CHAPTER 11
STOCKHOLDERS’ EQUITY
Student Learning Objectives and Related Assignment Materials
Student Learning
Objectives
Mini–
Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Compre–
hensive
Problems
Skills
Develop-
ment
Cases
Continuing
Cases
LO 11-1 Explain the
role of stock in
financing a
corporation.
1, 2, 3
1
4, 7
1†
LO 11-2 Explain and
analyze common
stock transactions.
4*, 5, 6
2, 3*, 4,
5, 6*, 7,
8*, 9,
11*, 17*
1, 3^, 4
A1, A3^,
A4, B1,
B3^, B4
1+, 2^+
1, 2, 4
1†
LO 11-3 Explain and
analyze cash
dividends, stock
dividends, and
stock split
transactions.
7, 8*, 9,
10
2, 4, 8*,
9, 10,
11*,
12^, 13,
14, 15,
16, 17*,
18
2, 3^, 4
A2, A3^,
A4, B2,
B3^, B4
1+, 2^+
1, 2, 3,
5, 6, 7
1†, 2^£
LO 11-4 Describe the
characteristics of
preferred stock
and analyze
transactions
affecting
preferred stock.
11, 12
3*, 4, 5,
6*, 7, 10
4
A4, B4
1†
LO 11-5 Analyze the
earnings per share
(EPS), return on
equity (ROE), and
price/earnings
(P/E) ratios.
13, 14
16, 17*
3^, 5
A3^, A5,
B3^, B5
1, 2, 3
1†, 2^£
LO 11-S1 Account
for owners’ equity
in other forms of
business.
15
18
LO 11-S2 Record
journal entries for
large and small
stock dividends.
16
19
2^+
(Table footnotes on next page.)
Student Learning Objectives and Related Assignment Materials, continued
* Animated solution included in the PowerPoint Slides.
^ Particularly challenging; requires students to combine multiple concepts in order to advance to the
next level of accounting knowledge.
+ The Comprehensive Problems are comprised of CP11-1, which also covers LO 8-2, 9-3, and 10-3, and
CP11-2, which also covers LO 3-3, 4-2, 4-3, 4-4, 6-3, 6-4, 7-3, 8-2, 9-2, 9-3, 9-5, 10-2, and 10-3.
† Continuing Case 11-1 builds on the story of Nicole’s Getaway Spa, introduced in earlier chapters. This
case focuses on analyzing stockholder equity transactions and preparing journal entries, contrasting
the voting rights of common and preferred stock, and deciding the impact of transactions on the ROE
ratio. This case will be extended in future chapters.
£ Continuing Case 11-2 builds on the story of Wiki Art Gallery (WAG), an instructional case in
Connect. This case focuses on deciding whether the company’s financial statements conform to GAAP
and interpreting the term “earnings multiplier.” The case will be extended in future chapters.
Overview
National Beverage is an ideal company to illustrate topics in this chapter because the stockholders’ equity
section of its balance sheet is clean and straightforward.
Students learn how to account for stock issuances, repurchases into treasury, cash dividends on common
and preferred stock, stock dividends, stock splits, and the effects of these transactions on key ratios.
Synopsis of Chapter Revisions
• Updated focus company illustrations with National Beverage Corp.
• New Spotlight on Business Decisions to discuss the government’s JOBS Act and crowdfunding
equity
• Revised list of reasons for stock repurchases, supported by new Spotlight on Business Decisions
involving Safeway’s treasury stock purchase to boost EPS
• Revised Spotlight on Business Decisions to quantify tax savings from National Beverage’s cash
dividend distribution prior to reaching the fiscal cliff
• Expanded illustration of dividend journal entries to include closing entry
• Simplified stock dividend discussion and moved journal entries for small and large stock dividends to
chapter supplement
• New section to illustrate simple statement of stockholders’ equity
• Revised EPS and ROE illustrations to show impact of preferred dividends
• Updated ratio analyses in Exhibit 11.7, involving National Beverage and PepsiCo
• Inserted cash dividends into demonstration case A and deleted demonstration case B
• Reviewed, updated, and introduced new end-of-chapter material, including new comprehensive
problem in a format that automatically posts journal entries to T-accounts and prepares a trial balance
PowerPoint Slides
Student Learning Objective
PowerPoint® Slides
LO 11-1 Explain the role of stock in financing a corporation.
11-2 through 11-6
LO 11-2 Explain and analyze common stock transactions.
11-7 through 11-20
LO 11-3 Explain and analyze cash dividends, stock dividends, and stock split
transactions.
11-21 through 11-30
LO 11-4 Describe the characteristics of preferred stock and analyze
transactions affecting preferred stock.
11-31 through 11-39
LO 11-5 Analyze the earnings per share (EPS), return on equity (ROE), and
price/earnings (P/E) ratios.
11-40 through 11-44
LO 11-S1 Account for owners’ equity in other forms of business.
11-45 through 11-53
LO 11-S2 Record journal entries for large and small stock dividends.
11-54 through 11-56
Animated Builds and Animated Solutions
PowerPoint® Slides
Mini-Exercise 11-4
11-58 through 11-59
Mini-Exercise 11-7
11-60
Exercise 11-3
11-61 through 11-62
Exercise 11-6
11-63 through 11-66
Exercise 11-8
11-67 through 11-70
Exercise 11-11
11-71 through 11-76
Exercise 11-17
11-77 through 11-81
Chapter Summary
LO 11-1 Explain the role of stock in financing a corporation.
• The law recognizes corporations as separate legal entities. Owners invest in a corporation and
receive capital stock that can be bought from and sold to other investors. Stock provides a number
of rights, including the rights to vote, to receive dividends, and share in residual assets at
liquidation.
LO 11-2 Explain and analyze common stock transactions.
• A number of key transactions involve common stock: (1) initial issuance of stock, (2) repurchase
of stock into treasury, and (3) reissuance of treasury stock. Each is illustrated in this chapter. Note
that these transactions have only balance sheet effects; corporations do not report income arising
from gains or losses on transactions involving their own stock.
LO 11-3 Explain and analyze cash dividends, stock dividends, and stock split transactions.
• Cash dividends reduce stockholders’ equity (Retained Earnings) and create a liability (Dividends
Payable) when they are declared by the board of directors (on the date of declaration). The
liability is reduced when the dividends are paid (on the date of payment).
• Stock dividends are pro rata distributions of a company’s stock to existing owners. The
transaction typically is accounted for by transferring an amount out of Retained Earnings and into
contributed capital accounts.
• A stock split also involves the distribution of additional shares to owners but no additional
amount is transferred into the contributed capital accounts. Instead, the per-share par value of
stock is reduced.
LO 11-4 Describe the characteristics of preferred stock and analyze transactions affecting
preferred stock.
• Preferred stock provides investors certain advantages including current dividend preferences and
a preference on asset distributions in the event the corporation is liquidated.
• If preferred stock carries cumulative dividend rights, any part of a current dividend that is not
paid (called dividends in arrears) must be paid in full before any additional dividends can be
paid.
LO 11-5 Analyze the earnings per share (EPS), return on equity (ROE), and price/earnings (P/E)
ratios.
• The earnings per share (EPS) ratio is calculated by dividing net income (less preferred dividends)
by the average number of shares of common stock outstanding during the year. This ratio makes
it easy to compare a company’s earnings over time, but it does not allow reliable comparisons
across companies because it does not adjust for likely differences in the number of shares that
each company has outstanding.
• The return on equity (ROE) ratio relates earnings to each dollar contributed to and retained by the
company on behalf of common stockholders. Because it is calculated using dollar amounts
contributed to and retained by a company, it allows comparisons to be made across companies.
• The price/earnings (P/E) ratio relates the company’s current stock price to its most recent annual
earnings per share, indicating the value investors place on the company’s stock.
Chapter Summary, continued
Accounting Decision Tools
1. Earnings per Share (EPS) = (Net Income – Preferred Dividends) ÷ Average Number of Common
Shares Outstanding
• It tells you the amount of income generated for each share of common stock owned by
stockholders.
• A higher ratio means greater profitability.
2. Return on Equity (ROE) = (Net Income – Preferred Dividends) ÷ Average Common
Stockholders’ Equity
• It tells you the amount earned for each dollar invested by common stockholders.
• A higher ratio means stockholders are likely to enjoy greater returns.
3. Price/Earnings (P/E) ratio = Current Stock Price (per share) ÷ Earnings per Share (annual)
• It tells you how many times more than the current year’s earnings investors are willing to pay for a
company’s common stock.
• A higher number means investors anticipate an improvement in the company’s future results.
Chapter Outline
Teaching Notes
I. Understand the Business
LO 11-1 Explain the role of stock in financing a corporation.
A. Corporate Ownership
1. Corporations can raise large amounts of money because
investors can easily participate in a corporation’s
ownership; this ease of participation is related to several
factors:
a. Shares of stock can be purchased in small amounts.
b. Ownership interests are transferable.
c. Stockholders are not liable for the corporation’s debts.
2. The law recognizes a corporation as a separate legal
entity.
3. To protect everyone’s rights, the creation and oversight of
corporations are tightly regulated by law.
a. Corporations are created by submitting an application
to a state government (not the federal government).
b. Because laws vary from state to state, you might
decide to create a corporation in a state other than the
one in which it operates.
4. Common stock––The basic voting stock issued by a
corporation to stockholders; owners of common stock
usually enjoy a number of benefits:
a. Voting rights––For each share you own, you get a set
number of votes on major issues.
b. Dividends––Stockholders receive a share of the
corporation’s profits when distributed as dividends.
c. Residual claim––If the company ceases operations,
stockholders share in any assets remaining after
creditors have been paid.
d. Preemptive rights––To retain their ownership
percentages, existing stockholders may be given the
first chance to buy newly issued stock before it is
offered to others.
B. Equity versus Debt Financing
Summarized in Exhibit 11.1
1. A company in need of a large amount of long-term
financing can obtain it through:
a. Equity financing––Issuing new stock to investors.
i. Equity does not have to be repaid. Debt must be
repaid or refinanced.
The “Spotlight on Business
ii. Dividends are optional. Interest must be paid on
debt.
Decisions” feature addresses
crowdfunding
b. Debt financing––Borrowing money from lenders.
i. Interest on debt is tax deductible. Dividends on
stock are not tax deductible.
ii. Debt does not change stockholder control. A stock
issue dilutes existing stockholders’ control.
Chapter Outline
Teaching Notes
II. Study the Accounting Methods
LO 11-2 Explain and analyze common stock transactions.
A. Common Stock Transactions
1. Items reported in the stockholders’ equity section of
balance sheets:
Illustrated in Exhibit 11.2
a. Contributed capital––Reports the amount of capital the
company received from investors’ contributions, in
exchange for the company’s common and preferred
stock.
b. Retained earnings––Reports the cumulative amount of
net income earned by the company less the cumulative
amount of dividends declared since the corporation
was first organized.
c. Treasury stock––Reports shares that were previously
owned by stockholders but have been bought back and
are now held by the corporation.
Accounting rules relating to
d. Accumulated Other Comprehensive Income (Loss)––
Reports unrealized gains and losses, which are
temporary changes in the value of certain assets and
liabilities the company holds.
Accumulated Other
Comprehensive
Income (Loss) are introduced
in Appendix D
B. Authorization, Issuance, and Repurchase of Stock
1. A corporation’s charter indicates the maximum number of
shares of stock that the corporation is allowed to issue.
Summarized in Exhibit 11.3
a. Authorized shares––The maximum number of shares
of capital stock of a corporation that can be issued, as
specified in the charter.
✓ Supplemental
Enrichment Activity
(Activity) #1
b. Issued shares––Shares of stock that have been
distributed by the corporation.
c. Treasury stock––Issued shares that have been
reacquired by the company.
d. Outstanding shares––Shares that are currently held
by stockholders (not the corporation itself).
2. Stock Authorization
a. Par value––An insignificant value per share of capital
stock specified in the charter; serves as the basis for
legal capital.
Stress that par value is not
related in any way to the
market value of stock.
i. Par value is an old concept originally introduced to
prevent stockholders from removing contributed
capital of businesses about to go bankrupt; stronger
laws and regulations exist today to prevent this
from happening.
• As a result, par value no longer has this use.
• However, some states charge corporate fees
based on total par value, so it is typically set at
a token amount.
b. No-par value stock––Capital stock that has no par
value specified in the corporate charter.
Chapter Outline
Teaching Notes
3. Stock Issuance––The sale of stock from the corporation
to an investor.
✓ Activity #2
a. Involves providing shares of a corporation’s
ownership, usually in exchange for cash.
i. Initial public offering (or IPO) ––The very first
sale of a company’s stock to the public.
ii. Seasoned new issue––Additional issuances of new
stock by the company if it has issued stock
previously.
b. Stock issuances for cash are recorded by:
i. Debiting Cash, crediting Common Stock (for the
number of shares sold times the par value per
share), and crediting Additional Paid-in Capital
account (for the cash received in excess of this
amount).
ii. If the corporate charter does not specify a par value
for the stock, the total proceeds from the sale of
stock will be credited to Common Stock.
4. Stock Exchanged Between Investors
a. When a company sells stock to the public, the
transaction is between the issuing corporation and the
buyer.
b. After this initial stock sale, investors can sell shares to
other investors without directly affecting the
corporation.
5. Stock used to Compensate Employees––To encourage
employees to work hard for a corporation, employee pay
packages often include a combination of base pay, cash
bonuses, and stock options.
a. Stock options allow employees to buy the company’s
stock at a predetermined price, often equal to the then-
current market price.
b. If stock price increases, employees can then exercise
their options to acquire the stock at the lower
predetermined price.
c. If stock price decreases, employees have not lost
anything.
d. Accounting rules require that, at the time the company
grants stock options, an expense must be reported for
the estimated cost associated with stock options even
if the option price equals the current stock price.
The specific accounting
procedures are covered in an
intermediate accounting
course.
Chapter Outline
Teaching Notes
6. Repurchase of Stock
a. A corporation may want to repurchase its stock from
existing stockholders to:
i. Send a signal to investors that the company itself
believes its own stock is worth purchasing.
ii. Obtain shares that can be reissued as payment for
purchases of other companies.
The “Spotlight on Business
Decisions” feature addresses
iii. Obtain shares to reissue to employees as part of
employee stock purchase plans.
the use of treasury stock
purchases to boost earnings
iv. Reduce the number of shares to increase per-share
measures of earnings and stock value.
per share (and executive
bonuses)
b. Most companies record the purchase of treasury stock
using the cost incurred to acquire the shares.
i. Stock repurchases are recorded by debiting
Treasury Stock and crediting Cash.
ii. Treasury Stock is not an asset.
ii. Treasury Stock is a permanent account that is
reported as contra-equity, subtracted from total
stockholders’ equity.
Stress that the +xSE notation
is a reminder
7. Reissuance of Treasury Stock
a. When a company resells shares of its treasury stock, it
does not report a gain or loss on sale, even if it issues
the shares for more or less than they cost when the
company reacquired them.
b. The reissuance of treasury stock at a price above its
repurchase price is recorded by debiting Cash,
crediting Treasury Stock (for its original cost), and
crediting Additional Paid-In Capital (for the excess).
c. If treasury stock were reissued at a price below its
repurchase price, the difference between the
repurchase price and the reissue price is recorded as a
reduction in Additional Paid-in Capital.
LO 11-3 Explain and analyze cash dividends, stock dividends, and stock split transactions.
C. Cash Dividends on Common Stock
1. Investors acquire common stock because they expect a
return on their investment. Return can come in two forms
dividends and increases in stock price.
a. Growth investment––Stocks that pay little or no
dividends.
b. Income investments––Stocks that consistently pay
dividends.
The “Spotlight on Business
Decisions” feature addresses
2. A corporation does not have a legal obligation to pay
dividends; it is a decision made by the board of directors.
the impact of tax rates on
dividends.
Chapter Outline
Teaching Notes
3. Board of directors considers tax consequences and
whether there are:
a. Sufficient retained earnings
i. State laws often restrict dividends to the balance in
Retained Earnings.
ii. Loan agreements may require minimum balance in
Retained Earnings; disclosure is required in the
financial statement notes
b. Sufficient cash to pay dividend.
4. Four important dates:
a. Declaration date––The date on which the board of
directors officially approves a dividend.
i. Dividends, a temporary account, and Dividends
Payable are both increased.
ii. Until the closing entries are recorded (see below),
the Dividends account is accounted for as a
decrease to Stockholders’ Equity.
iii. Dividends are not an expense; they are a
distribution of prior profits.
b. Record date––The date on which the corporation
prepares the list of current stockholders as shown on
its records; dividends can be paid only to the
stockholders who own stock on that date.
Stress that no entry is made
on this date.
c. Payment date––The date on which a cash dividend is
paid to the stockholders of record; the Cash and
Dividends Payable accounts are both decreased.
✓ Activity #3
d. Year-end:
i. Closing entries include the transfer of the
Dividends account balance (debit) to Retained
Earnings; entry includes a debit to Retained
Earnings and a credit to Dividends.
ii. This closing entry has no effect on total
stockholders’ equity.
D. Stock Dividends and Stock Splits
1. Stock dividend––A dividend that distributes additional
shares of a corporation’s own stock.
✓ Activity #5
a. Recorded by transferring an amount from Retained
Earnings to contributed capital accounts; amount
transferred depends on the size of the stock dividend..
i. Large stock dividend
• More than 25% of currently outstanding
shares.
• Transfer is recorded at par value and, so,
decrease in Retained Earnings equals increase
in Common Stock