Chapter 11 - porting and Interpreting Stockholders Equity

Authorized Currently Issued Treasury Stock 20,000 shares

300,000 shares 267,000 shares Outstanding 247,000 shares

Chapter 11
Reporting and Interpreting Stockholders Equity
ANSWERS TO MINI-EXERCISES M113 The number of issued shares cannot exceed the number authorized. The number authorized is given in the exercise (300,000). Currently issued shares consist of those outstanding with investors (247,000) and those in treasury (20,000). Thus, the number of currently issued shares is 267,000 (= 247,000 + 20,000). This implies the company can issue 33,000 additional shares (300,000 267,000) before it reaches the maximum authorized of 300,000. Prior to the new issuance, the number of authorized, currently issued, and treasury and outstanding shares can be illustrated as: M115 Cash Assets +7,500,000 Liabilities NE Stockholders Equity Common Stock +7,500,000

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dr Cash (+A) (100,000 $75).............................................. 7,500,000 cr Common Stock (+SE) (100,000 $75)........................

7,500,000

Assuming the no-par value stock is issued for the same price as the par value stock ($75 per share), the effects on total assets, total liabilities, and total stockholders equity do not differ between no-par and par value stock.

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M116 Common stock is the basic voting stock issued by a corporation. It ranks after preferred stock for dividends and assets distributed upon liquidation of the corporation. The dividend rate for common stock is determined by the board of directors, and is based on the companys profitability. The dividend rate for preferred stock often is fixed by a contract. Common stock has more potential for growth than preferred stock if the company is profitable. On the other hand, the investor may lose more money with common stock than with preferred stock if the company is not profitable. It is advisable to invest in the common stock. If the company is similar to National Beverage Corp., it will most likely be profitable, which will lead to greater dividends and share price appreciation. If this is the case, common stock likely will generate a greater return on the $100,000 than preferred stock would. M117 Total Assets 1. Sold 5,000 shares 2. Sold 10,000 shares 3. Purchased 20,000 shares of treasury stock Cash: increase by $250,000 Cash: increase by $370,000 Cash: decrease by $900,000 Total Liabilities No change No change Total Stockholders Equity Increase by $250,000 Increase by $370,000 Decrease by $900,000 Net Income No change No change

No change

No change

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M119 April 15, 2010: dr Dividends Declared (+D,-SE) (500,000 x 0.40)................ 200,000 cr Dividends Payable (+L)................................................. May 20, 2010: No journal entry is recorded on the date of record. June 14, 2010: dr Dividends Payable (-L)..................................................... 200,000 cr Cash (-A)....................................................................... M1110 Stock Dividend (1) (2) (3) (4) No change in total assets No change in total liabilities Increase in common stock No change in total stockholders equity: retained earnings decrease is equal to the increase in common stock. (5) Decrease in market value M1112 dr Retained Earnings (-SE)................................................... 100,000 cr Common Stock (+SE).................................................... (200,000 shares x 50% x $1 par value) M1113 Past Year 100,000 shares $2 Current Year 100,000 shares $2 Total to Preferred Stockholders Remainder Available for Common Stock Dividends Total Dividends = = $ 200,000 200,000 400,000 600,000 $1,000,000 100,000 M1111 Stock Split No change in total assets No change in total liabilities No change in common stock No change in total stockholders equity Decrease in market value

200,000

200,000

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M1114 EPS = Net Income Average Number of Common Shares Outstanding $23,000 11,500 = $2.00

ROE

= =

Net Income Average Stockholders' Equity $23,000 (240,000 + 220,000) 2 = 10.0%

A competing company could have higher net income but lower EPS and ROE ratios if it had more shares outstanding, which generated more stockholders equity when issued.

ANSWERS TO EXERCISES E114 Stockholders Equity December 31, 2010 Contributed Capital: Preferred Stock, 6%, par $8, authorized 50,000 shares, issued and outstanding, 15,000 shares................................................ $120,000 Additional Paid-in Capital, Preferred Stock*............................................. 255,000 Common Stock, par $1, authorized 200,000 shares, 20,000 issued and outstanding, 20,000 shares................................................ Additional Paid-in Capital, Common Stock**............................................ 380,000 Total Contributed Capital................................................................... 775,000 Retained Earnings*.......................................................................................... 30,000 Total Stockholders Equity........................................................................ $805,000
* $255,000 = ($25 - $8 par) x 15,000 shares ** $380,000 = ($40,000 x 10 organizers) (2,000 shares x $1 par x 10 organizers) ***$30,000 = $40,000 $10,000

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E1114 Comparative results: Items Number of shares outstanding Par per share Common Stock Additional Paid-in Capital Retained Earnings Total Stockholders Equity Before Stock Transactions 150,000 $1 $150,000 88,000 172,000 $ 410,000 Case 1 After 10% Stock Dividend 165,000 $1 $ 165,000 193,000 52,000 $ 410,000 Case 2 After 100% Stock Dividend 300,000 $1 $ 300,000 88,000 22,000 $ 410,000 Case 3 After Stock Split 300,000 $0.50 $ 150,000 88,000 172,000 $ 410,000

Case 1: The 10% stock dividend is a small stock dividend, which is recorded at the market value of the stock at the time of the dividend. Consequently, $120,000 is transferred out of Retained Earnings (10% x 150,000 shares x $8 market price), with $15,000 going to Common Stock (10% x 150,000 shares x $1 par) and the $105,000 excess going into Additional Paid-in Capital. Case 2: The 100% stock dividend is a large stock dividend, which is recorded at the par value of the stock. Consequently, $150,000 (100% x 150,000 shares x $1 par) is moved from Retained Earnings to the Common Stock account. Case 3: The stock split did not change any account balances; its only effects were to (1) double the shares outstanding and (2) decrease par value per share from $1.00 to $0.50. Note: None of the cases changed total stockholders equity ($410,000) because they did not involve the disbursement of assets.

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E1119 Req. 1 Assets Stockholders Equity (Treasury Stock) - $60,000,000 - $60,000,000

Treasury Stock account is a contra-equity account, meaning that it is subtracted from the total stockholders equity. Cash also decreases on the balance sheet by the same amount. Req. 2 Winnebago may have decided to repurchase its stock from existing stockholders for a number of reasons: (1) to send a signal to investors that the company itself believes its own stock is worth purchasing, (2) to obtain shares that can be reissued as payment for purchases of other companies, and (3) to obtain shares to reissue to employees as part of employee stock plans that provide workers with shares of the companys stock as part of their pay. Because of Securities and Exchange Commission regulations concerning newly issued shares, it is generally less costly for companies to give employees repurchased shares than to issue new ones. Req. 3 Shares that are held in treasury stock do not participate in dividend payments. As a result, the purchase of treasury stock will reduce the amount of dividends that Winnebago pays in future years. Req. 4 At the time, Winnebago likely believed its future was bright; the company was not concerned with the fact that a stock dividend causes a reduction in Retained Earnings (a true stock split doesnt cause a reduction in Retained Earnings). A company needs to have an adequate balance in retained earnings to declare cash dividends in the future. So, if Winnebago was expecting some financial struggles, the company would likely have used a 2-for-1 stock split because it doesnt reduce Retained Earnings, which means it doesnt reduce the ability to declare cash dividends in the future. Based on its strong financial history, Winnebago is likely expecting financial success in the near future, and does not care that Retained Earnings is reduced by a stock dividend because its future earnings will rebuild sufficient Retained Earnings to allow cash dividends to be declared again.

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E1119 (continued) Req. 5 This 100% stock dividend would decrease Retained Earnings by the par value of the shares, but it would not affect total stockholders equity because the Common Stock account would be increased by the same amount. The EPS ratio would decrease because the number of outstanding shares doubled. The ROE ratio would not change because as mentioned earlier, the total stockholders equity does not change when a 100% stock dividend is declared and issued.

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ANSWERS TO SKILLS DEVELOPMENT CASES S114 Req. 1 There are at least two reasons why this is appropriate. First, for investors who bought Activision stock in the initial public offering on June 9, 1983, the current market price (about $22) would be more than they initially contributed to the company. Second, even if investors had purchased their investments above the current market price, Activision is not undercutting the current market price nor is the company requiring existing stockholders to sell their stock back to the company. Consequently, stockholders who do not care to sell at the current market price are not required to, and those who do want to sell will be indifferent between selling the stock back to the company versus selling it to another stockholder. Req. 2 No, the answer would not be different because Activision still is offering to repurchase at the going market price. Req. 3 Generally speaking, when management purchases stock in the company they run, its a sign that theyre confident in the companys ability to perform well into the future and that the current market price of the companys stock (in their judgment) is too low. So, this seems to be a positive sign overall. Req. 4 Yes, this would be a concern because it suggests that management might be acting opportunistically buying when the stock price is low (at $13.32 in December 2002) and selling when the price is high (at $26.08 earlier in the year). Although this kind of behavior is what you could expect from other investors, management is in a position to know far more about the companys prospects than other outside investors. Because of this access to inside information, the timing of stock purchases and sales seems overly fortunate and somewhat suspicious. Also, by knowing that management is willing to sell the companys stock when the price is high, it weakens the credibility of managements stock purchase as a sign of expected future financial success for the company.

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