Chapter 11 – Stockholders’ Equity: Paid-In Capital
Financial and Managerial Accounting, 17e 11-1
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.
Chapter 11 – Stockholders’ Equity: Paid-In Capital
9. Account for treasury stock transactions.
Brief topical outline
A Corporations
1 Why businesses incorporate – see Your Turn (page 487)
2 Publicly owned corporations
a Publicly owned corporations face different rules
B Formation of a corporation
1 Organization costs
2 Rights of stockholders
3 Functions of the board of directors
4 Functions of the corporate officers
5 Stockholder records in a corporation
a Stockholders subsidiary ledger
b Stock transfer agent and stock registrar
C Paid-in capital of a corporation
1 Authorization and issuance of capital stock
a State laws affect the balance sheet presentation of stockholders’ equity
b Par value
c Issuance of par value stock
d No-par stock
2 Common stock and preferred stock
3 Characteristics of preferred stock – see Case in Point (page 493)
a Stock preferred as to dividends
b Cumulative preferred stock
c Other features of preferred stock
4 Book value per share of common stock
a Book value when a company has both preferred and common stock
D Market value
1 Accounting by the issuer
2 Accounting by the investor – see Case in Point (page 497)
3 Market price of preferred stock
4 Market price of common stock
5 Book value and market price
6 Stock splits
E Treasury stock
1 Recording purchases of treasury stock
2 Reissuance of treasury stock
3 Stock buyback programs
4 Financial analysis and decision making – see Your Turn (page 501) and
Ethics, Fraud, & Corporate Governance (page 502)
F Concluding remarks
Chapter 11 – Stockholders’ Equity: Paid-In Capital
Financial and Managerial Accounting, 17e 11-3
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
Critical
Thinking
Cases
1
A – B
1, 2
1
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
Comments and observations
Teaching objectives for Chapter 11
In this chapter, we provide a comprehensive introduction to factors affecting 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.
4 Illustrate 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.
5 Discuss 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.
8 Explain the nature and purpose of stock splits.
9 Explain 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
list of key terms at the end of the chapter. We recommend assigning several exercises and
Chapter 11 – Stockholders’ Equity: Paid-In Capital
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
Chevrolet, Pontiac,
Buick, Oldsmobile, and Cadillac. However, it has outstanding eight issues of capital stock
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 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.
Chapter 11 – Stockholders’ Equity: Paid-In Capital
Financial and Managerial Accounting, 17e 11-5
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.
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 – Stockholders’ Equity: Paid-In Capital
CHAPTER 11 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1 Lewis 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.
2 Perez 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.
3 Pike 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.
4 Which of the following most likely explains why a corporation’s stock trades at a very high
price-earnings ratio?
a Investors expect the corporation to have higher earnings in the future.
b The corporation pays a very low dividend on its stock.
c The corporation has several classes of stock outstanding.
d The corporation is large with very low risk.
5 Which of the following is not a characteristic of most preferred stocks?
a Preference as to dividends.
b No voting power.
c Convertible into common stock.
d Preference as to assets in the event of liquidation of the company.