now look at a couple of problems associated with the posting of transactions related to stock issuance.
Here we have Milton-Wilson Issuing 10,000 shares of stock of $1 par stock for $8 per share on March 10th. How to account for this par value stock…
First this is a cash transaction so we debit cash $80,000 and credit common stock for $10,000 or (10,000 shares times $1 par) and then remaining $7 per share is credited to the “additional paid in capital” account. Another account name used as an alternative of “additional paid in capital” is “capital in excess of par”. This account represents the money paid for the stock over par. So, “additional paid in capital” is credited for $70,000. As you can see both sides of the journal entry now balance.
Slide 7
Now, let us journalize the transaction again, but as a no par stock. First we debit cash for $80,000 (same as last slide) and then we credit common stock for $80,000. Yes! It is that easy.
Slide 8
Okay…time to apply what we just learned. Take a couple of minutes and do the problems on this slide and the next slide. The answers are a separate word document (see answer in T5M7issuanceproblem1.doc) available next to the transcript word doc.
Slide 9
More problems (see answer in T5M7issuanceproblem1.doc)
Slide 10
Next we have preferred stock. Now just because we call it preferred doesn’t mean it is preferred stock to a stockholder. Basically preferred stockholders’ receive dividends each year. Because they receive guaranteed dividends, preferred stockholders’ give up their right to vote on corporate issues.
In the case of bankruptcy, after creditors are paid, preferred stockholders receive any of the remaining assets over common stockholders. There are exceptions to the above rules. Once again, you need to review the incorporation papers for the company to understand what rights preferred stockholders have and don’t have. For instance, some preferred stockholders’ have the right to vote in corporate issues if they have not received payment of their dividends in three years.
Slide 11
Like common stock, preferred stock may or may not have par value. In this slide is an example of an issuance of preferred stock with $5 par value. The journal entry to record the stock issuance is similar to the common stock entry.
Slide 12
It is again time to apply what you have learned. So take a couple of minutes and prepare journal entries for these two transactions. The answers will be provided in a separate word doc found in this specific topic (see answer in T5M7issuanceproblem2.doc)
Slide 13
The final stock type we will be discussing is treasury stock. This stock is essentially issued stock that the company repurchased. In other words they sold the stock to the public then at a later date they bought the stock back. There are different reasons for why a company may want to purchase back its stock:
· They don’t want to issue new shares in order to provide company executives with stock options
· They want to reduce the outstanding shares in the market to make the remaining shares look more attractive to investors
· They want to go private. For instance in recent years the cost of complying with Sarbanes Oxley has led to several small companies to buy back all their stock and “go dark”. “Going dark” means they no longer trade their shares on the stock exchanges or they don’t trade publicly.
Slide 14
The treasury stock account is a contra stockholders’ equity account. In other words it reduces or offsets the other stockholders’ equity accounts. On the balance sheet it is a negative number just like the contra asset accounts accumulated depreciation and allowance for bad debt. In this slide and the next two slides are examples of treasury stock transactions. Notice that treasury stock is debited. This is “contrary” to increasing normal stockholders’ equity accounts.
Slide 15
Like I mentioned in the earlier slide this is another example of a treasury stock transaction
Slide 16
This is an example of a treasury stock with par value.
Slide 17
Dividends are payments by the company to the shareholder or owner of the stock. Dividends are reported either in the Statement of Retained Earnings or the Statement of Stockholders’ Equity. Not every company declares and pays dividends. Companies are not required by law to payout dividends. This is okay with investors who make their money by buying and selling stocks, not earning dividends.
Slide 18
There are three major dates in the life of a dividend. First the board of directors declares a dividend. Then there is the date of record which is means that those who own shares on this specific date will earn the dividend. And finally there is the payment date. That is the date the company sends the “dividend” check to the stockholders.
Slide 19
Okay, it is time to apply what we learned. How would you journalize the following dividend transactions? Take a stab at it and then move onto the next slide for the answer.
Slide 20
Notice that two of the three dates require a journal entry. The middle date…the date of record…does not require a journal entry. With that in mind let us talk about the date of declaration.
On the date of declaration the board declares a dividend and thus the company incurs a liability to its owners. So…the company must journalize this new liability by debiting Dividends which is a reduction of retained earnings and crediting Dividends Payable to recognize the company liability to the shareholders.
On the date of payment, the company simply makes a cash payment to shareholders effectively reducing its debt or liability.
Slide 21
Not all dividends are “cash” dividends sometimes a company issues a stock dividend where shareholders get additional stock based upon their current level of ownership. For example, let us say a company declared a stock dividend of 1 share for every 4 shares someone owns. We call this a “pro rata” distribution. This dividend distribution results in a decrease in retained earnings and an increase in additional paid in capital. When all is said and done total stockholders’ equity remains the same when stock dividends are declared and paid.
Slide 22
So…why would a company issue stock dividends? Well, it is one way to give your owners a dividend without impacting cash, or it could formally emphasize that a portion of the stockholders’ equity has been permanently reinvested. See the next slide for an example of how to journalize a stock dividend.
Slide 23
In this slide we see how a 10% stock dividend is calculated and journalized. First, 10% of the 10,000 outstanding shares are 1,000 new additional shares. The stock has an $8 par thus common stock is $8,000 and additional paid in capital is $4,000. As you can see the change has no net effect on the stockholders’ equity section of the balance sheet.