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Chapter 10 - Stockholders’ Equity
10-1
Chapter 10
Stockholders’ Equity
INSTRUCTOR’S MANUAL
Authors’ Perspectives
Now might be a good time to recap with your students where they’ve been and preview what
comes next. You can remind them that they’ve studied assets (chapters 4-7), in the order those
assets are presented in the balance sheet, and they’ve studied liabilities, both current and long-
term (chapters 8-9). Now, it’s time to discuss the third and final section of the balance sheet—
stockholders’ equity.
PART A: Invested Capital
LO10-1 Identify the advantages and disadvantages of the corporate form of ownership.
Corporation – The chapter begins by explaining the basics of the corporate form of business,
including the organization chart, stages of equity financing, and stockholder rights. The idea is to
give students a deeper understanding of how equity financing works. Students don’t always
associate the term “equity” with “stock” or “ownership” so this is a good reminder.
Common Stock – Common stockholders are introduced as the “true owners” of the business.
Basic journal entries for issuing common stock (par or no-par) are provided. Par value has no
Par Value is Not Value—Par “value” provides an interesting history lesson. We’ve inherited the
archaic concept of par value from early corporate law. Par value originally indicated the real
Chapter 10 - Stockholders’ Equity
10-2
Preferred Stock – Basic journal entries for issuing preferred stock are provided. There is
nothing different in recording these entries versus those for common stock. For those instructors
that wish to dive a little deeper into preferred stock, the concept of cumulative preferred
dividends is discussed and illustrated.
Treasury Stock is Not an Investment – Students often are surprised to learn that most
corporations buy back some of their own shares. Their first question usually is “Why?”
Answering the question presents an opening for interesting conversation. Students frequently
• Illustration 10-10 shows the time trend in dividend payments versus share purchases.
This illustration is provided to help motivate the magnitude and relevance of the topic to
students. The Decision Maker’s Perspective discusses the various reasons companies
acquire their own stock.
PART B: Earned Capital
LO10-5 Describe retained earnings and record cash dividends.
LO10-6 Explain the effect of stock dividends and stock splits.
Retained Earnings – In the previous section we examined paid-in capital, or invested capital.
Now we turn our attention to retained earnings, which might be thought of as earned capital.
Chapter 10 - Stockholders’ Equity
10-3
Dividends – Basic journal entries for dividends are provided. We distinguish between the
declaration date, record date, and payment date.
Students may be interested in the discussion in the Decision Maker’s Perspective of why
Stock Dividends and Stock Splits – Start by pointing out the contrast between a stock dividend
and a cash dividend. In a stock dividend, additional shares of stock are distributed to current
shareholders of the corporation, and neither the assets nor the liabilities of a company are
affected. In contrast, a cash dividend reduces the assets of a company.
Most students have never thought about a stock dividend and its impact on the company’s
With this understanding, you can now relate the example to stock splits. A 100% stock
dividend is the same as a 2-for-1 stock split (and is accounted for the same way). A stock split
lowers the trading price of the stock to a more acceptable trading range, making it attractive to a
larger number of potential investors (see the Decision Maker’s Perspective in this section).
PART C: Reporting Stockholders’ Equity
LO10-7 Prepare and analyze the stockholders’ equity section of a balance sheet and the
statement of stockholders’ equity.
Chapter 10 - Stockholders’ Equity
10-4
Stockholders’ Equity – Part C analyzes the stockholders’ equity section of the balance sheet.
The Decision Maker’s Perspective in this section is designed to help students understand why
ANALYSIS
LO10-8 Evaluate company performance using information on stockholders’ equity.
Equity Analysis – The chapter ends with the calculation of equity-related ratios for Ralph
Lauren vs. Abercrombie & Fitch. Ratios include the return on equity, dividend yield, earnings
per share, and the price-earnings ratio.
Chapter 10 - Stockholders’ Equity
10-5
Self-Study Materials
■ Let’s Review—Equity transactions (p. 506).
■ Let’s Review—Statement of stockholders’ equity (p. 513).
Chapter 10 - Stockholders’ Equity
10-6
Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
LO10-1 Identify the advantages and disadvantages of the corporate form of ownership.
The primary advantages of the corporate form of business are limited liability and the ability to
LO10-2 Record the issuance of common stock.
If no-par value stock is issued, the corporation debits Cash and credits Common Stock. If par
LO10-3 Understand unique features and recording of preferred stock.
Preferred stock has preference over common stock in receiving dividends and in the distribution
LO10-4 Account for treasury stock.
We include treasury stock in the stockholders’ equity section of the balance sheet as a reduction
LO10-5 Describe retained earnings and record cash dividends.
The declaration of cash dividends decreases Retained Earnings and increases Dividends Payable.
LO10-6 Explain the effect of stock dividends and stock splits.
Declaring stock dividends and stock splits is like cutting a pizza into more slices. Everyone has
more shares, but each share is worth proportionately less than before.
LO10-7 Prepare and analyze the stockholders’ equity section of a balance sheet and the
statement of stockholders’ equity.
Chapter 10 - Stockholders’ Equity
10-7
The stockholders’ equity section of the balance sheet presents the balance of each equity account
Analysis
LO10-8 Evaluate company performance using information on stockholders’ equity.
The return on equity measures the ability to generate earnings from the owners’ investment. It is
Chapter 10 - Stockholders’ Equity
10-8
A
As
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gn
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t
C
Ch
ha
ar
rt
ts
s
Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO10-1
Describe stages of equity financing
5
2
LO10-1
Provide examples of public and private corporations
5
and outstanding shares
8
LO10-2
Identify how many shares are authorized, issued,
and outstanding
5
9
LO10-2
Describe par value and how it used in recording the
issuance of stock
5
10
LO10-3
Discuss the three potential features of preferred
stock
5
15
LO10-5
Describe the declaration date, record date, and
payment date for a cash dividend
5
16
LO10-6
Explain the effects of a 100% stock dividend or a 2-
for-1 stock split
5
17
LO10-6
Contrast the effects of a cash dividend with a stock
dividend
5
18
LO10-6
Describe the effects of a 2-for-1 stock split on par
5
Chapter 10 - Stockholders’ Equity
10-9
Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE10-1
LO10-1
Cite advantages and disadvantages of a corporation
10
BE10-2
LO10-1
Understand an S corporation
10
BE10-3
LO10-2
Record issuance of common stock
5
BE10-4
LO10-2
Record issuance of common stock
5
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E10-1
LO10-1
Match terms with their definitions
10
E10-2
LO10-2, 10-3,
10-4
Explain the meaning of terms used in stockholders’
equity
15
E10-3
LO10-2
Record the issuance of common stock
25
E10-4
LO10-3
Determine the amount of preferred stock dividends
15
Chapter 10 - Stockholders’ Equity
10-10
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P10-1A
LO10-1
Match terms with their definitions
15
P10-2A
LO10-2, 10-3,
10-4, 10-5
Record equity transactions and indicate the effect on
the balance sheet equation
30
LO10-8
P10-2B
LO10-2, 10-3,
10-4, 10-5
Record equity transactions and indicate the effect on
the balance sheet equation
30
P10-3B
LO10-6
Indicate effect of stock dividends and stock splits
10
P10-4B
LO10-7
Analyze the stockholders’ equity section
15
Additional
Perspectives
Topic
Time
(Min.)
AP10-1
Continuing Problem: Great Adventures
35
AP10-2
Financial Analysis: American Eagle Outfitters, Inc.
15
AP10-3
Financial Analysis: The Buckle, Inc.
15
Chapter 10 - Stockholders’ Equity
10-11
Alternate Let’s Review
Problem #1
Forever Young has two classes of stock authorized: $100 par preferred and $1 par common. As
of the beginning of the year, 5,000 shares of common stock and no preferred shares have been
issued. The following transactions affect stockholders’ equity during the year:
January 10 Issue 1,000 additional shares of common stock for $30 per share.
March 1 Issue 1,000 shares of preferred stock for $105 per share.
July 1 Declare a cash dividend of $5 per share on preferred stock and $1.25 per share on
common stock to all stockholders of record on July 15.
July 31 Pay the cash dividend declared on July 1.
October 10 Purchase 500 shares of treasury stock for $28 per share.
November 1 Issue 200 shares of the treasury stock purchased on October 10 for $26 per share.
Forever Young has the following beginning balances in its stockholders’ equity accounts:
Preferred stock, $0; common stock, $5,000; additional paid-in capital, $20,000; and retained
earnings, $10,000.
Required:
1. Record each of these transactions.
2. Indicate whether each of these transactions increases (+), decreases (−), or has no effect
(NE), on total assets, total liabilities, and total stockholders’ equity.
Solution:
1.
January 10
Debit
Credit
Cash (1,000 × $30)
30,000
Chapter 10 - Stockholders’ Equity
July 31
Dividends Payable
12,500
Cash
12,500
(Pay cash dividends)
2.
Transaction
Total
Assets
Total
Liabilities
Total
Stockholders’
Equity
Chapter 10 - Stockholders’ Equity
10-13
Problem #2
This is a continuation of problem #1. Forever Young has two classes of stock authorized: $100
par preferred and $1 par value common. As of the beginning of 2021, no preferred stock has
been issued and 5,000 shares of common stock have been issued. The following transactions
affect stockholders’ equity during 2021:
January 10 Issue 1,000 additional shares of common stock for $30 per share.
March 1 Issue 1,000 shares of preferred stock for $105 per share.
July 1 Declare a cash dividend of $5 per share on preferred stock and $1.25 per share on
common stock to all stockholders of record on July 15.
July 31 Pay the cash dividend declared on July 1.
October 10 Purchase 500 shares of treasury stock for $25 per share.
November 1 Resell 200 shares of the treasury stock purchased on October 10 for $26 per share.
Forever Young has the following beginning balances in its stockholders’ equity accounts on
January 1, 2021: Preferred stock, $0; common stock, $5,000; additional paid-in capital, $20,000;
and retained earnings, $10,000. Net income for the year ended December 31, 2021, is $16,000.
Required:
Taking into consideration the beginning balances and all of the transactions during 2021, prepare
the following:
1. The stockholders’ equity section as of December 31, 2021.
2. The statement of stockholders’ equity for the year ended December 31, 2021.
Solution:
1.
Forever Young
Balance Sheet (partial)
December 31, 2021
Stockholders’ equity:
Chapter 10 - Stockholders’ Equity
10-14
2.
Forever Young
Statement of Stockholders’ Equity
For the year ended December 31, 2021
Preferred
Stock
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Treasury
Stock
Total
Stockholders’
Equity
Balance, January 1
-0-
5,000
20,000
10,000
-0-
35,000
Chapter 10 - Stockholders’ Equity
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Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, student can avoid making the same mistakes and gain a deeper
understanding of the chapter material.
Common Mistake
Some students confuse par value with market value. Par value is the legal capital per share that is
Common Mistake
Sometimes students confuse the purchase of treasury stock with investments in another
Common Mistake
Some students think, incorrectly, that retained earnings represent a cash balance set aside by the
company. In fact, the size of retained earnings can differ greatly from the balance in the Cash
account. Facebook reported $1.5 billion in retained earnings but only $410 million in cash.
Common Mistake
Chapter 10 - Stockholders’ Equity
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Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
How many of a
company’s shares are
Balance sheet
The number of authorized, issued, and
outstanding shares is normally
Question
Accounting Information
Analysis
How much profit has the
company made for its
shareholders that has not
been paid back to them
in dividends?
Balance in Retained Earnings
The balance in Retained Earnings
shows all net income less dividends
since the company began operations.
Question
Accounting Information
Analysis
Decision Maker’s Perspective
Limited Liability and Beneficial Tax Treatment
Wouldn’t it be nice to get the best of both worlds—enjoy the limited liability of a corporation
and the tax benefits of a sole proprietorship or partnership? An S corporation allows a company
Chapter 10 - Stockholders’ Equity
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Why Corporations Purchase Their Stock
What would motivate a company to buy back its own stock? Companies acquire their own stock
for various reasons:
1. To boost underpriced stock. When company management feels the market price of its stock
is too low, it may attempt to support the price by decreasing the supply of stock in the
marketplace. An announcement by Johnson & Johnson that it planned to buy up to $5 billion
Why Don’t Some Companies Pay Dividends?
Many companies that are unprofitable choose not to pay dividends. Management of these
companies may instead need to use that cash for strategic purposes to keep the company from
Chapter 10 - Stockholders’ Equity
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Why Declare a Stock Split?
Why would a company declare a 2-for-1 stock split when the stockholders are not really
receiving anything of substance? The primary reason is to lower the trading price of the stock to
Why Doesn’t Stockholders’ Equity Equal the Market Value of Equity?
The market value of equity is the price investors are willing to pay for a company’s stock. The
market value of equity equals the stock price times the number of shares outstanding. On the
other hand, the book value of equity equals total stockholders’ equity reported in the balance
sheet. Market value and book value generally are not the same, and often are vastly different. For
example, Nvidia reported total stockholders’ equity of about $6 billion, yet its market value at
this same time was over $63 billion. Why?
Keep in mind that stockholders’ equity is equal to assets minus liabilities. An asset’s book
Chapter 10 - Stockholders’ Equity
Ethical Dilemma
Intercontinental Clothing Distributors has paid cash dividends every year since the company was
founded in 1990. The dividends have steadily increased from $0.05 per share to the latest
dividend declaration of $1.00 per share. The board of directors is eager to continue this trend
despite the fact that earnings fell significantly during the recent quarter. The chair of the board
proposes a solution. He suggests a 5% stock dividend in lieu of a cash dividend, to be
accompanied by the following press announcement: “In place of our regular $1.00 per share cash
dividend, Intercontinental will distribute a 5% stock dividend on its common shares, currently
trading at $20 per share. Changing the form of the dividend will permit the company to direct
available cash resources to the modernization of facilities and other capital improvements.
Is a 5% stock dividend on shares trading at $20 per share equivalent to a $1.00 per share cash
dividend? Is the chair’s suggestion ethical?
Key Issues
• Is a stock dividend equivalent to a cash dividend?
Option 1: Replace the cash dividend with a stock dividend
• Replacing the cash dividend with a stock dividend frees up available cash.
Option 2: Decrease the cash dividend payment with no replacement stock dividend
• It may appear deceptive to replace something of real substance (cash dividends) with
something of no real substance (stock dividends).
Option 3: Eliminate dividend payments entirely
• Eliminating the dividend payments also frees up available cash without any perceived
