Chapter 11 – Reporting and Interpreting Owners’ Equity
11-1
CHAPTER 11
REPORTING AND INTERPRETING OWNERS’ EQUITY
Learning Objectives and Related Assignment Materials
Learning Objectives
Mini-
Exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
1. Explain the role of stock in the capital
structure of a corporation.
1, 2
1,2, 3, 4,
5, 6, 7, 8,
9, 12, 14
4, 5
3, 4
1, 2, 7
2. Analyze the earnings per share ratio.
1
1
3. Describe the characteristics of
common stock and analyze
transactions affecting common stock.
3, 4, 5
2, 3, 4, 5,
6, 7, 8, 9,
10, 11,
12, 13,
14, 15,
16, 22
1, 2, 3, 4,
5, 6, 7
1, 2, 3
1, 2, 7
4. Discuss dividends and analyze
transactions.
6, 7
4, 5, 12,
13, 14,
16, 17,
18, 19,
20, 25
1, 6, 8, 9,
10, 11
1, 4
1, 2, 3, 4,
5, 6, 7
5. Analyze the dividend yield ratio.
14
3
6. Discuss the purpose of stock
dividends, stock splits, and report
transactions.
9, 10
17, 19,
21, 23,
24
1, 6, 8, 9,
10, 11
1, 4
2, 3, 5, 7
7. Describe the characteristics of
preferred stock and analyze
transactions affecting preferred stock.
4, 8
3, 9, 10,
11, 18,
19, 20
2, 3, 8,
10, 11
2, 4
7
8. Discuss the impact of capital stock
transactions on cash flows.
16
7, 9
Chapter Supplement: Accounting for
owners’ equity for sole proprietorships
and partnerships
12
Synopsis of Chapter Revisions
Focus Company: The Kroger Company
▪ Focus and contrast company data updated.
▪ New GUIDED HELP feature provides free access to step-by-step video instruction on recording
transactions related to stock dividends and stock splits.
▪ New section on the statement of changes in stockholders’ equity.
▪ New CONTINUING CASE added to the end-of-chapter problems. Students are asked to record the
repurchase of shares by Pool Corporation, a public company, as well as all necessary entries related to
its dividends.
▪ New and updated real companies, as well as modified accounts, names, and amounts for fictional
companies in end-of-chapter exercises, problems, and cases.
Chapter 11 – Reporting and Interpreting Owners’ Equity
PowerPoint Slides
Learning Objectives
PowerPoint® Slides
1. Explain the role of stock in the capital structure of a corporation.
11-1 through 11-6
2. Analyze the earnings per share ratio.
11-7 through 11-8
3. Describe the characteristics of common stock and analyze transactions
affecting common stock.
11-9 through 11-19
4. Discuss dividends and analyze transactions.
11-20 through 11-21
5. Analyze the dividend yield ratio.
11-22
6. Discuss the purpose of stock dividends, stock splits, and report transactions.
11-23 through 11-25
7. Describe the characteristics of preferred stock and analyze transactions
affecting preferred stock.
11-26 through 11-31
8. Discuss the impact of capital stock transactions on cash flows.
11-32
Chapter Supplement: Accounting for owners’ equity for sole proprietorships
and partnerships
11-33 through 11-40
Related Video Programs
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-3
Chapter Take-Aways
1. Explain the role of stock in the capital structure of a corporation.
The law recognizes corporations as separate legal entities. Owners invest in a corporation and receive
capital stock that can be traded on established stock exchanges. Stock provides a number of rights,
including the right to receive dividends.
2. Analyze the earnings per share ratio.
The earnings per share ratio facilitates the comparison of a company’s earnings over time or with
other companies’ at a single point in time. By expressing earnings on a per share basis, differences in
the size of companies become less important.
3. Describe the characteristics of common stock and analyze transactions affecting common stock.
Common stock is the basic voting stock issued by a corporation. Usually it has a par value, but no-par
stock can be issued. Common stock offers some special rights that appeal to certain investors.
A number of key transactions involve capital stock: (1) initial sale of stock, (2) treasury stock
transactions, (3) cash dividends, and (4) stock dividends and stock splits. Each is illustrated in this
chapter.
4. Discuss dividends and analyze transactions.
The return associated with an investment in capital stock comes from two sources: appreciation and
dividends. Dividends are recorded as a liability when they are declared by the board of directors (i.e.,
on the date of declaration). The liability is satisfied when the dividends are paid (i.e., on the date of
payment).
5. Analyze the dividend yield ratio.
The dividend yield ratio measures the percentage of return on an investment from dividends. For most
companies, the return associated with dividends is very small.
6. Discuss the purpose of stock dividends, stock splits, and report transactions.
Stock dividends are pro rata distributions of a company’s stock to existing owners. The transaction
involves transferring an additional amount into the common stock account. A stock split also involves
the distribution of additional shares to owners but no additional amount is transferred into the
common stock account. Instead, the par value of the stock is reduced.
7. Describe the characteristics of preferred stock and analyze transactions affecting preferred
stock.
Preferred stock provides investors certain advantages including dividend preferences and a preference
on asset distributions in the event the corporation is liquidated.
8. Discuss the impact of capital stock transactions on cash flows.
Both inflows (e.g., the issuance of capital stock) and outflows (e.g., the purchase of treasury stock)
are reported in the Financing Activities section of the statement of cash flows. The payment of
dividends is reported as an outflow in this section.
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-4
Key Ratios
The earnings per share ratio states the income of a corporation on a per share basis. The ratio is
computed as follows:
Earnings per Share = Net Income ÷ Average Number of Shares of Common Stock Outstanding
The dividend yield ratio measures the dividend return on the current price of the stock. The ratio is
computed as follows:
Dividend Yield Ratio = Dividend per Share ÷ Market Price per Share
Finding Financial Information
Balance Sheet
Under Current Liabilities
Dividends, once declared by the board of
directors, are reported as a liability (usually
current).
Under Noncurrent Liabilities
Transactions involving capital stock do not
generate noncurrent liabilities.
Under Stockholders Equity
Typical accounts include:
Preferred stock
Common stock
Capital in excess of par
Retained earnings
Treasury stock
Income Statement
Capital stock is never shown on the income
statement. Dividends paid are not an expense.
They are a distribution of income and are,
therefore, not reported on the income
statement.
Statement of Stockholders’ Equity
This statement reports detailed information
concerning stockholders’ equity, including (1)
amounts in each equity account, (2) number
of shares outstanding, (3) impact of
transactions such as earning income, payment
of dividends, and purchase of treasury stock.
Statement of Cash Flows
Under Financing Activities
+ Cash inflows from initial sale of stock
+ Cash inflows from sale of treasury
stock
– Cash outflows for dividends
– Cash outflows for purchase of treasury
stock
Notes
Under Summary of Significant Accounting Policies
Usually, very little information concerning capital stock is provided in this summary.
Under a Separate Note
Most companies report information about their stock option plans and information about major
transactions such as stock dividends or significant treasury stock transactions. An historical
summary of dividends paid per share is typically provided. Also, dividends in arrears on preferred
stock, if any, would be reported in a note.
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-5
Chapter Outline
Teaching Notes
1. Explain the role of stock in the capital structure of a corporation.
Ownership of a Corporation
Show Video Program #13
A. Benefits of Stock Ownership
1. Owners of common stock receive a number of benefits:
a. A voice in management – Vote at the annual stockholders’
meeting with a number of votes equal to the number of
shares owned
b. Dividends – A proportional share of the distribution of
profits
c. Residual claim – A proportional share of the distribution
of remaining assets upon the liquidation of the company
2. Analyze the earnings per share ratio.
B. Authorized, Issued, and Outstanding Shares
Illustrated in Exhibit 11.1
1. Authorized number of shares – Maximum number of
shares of a corporation’s capital stock that can be issued
as specified in the charter
2. Issued shares – Total number of shares of stock that have
been sold
3. Outstanding shares – Total number of shares of stock that
are owned by stockholders on any particular date
a. Treasury stock – Stock that has been bought back
b. When a company buys back its stock, a difference is
created between the number of issued shares and the
number of outstanding shares (that is, shares currently
held by individual stockholders)
c. Treasury stock is included in “issued” but not in
“outstanding”
Use Supplemental
Enrichment Activity #1
C. Key Ratio Analysis: Earnings per Share (EPS)
1. Earnings per Share (EPS) = Net Income ÷ Average
Number of Common Shares Outstanding
2. Measures how well a company is performing
3. Useful in comparing companies of different sizes
4. While an effective and widely used measure of
profitability, it can be misleading if there are significant
differences in the market values of shares being compared
3. Describe the characteristics of common stock and analyze transactions affecting common stock.
II. Common Stock Transactions
A. Terminology
1. All corporations must issue common stock, but only some
issue preferred stock
2. Common stock – Basic voting stock issued by a
corporation
3. Par value – Nominal value per share of capital stock
specified in the charter; basis for legal capital
4. Legal capital – Permanent amount of capital defined by
state law that must remain invested in the business; serves
as a cushion for creditors
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-6
5. No-par value stock – Capital stock that has no par value
specified in the corporate charter
B. Initial Sale of Stock
1. Two names applied to transactions involving the initial
sale of a company’s stock to the public:
a. Initial public offering (IPO) – The very first sale of a
company’s stock to the public (i.e., when the company
first “goes public”)
b. Seasoned new issue – Additional sales of new stock to
the public once a company’s stock has been traded on
established markets
2. The Kroger Co. sold 100,000 shares of its $1 par value
stock for $20 per share
dr Cash (+A)
2,000,000
cr Common Stock (+SE)
100,000 x $1
100,000
cr Capital in Excess of Par
(+SE)
1,900,000
Assets = Liabilities + Stockholders’ Equity
Cash (A) + 2,000,000 = Common Stock (SE) + 100,000 +
Capital in Excess of Par (SE) + 1,900,000
3. The common stock account is credited for the number of
shares sold times the par value per share and the capital in
excess of par account is credited for the remainder
a. If corporate charter does not specify a par value, stated
value is used in the same manner
b. If no par or stated value, entire proceeds from the sale
will be entered in the common stock account
C. Sale of Stock in Secondary Markets
1. When a company sells stock to the public, the transaction
is between the issuing corporation and the buyer
2. Subsequent to the initial sale, investors can sell shares to
other investors without directly affecting the corporation
3. If an investor sold 1,000 shares of The Kroger Co. stock
to another investor, The Kroger Co. would not record a
journal entry
D. Stock Issued for Employee Compensation
1. Advantage of the corporate form is the ability to separate
the management of a business from its ownership
2. Separation can be a disadvantage because some managers
may not act in the owners’ best interests; problem can be
overcome in a number of ways:
a. Compensation packages can be developed to reward
managers for meeting goals important to stockholders
b. Another strategy is to offer managers stock options,
which permit them to buy stock at a fixed price
i. The options specify that shares could be bought at
the then-current market price
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-7
ii. Granting a stock option is a form of compensation,
even if the grant price and the current stock price
are the same
iii. A stock option is a risk-free investment
• If you hold a stock option and the stock price
declines, you have lost nothing
• If the stock price increases, you can exercise
your option at the low grant price and sell the
stock at the higher price for a profit
E. Repurchase of Stock
1. Treasury stock – A corporation’s own stock that has been
issued but subsequently reacquired and is still being held
by that corporation
2. The Kroger Co. bought 100,000 shares of its stock in the
open market when it was selling for $20 per share
dr Treasury Stock (–SE)
2,000,000
cr Cash (–A)
2,000,000
Assets = Liabilities + Stockholders’ Equity
Cash (A) – 2,000,000 = Treasury Stock (SE) – 2,000,000
3. Treasury Stock account is a contra-equity account,; it is
subtracted from total stockholders’ equity
4. When a company sells its treasury stock:
a. GAAP does not permit a corporation to report income
or losses from investments in its own stock
b. Transactions with the owners are not normal profit-
making activities
5. The Kroger Co. re-sold 10,000 shares of treasury stock
for $30 per share (purchased at $20 per share)
dr Cash (+A)
300,000
cr Treasury Stock (+SE)
(10,000 x $20)
200,000
cr Capital in Excess of Par
(+SE)
100,000
Assets = Liabilities + Stockholders’ Equity
Cash (A) + 300,000 = Treasury Stock (SE) + 200,000 +
Capital in Excess of Par (SE) + 100,000
6. Instead, The Kroger Co. re-sold the 10,000 shares of
treasury stock for only $15 per share (purchased at $20
per share)
dr Cash (+A)
150,000
dr Capital in Excess of Par
(–SE)
50,000
cr Treasury Stock (+SE)
(10,000 x $20)
200,000
Refer students to Pause for
Feedback – Self-Study Quiz
Assets = Liabilities + Stockholders’ Equity
Cash (A) + 150,000 = Capital in Excess of Par (SE)
100,000 (SE) – 50,000 + Treasury Stock (SE) + 200,000
Use Supplemental
Enrichment Activity #2
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-8
4. Discuss dividends and analyze transactions.
III. Key Ratio Analysis: Dividends on Common Stock
Show Video Program #14
A. Return on Stock Investments
1. Investors buy common stock because they expect a return
on their investment
2. Return on investment can come in two forms:
a. Stock price appreciation
b. Dividends
5. Analyze the dividend yield ratio.
B. Key Ratio Analysis: Dividend Yield Ratio
1. Dividend Yield = Dividends per Share ÷ Market Price per
Share
2. Ratio measures return on investment based on dividends
3. Often potential capital appreciation is a much more
important consideration than dividend yield; analysts
should also assess the future earnings potential of the
company
C. Declaration and Payment of Dividends
1. Three important dates:
a. Declaration date – Date on which the board of
directors officially approves a dividend; company
records a liability related to the dividend on this date
b. Record date – Dividends can be paid only to the
stockholders who own stock on that date; no entry
c. Payment date – Date on which a cash dividend is paid
to the stockholders of record
2. On June 25, the board of The Kroger Co. declares a
$0.115 per share dividend on its 561 million outstanding
shares
dr Retained Earnings (–SE)
64,515,000
cr Dividends Payable (+L)
64,515,000
Assets = Liabilities + Stockholders’ Equity
0 = Dividends Payable (L) + 64,515,000 + Retained
Earnings (SE) – 64,515,000
3. On December 1, The Kroger Co. pays the dividend
Use Supplemental
Enrichment Activity #3
dr Dividends Payable (–L)
64,515,000
cr Cash (–A)
64,515,000
Assets = Liabilities + Stockholders’ Equity
Cash (A) – 64,515,000 = Dividends Payable (L)
– 64,515,000
See Financial Analysis
feature “Impact of Dividends
on Stock Price”
4. Two fundamental requirements for payment of a cash
dividend:
Refer students to Pause for
Feedback – Self-Study Quiz
a. Sufficient retained earnings
b. Sufficient cash
Chapter 11 – Reporting and Interpreting Owners’ Equity
11-9
6. Discuss the purpose of stock dividends, stock splits, and report transactions.
IV. Stock Dividends and Stock Splits
A. Stock Dividends
1. Stock dividend – A distribution of additional shares of a
corporation’s own stock to its stockholders on a pro rata
basis at no cost to the stockholder
2. Value of a stock dividend is the subject of much debate
a. A stock dividend by itself has no economic value
i. All stockholders receive a pro rata distribution of
shares, which means that each stockholder owns
exactly the same portion of the company as before
ii. The stock market reacts immediately when a stock
dividend is issued; stock price falls proportionally
b. In reality, the fall in price is not exactly proportional
to the number of new shares issued
i. In some cases, the stock dividend makes the stock
more attractive to new investors
ii. In other cases, stock dividends are associated with
increases in cash dividends, which are attractive to
some investors
3. When a stock dividend occurs, the company must transfer
an amount out of the Retained Earnings account (or
Capital in Excess of Par account, if there is not a
sufficient balance in Retained Earnings); amount
transferred depends on relative size of the stock dividend
a. Large stock dividend
i. Distribution of additional shares that amount to
more than 20% –25% of outstanding shares
ii Amount transferred to the Common Stock account
is based on the par value of the shares issued
b. Small stock dividend
i. Distribution of additional shares that amount to less
than 20% –25% of outstanding shares
ii. Amount transferred is the total market value of the
shares issued, with the par value of the stock
transferred to the Common Stock account and the
excess transferred to the Capital in Excess of Par
account
4. The Kroger Co. issued 400,000,000 shares as a large
stock dividend
dr Retained Earnings (–SE)
$1 par x 400,000,000
400 mill
cr Common Stock (+SE)
400 mill
Assets = Liabilities + Stockholders’ Equity
0 = Retained Earnings (SE) – 400 mill + Common Stock
(SE) + 400 mill
5. Stock dividends do not change total stockholders’ equity;
only the balances of some of the accounts that constitute
stockholders’ equity were changed
Use Supplemental
Enrichment Activity #4
Chapter 11 – Reporting and Interpreting Owners’ Equity
11–10
B. Stock Splits
1. Stock split – An increase in the total number of
authorized shares by a specified ratio; it does not decrease
retained earnings
2. Stock splits are similar to a stock dividend, but quite
different in terms of their impact on the stockholders’
equity accounts.
a. In a stock split, the total number of authorized shares
is increased by a specified amount; in a 2-for-1 stock
split, each share held is called in and two new shares
are issued in its place
b. Stock split is accomplished by reducing the par or
stated value per share of all authorized shares, so that
their total par value is unchanged
i. If The Kroger Co. executes a 2-for-1 stock split, it
reduces the par value of its stock from $1 to $0.50
and doubles the number of shares outstanding
ii. A stock split does not result in the transfer of a
dollar amount to the Common Stock account; the
reduction in the par value per share compensates
for the increase in the number of shares
Use Supplemental
Enrichment Activity #5
3. A stock dividend requires a journal entry; a stock split
does not but is disclosed in the notes to the financial
statements
Refer students to Pause for
Feedback – Self-Study Quiz
C. Statement of Changes in Stockholders’ Equity
Illustrated in Exhibit 11.2
1. Required by GAAP – purpose is to show changes in the
key components of stockholders ‘equity, including
common stock, paid-in capital, treasury stock, and
retained earnings
2. Also reports accumulated other comprehensive gain (loss)
– Certain items that bypass the income statement because
they have not satisfied the revenue recognition criteria
a. Unrealized hold gains or losses from available-for-sale
securities
i. Occur when a company holds stock in another
company and is prepared to sell them when cash is
needed
ii. Under GAAP, gains and losses are reported on the
income statement only when the stock is sold
iii. Unrealized gains and losses that occur before the
stock is sold are included in comprehensive income
b. Foreign currency translation gains and losses
i. When a company invests in a foreign country, the
investment is made in that country’s currency.
ii. The exchange rate between the U.S. dollar and
foreign currencies changes on a daily basis,
resulting in foreign currency translation gains and
losses
Chapter 11 – Reporting and Interpreting Owners’ Equity
11–11
iii. These gains and losses are not recorded on the
income statement until the foreign currency is
converted back into U.S. dollars
iv. The unrealized translation gains and losses are
included in comprehensive income
7. Describe the characteristics of preferred stock and analyze transactions affecting preferred stock.
VI. Preferred Stock
See International Perspective
feature “What’s in a Name?”
A. Issuance of Preferred Stock
1. In addition to common stock, some corporations issue
preferred stock
2. Preferred stock differs from common stock based on a
number of rights granted to the stockholders:
a. Preferred stock does not grant voting rights; one of the
main reasons corporations issue preferred stock to
raise equity capital
b. Preferred stock is less risky because holders receive
priority payment of dividends and distribution of
assets if the corporation goes out of business
c. Preferred stock typically has a fixed dividend rate
B. Dividends on Preferred Stock
1. Current dividend preference – Requires the current
preferred dividend to be paid before any dividends are
paid on the common stock
a. Always a feature of preferred stock.
b. After the current dividend preference has been met
and if no other preference is operative, dividends can
be paid to the common stockholders
2. Cumulative dividend preference – Requires that if all or a
part of the current dividend is not paid in full, the
cumulative unpaid amount (known as dividends in
arrears) must be paid before any common dividends can
be paid
Use Supplemental
Enrichment Activity #6
a. If preferred stock is noncumulative, dividends can
never be in arrears; any preferred dividends that are
not declared are permanently lost
b. Preferred stockholders are unwilling to accept this
unfavorable feature; preferred stock is usually
cumulative.
See Financial Analysis
feature “Restrictions on the
Payment of Dividends”
8. Discuss the impact of capital stock transactions on cash flows.
C. Focus on Cash Flows – Financing Activities
Illustrated in Exhibit 11.3
1. The cash proceeds from the issuance of capital stock are
added in computing cash flows from financing activities
2. The cash used to purchase of treasury stock is subtracted
in computing cash flows from financing activities
3. The cash proceeds from the sale of treasury stock are
added in computing cash flows from financing activities
See Financial Analysis
feature “Restrictions on the
Payment of Dividends”
4. The cash used to pay cash dividends is subtracted in
computing cash flows from financing activities
Chapter 11 – Reporting and Interpreting Owners’ Equity
11–12
VI. Chapter Supplement: Accounting for Owners’ Equity for Sole
Proprietorships and Partnerships
A. Owner’s Equity for a Sole Proprietorship
1. Sole proprietorship – Unincorporated business owned by
one person
a. Only two owners’ equity accounts are needed:
i. A capital account for the proprietor
ii. A drawing (or withdrawal) account for the
proprietor
b. The capital account of a sole proprietorship serves two
purposes:
i. To record investments by the owner
ii. To accumulate periodic income or loss
c. The drawing account is used to record the owner’s
withdrawals of cash or other assets from the business;
closed to the capital account at the end of each
accounting period
d. The capital account reflects the cumulative total of all
investments by the owner and all earnings of the entity
less all withdrawals from the entity by the owner
2. In most respects, the accounting for a sole proprietorship
is the same as for a corporation.
Recording of transactions
illustrated in Exhibit 11.4
a. Because a sole proprietorship does not pay income
taxes, its financial statements do not reflect income tax
expense or income taxes payable
b. Instead, the net income of a sole proprietorship is
taxed when it is included on the owner’s personal
income tax return
c. Owner’s salary is not recognized as an expense in a
sole proprietorship; it is accounted for as a distribution
of profits (i.e., a withdrawal)
B. Owners’ Equity for a Partnership
1. Partnership (per Uniform Partnership Act) – An
association of two or more persons to carry on as co-
owners of a business for profit
a. Agreement between the partners constitutes a
partnership contract
i. Agreement should specify matters such as division
of periodic income, management responsibilities,
transfer or sale of partnership interests, disposition
of assets upon liquidation, and procedures to be
followed in case of the death of a partner
ii. If the partnership agreement does not specify these
matters, the laws of the resident state are binding
b. Primary advantages:
i. Ease of formation
ii. Complete control by the partners
iii. Lack of income taxes on the business itself
Chapter 11 – Reporting and Interpreting Owners’ Equity
11–13
c. Primary disadvantage:
i. Unlimited liability of each partner for the
partnership’s debts
ii. If the partnership does not have sufficient assets to
satisfy outstanding debt, creditors of the
partnership can seize the partners’ personal assets
2. Accounting for a partnership follows the same underlying
principles as any other form of business organization,
except for those entries affecting equity
Recording of transactions
illustrated in Exhibit 11.5
a. Separate capital and drawing accounts must be
established for each partner
b. Investments by each partner are credited to that
partner’s capital account; withdrawals are debited to
the respective partner’s drawing account
c. The net income of a partnership is divided among the
partners in accordance with the partnership agreement
and credited to each account
d. The respective drawing accounts are closed to the
partner capital accounts
e. After the closing process, each partner’s capital
account reflects the cumulative total of all of that
partner’s investments plus that partner’s share of the
partnership earnings less all that partner’s withdrawals
3. The financial statements of a partnership follow the same
format as those for a corporation except that:
a. The income statement includes an additional section
entitled Distribution of Net Income
b. The partners’ equity section of the balance sheet is
detailed for each partner
c. The partnership has no income tax expense because
partnerships do not pay income tax (partners must
report their share of the partnership profits on their
individual tax returns)
d. Salaries paid to the partners are not recorded as
expenses but are treated as distributions of earnings