Transcript Financial Accounting and Accounting Standards

Chapter 8
Stockholders’ Equity
1.
2.
3.
4.
5.
6.
7.
8.
Account for the issuance of capital stock.
Describe a compensatory stock option plan.
Account for share appreciation rights.
Describe the characteristics of preferred stock.
Know the components of contributed capital.
Understand the accounting for treasury stock.
Recognize compensation expense for a
compensatory stock option plan using the fair value
method. Account for a fixed compensatory stock
option plan.
Account for a performance-based compensatory
stock option plan.
Owners’or Stockholders’Equity



Represents the owners’ residual interest in total
assets after liabilities are recognized.
Difference between the assets and the liabilities of
a company.
Is sometimes referred to as net assets.
Formation of a Corporation

State laws dictate the incorporation process.

Articles of incorporation are filed with the state.
-- Specify the purpose of the business, its location,
classes and number of shares of capital stock
authorized, etc.

The state issues a corporate charter.

A board of directors is selected.
Classifications of Corporations

Public corporations
-- Government-owned: FDIC, TVA

Private corporations
-- Nonstock corporations
 Nonprofit organizations that do not issue stock:
churches, colleges, charities
-- Stock corporations
 Closed corporations: few stockholders
 Open corporations: publicly traded
Characteristics of Capital Stock
Ownership of common stock usually entitles the
holder to the . . .
◦ Right to vote.
◦ Right to participate in earnings through declared
dividends.
◦ Right to participate in distribution of assets at
liquidation.
◦ Right to retain percentage of ownership in the
corporation when new shares are issued
(preemptive right).
Concepts and Definitions




Corporations are a separate legal
entity.
Issues of stock are recorded in
conformity with the cost principle.
Sales and repurchases of shares do
not affect periodic net income.
Stockholders’equity is separated
from debt of the entity.
Concepts and Definitions

Categories of equity
-- Contributed capital (Paid-in capital)
 Capital Stock: Preferred and Common
 Additional paid-in capital
-- Retained earnings
 Unappropriated and appropriated
-- Unrealized capital
 Increases or decreases in equity that do
not result from stock transactions or from the
retention of retained earnings.
Concepts and Definitions
Classification of capital stock
◦ Authorized
◦ Issued
◦ Unissued
◦ Treasury stock
◦ Outstanding
◦ Subscribed
Authorized, Issued, and Outstanding Capital
Stock
Authorized
Shares
The maximum number
of shares of capital
stock that can be sold
to the public is called
the authorized number
of shares.
Authorized, Issued, and Outstanding Capital
Stock
Authorized
Shares
Issued
shares are
authorized
shares of
stock that
have been
sold.
Unissued
shares are
authorized
shares of
stock that
have never
been sold.
Authorized, Issued, and Outstanding Capital
Stock
Outstanding shares are
issued shares that are owned
by stockholders.
Authorized
Shares
Issued
Shares
Outstanding
Shares
Treasury
Shares
Unissued
Shares
Treasury shares are
issued shares that have
been reacquired by the
corporation.
Corporations

Advantages
-- Limited liability
-- Capital accumulation
-- Ease of ownership transfer

Disadvantages
-- Increased taxation
-- Difficulties of control
-- Regulation
Features of Equity Securities

Par value stock
-- Designated dollar amount per share stated in the
corporate charter.
-- No relationship to market value.

Nopar stock
-- Dollar amount per share not designated in
corporate charter.
-- Corporations can assign a stated value per share
(treated as if par value).
Features of Equity Securities
Legal capital is . . .
-- That portion of stockholders’equity that must be
contributed to the firm at the issuance of stock.
-- The amount of capital, required by state law, that
must remain invested in the business.
-- Refers to par value, stated value, or full amount
paid for nopar stock.
Features of Equity Securities
Common stock . . .
-- Is the basic voting stock of the corporation.
-- Ranks after preferred stock for dividend and
liquidation distribution.
-- Has dividend rates determined by the board of
directors based on the corporation’s profitability.
Features of Equity Securities
Preferred stock . . .
-- Has dividend and liquidation preference over
common stock.
-- Generally does not have voting rights.
-- Usually has a par or stated value.
-- May be convertible, callable, and/or redeemable.
Features of Equity Securities
Preferred stock dividends . . .
-- Are usually stated as a percentage of the par or
stated value.
-- May be cumulative or noncumulative.
-- May be partially participating, fully
participating, or nonparticipating.
Preferred Stock
Cumulative Dividends


Provides that dividends not declared in previous
years accumulate and must be paid in full when
dividends are declared in later years before
dividends can be paid on common stock.
Dividends in arrears are not liabilities until declared.
However, the per share and aggregate amounts
must be disclosed.
Preferred Stock
Example
Kites, Inc. has the following stock outstanding:
Common, $1 par value, 100,000 shares
Preferred, 3%, $100 par value, cumulative, 5,000 shares
Preferred, 6%, $50 par value, noncumulative, 3,000 shares
Dividends were paid every year except for the prior
year. In the current year the board of directors
declares dividends of $50,000.
How much in dividends does each class of stock
receive?
Preferred Stock
Example
Preferred stock (cumulative)
Arrearage ($100 par ×3% ×5,000 shares)
Current Yr.($100 par ×3% ×5,000 shares)
$ 15,000
15,000
$30,000
Preferred Stock
Example
Preferred stock (cumulative)
Arrearage ($100 par ×3% ×5,000 shares)
Current Yr.($100 par ×3% ×5,000 shares)
Preferred stock (noncumulative)
Current Yr.($50 par ×6% ×3,000 shares)
$ 15,000
15,000
$30,000
9,000
Preferred Stock
Example
Preferred stock (cumulative)
Arrearage ($100 par ×3% ×5,000 shares)
Current Yr.($100 par ×3% ×5,000 shares)
$ 15,000
15,000
Preferred stock (noncumulative)
Current Yr.($50 par ×6% ×3,000 shares)
Common stock
Current Yr.($50,000 dividend - $39,000 to preferred)
Total dividend declared
$30,000
9,000
11,000
$50,000
Preferred Stock
Participating Preferences

Nonparticipating
Limits the yearly dividends to the specified rate plus
any arrearage for cumulative stock.

Partially participating
Allows dividends above the specified rate on a pro
rata basis with common stock up to a limit specified
in the corporate charter.
Preferred Stock
Participating Preferences

Fully participating
Allows dividends above the specified rate on a pro
rata basis with common stock without any limits.
Preferred Stock
Example
Kites, Inc. has the following stock outstanding:
Common, $1 par value, 100,000 shares
Preferred, 3%, $100 par value, noncumulative, 5,000 shares
Dividends were paid every year except for the prior year.
The preferred is partially participating up to 5%. In the
current year the board of directors declares dividends of
$60,000. How much in dividends does each class of
stock
receive?
Preferred Stock
Example
Preferred
Common
Total
Preferred stock (noncumulative)
($100 par ×3% ×5,000 shares)
$
$ 15,000
15,000
Common stock (3% matching)
($1 par ×100,000 shares = $100,000 ×3%)
$
3,000
18,000
Preferred Stock
Example
Preferred
Common
Total
Preferred stock (noncumulative)
($100 par ×3% ×5,000 shares)
$
$ 15,000
15,000
Common stock (3% matching)
$
($1 par ×100,000 shares = $100,000 ×3%)
3,000
18,000
Preferred stock (participating 2%)
($100 par ×2% ×5,000 shares)
28,000
10,000
Common stock (2% matching)
($100,000 ×2%)
2,000
30,000
Preferred Stock
Example
Preferred
Common
Total
Preferred stock (noncumulative)
($100 par ×3% ×5,000 shares)
$ 15,000
$ 15,000
Common stock (3% matching)
$
($1 par ×100,000 shares = $100,000 ×3%)
3,000
18,000
Preferred stock (participating 2%)
($100 par ×2% ×5,000 shares)
10,000
28,000
Common stock (2% matching)
($100,000 ×2%)
2,000
30,000
30,000
60,000
Common stock (remainder)
($60,000 - $30,000)
Total dividend declared
$ 25,000
$ 35,000
Issuing Stock for Cash
Par value stock:
Cash
(DEBIT)
Common Stock, par value
Additional Paid-in Capital, Common Stock
(CREDIT)
(CREDIT)
In this entry, Common Stock is credited for the par
value of the stock issued. The excess over par is
credited to the Contributed Capital in Excess of Par
account.
Issuing Stock for Cash
Nopar stock:
Cash
Common Stock
(CREDIT)
(DEBIT)
Stated value stock:
Cash
(DEBIT)
Common Stock, stated value
(CREDIT)
Additional Paid-in Capital, Common Stock
(CREDIT)
In this entry, Common Stock is credited for the stated
value of the stock issued. The excess over stated value is
credited to the Contributed Capital in Excess of Stated
Value account.
Stock Subscriptions
A corporation enters into a subscription contract with
several subscribers that calls for the purchase of 1,000
shares of $6 par common stock at a price of $13 per share.
A $3 per share down payment is required, with the
remaining $10 due in one month.
Cash
Subscription Receivable: Common
Stock
Common Stock Subscribed
Additional Paid-in Capital on
Common Stock
3,000
$6 x 1,000
10,000
6,000
7,000
Stock Subscriptions
The $10 per share final payment was received from
subscribers to 950 of the 1,000 shares.
Cash
Subscription Receivable:
Common Stock
9,500
Common Stock Subscribed
Common Stock, $6 par
5,700
9,500
5,700
950 x $6
Stock Subscriptions
When a default occurs, the accounting is determined by
the relevant contract provisions, such as-1.
Return to the subscriber the entire amount paid
in.
2.
Return to the subscriber the entire amount paid
in, less any costs incurred to reissue the stock.
3.
Issue to the subscriber a lesser number of
shares based upon the total amount of payment
received.
4.
Require the forfeiture of all amounts paid in.
Stock Subscriptions
The subscriber to the 50 remaining shares defaults on the
contract. The contract requires the forfeiture of all
amounts paid in.
Common Stock Subscribed
300
Additional Paid-in Capital on Common
Stock
350
Subscription Receivable:
Common Stock
Additional Paid-in Capital from 50 X $10
Subscription Default
50 X $6
50 X $7
500
150
Issuing Stock
for Noncash Assets


Use the current market value of the stock issued or
the noncash consideration received, whichever is
most reliably determinable.
If market values cannot be determined, use
appraised values.
Combined Sales of Stock
Total proceeds must be allocated among the
classes of stock issued:
◦ Proportional method
Allocate the lump-sum received among the classes of
stock issued based on their relative market values.
◦ Incremental method
Allocate a portion of the lump-sum received to one
security based on that security’s market value and
allocate the remainder to the other security.
Combined Sales of Stock
Example
A corporation issues 100 packages of securities for $82.80
per package. Each package consists of two shares of $10
par common stock (market value, $16 per share) and one
share of $50 par preferred stock (market value, $60 per
share).
Common Stock: $16 x 2 shares x 100
Preferred Stock: $60 x 1 share x 100
Total market value
= $ 3,200
= 6,000
$9,200
Combined Sales of Stock
Example
A corporation issues 100 packages of securities for $82.80
per package. Each package consists of two shares of $10
par common stock (market value, $16 per share) and one
share of $50 par preferred stock (market value, $60 per
share).
Common Stock:
$3,200
x
$8,280
= $2,880
x
$8,280 = 5,400
$9,200
Preferred Stock:
$6,000
$9,200
$8,280
Combined Sales of Stock
Example
A corporation issues 100 packages of securities for $82.80
per package. Each package consists of two shares of $10
par common stock (market value, $16 per share) and one
share of $50 par preferred stock (market value, $60 per
share).
Cash
Common Stock
Additional Paid-in Capital on Com. Stock
Preferred Stock, $50 par
Additional Paid-in Capital on Pref. Stock
8,280
2,000
880
5,000
400
Stock Issue Costs
Costs incurred to issue stock
◦ Registration fees
◦ Underwriter commissions
◦ Attorney and accountant fees
◦ Printing costs
◦ Clerical costs
◦ Promotional costs
Stock Issue Costs
Two methods of accounting for stock issue
costs:
Offset method
Debit costs to Contributed Capital in Excess of Par.
Deferred charge method
Debit an intangible asset and amortize over a reasonable
period.
Stock Issuance Costs
The FASB is planning to
change GAAP so that all
stock issuance costs are
expensed as incurred.
Unrealized Capital
Represents an increase or decrease in stockholders’equity
not arising from earnings, dividend payments, or a change in
contributed capital. Examples include:
◦ Unrealized holding gains and losses on available for sale
securities.
◦ Gains and losses resulting from translating foreigndenominated financial statements into US currency.
◦ Guarantees of ESOP debt.
◦ Pension liability adjustments.
Any
questions?
Treasury Stock
Repurchased shares of a corporation’s own stock
The shares are retired or used to:
 Issue in employee stock option programs.
 Establish a market for the company’s stock.
 Purchase assets.
 Issue as a stock dividend.
 Increase earnings per share.
 Reduce ownership.
 Thwart takeover attempts.
 Reduce dividend payments.
Treasury Stock
Characteristics

Usually does not have:
-- Voting rights
-- Dividends rights
-- Preemptive rights
-- Liquidation rights


Reduces both assets and stockholders’ equity
Is classified as a contra account to stockholders’
equity
Treasury Stock
Recording and Reporting
Cost method
(one-transaction concept)
Par value method
(dual-transaction concept)
Treasury Stock
Cost Method
The purchase and subsequent sale of treasury
stock are viewed as one transaction with two parts.
Treasury Stock
Cost Method

Acquisition of Treasury Stock
-- Recorded at cost to acquire.
Treasury Stock
(DEBIT)
Cash

(CREDIT)
Issuance of Treasury Stock
-- Treasury Stock credited for cost.
-- Difference between cost and issuance price is
(generally) recorded in Additional Paid-in CapitalTreasury Stock.
Treasury Stock
Cost Method
Ball issues 6,000 shares of $10 par common stock for
$12 per share:
Cash
Common Stock $10 par
Additional Paid-in Capital on
Common Stock
72,000
60,000
12,000
Treasury Stock
Cost Method
Reacquisition of 1,000 shares of common stock at $13
per share:
Treasury Stock
Cash
13,000
13,000
Treasury Stock
Cost Method
Reissuance of 600 shares of treasury stock at $15 per
share:
Cash
Treasury Stock
Additional Paid-in Capital from
Treasury Stock
9,000
7,800
1,200
Treasury Stock
Cost Method
Reissuance of another 200 shares of treasury stock at
$8 per share:
Cash
Additional Paid-in Capital from
Treasury Stock
Treasury Stock
1,600
1,000
2,600
Treasury Stock
Cost Method
Reissuance of another 100 shares of treasury stock at
$10 per share:
Cash
Additional Paid-in Capital from
Treasury Stock
Retained Earnings
Treasury Stock
1,000
200
100
1,300
Treasury Stock
Par Value Method
Date of acquisition
◦ Debit Treasury Stock for the par value, stated value, or
average amount previously credited to the capital stock
account for nopar stock.
◦ Debit Additional Paid-in Capital for the proportionate
amount of any excess over par or stated value that was paid
by stockholders when the shares were originally issued.
◦ Debit or credit Additional Paid-in Capital from Treasury
Stock as required.
-- Debit cannot exceed the credit balance in the account.
Any excess is debited to Retained Earnings.
◦ Credit Cash.
Treasury Stock
Par Value Method
Date of resale
◦ Debit Cash.
◦ Credit Treasury Stock for the par value, stated value,
or average amount previously credited to the capital
stock account for nopar stock.
◦ Credit Additional Paid-in Capital fromTreasury
Stock or debit Additional Paid-in Capital from
Treasury Stock (and Retained Earnings, if necessary).
Treasury Stock
Par Value Method
Issuance of 6,000 shares of $10 par common stock for
$12 per share:
Cash
Common Stock $10 par
Additional Paid-in Capital on
Common Stock
72,000
60,000
12,000
Treasury Stock
Par Value Method
Reacquisition of 1,000 shares of common stock at $13
per share:
Treasury Stock
Additional Paid-in Capital on
Common Stock
Retained Earnings
Cash
10,000
2,000
1,000
13,000
Treasury Stock
Par Value Method
Reissuance of 600 shares of treasury stock at $15 per
share:
Cash
Treasury Stock
Additional Paid-in Capital on
Common Stock
9,000
6,000
3,000
Treasury Stock
Par Value Method
Reissuance of another 200 shares of treasury stock at
$8 per share:
Cash
Additional Paid-in Capital on
Common Stock
Treasury Stock
1,600
400
2,000
Treasury Stock
Par Value Method
Reissuance of another 100 shares of treasury stock at
$10 per share:
Cash
Treasury Stock
1,000
1,000
Treasury Stock
Cost Method
Contributed Capital:
Common stock, $10 par (20,000 shares authorized,
6,000 shares issued , of which 100 are being held
in treasury)
Additional paid-in capital on common stock
Total contributed capital
Retained earnings
Accumulated other comprehensive income
Total contributed capital, retained earnings, and
accumulated other comprehensive income
Less: Treasury stock (100 shares at cost)
Total Stockholders’ Equity
$ 60,000
12,000
$ 72,000
39,900
10,000
$121,900
(1,300)
$120,600
Treasury Stock
Par Value Method
Contributed Capital:
Common stock, $10 par (20,000 shares authorized,
6,000 shares issued)
Less: Treasury stock (100 shares at par)
Common stock outstanding (5,900 shares)
Additional paid-in capital on common stock
Total paid-in capital
Retained earnings
Accumulated other comprehensive income
$ 60,000
(1,000)
$ 59,000
12,600
$ 71,600
39,000
10,000
Total Stockholders’ Equity
$120,600
Stock Received by Donation
When stockholders
donate shares to the
corporation, the
corporation debits
Treasury Stock and
credits a revenue or
gain account.
Retirement of Treasury Stock
When treasury shares are formally retired, the
corporation credits the Treasury Stock account and
debits all capital accounts related to the treasury
shares on a proportional basis.
Convertible Preferred Stock


Provides stockholders an option to exchange their
shares, within a specified time period, for other
classes of stock, usually common stock, at a
specified rate.
Accounting treatment is the same as convertible
bonds.
Convertible Preferred Stock
Ness Corporation originally issued 500 shares of $100 par
convertible preferred stock at $120 per share. Each share of
preferred stock may be converted into four shares of $20 par
common stock.
Preferred Stock, $100 par
Additional Paid-in Capital on Preferred
Stock
Common Stock, $20 par
Additional Paid-in Capital from
Preferred Stock Conversion
Continued
50,000
10,000
40,000
20,000
Convertible Preferred Stock
Alternatively, assume each preferred share may be
converted into seven shares of common stock.
Preferred Stock, $100 par
Additional Paid-in Capital on Preferred
Stock
Retained Earnings
Common Stock, $20 par
50,000
10,000
10,000
70,000
Stock Rights

Rights issued by the corporation that give the holder
an option to acquire a specified number of shares of
capital stock under prescribed conditions within a
stated period of time.The document of ownership is
called a stock warrant.
Normally arise:
1.As compensation to employees
2.As compensation to employees
3.As fractional share rights
4.To make a security more attractive
Stock Rights
Important Dates

Announcement date of the rights offering

Issuance date of the rights

Expiration date of the rights

Between the issuance date and the expiration date,
the rights and the related stock are sold separately
and each have a separate price.
Stock Rights
Preemptive Rights



Stock rights issued to existing shareholders in
advance of a new stock issuance.
No entries required on announcement date or on
issuance date of the rights.
On exercise date
◦ debit Cash.
◦ credit Capital Stock and Additional Paid-in Capital.
Stock Compensation Plans

Used to
-- recruit and retain outstanding employees.
-- encourage employee ownership.
-- obtain additional capital from equity owners.

Most critical accounting issue is whether the
program causes additional expenses for the
corporation (or grantor).
Stock Compensation Plans
New FASB standard requires companies to recognize
compensation cost using the fair-value method.*
Under fair-value method, companies use acceptable
option-pricing models to value the options at the
date of grant.
*“Accounting for Stock-Based Compensation,”Statement of Financial Accounting
Standards No. 123 (Norwalk, Conn: FASB, 1995); and “Share-Based
Payment,”Statement of Financial Accounting Standard No. 123(R) (Norwalk,
Conn: FASB, 2004).
Stock Compensation Plans

Noncompensatory plans
allow employees to purchase stock at a price that is
not significantly lower than the current market price.

Compensatory plans
allow employees to purchase stock at a price that is
significantly lower than the current market price at
the measurement date.
Stock Options
Noncompensatory Plans
Criteria stated in APB Opinion No. 25
1. Includes substantially all full-time employees
meeting certain criteria.
2. Stock is offered to eligible employees either
equally or on the basis of a uniform percentage of
salary or wages.
3. Exercise time is limited to a reasonable period.
4. The discount from market price is not significant.
Stock Options
Noncompensatory Plans
Criteria stated in FASB No. 123(R)
1. Substantially all full-time employees participate
on an equitable basis.
2. The discount from market is small.
3. The plan offers no substantive option feature.
Stock Options
Noncompensatory Plans

Accounted for based on the cost principle.

Record a liability at the time of issuance
-- Valued at amount contributed by employees.

On date of issuance of stock
-- debit the liability.
-- credit Capital Stock (for par value) and contributed
capital.
Stock Options
Compensatory Plans


Any plan that fails to meet one of the four criteria
for noncompensatory plans is classified as a
compensatory plan.
The measurement date is the first date when the
grantor knows
-- the number of shares an employee is eligible to
receive.
-- the option price.
Stock Options
Compensatory Plans
Determining Expense
Compensation expense based on the fair value
of the options expected to vest on the date the
options are granted to the employee(s) (i.e., the
grant date).
Allocating Compensation Expense
Over the periods in which employees perform
the service—the service period.
Stock Compensation Plans
Example
On January 1, 2006, Nichols Corporation granted 10,000 options to
key executives. Each option allows the executive to purchase one
share of Nichols’ $5 par value common stock at a price of $20 per
share. The options were exercisable within a 2-year period
beginning January 1, 2008, if the grantee is still employed by the
company at the time of the exercise. On the grant date, Nichols’
stock was trading at $25 per share, and a fair value option-pricing
model determines total compensation to be $400,000. On May 1,
2008, 8,000 options were exercised when the market price of
Nichols’ stock was $30 per share. The remaining options lapsed in
2010 because executives decided not to exercise their options.
Stock Compensation Plans
Example
Prepare the necessary journal entries related to the
stock option plan for the years 2006 through 2010.
1/1/06 No entry on date of grant.
12/31/06 Compensation expense
200,000
Paid-in capital-stock options
200,000
($400,000 x ½)
200,000
12/31/07 Compensation expense
Paid-in capital-stock options
200,000
Stock Compensation Plans
Example
Prepare the necessary journal entries related to the stock
option plan for the years 2006 through 2010.
5/1/08
Cash (8,000 x $20)
160,000
Paid-in capital-stock options
320,000
Common stock (8,000 x $5)
Paid-in capital in excess of par
40,000
440,000
($400,000 x 8,000 / 10,000 = $320,000)
1/1/10
Paid-in capital-stock options
80,000
Paid-in capital-expired options
($400,000 – $320,000)
80,000
Measuring the Fair Value of Fixed Stock Options


Requires the application of a complex pricing
model.
Variables include:
Exercise price
Current market price of the stock
Risk-free rate of interest
Expected life of the options
Expected volatility of the stock price
Expected dividend yield of the stock
Measuring the Fair Value of Fixed Stock Options
TCC = FV
×
Total
Compensation
Cost
Fair Value
of an option
[
N
× (1 - FR)
Number
of options
SP
]
Service
Period
Expected annual
forfeiture rate
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Chapter8
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