Fundamental

Financial Accounting
Concepts
Fourth Edition
by
Edmonds, McNair, Milam, Olds

PowerPoint® presentation by
J. Lawrence Bergin
11- 2

Chapter 11

Accounting
for
Equity
Transactions

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 3

Characteristics of Different Forms

of Business Organization
Issues in deciding between sole
proprietorship, partnership, or corporation

◆ Personal liability
◆ Taxation
◆ Transfer of ownership
◆ Ability to raise capital
◆ Government regulation
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 4

Equity in Proprietorships
◆ Contributed capital and retained
earnings are combined into a
single capital account:
John Doe, Capital $XXXX

◆ Distributions are called

withdrawals. As withdrawals
increase, equity decreases.
John Doe, Withdrawals $XXXX

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 5

Equity in Partnerships
◆ Each partner has her/his own
separate “capital” account, each
containing the partner’s invested
capital and share of retained
earnings.
◆ As with proprietorships, partnerships
use withdrawal accounts for the
distributions made to the owners.
Each partner has his/her own
“withdrawal” (or “Drawing”) account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 6

Corporations
◆ A corporation is a popular form of
business because . . .
➊ It is simple for individuals to purchase
small amounts of stock.
➋ It allows for an easy transfer of
ownership through established markets,
like the New York Stock Exchange.
➌ It provides stockholders with limited
liability.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 7

Corporations
◆ Because a corporation is a separate
legal entity, it can . . .
● Own assets.
● Incur liabilities.
● Sue and be sued.
● Enter into contracts independent of the
stockholder owners.
◆ Many Americans own stock through a
mutual fund or pension program.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 8

Ownership of a Corporation
◆ Owners of common stock generally
receive the following rights:
● Voting (in person or by proxy).
● Distributions of profits (in the form of Dividends).
● Distributions of assets in a liquidation.
● Offers to purchase shares of a new stock
issue (pro rata basis).

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 9

Creating a Corporation
◆ State laws govern the creation of
corporations.
◆ An application for a charter (or articles
of incorporation) must include the
corporation’s name and purpose, kinds
and amounts of capital stock
authorized, and other detailed
information.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 10

Creating a Corporation
Once the state
issues a charter,
the stockholders
elect a board of
directors.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 11

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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 12

Authorized, Issued, and

Outstanding Capital Stock
Authorized
Shares
Issued Unissued
shares shares have
have been
sold. never been
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 13

Authorized, Issued, and

Outstanding Capital Stock
Authorized owned by stockholders.
Shares

Outstanding
Unissued
Issued Shares
Shares
Shares

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 14

Authorized, Issued, and

Outstanding Capital Stock
Authorized owned by stockholders.
Shares

Outstanding
Unissued
Issued Shares
Shares
Shares
Treasury reacquired by the
Shares corporation.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 15

Sale and Issuance of Capital

Stock

◆ An initial public offering (IPO) is the very

first time a corporation sells stock to the
public.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 16

Common Stock
◆ Basic voting stock of the corporation
◆ Ranks after preferred stock for dividend
and liquidation distribution.
◆ Dividend rates are determined by the
board of directors based on the
corporation’s profitability
and other factors.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 17

Par Value and No-par Value

Stock
◆ Par value
● Isa nominal value per share of capital
stock specified in the charter.
● Has no relationship to market value.
● Serves as the basis for legal capital.

◆ Legal capital is the amount of capital,

required by the state, that must remain
invested in the business.
● It serves as a cushion for creditors.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 18

Par Value and No-par Value Stock

◆ No-par value is capital stock that does
not have an amount per share specified
in the charter.
◆ When no-par stock is issued by a
corporation, the amount of legal capital
is defined by the state.
◆ Stated value is an amount per share
that is specified by the corporation
when it issues no-par stock.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 19

Preferred Stock
◆ Has dividend and liquidation preference
over common stock.
◆ Cumulative preferred stock has a
preference for all past dividends over any
paid to common shareholders.
◆ Generally does not have voting rights.
◆ Usually has a par or stated value.
◆ Usually has a fixed dividend rate that is
stated as a percentage of the par value.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 20

Special Features of Preferred

Stock
◆ Convertible preferred stock may be
exchanged for common stock. (It’s up
to the stockholder to decide.)

◆Callablepreferred stock may be

purchased by the corporation at a
predetermined price.

(It’s the company’s choice.)The McGraw-Hill Companies, Inc., 2003

McGraw-Hill/Irwin ©
11- 21

Accounting for Capital Stock

Transactions
◆ Two primary sources of stockholders’ equity:
● Contributed capital
◆ Par or stated value of issued stock.
◆ Additional paid-in capital in excess of par or

stated value.
● Retained earnings
◆ The cumulative net income earned by the
corporation less the cumulative dividends
declared by the corporation.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 22

Accounting for the Issue of

Common Stock
◆ When stock is issued, the equity
account Common Stock is
credited (increased) for the par or
stated value of the stock.
◆ If the stock sold for more than par,
the additional amount is credited
(increased) to the equity account
Paid in Capital in Excess of Par,
Common Stock.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 23

Record these transactions using the

Horizontal model then state their effects:
1. ABC Co. issued 21 shares of $10 par common stock for $12 each.
2. ABC Co. issued 10 shares of $100 par, 6% cumulative preferred
stock for $110 per share.
3. ABC Co. bought back 2 shares of its $10 par common stock at a
cost of $11 per share.
4. ABC Co. reissued 1 share of its $11 Treasury Stock for $13.
5. On 12/7 ABC declared dividends totaling $200. Last year preferred
dividends were not paid. (Assume sufficient R.E. exists.)
6. On 12/30, paid the dividends to stockholders’ of record on 12/24.
7. ABC declared and distributed a 10% stock dividend on outstanding
common stock. The market value on the declaration date was $15 per
share. (Assume sufficient R/E exists.)
8. The Board appropriated $20 of Ret. Earnings for future plant expansion.
9. At year-end, the company closed out the “Dividends Declared” account.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 24

Accounting for Capital Stock Transactions

The following abbreviations are used in the
horizontal model.
D/P = Dividends Payable
P/S = Preferred Stock C/S = Common Stock
PICinX-PS = Paid in Capital in Excess of par, Pref. Stock
PICinX-CS = Paid in Capital in Excess of par, Common Stk.
PICinTrStk = Paid in Capital in Excess of Cost from
Treasury Stock transactions
Unapp R.Earn = Unappropriated Retained Earnings
Approp R. Earn = Appropriated Retained Earnings
Divid Decl’d = (Cash) Dividends Declared
T.Stk or Treas. = Treasury Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 25

Complete the Horizontal Model

Note: Last year the company issued ten $10 common
shares for $12 each and earned a $300 Net Income.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1
2
3
4
5
6
7
8
9
B

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 26

Record the financial statement effect of each

transaction on this form.
Tran. Inc. Statem’t St. of Ch. in Stk. Eq. Cashflow
1.
2.
3.
4.
5.
6.
7.

8.
9.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 27

Special Note regarding the

Horizontal Model
◆ The horizontal model that follows
only has a Balance Sheet section.
Why?
➨ We needed to save space and,
➨ The Income Statement is NOT
AFFECTED by any of the stock
transactions described in this chapter.
➨ ALL stock and dividend transactions
affecting cash will be Financing Activities
on the cashflow statement.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 28

1. ABC Co. issued 21 shares of $10

par common stock for $12 per share.
Asset=Liability+ Stockholders’ Equity
Paid in Capital + Retained Earnings - T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC +Unapp +Approp - Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42

◆ Income Statement: No effect.

◆ Statement of Changes in Equity:
Stk.Eq. (PIC) increases by a total of $252.
◆ Statem’t of Cash Flows: Fin. Activ. $252 cash inflow.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 29

Accounting for the Issue of

Preferred Stock
◆ When stock is issued, the equity
account Preferred Stock is
credited (increased) for the par or
stated value of the stock.
◆ If the stock sold for more than par,
the additional amount is credited
(increased) to the equity account
Paid in Capital in Excess of Par,
Preferred Stock.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 30

2. ABC Co. issued 10 shares of $100 par, 6%

cumulative preferred stock for $110 per share.

Asset=Liability + Stockholders’ Equity

Paid in Capital + Retained Earnings - T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC + Unapp +Approp - Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100

◆ Income Statement: No effect.

◆ Statement of Changes in Stockholders’ Equity:
Stk.Eq. (PIC) increases by a total of $1,100.
◆ Statem’t of Cash Flows: Fin. Activ. $1100 inflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 31

Treasury Stock
◆ A corporation’s own stock that had been
issued but was subsequently reacquired
and is still being held by that corporation.
◆ Why would a corporation reacquire its
own stock?
● To reduce the shares outstanding.
● Because the market price is low.
● To increase earnings per share, if shares
won’t be reissued soon.
● To use in employee stock option programs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 32

Treasury Stock
◆ is considered issued stock but not
outstanding stock.
◆ has no voting or dividend rights.
◆ is a contra equity account.
◆ reduces total stockholders’ equity on
the Balance Sheet.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 33

3. ABC Co. bought back 2 shares of its

$10 par common stock for $11 per share.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC + Unapp +Approp - Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22

◆ Income Statement: No effect.

◆ Statement of Changes in Stockholders’ Equity:
Stk.Eq. decreases because T.S. (contra Eq.) increases.
◆ Statem’t of Cash Flows: Financing Activ. $22 outflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 34

Treasury Stock Transactions

◆ Treasury stock is recorded at cost.
◆ The account, Treasury Stock, is contra to all
of Equity and subtracted at the end of the
Equity section on the Balance Sheet.
◆ If the treasury stock is subsequently resold for
more than the cost, another equity account,
PIC-Treasury Stock, would be credited
(increased) for the excess over cost. If resold
for less than cost, debit (decrease) PIC-Tr.Stk.
◆ NO gains or losses are recorded on the
purchase or on the reissue of treasury stock.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 35

4. ABC Co. reissued 1 share of its $11

Treasury Stock for $13 per share.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC + Unapp +Approp - Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
◆ Income Statement: No effect.
◆ Statement of Changes in Stockholders’ Equity:
Stk.Eq. increases because T.S. (contra Eq.) decreases & PIC incr.
◆ Statem’t of Cash Flows: Financing Activ. $13 inflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 36

Accounting for Cash Dividends

◆ Dividends must be declared by the board of
directors before they can be paid.
◆ The corporation is not legally required to
declare (and subsequently pay) dividends.
◆ Once a cash dividend is declared, a liability
(Dividends Payable) is created.
◆ Cash dividends require sufficient cash and
retained earnings, but NOT necessarily
Net Income in the current year, to cover the
dividend.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 37

Dividend Dates
◆ Date of declaration
◆ Date of record
◆ Date of actual payment to shareholders
January

24
30

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 38

Dividends on Preferred Stock

◆ Current preferred dividends must be paid before
paying any dividends to common stock.
◆ If a preferred dividend is not paid, the unpaid
amount is either cumulative (a dividend in
arrears) or noncumulative.
● Cumulative: Unpaid dividends must be paid
before common dividends.
● Noncumulative: Unpaid dividends are lost.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 39

Calculating Preferred and

Common Dividends
◆ Remember ABC Co. has 10 shares of
$100 par, 6% cumulative preferred stock
outstanding. Assume that NO dividends
were paid in 2004.
◆ At the end of 2005, the Board of Directors
declares a total of $200 worth of
dividends for its preferred and common
shareholders.
◆ How much will go to the preferred
shareholders?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 40

Preferred Shareholders
get their dividends first:
◆ Cumulative means that the preferred shareholders
get all the past dividends that they were not paid
(called “dividends in arrears” which must be
footnoted, but NOT reported as a liability on the
balance sheet) before common stockholders can
receive a dividend.
◆ 10 preferred shares x $100 par x .06 = $60/year
◆ They get a total of $120: $60 for 2004 dividends in
arrears and $60 for 2005 current year dividend.
◆ Common shareholders get the remaining $80.
($80/30 shares outstanding=$2.67 per share.)
[31 shares issued - 1 still in Treasury = 30 shares outstanding.]

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 41

5. On 12/7 ABC declared dividends totaling

$120 on Preferred and $80 on Common.
(Assume sufficient Unappropriated Ret. Earnings exist.)
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC + Unapp +Approp Divid.- Treas.

B 420 Pref Com par 100
par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200

◆ Income Statement: No effect.

◆ Statement of Changes in Stockholders’ Equity:
R. Earn. decreases because Div. (contra Eq.) increases.
◆ Statem’t of Cash Flows: No effect.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 42

6. On 12/30 ABC Co. paid the dividends

to the stockholders of record on 12/24.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+D/P+P/S+C/S+PICin+PICin+ PIC + Unapp +Approp Divid.- Treas.

B 420 Pref Com par par100 X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
◆ Income Statement: No effect.
◆ Statement of Changes in Stk. Equity: No effect.
◆ Statem’t of Cash Flows: $200 Financing Act. outflow.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 43

Journal entries:
Dividends 200
Dividends Payable, Pref. 120
Dividends Payable, Com. 80
To record the declaration of cash dividends.

What is the journal entry when the dividends are

actually paid to the shareholders?

Dividends Payable, Pref. 120

Dividends Payable, Com. 80
Cash 200
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 44

Cash Dividends
◆ What’s needed to pay cash dividends?
● retained earnings
● cash (but, could borrow cash to pay dividend)
● no restrictions from outsiders

◆ Effects of cash dividends on financial

statements
● decreases Assets (when they are actually
paid) and Retained Earnings (dividends).
● NO EFFECT on Net Income.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 45

Accounting for Stock

Dividends
◆ Stock dividends are distributions to
stockholders of additional shares of stock,
NOT CASH!
◆ Why issue a stock dividend?
◆ Low on cash (but want to “reward”
stockholders)
◆ To decrease market price of stock. Why?
◆ To increase number of stockholders
(assuming some of the newly issued
stock will be sold).

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 46

Accounting for Stock

Dividends
◆ All stockholders receive the same percentage
increase in the number of shares they own
(pro rata basis).

◆ No change in total stockholders’ equity.

◆ No change in par values.

◆ Affect on financial statements?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 47

7. ABC declared a 10% stock dividend on Com. Stk.

[30 outstanding $10 par shares, $15 market value each.]
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100 par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
7

◆ Income Statement:
◆ Statement of Changes in Stockholders’ Equity:
◆ Statemen’t of Cash Flows:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 48

Valuing the Stock Dividend

How many new shares are issued?
Stock Dividend % X # shares outstanding
% X shares
= new shares
Value of the STOCK dividend?
# of new shares X Market value on date
of declaration
shares X $
= $ in total
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 49

Valuing the Stock Dividend

How many new shares are issued?
Stock Dividend % X # shares outstanding
10% X 30 shares
= 3 new shares
Value of the STOCK dividend?
# of new shares X Market value on date
of declaration
3 shares X $15
= $45 in total
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 50

Valuing the Stock Dividend

How is the $45 allocated to the stock accounts?
Value of Stock dividend $
Less: $10 par value of 3 new shares
= Paid in Capital in excess of par-C.S. $
Question: What if the Common Stock was
“no par” stock?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 51

Valuing the Stock Dividend

How is the $45 allocated to the stock accounts?
Value of Stock dividend $45
Less: $10 par value of 3 new shares 30
= Paid in Capital in excess of par-C.S. $15
Question: What if the Common Stock was
“no par” stock?
Then all $45 would go into the “Common
Stock - No par” account.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 52

7. ABC declared a 10% stock dividend on Com. Stk.

[30 outstanding $10 par shares, $15 market value each.]
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100 par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
7 30 15 (45)

◆ Income Statement: No effect.

◆ State. of Ch. in Eq: No effect on total Eq, but less R.E, more PIC.
◆ Statem’t of Cash Flows: NO EFFECT! (Not a CASH div.)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 53

Retained Earnings
◆ Appropriating (or Restricting) Retained
Earnings
● Board of Directors can restrict (imposed by
outsiders) or appropriate (company’s choice)
portions of retained earnings.
◆ It is a way of communicating why more
dividends are not being paid.
◆ Does NOT change TOTAL Ret. Earnings.

An appropriation (or “restriction”) only separates the

retained earnings into two categories, unappropriated
and appropriated. (Must have Unappropriated or
Unrestricted R.E. to declare dividends.)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 54

8. Board appropriated $20 of Retained Earn.

for future plant expansion.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100 par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
7 30 15 (45)
8 (20) 20
◆ Income Statement: No effect.
◆ State. of Ch. in Eq: No change in TOTAL Ret. Earn. or Equity.
◆ Statem’t of Cash Flows: No effect.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 55

9. At year-end, the company closed out the

“Dividends Declared” account.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100 par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
7 30 15 (45)
8 (20) 20
9 (200) (200)
B

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 56

What is the financial statement effect of each

transaction:
Tran. Inc. Statem’t St. of Ch. in Stk. Eq. Cashflow
1. No effect Paid in Cap. Increased Inflow F.A.
2. No effect Paid in Cap. Increased Inflow F.A.
3. No effect Stk. Eq. Decreased Outflow F.A.
4. No effect Stk. Eq. Inc, b-cuz TS dec. Inflow F.A.
5. No effect R.E dec. b-cuz Div. Increase No effect
6. No effect No effect (asset & Liab. dec.) Outflow F.A.
7. No effect No effect on TOTAL Stk.Eq. NO effect
(but less R.E. and more PIC) (stock given,
not cash.)
8. No effect No effect, Total Ret. E. same No effect
9. No effect No effect, Total RE same No effect
(close of Div. offset by RE decr.)

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 57

Calculate final balances for the Stockholders’

Equity section of the year-end Balance Sheet.
Asset=Liability + Stockholders’ Equity
Paid in Capital + Retained Earnings T.Stk

Cash=D/P+ D/P+P/S +C/S+PICin+ PIC + PICin+Unapp+Approp Divid.- Treas.

B 420 Pref Com par 100 par X-PS X-CS
20 TrStk R.Earn
300 R. Earn. Decl’d @ cost
1 252 210 42
2 1100 1000 100
3 (22) 22
4 13 2 (11)
5 120 80 200
6 (200) (120) (80)
7 30 15 (45)
8 (20) 20
9 (200) (200)
B 1563 0 0 1000 340 100 77 2 35 20 0 11
Stockholders’ Equity section of Balance Sheet on next slide.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 58

Stockholders’ Eq. section of ABC’s Balance Sheet

Stockholders’ Equity:
Preferred Stock, $100 par, 6% cumulative,
xxx shares authorized, 10 shares issued & outstand’g $
Common Stock, $10 par, yyy shares authorized,
31 shares issued, 30 shares outstanding
Paid-in-Capital in Excess of Par-Preferred
Paid-in-Capital in Excess of Par-Common
Paid-in-Capital in Excess of Cost-Treasury Stock
Total Paid-in-Capital $1,519
Retained Earnings
Appropriated $
Unappropriated
Total Retained Earnings
Total $
Less: Treasury Stock, 1 share at cost
Total Stockholders’ Equity $1,563

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 59

Stockholders’ Eq. section of ABC’s Balance Sheet

Stockholders’ Equity:
Preferred Stock, $100 par, 6% cumulative,
xxx shares authorized, 10 shares issued & outstand’g $1,000
Common Stock, $10 par, yyy shares authorized,
31 shares issued, 30 shares outstanding 340
Paid-in-Capital in Excess of Par-Preferred 100
Paid-in-Capital in Excess of Par-Common 77
Paid-in-Capital in Excess of Cost-Treasury Stock 2
Total Paid-in-Capital $1,519
Retained Earnings
Appropriated $20
Unappropriated 35
Total Retained Earnings 55
Total $1,574
Less: Treasury Stock, 1 share at cost (11)
Total Stockholders’ Equity $1,563

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 60

Accounting for Stock Splits

◆ Distributions of 100% or more of
stock to stockholders.
◆ Decreases par value per share of
stock, but total par value stays the
same.
◆ Increases number of outstanding
shares.
◆ No change in total stockholders’
equity.
◆ Does not require a journal entry.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 61

Stock Split: example

◆ XYZ Co. has 1000 shares outstanding.
Each share has a $10 par value, but is selling
on the NYSE for $80 per share.
The Company declares a 4 for 1 stock split.

Complete the following:

Before After
1,000 4,000
# shares outstanding $10 $2.50
Par value per share $10,000 $10,000
Total par value $80,000 $80,000
Total stock market value $80 $20
Market value per share
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 62

Stock Split: example

◆ XYZ Co. has 1000 shares outstanding.
Each share has a $10 par value, but is selling
on the NYSE for $80 per share.
The Company declares a 4 for 1 stock split.

Complete the following:

Before After

# shares outstanding
Par value per share
Total par value
Total stock market value
Market value per share
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 63

Stock Split: example continued

◆ XYZ Co. has 1000 shares outstanding.
Each share has a $10 par value, but is selling
on the NYSE for $80 per share.
The Company declares a 4 for 1 stock split.
Ms. Smith owned 100 shares before the split.
Complete the following for Ms. Smith’s stock:
Before After
100 400
# shares owned…………... 1,000 4,000
Total company shares…... 10% 10%
% of stock owned………...
Total market value of $8,000 $8,000
Ms. Smith’s
Remember, the stockstock…….
price dropped from $80 to $20 per share.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 64

Stock Split: example continued

◆XYZ Co. has 1000 shares outstanding.
Each share has a $10 par value, but is selling
on the NYSE for $80 per share.
The Company declares a 4 for 1 stock split.
Ms. Smith owned 100 shares before the split.
Complete the following for Ms. Smith’s stock:
Before After

# shares owned…………...
Total company shares…...
% of stock owned………...
Total market value of
Remember, the stockstock…….
Ms. Smith’s price dropped from $80 to $20 per share.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 65

Retained Earnings
Represents the net income (loss) that has
been earned less dividends that have
been declared since the first day of
operations for the company.
Example (amounts assumed)

Balance January 1, 2004 $ 500,000

+ Net income for 2004 30,000
- Dividends for 2004:
Cash dividends (10,000)
Stock dividends ( 5,000)
Balance January 31, 2004 $ 515,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
11- 66

Retained Earnings

◆ What affects Retained Earnings?

● net income (or loss) [through closing entries]
● cash dividends
● stock dividends
● prior period adjustments
◆ Accounting ERRORS made in previous years
that are being corrected now.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 67

Price-Earnings Ratio
Selling price of one share of stock
Earnings per share*

This ratio is used by analysts to evaluate the

future prospects of a company.
◆ The higher the PE ratio, the more optimistic investors
are about a company’s future.
* Earnings per share = (net income - preferred dividends)
divided by the weighted average number of common
shares of outstanding stock. [Why is the “weighted
average” number of shares used?]

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

11- 68

Chapter 11

The End

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003