Accounting For Managers
Professor ZHOU Ning
SCHOOL OF ECONOMICS AND MANAGEMENT
BEIHANG UNIVERSITY
[email protected]
Chapter 9
Sources of Capital: Owners’ Equity
The objectives of chapter 9



Ownership in a corporation
Earnings per share
Equity in nonprofit organizations
9-3
Principal Legal Forms of Business



Sole proprietorship.
Partnership.
Corporation.
9-4
Ownership in a Corporation


Evidenced by stock certificate.
Corporate charter (filed with state).


Indicates maximum number of shares
allowed to issue.
Owners’ equity called:

Shareholders’ or stockholders’ equity.
9-5
Preferred Stock




Usually issued with a face or par value.
In case of liquidation, entitled to receive
par value after liabilities settled and
before common shareholders receive
anything.
Pays stated dividend.
Dividend is not tax deductible as is
interest expense paid to debt holders.
9-6
Types of Preferred Stock
In 2006, Cotting Corporation did not pay the $9 dividend on each
 share
Cumulative
preferred:
dividends
in arrears
of its $9 cumulative
preferred stock.
Hence, no dividend
could
be
paidcurrent
on the common
stock
in 2006. In 2007
holder
Cotting’s
and
year’s
dividends
must
beofpaid
common stock cannot be paid any dividend unless $18 is paid on
before
common
dividends
can be
paid.
the
$9 cumulative
preferred(2007’s
$9 dividend
+ the
$9 from 2006).


Convertible preferred: convertible into a
specified number of shares of common.
Redeemable preferred: may be redeemed
by investor on or after a certain date at a
certain price (usually higher than par value).

SEC requires that it be shown on the BS between
Liabilities and Owners’ Equity.
9-7
Common Stock




Residual interest in net assets after all
creditors and preferred shareholders.
Par or stated value usually a nominal (small,
meaningless) amount.
Book value of common stock = total common
shareholders’ equity.
Common shareholders’ equity = Paid in
capital + retained earnings.
9-8
Common Stock (con.)

Paid in capital = Common stock at par
(or stated value) + capital contributed in
excess of par (also called “Additional
paid in capital” or “Other paid in capital”)
Dr. Cash
$700,000
Cr. Common stock at par
$100,000
Additional Paid-in Capital
600,000
9-9
Common Stock (con.)

Issuance cost.

Investment banker, legal, auditing, printing;
subtracted from Additional paid in capital
(shown net on the balance sheet).
Dr. Additional Paid-in Capital
Cr. Cash or accounts
$20,000
$20,000
9-10
Shareholder Sells Stock to Another Party


No affect on company accounts.
Company notes change of owners
and address of owners.
9-11
Treasury Stock


Corporation’s own stock that has been
issued and reacquired.
Reasons to reacquire own stock:







Limited investment opportunities.
Believe stock price is low.
To increase stock price.
To increase EPS.
Needed for acquisition.
To issue stock bonus to employees.
To prevent hostile takeover.
9-12
Accounting for Treasury Stock

Cost method (simpler method, a contra account
within shareholders’ equity):
 At acquisition, treasury stock:
Dr. Treasury stock
Cr. Cash

$10,000
$10,000
If reissued above cost:
Dr. Cash
$12,000
Cr. Paid-in capital
$2,000
Treasury stock
10,000

If reissued below cost:
Dr. Cash
Paid-in capital
Cr. Treasury stock
$8,000
$2,000
$10,000
9-13
Retained Earnings

Cumulative net income earned since
inception of company less cumulative
total dividends paid.
9-14
Appropriation of RE (Reserves)

Indicates retained earnings that are not
available for dividends.


Not a reduction of RE.


For example, restricting dividends due to needs for
planned future plant expansion.
Just designating a portion of RE to be restricted for
a specific purpose.
Appropriating RE does not mean that cash is
set aside cash. That is a separate decision.
9-15
Cash Dividends

At declaration (vote of the BOD):
Dr. Retained earning
$6,000
Cr. Dividend payable
$6,000

At payment:
Dr. Dividend payable
Cr. Cash
$6,000
$6,000
9-16
Stock Split





Each shareholder receives a multiple of
shares previously held.
(As in a stock dividend,) no change in total
shareholders’ equity.
No change to dollar amounts of account
balances. Par value per share is reduced
proportionately.
Reduce the price of a share of stock.
On the view point of shareholders, it may add
value to the corporation.
9-17
Stock Dividends



Increases every shareholders’ interest by the
same proportion of shares, say 5%.
Recorded at market value of the shares
distributed.
If the stock dividend is greater than 20-25%, it
is basically treated as a stock split.
9-18
Stock Dividends Example

If company A declared a 5% stock dividend to the
holders of its 100,000 outstanding shares (par value of
$1) when the market price of a share was $10.50, the
entry would be:
Dr. Retained earning
$52,500
Cr. Common stock at par
$5,000
additional paid-in capital
47,500


$52,500=$10.50/per share* 5,000 shares –FV
Total amount of owner’s equity is not changed by this
transaction.
9-19
Spin-offs


Company owns shares of another
company that it distributes to
shareholders.
Accounting is similar to a cash dividend
except credit is to the asset account,
Investments (instead of Cash).
Dr. Retained earning
Cr. Investment
$6,000
$6,000
9-20
Warrants


The right to purchase shares of
common stock at a stated price within a
given time period.
Negotiable (can be bought and sold).
9-21
Stock Options


Same as a warrant but not negotiable.
GAAP requires Fair value based method:


Expenses fair value of options over their
vesting period.
Vesting means option can be exercised
even if employee leaves the company.
9-22
Employee Stock Ownership Plan (ESOP)



A program of setting aside stock for
benefit of employees as a group.
Contributions to plan are tax deductible.
Separate entity whose assets do not
appear on balance sheet, but are
disclosed in notes.
9-23
Balance sheet presentation
9-24
Earnings Per Share (EPS)

GAAP requires reporting of:

Basic earnings per share

Diluted EPS.
9-25
Basic EPS Example


Net income available to common shareholders
= Net income – preferred dividends
Treasury stock is not considered outstanding.

In above example, if the company has outstanding
100,000 shares of $8 preferred stock, the basic EPS:
9-26
Diluted EPS Example

If converted method: to measure the potential dilutive
effect of basic EPS from convertible securities.(assumes
convertible security has been converted)
 In above example, if the 100,000 preferred stock can
be convertible into 200,000 common shares, two
adjustment must be made under assuming conversion
of the preferred stock:
a)
b)
The $800,000 preferred stock dividends that would not have
to be paid are added back to the $6,200,000 income
applicable to common stock used in the basic EPS calculation.
Convertible 200,000 shares are added to the actual 1,000,000
common shares outstanding.
9-27
Diluted EPS Example (con.)

Treasury stock method:


Assumes options or warrants are exercised and cash received by
corporation is used to purchase its stock at the average price of
stock during the period.
Net of number of common shares issued when options or
warrants are assumed exercised less assumed number of shares
purchased is added to denominator of basic EPS calculation.
 In above example, if it has stock option for 100,000 common
shares issued in 2005 at an exercise price of $10 per share,
two adjustment must be made under assuming the options
are exercise: (common stock in 2006 was $20 per share)
a) Issued 100,000 common shares and received $1m
b) Use $1m to buy 50,000 shares (market price), net of
number of common shares was 100,000-50,000=50,000
Discussion problem 9-2, P260
9-28
Answer for Discussion problem 9-2
600,000X$6.5
•Basic earnings per share =
•Diluted earnings per share =
($19,550,0 00  $3,900,000 )
 $7.83
?
2,000,000 shares
($19,550 ,000  $3,900 ,000 )
?
 $7.45
2,000 ,000  (200 ,000  100 ,000 ) *
*Assume 200,000 optional shares issued less assumed 100,000 shared
repurchased with option payments (200,000 shares x $10 per
exercised option) at $20 per share.
9-29
Equity in Nonprofit Organizations

Capital contributions usually in form of
endowment or contributed plant.



Endowment = contributions whose principal
is to be kept intact; earning on principal are
available to finance current operations.
Contributed plant = contributed buildings,
other assets, or funds to acquire assets.
Operating contributions are revenue not
contributed capital.
9-30
Summary of Chapter 9



Ownership in a corporation
Earnings per share
Equity in nonprofit organizations
9-31
Assignments of Chapter 9


Problem 9-1
Problem 9-7
9-32
Thank you
9-33