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.
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.
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.
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
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.
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
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
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
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, 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.
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.
More problems (see answer in T5M7issuanceproblem1.doc)
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.
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.
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)
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.
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.
Like I mentioned in the earlier slide this is another example of a
treasury stock transaction
This is an example of a treasury stock with par value.
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.
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.
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.
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.
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.
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.
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