Stockholder’s Equity Handout – Flashcards
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Stockholders' Equity
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is the owners' claim to the net assets (i.e., assets minus liabilities) of a corporation. It is generally presented on the statement of financial position (balance sheet) as the last major section (following liabilities)
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The various elements constituting stockholders' equity must be clearly classified according to source
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The stockholders' equity section of the balance sheet contains five major components: (1) capital stock; (2) additional paid-in capital; (3) retained earnings or deficit; (4) accumulated other comprehensive income; and (5) treasury stock. When an entity presents consolidated financial statements, any non-controlling interest must be shown in equity
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Capital Stock
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Legal capital is the amount of capital that must be retained by the corporation for the protection of creditors. The par or stated value of both preferred and common stock is legal capital and is frequently referred to as "capital" stock (all such instruments/securities are subject to restrictions on distributions to shareholders that stem from corporate law rather than contract law
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Par Value
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Generally, preferred stock is issued with a par value, but common stock may be issued with or without a par value. No-par common stock may be issued as true no-par stock or no-par stock with a stated value. Any excess of the actual amount received over the par or stated value of the stock is accounted for as additional paid-in capital.
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Authorized, Issued, and Outstanding
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A corporation's charter contains the amounts of each class of stock that it may legally issue, and this is called "authorized" capital stock. When part or all of the authorized capital stock is issued, it is called "issued" capital stock. Because a corporation may own issued capital stock in the form of treasury stock, the amount of issued capital stock in the hands of shareholders is called "outstanding" capital stock. Capital stock may be (1) authorized, (2) authorized and issued, or (3) authorized, issued, and outstanding. The number of shares of each class of stock authorized, issued, and outstanding must be disclosed
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Authorized
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Could be sold
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Issued
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Have been sold at any point
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Outstanding
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In pockets of investors
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Common Stock
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Is the basic ownership interest in a corporation. Common shareholders bear the ultimate risk of loss and receive the ultimate benefits of success, but they are not guaranteed dividends or assets upon dissolution. Common shareholders generally control management. They have the right to vote, the right to share in earnings of the corporation, and the right to share in assets upon liquidation after satisfaction of creditors' claims and those of preferred shareholders
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Preferred Stock
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Is an equity security with preferences and features not associated with common stock. Preferred stock may include a preference relating to dividends, which may be cumulative or non-cumulative and participating or nonparticipating. Preferred stock may also include a preference relating to liquidation. Usually, preferred stock does not have voting rights
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Cumulative Preferred Stock
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The cumulative feature provides that all or part of the preferred dividend not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders. The accumulated amount is referred to as dividends in arrears. The amount of dividends in arrears is not a legal liability, but it must be disclosed in total and on a per share basis either parenthetically on the balance sheet or in the footnotes
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Non-Cumulative Preferred Stock
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With non-cumulative preferred stock, dividends not paid in any year do not accumulate. The preferred shareholders lose the right to receive dividends that are not declared
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Participating Preferred Stock
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The participating feature provides that preferred shareholders share (participate) with common shareholders in dividends in excess of a specific amount. The participation may be full or partial. Fully participating means that preferred shareholders participate in excess dividends without limit. Generally, preferred shareholders receive their preference dividend first, and then additional dividends are shared between common and preferred shareholders. Partially participating means preferred shareholders participate in excess dividends, but to a limited extent (e.g., a percentage limit)
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Non-Participating Preferred Stock
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When preferred stock is non-participating , preferred shareholders are limited to the dividends provided by their preference. They do not share in excess dividends
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Preference upon Liquidation
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Preferred stock may include a preference to assets upon liquidation of the entity. If the liquidation preference is significantly greater than the par or stated value, the liquidation preference must be disclosed. The disclosure of the liquidation preference must be in the equity section of the balance sheet, not in the notes to the financial statements
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Convertible Preferred Stock
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Convertible preferred stock may be exchanged for common stock (at the option of the stockholder) at a specified conversion rate
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Callable (Redeemable) Preferred Stock
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Callable preferred stock may be called (repurchased) at a specified price (at the option of the issuing corporation). The aggregate or the per share amount at which the preferred stock is callable must be disclosed either on the balance sheet or in the footnotes
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Mandatorily Redeemable Preferred Stock
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(Liability, don't include in equity) Mandatorily redeemable preferred stock is issued with a maturity date. Similar to debt, mandatorily redeemable preferred stock must be bought back by the company on the maturity date. Mandatorily redeemable preferred stock must be classified as a liability, unless the redemption is required to occur only upon the liquidation or termination of the reporting entity
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Additional Paid-In Capital
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Is generally contributed capital in excess of par or stated value. It can arise from many other different types of transactions. Examples include the sale of treasury stock at a gain, quasi-reorganization, the issuance of liquidating dividends, conversion of bonds, and the declaration of a small stock dividend. Additional paid-in capital from these sources may be aggregated and shown as one amount on the balance sheet
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Retained Earnings
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Retained earnings (or deficit) is accumulated earnings (or losses) during the life of the corporation that have not been paid out as dividends. The amount of accumulated retained earnings is reduced by distributions to stockholders and transfers to additional paid-in capital for stock dividends. Retained earnings does not include treasury stock or accumulated other comprehensive income
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Formula
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Net income (Loss) - Dividends declared (not paid) +/- Prior period adjustments +/- Accounting changes reported retrospectively + Adjustment from quasi-organization = Retained Earnings
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Classification of Retained Earnings
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Retained earnings may be classified as either appropriated or unappropriated
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What is the purpose of appropriating retained earnings ?
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The purpose of appropriating retained earnings is to disclose to the shareholders that some of the retained earnings are not available to pay dividends because they have been restricted for legal or contractual reasons (e.g., a bond indenture) or as a discretionary act of management for specific contingency purposes (e.g, plant expansion). An appropriation of retained earnings may not be used to absorb costs or losses and may not be transferred to income
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Quasi-Reorganization
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A quasi-reorganization (or corporate readjustment) is an accounting adjustment (not a legal reorganization) that revises the capital structure of a corporation as though it had been legally reorganized. It allows a corporation with a significant deficit in retained earnings to eliminate that deficit. A quasi reorganization requires formal approval by the shareholder
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Purpose of Quasi-Reorganization
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To restate overvalued assets to their lower fair values (and thus reduce future depreciation) and to eliminate a retained earnings deficit (and thus facilitate the declaration of dividends)
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Procedures
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a. Revalue assets to current fair values and liabilities to their present values. (No net increase in asset value is permitted, and the write-down is charged directly to retained earnings, thus increasing the deficit temporarily) b. Bring retained earnings to zero (i.e., eliminate the deficit) against additional paid-in capital. (If additional paid-in capital is insufficient to absorb the deficit, more additional paid-in capital can be created by reducing the par or stated value of the stock, thus reducing capital stock). c. Following a quasi-reorganization, retained earnings on the balance sheet must be dated to show the date of the adjustment, and that date must continue to be disclosed until such time as it is insignificant (usually 3 -10 years)
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Accumulated other comprehensive income
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Components of accumulated other comprehensive income include pension adjustments, unrealized gains and losses on available-for-sale securities, foreign currency translation adjustments, anddeferred gains and losses on the effective portion of cash flow hedges.These components of other comprehensive income are not included in determining net income, and, therefore, do not enter into retained earnings. Rather, they are recognized in the period in which they occur and are combined with net income to determine comprehensive income. Total accumulated other comprehensive income must be shown in the shareholders' equity section separate from capital stock, additional paid-in capital, and retained earnings
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Treasury Stock
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Treasury stock is a corporation's own stock that has been issued to shareholders and subsequently reacquired (but not retired). Treasury shareholders are not entitled to any of the rights of ownership given to common shareholders, such as the right to vote or to receive dividends. In addition, a portion of retained earnings equal to the cost of treasury stock may be restricted and may not be used as a basis for the declaration or payment of dividends (depending on applicable state law)
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Accounting for a Stock Issuance
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If par (or stated) value exists, stock may be issued above, at, or below par (or stated) value. Often stock subscriptions are sold before the stock is actually issued
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Stock Issued above Par Value
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If stock is issued above par value, cash will be debited for the proceeds, common (or preferred) capital stock will be credited for par (or stated) value, and additional paid-in capital will be credited for the excess over par (or stated) value
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Stock Issued at Par Value
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If stock is issued at par value, cash will be debited and common (or preferred) capital stock will be credited for the proceeds. There is no entry to additional paid-in capital
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Stock Issued below Par Value
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If stock is issued at less than par (or stated) value, additional paid-in capital would be debited to reflect a discount on the stock. The discount represents a contingent liability to the original owners
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Stock Subscriptions
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Frequently, a corporation sells its capital stock by subscription. This means that a contractual agreement to sell a specified number of shares at an agreed-upon price on credit is entered into. Upon full payment of the subscription, a stock certificate evidencing ownership in the corporation is issued
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Stock Rights
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A stock right provides an existing shareholder with the opportunity to buy additional shares. The right usually carries a price below the stock's market price on the date the rights are granted. The issuance of stock rights requires a memorandum entry only. It is possible that the rights may be subsequently redeemed by the company, which will cause a decrease in stockholders' equity in the amount of the redemption price
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Distribution to Shareholders
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A dividend is a pro rata distribution by a corporation based on the shares of a particular class of stock and usually represents a distribution of earnings. Cash dividends are the most common type of dividend distribution, although there are many other types. Preferred stock usually pays a fixed dividend, expressed in dollars or as a percentage
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Date of Declaration
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The declaration date is the date the board of directors formally approves a dividend. On the declaration date, a liability is created (dividends payable) and retained earnings is reduced (debited)
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Date of Record
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The date the BOD specifies as the date the names of the shareholders to receive the dividend are determined (no journal entry entry)
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Date of Payment
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The date of payment is the date on which the dividend is actually disbursed by the corporation or its paying agent
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Cash Dividends
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Cash dividends distribute cash to shareholders and may be declared on common or preferred stock. They are paid from retained earnings. Dividends are paid only on authorized, issued, and outstanding shares. They are not paid (or declared) on treasury stock
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Property (In-Kind) Dividends
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Property dividends distribute noncash assets (e.g., inventory, investment securities, etc.) to shareholders. They are non-reciprocal transfers of nonmonetary assets from the company to its shareholders. On the date of declaration, the property to be distributed should be restated to fair value and any gain or loss should be recognized in income. The dividend liability and related debit to retained earnings should be recorded at the fair value of the assets transferred
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Scrip Dividends
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Scrip dividends are simply a special form of notes payable whereby a corporation commits to paying a dividend at some later date. Scrip dividends may be used when there is a cash shortage. On the date of declaration, retained earnings is debited and notes payable (instead of dividends payable) is credited. Some scrip dividends even bear interest from the declaration date to the date of payment (and, thus, require accrual)
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Liquidating Dividends
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Occur when dividends to shareholders exceed retained earnings. Dividends in excess of retained earnings would be charged (debited) first to additional paid-in capital and then to common or preferred stock (as appropriate). Liquidating dividends reduce total paid-in capita
