Stockholder’s Equity

COMPONENTS OF S/E

Par Value
• Required: report total par value for all shares issued and outstanding
• Represents legal capital of corporation (provides minimal protection for creditors)
• In most states, corporations cannot pay any dividends out of par value

APIC
• What shareholders were willing to pay in excess of par or stated value

Retained Earnings
• Cumulative NI of the corporation since incorporation after subtracting dividends

Accumulated Other Comprehensive Income (OCI)

• Is cumulative
Items
• Foreign currency translation adjustment
• Gain/Loss on AFS security

DIVIDENDS
If declared dividend is > accumulated earnings = “partially liquidating dividend”
Retained Earnings 1500 [balance of R/E available to distribute]
APIC 250
Dividends Payable 1750 [amount of dividend declaration]

Pure Liquidating Dividend (by definition: return of capital)

APIC xx
Dividend payable xx

Preferred Dividends
Cumulative – P/S dividends in arrears must be paid before common shareholders get paid
Participating – Puts a limit/ceiling on what common stockholders may receive (same rate as preferred)
• Ex: After P/S have been paid, common S/H entitled to (P/S % * C/S par value)
Non-Participating – Following payment of fixed P/S dividend, remainder goes to Common
Stockholders

Dividends in Arrears
• Report divs in arrears as a disclosure. No liability exists until divs are declared by board.

Payment order for Dividends

1. Cumulative P/S dividends in arrears
2. Current year P/S dividends
3. Common stockholders
a. If P/S is participatingà limited to (Par * P/S rate)
b. If P/S is nonparticipatingàThe rest all goes to the common stockholders
4. Remainder: Participation (if applicable)
 a. Allocate to Common and Preferred Shareholders based on relative par value

STOCK DIVIDENDS
• Dividend declared in the form of shares
• Guideline:
• If shares outstanding increases by 25% or more, treat as a split
• Less than a 25% increase in shares, treat as stock dividend

Recording a Stock Dividend

• Use FMV at date of declaration
• Stock dividends or splits never affect total S/E (BV or corporation)
• In essence, have capitalized a portion of R/E
• Increases total shares outstanding by x%

R/E 300,000 [6,000 new shares * $50/share FMV @

declaration date]
C/S 60,000 [6,000 shares * $10 par]
APIC 240,000 [PLUG, to balance]

Recording a Stock Split

• Example: 100% stock div (2 for 1 stock split)
• Use PAR VALUE at date of declaration
Two ways to handle
1. Memo entry only: Shares outstanding double, par is cut in half
2. Book a JE (capitalize R/E @ par): To maintain par value (for legal reasons, bylaws, etc…)

R/E 600,000 [60,000 new shares * $10 par]

C/S 600,000

Receiving a Stock Dividend/Stock Split

• Memorandum entry only: Recalculate cost per share
• No Income associated with transaction in financial accounting

Cash Dividend Entry @ Declaration

R/E xx
Cash dividend payable xx

Property Dividends
• Dividends issued in the form other than cash or same company stock
• Ex: MSFT sends you 100 shares of AOL as a dividend = property dividend
• KEY: Always record @ FMV of property on date of declaration
• If N/P is issued in lieu of cash, Dr. R/E by face amount only (interest expense not part of
div)
Property Dividend Example JE: on 12/1/x1, declared property dividend of marketable securities (CV =
60K, FMV = 78K)

R/E 78K
Investment in Mkt Sec’s 60K [carrying amount]
Gain on investment 18K [must recognize gain upon
disposal]

Stock Options (meant to be compensation)

• WHEN TO MEASURE: Day of the stock option grant
• VALUATION: Use the fair value of the stock options on the day of the grant
• FMV of option will be given on the CPA exam

Black-Scholes Model to estimate FV of Options

DEVILS – helpful pneumonic

Dividends
What are the expected dividends from the shares?
Exercise Price
At what price can employees buy the stock?
Volatility
How volatile is the stock?
Interest Rates
High or low in terms of discounting?
Life of options
How long do I have to exercise the option (when does it expire)?
Stock Price
What is the stock trading at on the day of the grant?

JE on day of the stock option grant

Deferred Compensation 160K [FMV of option @ date of grant]
“contra equity acct”
Stock Options Outstanding 160K [FMV of option]
“S/E account”

KEY: Must allocate compensation over time service is rendered (4 years in this example)!!!

NOTE: “Deferred Compensation” is contra to S/E (reduces net S/E)

12/31/x1
Compensation Expense 40K [160K / 4 years of service]
Deferred Compensation 40K

Upon Exercise of Stock Options

Cash 250K [10,000 shares @ $25/share option price paid by
option holder]
Stock Options Outstanding 160K
C/S 100K [10K shares @ $10 par issued]
 APIC 310K [PLUG]

*Note: Exercise of options has no effect on allocating compensation over service years

TREASURY STOCK (contra to Common Stock account)

• When a corporation acquire shares of its own stock, they immediately go to the treasury
• T/S are considered authorized & issued, but NOT outstanding
• Reported in B/S as a “contra equity item” (Dr. bal- reduces total S/E)
• Cost of T/S places restriction on R/E available for distribution as dividends
• Footnote required: Can distributed all of R/E, except cost of T/S

Methods to Account for Treasury Stock

Assumptions: $10 par, $5 APIC, per share. 1000 shares issued

Cost Method
To record acquisition of T/S (at $18/share)
T/S 3,600 [200 shares acquired * $18 cost/share]
Cash 3,600
To record Sale of T/S (at $20/share)
Cash 2,000 [100 shares * $20/share sale price]
T/S 1,800 [@ cost of T/S]
APIC – T/S 200 [PLUG, never realize gain when dealing
with T/S]

To record Sale of remaining T/S (at $12/share)

Cash 1,200 [100 shares * $12/share]
APIC- T/S 200 [wipe out first, to extent of acct bal from previous T/S
gains]
R/E 600 [PLUG, to balance]
T/S 1,800 [@ cost]

RULE: When selling T/S for a loss, can only debit APIC-T/S to the extent of prior gains on T/S
• i.e. – The APIC-T/S account CANNOT HAVE A DEBIT BALANCE!!!!

Par Value Method

Assumptions: $10 par, $5 APIC, per share. 1000 shares issued

To record acquisition of T/S (200 shares @ $18/share)

T/S 2,000 [200 shares * $10 par]
APIC 1,000 [$5 original APIC/share * 200 shares]
R/E 600 [PLUG]
Cash 3,600 [$18/sh * 200 shares acquired]

To record selling T/S (200 shares @ $14/share)

Cash 2,800 [200 shares *$14/sh]
T/S 2,000 [T/S is at par, not cost!]
APIC 800 [PLUG]
 Stock Subscription w/partial down payment in current year
Cash xx [20% down payment]
Subscriptions receivable xx [balance due, 80%]
C/S subscribed xx [shares * par]
APIC xx [PLUG]

Incorporating @ FMV and issuing common stock

Assets xx [@FMV]
Liabilities xx [@FMV]
C/S – Par xx
APIC xx [PLUG = FV of net assets – par value of c/s
issued]

Appropriation of R/E
• Most states require that R/E be appropriated for the amount of T/S held @ B/S date
• Purpose: Restrict a portion of R/E from being available for dividends

Quasi-Reorganization
Primary Purpose: Eliminate accumulated deficit (negative R/E balance) so the company has a
fresh start with a $0 balance in R/E
• Involves restating assets to FMV and reducing the par value of C/S
C/S 250K [$25 reduction in par value * 10,000 shares]
R/E 210K [to eliminate 210K Dr. balance (deficit) in R/E
prior to re-org]
APIC 40K [PLUG]

Repurchase and retirement of Stock

• Par = $10; Issue price = $25; Reacquisition Price = $20
C/S – Par 10
APIC – C/S 15
Cash 20
APIC – retirement 5 [PLUG]

Note: Retained earnings can be decreased, but never increased, as a result of the acquisition and
retirement of its own common stock

Partnership Formation

BONUS METHOD for allocating capital accounts

• Assumes unidentifiable assets contributed to the PTP do not constitute a PTP asset
• Allocates total invested capital (identifiable) equally to PTR’s or according to PTP agreement
• Does not create intangible assets (goodwill)
• Use old profit/loss ratio to allocate bonus to old partners upon admission of new PTR
• Total capital of new PTP = (FV of new assets contributed) + (original PTR capital balances)
• Each PTR’s capital account then = (total PTP capital) * (that PTR’s capital interest %)
Retirement under Bonus Method
 • If final settlement to retiring PTR exceeds capital balance (represents unrecorded goodwill),
the excess is recorded as a decrease to the remaining PTR’s capital accounts

GOODWILL METHOD
• Revalues assets of PTP by recording goodwill, increases PTR’s capital accounts by same amt

Example: X contributes assets w/FMV of $60K, Y contributes $20K cash, each partner is entitled to an
equal initial capital balance under the PTP agreement. Under the goodwill method, what is Y’s capital
balance?
Answer: $60,000 (20K cash + 40K goodwill: the contributed unidentifiable asset)
Cash 20K
I/D Assets 60K
Goodwill 40K
X, capital 60K
Y, capital 60K
Example #2: Net assets of old PTP = 320K; New PTR pays 140K for 25% interest; goodwill is to be
recorded.

Implied value of PTP = 140K/25% = 560K

Identifiable assets of new PTP = 320K (old) + 140K (cash) = (460K)
Goodwill to allocate to old PTR’s based on profit/loss % = 100K

**So if old PTR A had 40% interest in profit/loss, he adds 40K to his capital account (G.W.)