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Chapter 11 – Stockholders' Equity: Paid-In Capital
11 STOCKHOLDERS’ EQUITY:
PAID-IN CAPITAL
Chapter Summary
This, the first of two chapters on stockholders’ equity, treats topics concerned with the
paid-in capital of a corporation. Consideration of issues relative to retained earnings is deferred
to Chapter 12.
The advantages and disadvantages of the corporate form are reviewed in detail, and the
distinctions between public and closely held corporations are explained. An extensive discussion
of the formation of a corporation highlights the rights of stockholders and the roles of corporate
directors and officers.
The treatment of accounting procedures regarding paid-in capital concentrates on the
issuance of capital stock and the stockholders’ equity section of the balance sheet. The concept
of par value is explained in detail, as is additional paid-in capital. The introduction of preferred
stock leads to more complex illustrations of the stockholders’ equity section. Preferences with
respect to dividends and assets are explained and illustrated. Call and conversion features of
preferred stock are also introduced. Other topics dealing with capital stock that are covered
include issuance for assets other than cash, donated capital, and stock subscriptions.
The calculation of book value per common share is explained and illustrated before
attention turns to factors concerning market values. The significance of market price to the
issuing corporation is contrasted to its significance to the investor. We then explain the roles of
interest rates and investor expectations in the determination of market prices.
Since stock splits and treasury stock transactions impact the presentation of paid-in
capital on the balance sheet, they are also introduced in this chapter. Journal entries to record
both the purchase and reissuance of treasury shares are provided. We explain and emphasize that
profits and losses on treasury stock transactions are not recognized.
Learning Objectives
1. Explain the advantages and disadvantages of organizing a business as a corporation.
2. Distinguish between publicly owned and closely held corporations.
3. Explain the rights of stockholders and the roles of corporate directors and officers.
4. Account for paid-in capital and prepare the equity section of a corporate balance sheet.
5. Contrast the features of common stock with those of preferred stock.
6. Discuss the factors affecting the market price of preferred stock and common stock.
7. Explain the significance of book value and market value of capital stock.
8. Explain the purpose and the effects of a stock split.
Financial Accounting, 16e 11- 1
9. Account for treasury stock transactions.
Brief topical outline
ACorporations
1 Why businesses incorporate – see Your Turn (page 487)
1Publicly owned corporations
aPublicly owned corporations face different rules
B Formation of a corporation
2Organization costs
3Rights of stockholders
4Functions of the board of directors
4Functions of the corporate officers
5Stockholder records in a corporation
aStockholders subsidiary ledger
bStock transfer agent and stock registrar
C Paid-in capital of a corporation
1Authorization and issuance of capital stock
aState laws affect the balance sheet presentation of stockholders’ equity
bPar value
cIssuance of par value stock
dNo-par stock
2Common stock and preferred stock
3Characteristics of preferred stock – see Case in Point (page 493)
aStock preferred as to dividends
bCumulative preferred stock
cOther features of preferred stock
4Book value per share of common stock
aBook value when a company has both preferred and common stock
DMarket value
1 Accounting by the issuer
2 Accounting by the investor – see Case in Point (page 497)
3Market price of preferred stock
4Market price of common stock
5Book value and market price
6Stock splits
ETreasury stock
1Recording purchases of treasury stock
2 Reissuance of treasury stock
3Stock buyback programs
4 Financial analysis and decision making – see Your Turn (page 501) and
Ethics, Fraud, & Corporate Governance (page 502)
FConcluding remarks
Chapter 11 – Stockholders' Equity: Paid-In Capital
Topical coverage and suggested assignment
Homework Assignment (To Be Completed Prior to Class)
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises
Exercises Problems Critical
Thinking
Cases
1 A - B 1, 2 1 3
2 C – D 3, 4, 5, 8 3, 4, 6 4, 5, 6 6
3 E – F 12, 13, 14 8, 9, 10 7, 8, 9 6
Comments and observations
Teaching objectives for Chapter 11
In this chapter, we provide a comprehensive introduction to factors a ecting
paid-in capital and its presentation on the balance sheet. Our teaching
objectives are to:
1 Discuss the advantages and disadvantages of corporations.
2 Explain the nature of a publicly owned corporation.
3 Explain the roles of corporate directors and officers and the rights of stockholders.
4Illustrate accounting for the issuance of capital stock in exchange for cash or other assets.
Explain the role of an underwriter in the issuance of capital stock.
5Discuss the typical features of preferred stock and contrast these features with those of
common stock.
6 Illustrate the computation of book value per share (with preferred stock outstanding).
Distinguish among the concepts of book value, par value, and market value.
7 Explain the most important determinants of the market values of preferred and common
stock.
8Explain the nature and purpose of stock splits.
9Explain the rationale for treasury stock transactions, and illustrate the related accounting
entries.
General comments
This chapter builds on the introduction to corporations earlier in the text. Because of the
new terminology introduced, we always assign Exercise 2 and also advise students to study the
Chapter 11 – Stockholders' Equity: Paid-In Capital
list of key terms at the end of the chapter. We recommend assigning several exercises and
problems requiring students to prepare the stockholders' equity section of a corporate balance
sheet. The assignment material has been written to assist in this regard. Once students have a
basic understanding of stockholders' equity, we find it helpful to review either Problem 5 or 6 in
class, calling on students to explain their answers to each part. Exercise 5 is a shortened version
of these problems and is suitable for use as a quiz.
In discussing preferred stock, we point out the similarities between preferred stock and
long-term debt. You may find the asides below useful in such discussions.
We emphasize the relationship (or lack thereof) among par value, book value, and market
value of a share of stock. Problem 7 is designed for this purpose and it can be covered quickly in
class.
Discussion Question 10 makes the important point that secondary market activity does
not directly affect the financial position of the company that issued the securities. We have been
careful to make this point in the textbook and in our classrooms ever since the great stock market
crash of 1987. This crash brought to our attention that even many senior accounting majors
failed to recognize this point.
An aside The basic purpose of issuing preferred stock is to raise capital from a particular type of
investor. Just as General Motors offers several makes of cars to attract different consumers, it
offers several types of stock to appeal to different investors. In fact, GM now offers more "lines"
of stock than of cars. The company produces five makes of automobile ¾ Chevrolet, Pontiac,
Buick, Oldsmobile, and Cadillac. However, it has outstanding eight issues of capital stock ¾
five issues of preferred (three of which are convertible), its basic common stock, and two
"special issues" of common stock (minority interests in several GM subsidiaries). Six of GM's
eight stock issues are traded daily on the New York Stock Exchange; the other two are held by
employee pension plans.
Another aside In some respects, preferred stock more closely resembles debt than equity. For
example, preferred dividends are fixed in amount, rather than dependent upon the level of
earnings. Also, preferred stockholders usually have no voting power. The key criterion
distinguishing preferred stock from a liability is that liabilities mature ¾ that is, they ultimately
must be paid off. The SEC has taken the position that the "redeemable" preferred stock issued
by several corporations should be classified in the balance sheet as debt rather than equity. The
redeemable shares could be redeemed at their par value for cash, at the option of the shareholder.
In making the decision, the SEC felt that the redemption option made the shares equivalent to
demand notes payable rather than equity securities.
Supplemental Exercises
Group Exercise
Go to http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-stocksplit and
research the history of Hewlett-Packard’s stock. Since going public how often has Hewlett-
Packard split its common stock? What was the average share price prior to these splits? Discuss
why the company split its shares on these occasions.
Chapter 11 – Stockholders' Equity: Paid-In Capital
Internet Exercise
Access the latest annual report of Pepsico at http://www.pepsico.com/ and locate the
consolidated balance sheet. How many shares of treasury stock does Pepsico own as of
December 31?
CHAPTER 11 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1Lewis Corporation issued 125,000 shares of $5 par value capital stock at date of incorporation
for cash at a price of $9 per share. During the first year of operations, the company earned
$140,000 and declared a dividend of $100,000. At the end of this first year of operations, the
balance of the Capital Stock account is:
a$765,000. c$625,000.
b$1,000,000. d$665,000.
2Perez Corporation has 100,000 shares of $1 par value common stock and 20,000 shares of 8%
cumulative preferred stock, $100 par value, outstanding. The balance in Retained Earnings at
the beginning of the year was $1,600,000, and one year's dividends were in arrears. Net
income for the current year was $870,000. If Perez Corporation paid a dividend of $2 per share
on its common stock, what is the balance in Retained Earnings at the end of the year?
a$2,150,000. c$2,110,000.
b$2,270,000. d$1,950,000.
3Pike Corporation has total stockholders’ equity of $8,690,000 as of December 31, 2009. The
company has 300,000 shares of $2 par value common stock and 20,000 shares of 8%
cumulative preferred stock, $100 par value, outstanding. Due to lower-than-expected net
income, no dividends were declared by Pike’s board of directors for 2009. The book value per
share of common stock is:
a$25.00. c$23.00.
b$21.77. d$25.60.
4Which of the following most likely explains why a corporation’s stock trades at a very high
price-earnings ratio?
aInvestors expect the corporation to have higher earnings in the future.
bThe corporation pays a very low dividend on its stock.
cThe corporation has several classes of stock outstanding.
dThe corporation is large with very low risk.
5Which of the following is not a characteristic of most preferred stocks?
aPreference as to dividends.
bNo voting power.
cConvertible into common stock.
dPreference as to assets in the event of liquidation of the company. CHAPTER 11
NAME # __________________
10-MINUTE QUIZ B SECTION
Financial Accounting, 16e 11- 5
Chapter 11 – Stockholders' Equity: Paid-In Capital
Shown below is information relating to the stockholders’ equity of Revere Corporation at
December 31, 2009
8% cumulative preferred stock, $100 par,
50,000 shares authorized, 15,000 shares issued....................................... $1,500,000
Common stock, $5 par, 1,500,000 shares authorized,
1,300,000 shares issued and outstanding................................................. 6,500,000
Additional paid-in capital: preferred stock.................................................. 250,000
Additional paid-in capital: common stock.................................................. 3,750,000
Retained earnings....................................................................................... 3,260,000
Each account needs a $ sign.
Answer the following questions based on the stockholders’ equity section given above.
1Refer to the above data. The average issue price per share of Revere’s preferred stock
was:
a$117. b$100. c$110. d$34.50.
2Refer to the above data. The total amount of Revere’s paid-in capital at December 31,
2009, is:
a$ 8,000,000.
b$15,260,000.
c$12,000,000.
d$ 4,000,000.
3Refer to the above data. Revere’s total legal capital at December 31, 2009, is:
a$12,000,000.
b$15,260,000.
c$11,260,000.
d$ 8,000,000.
4Refer to the above data. The book value per share of common stock, assuming current-
year preferred dividends have been paid, is:
a$9.23. c$8.66.
b$10.39. d$6.15.
5Refer to the above data. The balance in Retained Earnings at the beginning of the year
was $2,710,000, and there were no dividends in arrears. Net income for 2009 was
$2,250,000. What was the amount of dividend declared on each share of common stock
during 2009?
a$1.30. c$1.21.
b$2.40. d$3.72.
CHAPTER 11 NAME #
10-MINUTE QUIZ C SECTION
Shown below is information relating to the stockholders’ equity of Novake Corporation at December
31, 2010:
8% cumulative preferred stock, $100 par,
100,000 shares authorized, 7,000 shares issued................................................ $ 700,000
Common stock, $3 par, 1,000,000 shares authorized,
500,000 shares issued and outstanding............................................................. 1,500,000
Additional paid-in capital: preferred stock........................................................... 400,000
Additional paid-in capital: common stock............................................................ 500,000
Retained earnings................................................................................................ 800,000
From the above information, compute the following:
1The total amount of legal capital: $__________
2The total amount of paid-in capital: $__________
3The average issue price per share of preferred stock: $_____ per share
4The book value per share of common stock (assume current-year preferred dividends have been paid)
$_____ per share
5The balance in Retained Earnings at the beginning of the year was $650,000, and there were no
dividends in arrears. Net income for 2010 was $475,000. What was the amount of dividend declared
on each share of common stock during 2010? $_____ per share
CHAPTER 11 NAME #
10-MINUTE QUIZ D SECTION
1.Shown below is the stockholders’ equity section of Powell’s balance sheet at December 31,
2009:
Stockholders’ equity:
Common stock, $2 par value, 500,000 shares authorized,
?? shares issued......................................................................................... $ 500,000
Additional paid-in capital: common stock........................................................ 1,750,000
Total paid-in capital.................................................................................... $2,250,000
Retained earnings.............................................................................................. 2,400,000
Total stockholders’ equity.................................................................................. $4,650,000
In 2010, the following events occurred:
Powell issued 2,500 shares of $2 par common stock as payment for legal services. Although
Powell’s stock is not traded on any exchange, the agreed-upon value of the legal services is
$80,000.
Powell issued 4,500 shares of 6% cumulative preferred stock, $100 par value, for $106 per share.
The board of directors declared a dividend of $1.25 per share on the common stock.
Powell’s net income for 2007 was $675,000.
Instructions
Complete in good form the stockholders’ equity section of a balance sheet prepared for Powell at
December 31, 2010.
Stockholders’ equity:
6% cumulative preferred stock, $100 par value,
10,000 shares authorized, 4,500 shares issued........................... $
_______
Total paid-in capital......................................................................... $
Total stockholders’ equity.................................................................................$________
Financial Accounting, 16e 11- 7
Chapter 11 – Stockholders' Equity: Paid-In Capital
SOLUTIONS TO CHAPTER 11 10-MINUTE QUIZZES
QUIZ A QUIZ B
QUIZ C
1
$700,000 + $1,500,000 = $2,200,000 total legal capital
2
stock/500,000 shares common stock outstanding = $6.40 book value per share of common stock
5
Retained earnings, beginning of year.......................................................................... $ 650,000
Net income................................................................................................................. 475,000
Amount of dividends to common stockholders........................................................... $269,000
$269,000/500,000 shares common stock = $.54 dividend per share
QUIZ D
Stockholders’ equity:
6% cumulative preferred stock, $100 par value,
10,000 shares authorized, 4,500 shares issued................................................... $ 450,000
Common stock, $2 par value, 500,000 shares
Chapter 11 – Stockholders' Equity: Paid-In Capital
Retained earnings.................................................................................................... 2,732,375*
Total stockholders’ equity........................................................................................ $5,539,375
Financial Accounting, 16e 11- 9
Chapter 11 – Stockholders' Equity: Paid-In Capital
Assignment Guide to Chapter 11
Brief
Exercises
Exercises Problems Cases Net
1-10 1-15 1 2 3 4 5 6 7 8 9 1 2 3 4 5
Time estimate (in minutes) <15 <15 40 40 25 30 30 30 15 30 50 15 25 30 20 30
Difficulty rating E E M M S M M M E M S M S M E E
Learning Objectives:
1, 2 √
1. Explain the advantages and
disadvantages of organizing a business
as a corporation.
2. Distinguish between publicly owned and
closely held corporations. 1, 2 √
3. Explain the rights of stockholders and
the roles of corporate directors and
officers. 1, 2 √
4. Account for paid-in capital and prepare
the equity section of a corporate balance
sheet.
1, 2, 9, 10
2, 3, 4, 5, 7, 8,
12, 13, 15
√ √ √ √
5. Contrast the features of common stock
with those of preferred stock. 3, 4, 5 2, 3, 4, 5, 6, 8 √√ √ √
6. Discuss the factors affecting the market
price of preferred stock and common
stock. 2, 5, 6, 8 √√
7. Explain the significance of book value
and market value of capital stock. 6, 7 2, 5, 7, 8, 15 √√ √ √
√
8. Explain the purpose and effects of a
stock split.
8, 9 2, 6, 10, 13,
14 √√
9. Account for treasury stock transactions. 10 2, 9, 11, 14 √ √
11- 10 Instructor’s Resource Manual
