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Summary
A corporation’s balance sheet contains assets, liabilities, and a stockholders’ equity section.
Stockholders’ equity is made up of contributed capital (the stockholders’ investments)
and retained earnings (earnings that have remained in the business), and sometimes
treasury stock.
A corporation may disclose more detail in a statement of stockholders equity, which
summarizes changes in components of the stockholders equity section of the balance sheet.
When only one type of stock is issued by a corporation, it is called common stock. Because
common stockholders’ claim to assets in case of liquidation ranks behind that of creditors
and preferred stockholders, common stock is considered the residual equity of a corporation.
The second kind of stock a company can issue is preferred stock. Preferred stock has
preference over common stock in one or more areas.
The maximum number of shares that can be issued is stipulated in the corporation's state
charter. This maximum amount is known as the authorized shares. The shares sold or
otherwise transferred to stockholders are the issued shares of a corporation. Shares that
have been issued to stockholders and remain in circulation, having been neither bought
back by the corporation nor given back by the stockholder, are called outstanding shares.
Treasury stock consists of shares bought back and being held by the corporation.
Holders of preferred stock are given preference over common shareholders when dividends
(and liquidating dividends) are declared; that is, the holders of preferred shares must receive
a certain amount of dividends before the holders of common shares can receive dividends.
This dividend is a speci)c dollar amount or percentage of par value. At times, preferred
stockholders do not receive the full amount of their annual dividends. When the stock is
noncumulative preferred stock, unpaid dividends are not carried over to the next period.
When the stock is cumulative preferred stock, the unpaid amount is carried over to the
next year. Unpaid “back dividends” are called dividends in arrears and should be
disclosed either on the balance sheet or in a note.
An owner of convertible preferred stock has the option to exchange each share of
preferred stock for a set number of shares of common stock.
Most preferred stock is callable preferred stock, meaning that the corporation has the
right to buy the stock back for cancellation at a speci)ed call or redemption price. Holders of
convertible preferred stock can choose instead to convert it to common stock.
Par value is the legal value established for a share of stock. Capital stock (common or
preferred) may or may not have a par value, depending on the speci)cations in the charter.
When par value stock is issued, the Capital Stock account is credited for the legal capital
(par value), and any proceeds received in excess of par value are recorded as Additional
Paid-in Capital. Both accounts appear in the stockholders’ equity section of the balance
sheet as part of contributed capital.
No-par stock is stock for which par value has not been established; it may be issued with
or without a stated value. Stated value (which is established by the board of directors)
constitutes the legal capital for a share of no-par stock. The total stated value is recorded in
the Capital Stock account. Any amount received in excess of the stated value is recorded as
Additional Paid-in Capital. If no stated value is set, however, the entire amount received
constitutes legal capital and is credited to Capital Stock.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 2
When stock is issued in exchange for assets or for services rendered, the assets should be
recorded at the fair market value of the stock given up. If the stock’s fair market value
cannot be determined, the transaction is recorded at the fair market value of the assets or
services.
The following journal entries are introduced in this section for the issuance of stock:
Cash XX (amount invested)
Common Stock XX (legal capital amount)
Additional Paid-in Capital XX (excess of par)
Issued par value common stock for amount in excess
of par value
Cash XX (amount invested)
Common Stock XX (legal capital amount)
Issued no-par common stock (no stated value
established)
Cash XX (amount invested)
Common Stock XX (legal capital amount)
Additional Paid-in Capital XX (excess of stated value)
Issued no-par common stock with stated value for
amount in excess of stated value
Legal(or Other) Expenses XX (fair market value of
services)
Common Stock XX (par value)
Additional Paid-in Capital XX (excess of par)
Issued par value common stock for services when no
market value for the stock exists.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 3
Land (or Other Asset) XX (fair market value of stock)
Common Stock XX (par value)
Additional Paid-in Capital XX (excess of par)
Issued par value common stock with a market value
in excess of par value for an asset
A company's treasury stock, as explained earlier, comprises common or preferred shares
that are issued but no longer outstanding. Treasury stock may be purchased for a variety of
reasons: (1) to distribute to employees through stock option plans, (2) to maintain a
favorable market for the company’s stock, (3) to increase earnings per share, (4) to use in
purchasing other companies, and (5) to prevent a hostile takeover of the company.
Treasury stock can be held inde)nitely, reissued, or retired; it carries no rights until it is
reissued. Treasury stock appears on the balance sheet as the last item in the stockholders’
equity section as a deduction.
When treasury stock is purchased, Treasury Stock, Common is debited for the purchase cost.
The stock may be reissued at cost, above cost, or below cost. When cash received from
reissuance exceeds the cost, the di?erence is credited to Paid-in Capital, Treasury Stock.
When cash received from reissuance is less than the cost, Paid-in Capital, Treasury Stock is
debited for the di?erence up to its credit balance. If an insu@cient credit balance, Retained
Earnings is debited for the remaining di?erence. In no instance should a gain or loss account
be established.
When treasury stock is retired, all the contributed capital associated with the retired shares
must be removed from the accounts. When less was paid on reacquisition than was
contributed originally, the di?erence is credited to Paid-in Capital, Retirement of Stock. When
more is paid, the di?erence is debited to Retained Earnings.
The following journal entries are introduced in this section for treasury stock transactions:
Treasury Stock, Common XX (cost)
Cash XX (amount paid)
Acquired shares of the company’s common stock
Cash XX (resale price)
Treasury Stock, Common XX (cost)
Reissued shares of treasury stock at cost
Cash XX (resale price)
Treasury Stock, Common XX (cost)
Paid-in Capital, Treasury Stock XX (“gain”)
Sold shares of treasury stock at above cost
Cash XX (resale price)
Paid-in Capital, Treasury Stock XX (“loss”)
Retained Earnings XX (“loss”)
Treasury Stock, Common XX (cost)
Sold shares of treasury stock at below cost when
Paid- in Capital, Treasury Stock has insu@cient credit
balance to cover di?erence.
Common Stock XX (par value)
Additional Paid-in Capital XX (excess of par)
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 4
Retained Earnings XX (premium paid)
Treasury Stock—Common XX (cost)
Retired treasury stock; cost exceeded original
issue proceeds
If the above treasury stock had been retired for an amount less than the original investment
amount, then instead of Retained Earnings being debited for the excess paid, Paid-in Capital,
Retirement of Stock would be credited for the di?erence.
A dividend is a distribution among stockholders of the assets that a corporation’s earnings
have generated. These assets are normally distributed in cash.
Dividends can be paid quarterly, semiannually, annually, or at other times as declared by
the board of directors. A dividend that exceeds retained earnings is not allowed in most
states. When such a dividend is declared, it is called a liquidating dividend and is usually
paid when a company is going out of business or reducing its operations.
Dividends are declared on the declaration date, specifying that the owners of the stock on
the record date will receive the dividends on the date of payment.
When cash dividends are declared, the Dividends account is debited and Dividends Payable
is credited; when they are paid, Dividends Payable is debited and Cash is credited. The
Dividends account is closed to Retained Earnings at the end of the period. No journal entry is
made on the record date. After the record date, stock is sold ex-dividend (without dividend
rights).
The following journal entries were introduced in this section for cash dividends transactions:
Dividends XX
Dividends Payable XX
Declared a cash dividend on common stock
Dividends Payable XX
Cash XX
Paid cash dividend on common stock
A stock dividend is a pro rata distribution of shares of stock to a corporation’s
stockholders. The main reasons that stock dividends are declared are to (1) e?ect a noncash
distribution, (2) reduce the stock’s market price, (3) allow a nontaxable distribution, and (4)
increase the company’s permanent capital by transferring an amount from retained earnings
to contributed capital. The result of a stock dividend is the transfer of a portion of retained
earnings to contributed capital. For a small stock dividend (less than 20 to 25 percent), the
market value of the shares distributed is transferred from retained earnings. For a large
stock dividend (greater than 20 to 25 percent), the par or stated value is transferred. A stock
dividend does not change total stockholders’ equity, nor does it change each stockholder’s
proportionate equity in the company.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 5
A stock split is an increase in the number of shares of stock outstanding with a
corresponding decrease in the par or stated value of the stock. For example, a 3-for-1 split
on 40,000 shares of $30 par value stock results in the distribution of 80,000 additional
shares (that is, a former owner of 1 share now owns 2 more shares) and the reduction of par
value to $10. The amount for each component of stockholders’ equity is not a?ected.
The purpose of a stock split is to improve the stock’s marketability by decreasing the stock’s
market price. Thus, if a stock were selling for $180 per share, a 3-for-1 split would probably
cause the market price to decline to approximately $60 per share. A memorandum entry
should be made for a stock split, disclosing the decrease in par or stated value as well as the
increase in shares of stock outstanding.
The following journal entries were introduced in this section for stock dividend transactions:
Stock Dividends XX (amount transferred)
Common Stock Distributable XX (par value amount)
Additional Paid-in Capital XX (excess of par)
Declared a stock dividend on common stock (less
than 25 percent)
Common Stock Distributable XX (par value amount)
Common Stock XX (par value amount)
Distributed a stock dividend
The statement of stockholders’ equity (also called the statement of changes in
stockholders’ equity) can be used in place of the statement of retained earnings. It is
basically a labeled computation of the changes in the stockholders’ equity accounts during
the accounting period. It contains all the components of the statement of retained earnings
as well as a summary of the period’s stock transactions.
The book value of a company’s stock represents the total assets of the company less its
liabilities. The book value per share is the equity of the owner of one share of stock in the
net assets of the corporation. It is calculated by dividing stockholders’ equity by the number
of outstanding and subscribed shares. When a company also has preferred stock, the call or
par value of the preferred stock plus any dividends in arrears is deducted from stockholders’
equity in calculating the book value per share of common stock.
Relevant Examples and Exhibits
Exhibit 2 Stockholders’ Equity Section of a Balance Sheet
Exhibit 3 Relationship of Authorized Shares to Unissued, Issued, Outstanding, and
Treasury Shares
Example: Dividends in Arrears
Example: Dividend Distribution
Example: Issuing Stock Above Par Value
Example: Issuing No-Par Stock with No State Value
Example: Issuing No-Par Stock with a Stated Value
Example: Issuing Stock for Noncash Assets When No Market Value for the Stock Exists
Example: Issuing Stock for Noncash Assets When Market Value for the Stock Exists
Example: Purchase of Treasury Stock
Example: Sale of Treasury Shares at Cost
Example: Sale of Treasury Shares Above Cost
Example: Sale of Treasury Shares Below Cost
Example: Retiring Treasury Stock
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 6
Example: Cash Dividends at the Declaration Date, Record Date, and Payment Date
Example: Stock Dividends at the Declaration Date, Record Date, and Payment Date
Example: Stock Split
Example: E?ect of a Stock Split on Stockholders’ Equity
Exhibit 4 Statement of Stockholders’ Equity
Exhibit 5 Stockholders’ Equity Section of a Balance Sheet
Example: Book Value for Common and Preferred Stock
Example: Book Value for Dividends in Arrears
Exhibit 6 Stockholders’ Equity Section of the Balance Sheet
Teaching Strategy
Show students the balance sheet that follows. Then conceal the asset part while discussing
the components of stockholders’ equity. Each time a new account is introduced, show this
balance sheet and locate the new account with the students. At this point, do not go into
detail about each account; simply emphasize that there are two major categories—
contributed capital and retained earnings. Show how the credit to capital is speci)cally
stated when an owner contributes to (buys stock in) a corporation. (Short Exercise 4 is a
good illustration.) Case 5 deals with stockholders’ equity.
Balance Sheet
Corporation Name
12/31/x1
Current Assets: Current Liabilities:
Cash Notes Payable
Marketable Securities Accounts Payable
Notes Receivable Salaries Payable
Accounts Receivable Dividends Payable
Subscriptions Receivable
Inventory Total Current Liabilities
Prepaid Expenses
Long-Term Liabilities:
Total Current Assets Bonds Payable
Total Liabilities
Property, Plant, and Equipment:
Land Stockholders’ Equity
Building
Less Accumulated Depreciation Contributed Capital:
Equipment Preferred Stock
Less Accumulated Depreciation Common Stock
Common Stock Distributable
Total Property, Plant, and Equipment Additional Paid-in Capital
Total Contributed Capital
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 7
Intangible Assets:
Trademarks Retained Earnings
Patents
Goodwill
Total Contributed Capital and
Retained Earnings
Less Treasury Stock
Total Intangible Assets
Total Stockholders’ Equity
Total Assets Total Liabilities and Stockholders’
Equity
Explain preferred stock as stock that has preference over common stock when dividends are
paid and when assets are distributed if the corporation is liquidated. Note that preferred
stock usually has no voting rights.
List the following and explain each characteristic:
Characteristics of preferred stock:
Cumulative—stockholder’s advantage
Noncumulative—corporation’s advantage
Convertible—stockholder’s advantage
Callable—corporation’s advantage
Refer back to the terms cumulative and noncumulative. Use Short Exercise 5 and Exercises
3A, 4A and 5A to show the e?ect of each. Use or assign Case 3 to illustrate issuing stock.
Explain par value and stated value and how they limit the dollar amount to credit the stock
accounts. Use Short Exercise 6 and Exercises 6A and 7A to demonstrate the issuance of
stock.
When stock is issued for noncash assets, students have di@culty understanding the amount
to debit the noncash asset the corporation receives. The misunderstanding seems to arise
because the amount is the fair market value of what is given up if the stock’s fair market
value is known. If it is not known, then the amount of the debit is the fair market value of
what is received. Show the following chart:
Noncash Asset
Received Stock Issued
Amount to Debit the
Asset Received
Fair Market Value (FMV) unknown
FMV known
FMV known
FMV known
FMV unknown
FMV known
FMV of stock
FMV of asset
FMV of stock
Use Short Exercise 7 and Exercise 8A to demonstrate the issuance of stock for noncash
assets.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 8
After explaining why a company purchases its own stock, if time permits and if students
need the visual presentation, write out the journal entries as follows:
Purchase: Treasury Stock at cost
Cash at cost
Reissue at cost: Cash at cost, which equals reissue price
Treasury Stock
Reissue at more than cost: Cash at reissue price
Treasury Stock at cost
Paid-in Capital, Treasury Stock
Reissue at less than cost: Cash at reissue price
Paid-in Capital, Treasury Stock for
di?erence between cost and reissue
price, not to exceed its credit balance
Retained Earnings if the credit balance in
Paid-in Capital, Treasury Stock is
insu@cient
Treasury Stock, Common
Work Short Exercises 8 and 9 and Exercises 9A and 10A for practice. Exercise 10A includes
the retirement of treasury stock. Use Case 2 to illustrate the purposes of treasury stock.
After explaining what a stock dividend is and why it is given, “walk” the students through the
entries in the text for Wing Corporation. Also, use the illustrations in the text to show the
“before” and “after” e?ect on stockholders’ equity of declaring a stock dividend. Show that
a stock dividend represents, in e?ect, a reshuLing of stockholders’ equity.
Use the illustrations in the text to show the “before” and “after” e?ect on stockholders’
equity of declaring a stock split. Show that there is no change in the numerical totals.
There is only a change in the par value, shares issued, and shares outstanding.
Short Exercises 11, 12, 13 and Exercises 13A, 14A, and 15A cover stock dividend and stock
split transactions.
After de)ning book value and book value per share, use the following model to show how
book value is calculated. Short Exercise 15 and Exercise 17A cover this topic.
Section 3: Business Applications
Business Applications
Evaluate dividend policies
oDividend yield
Evaluate pro)tability
oReturn on equity
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 9
Evaluate investors’ con)dence in a company’s future
oPrice/earnings ratio
Evaluate stock options
Lecture Outline
I. Investors use the dividend yield ratio to evaluate the amount of dividends they receive.
A. The dividend yield is computed as: Dividends per Share ÷ Market Price per
Share
II. The return on equity ratio is a common measure of management’s performance.
A. The return on equity is computed as: Net Income ÷ Average Total
Stockholders’ Equity
III. The price/earnings (P/E) ratio is a measure of investors’ con)dence in a company’s
future.
A. The P/E ratio is computed as: Market Price per Share ÷ Earnings per Share
IV. The best information regarding cash Oows related to equity transactions is found in the
)nancing section of the statement of cash Oows.
A. The following a reOections of a company’s success:
1. Increasing treasury stock purchases
2. Decreasing new stock issues
3. Cash dividends
V. Stock option plans give employees the right to purchase stock in the future at a )xed
price.
A. These plans are a means of both motivating and compensating employees.
B. Investors evaluate these plans to determine their e?ect on:
1. Current and future )nancial statements.
2. The value of their investments.
Summary
The dividend yield is a ratio that measures the return on a stock investment from
dividends. The dividend yield is calculated by dividing dividends per share by market price
per share.
The return on equity is a ratio that measures management’s performance by dividing net
income by average stockholders’ equity. It is used to evaluate companies and even to
determine top executives’ compensation.
The price/earnings (P/E) ratio, a measure of investors’ con)dence in a company’s future,
is calculated by dividing the market price per share by the earnings per share.
Stock option plans are agreements whereby employees may purchase a speci)ed quantity
of the company’s stock at a )xed price for a stated period. If only certain employees (usually
management) are eligible for this bene)t, the plan is said to be compensatory. The amount
of compensation equals the market price on the date the option is granted minus the option
price. The amount in excess of the exercise price must be either recorded as compensation
expense over the grant period or reported in the notes to the )nancial statements.
Relevant Examples and Exhibits
Ratio: Dividend Yield
Ratio: Return on Equity
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 13: Accounting for Corporations Instructor’s Manual, p. 10
Ratio: Price/Earnings Ratio
Teaching Strategy
Use Short Exercise 16 and Exercise 18A to demonstrate dividend yield and price/earnings
ratios. Problem 9 can be used to demonstrate preferred and common stock dividends and
dividend yield. Problem 10 provides comprehensive stockholders’ equity transactions and
)nancial ratios.
Student Engagement Tactics
00. Assign Case 6 to small groups in class. Use previously established groups or assign
groups randomly. Each group should select a representative to speak for the group.
00. Be clear on the expected output of the learning activity. Identify questions to address
and determine whether written answers are necessary. For example, ask one person
from each group to present one alternative and explain why that alternative would be
best.
00. Elicit as many alternatives as possible for the class to consider. After each group has
presented one alternative, if time permits, ask if any other alternatives might be
available.
00. Allow groups one or two minutes to consider which alternative they prefer and why. Poll
the class as to their preferred response.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
