StockholdersEquity

StockholdersEquity - Accounting 620 Financial Measurement...

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Unformatted text preview: Accounting 620 Financial Measurement and Reporting Fall 2011 Session 9 – Stockholders’ Equity Professor Damon M. Fleming 1 Coverage overview • • • • • • • Corporate legal entity Corporate capital Issuance of stock Dividends Stock splits Treasury stock Presentation and disclosure Session 9 - Stockholders' Equity 2 Primary guidance • US GAAP guidance for accounting for stockholders’ equity is mainly contained in the following: – – – – FASB ASC 505-10, Overall FASB ASC 505-20, Stock dividends and stock splits FASB ASC 505-30, Treasury stock FASB ASC 480-10, Distinguishing liabilities from equity • IFRS guidance is contained in the following standards: – – – – IAS 1, Presentation of Financial Statements IFRS 7, Financial Instrument Disclosures IAS 32, Financial Instruments: Presentation IAS 39, Financial Instruments: Recognition and Measurement Session 9 - Stockholders' Equity 3 Corporate legal entity • US: corporations are legal entities organized under the laws of a state government to engage in business or other activities. Characteristics include: – – – – Limited liability Controlled by shareholders Unlimited life Issue shares of stock to raise capital • International: corporate organization is dependent on the laws of the respective countries, and may be different than the US Session 9 - Stockholders' Equity 4 Corporate capital • Capital Stock – The stated or par value of the stock issued • Par value: pre-determined minimum value of stock – Generally represents the stockholders’ maximum liability to creditors in the case of insolvency (i.e., bankruptcy) – Authorized shares—total number of shares authorized in the corporate charter – Issued shares—total number of shares issued to shareholders of a company, regardless of whether they are insiders, institutional investors or the general public (including treasury stock) – Outstanding shares—stock currently held by investors (excluding treasury stock) • Additional Paid-In Capital (APIC) – Paid-in capital in excess of the par or stated value • APIC = Sale Price – Par Value Session 9 - Stockholders' Equity 5 Common stock • Common stock is an equity security that represents the residual interest in a corporation • Common stock characteristics – Distributions are subordinate to the rights of other securities – Bears greater risk, but may also reap the greater rewards • Four Basic Rights – – – – Voting rights Dividend rights Preemptive right to purchase stock Rights to share in the distribution of assets Session 9 - Stockholders' Equity 6 Preferred stock • Preferred stock is an equity security that has certain preferences not held by common stock. These preferences often include: – Preference to assets in the event of a liquidating distribution – Preference in dividend distributions – Dividends specified as a stated percentage of par value or dollar amount per share • Preferred stock may also contain certain features: – Cumulative—requires that if the corporation fails to pay a dividend in any year, it must pay all dividends in arrears before paying any dividends to common stock holders – Redeemable—option to redeem shares at a specified price per share – Convertible—option to convert preferred shares into common shares • Called “preference shares” under IFRS Session 9 - Stockholders' Equity 7 Preferred stock • US GAAP accounts for preferred shares based on the specific terms and conditions of the security – For example, if redemption is required upon the occurrence of certain contingent events (e.g., IPO, change in control, performance achievement) or at the option of the holder, then the financial instrument would be accounted for as a liability. However, if redemption is not certain to occur (general assumption), the instrument would be accounted for as equity. • IFRS requires preference shares to be evaluated to determine whether the exhibit fundamental characteristics of debt – Evaluation of redemption option or other terms to determine “split accounting” for the liability and equity components Session 9 - Stockholders' Equity 8 Issuance of stock Example 1 – cash stock issuance Abling Co. issued 5,000 shares of $0.01 par value common stock for $25 per share and 1,000 shares of $10 par value preferred stock (with no redemption or other features) for $35 per share. Prepare the journal entries to record the issuance of the common and preferred stock. Session 9 - Stockholders' Equity 9 Issuance of stock Example 1 - solution To record issuance of 5,000 shares of common stock. To record issuance of 1,000 shares of preferred stock. Session 9 - Stockholders' Equity 10 Stock subscription • Stock subscription represents a contract to purchase shares of stock in the future – Generally accompanied by a up-front partial payment – Full payment is required before shares are issued • If the subscriber defaults on the subscription contract, then any amounts paid to the corporation may be: – Returned in full – Retained by the corporation – A equivalent number of shares issued Session 9 - Stockholders' Equity 11 Stock subscription Example 2 – stock subscription Abling Co. received subscriptions for 20,000 shares of $0.01 par value common stock for $28 per share. The subscription agreement required an initial payment of 25% of the subscription price. The balance of the purchase price was paid prior to stock issuance. Prepare the journal entries to record the stock subscription and subsequent stock issuance. Session 9 - Stockholders' Equity 12 Stock subscription Example 2 - solution To record subscription for 20,000 shares of common stock. To record receipt of subscription receivable. Session 9 - Stockholders' Equity 13 Cash dividends Distribution to stockholders of a proportionate share of retained earnings Declaration Date •Dividend resolution approved by BOD •Declared dividend becomes a liability •Retained earnings decreases Record Date Payment Date •Must own stock as of this date to receive declared dividend •No accounting entry needed •Dividend liability is paid •Retained earnings is not affected Session 9 - Stockholders' Equity 14 Cash dividends Example 3 – issuance of cash dividend At Dec. 31 of 20X1 and 20X2, Oliver Co. had outstanding 5,000 shares of $50 par value 5% cumulative preferred stock and 20,000 shares of $1 par value common stock. At Dec. 31, 20X1, dividends in arrears on the preferred stock were $6,250. Cash dividends declared in 20X2 totaled $22,000. 1. Determine the amount of dividends to be paid to preferred and common stock. 2. Prepare the journal entries to record the declaration and payment of the dividends. Session 9 - Stockholders' Equity 15 Cash dividends Example 3 - solution Dividend Allocation Calculation: Cash dividends declared in 20X2 Dividends in arrears at 12/31, 20X1 Dividends for 20X2 Cash dividends payable to preferred stock Cash dividends payable to common stock Session 9 - Stockholders' Equity 16 Cash dividends Example 3 – solution (continued) To record declaration of dividends in 20X2. To record payment 20X2 dividends. Session 9 - Stockholders' Equity 17 Stock dividends • Issuance to stockholders a corporation’s own common stock in proportion to their existing holdings • Small stock dividends – <25% of outstanding stock – Record at fair value of stock (at date of declaration) • Large stock dividends – >25% of outstanding stock – Record at par value Session 9 - Stockholders' Equity 18 Stock dividends Example 4 – issuance of stock dividend The following stock dividends were declared and distributed by Moon Corp. during the current year: % of Common Shares Outstanding at Declaration Date # of Shares Issued as a Dividend Fair value per share Par value per share 10 120,000 $1.25 $0.01 28 420,000 $1.00 $0.01 Prepare the journal entries to record the stock dividends. Session 9 - Stockholders' Equity 19 Stock dividends Example 4 - solution To record issuance of 10% stock dividend. To record issuance of 28% stock dividend. Session 9 - Stockholders' Equity 20 Stock splits • Forward stock splits – Increase the number of shares outstanding and proportionately decrease the par value of the stock • Reverse stock splits – Decrease the number of shares outstanding and proportionately increase the par value of the stock • Generally only a memorandum entry made to adjust the number of shares issued in relation to the adjustment in the par value Session 9 - Stockholders' Equity 21 Treasury stock • Treasury stock is common or preferred stock that has been reacquired from the market • Stock buyback examples – S&P 500 stock buybacks up 63% from Q1 2010 (June 29, 2011) – NewsCorp. announced $5 billion stock buyback after shares drop amid phone hacking scandal (July 12, 2011) – Walgreens announced $2 billion share repurchase program (July 13, 2011) • Why do companies repurchase shares from the market? Session 9 - Stockholders' Equity 22 Treasury stock • Overview of treasury stock – Treasury stock is not an asset – No gains or losses are recognized on treasury stock transactions • Two methods for accounting for treasury stock transactions – Cost method (most common) – Par value method (note: total stockholders’ equity is the same under both methods) • IFRS is similar, except that treasury stock is referred to as “treasury shares” Session 9 - Stockholders' Equity 23 Treasury stock • The Cost Method treats the purchase and subsequent disposition of treasury stock as one transaction • Treasury stock is recorded and carried at the acquisition cost – Reissued in Excess of Acquisition Cost • Excess is credited to APIC – Treasury Stock (TS) – Reissued at Less than Acquisition Cost • Deficit is first charged against any balance in APIC – TS, then the excess (if any) is charged to retained earnings – When multiple blocks of treasury stock have been acquired, the FIFO method is generally used at reissuance • Treasury stock can be retired—at such time the stock is classified as authorized and unissued Session 9 - Stockholders' Equity 24 Treasury stock • The Cost Method treats the purchase and subsequent disposition of treasury stock as one transaction • Treasury stock is recorded and carried at the acquisition cost – Reissued in Excess of Acquisition Cost • Excess is credited to APIC – Treasury Stock (TS) – Reissued at Less than Acquisition Cost • Deficit is first charged against any balance in APIC – TS, then the excess (if any) is charged to retained earnings – When multiple blocks of treasury stock have been acquired, the FIFO method is generally used at reissuance • Treasury stock can be retired—at such time the stock is classified as authorized and unissued Session 9 - Stockholders' Equity 25 Treasury stock Example 5 – cost method for treasury stock On February 15, Abling Co. repurchased 500 shares of its common stock ($0.01 par) at $19 per share that originally sold for $25 per share. On April 2, 250 of these shares were reissued at $23 per share. On May 1, 200 of these shares were retired. Prepare the journal entries to record the stock acquisition, reissuance, and retirement transactions. Session 9 - Stockholders' Equity 26 Treasury stock Example 5 - solution To record acquisition of 500 shares ($19 per share) of treasury stock. To record reissuance of 250 shares of treasury stock at $23 per share. Session 9 - Stockholders' Equity 27 Treasury stock Example 5 – solution (continued) To record retirement of 200 shares common stock originally issued at $25 and reacquired at $19 . Session 9 - Stockholders' Equity 28 Equity transaction effects on retained earnings Transaction Effect on RE Amount Dividends: cash or property Decrease Amount of cash or FV of property Stock dividends: - Small (<25%) - Large (>25%) Decrease Decrease FV of stock distributed Par value of stock distributed Stock splits: - Par changed proportionally No change N/A No change No change or decrease N/A N/A [if cost <(par + APIC)] Purchase price in excess of par and pro rata APIC No change or decrease N/A/ [if sale price > cost] Excess of cost over sale price, but first offset to APIC - TS N/A Acquisition of treasury stock: - Cost method - Par value method Sale of treasury stock: - Cost method - Par value method No change Session 9 - Stockholders' Equity 29 Presentation and disclosure • Issuers must present a reconciliation of the changes in each component of stockholders’ equity • State the amount per share and in the aggregate for each class of shares for any dividend distributions – IFRS requires this information to be presented in a statement of changes in equity. US GAAP does not require this statement, but it is predominately used. • Other disclosures – Description of preferences for all classes of preferred shares – Description and quantitative summary of what an entity manages as capital (e.g., some entities regard certain financial liabilities as part of capital) – Any externally imposed capital requirements and how such requirements are integrated into the management of capital Session 9 - Stockholders' Equity 30 Questions/Comments? Session 9 - Stockholders' Equity 31 ...
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