Chapter 11 Corporations: Organization, Stock Transactions, and Dividends 219
Key Terms and Definitions
• Treasury Stock – Stock that a corporation has once issued and then reacquires.
Relevant Example Exercises and Exhibits
• Example Exercise 11-5 Entries for Treasury Stock
SUGGESTED APPROACH
The term “treasury stock” originated because the treasurer’s office of a corporation usually has the
responsibility for purchasing and maintaining custody of such stock. The text presents the cost method of
accounting for treasury stock. The par value method is mentioned only in a footnote. The following
Demonstration Problem presents sample entries that you can review with your class.
You should also stress that treasury stock is the only “stock” account that is not recorded at par. The cost
of treasury stock, not the par value, is debited to the account.
DEMONSTRATION PROBLEM—Entries for Treasury Stock
Record the following entries for Lawry Corporation:
Lawry purchased 1,000 shares of $5 par value common stock for $10 per share.
Treasury Stock…………………………………….. 10,000
Cash……………………………………….. 10,000
220 Chapter 11 Corporations: Organization, Stock Transactions, and Dividends
When purchasers of treasury stock pay more than the cost of the stock, they have contributed additional
capital to the corporation. When treasury shares are sold at a price below their cost, Paid-In Capital from
Sale of Treasury Stock is debited, thus reducing stockholder’ equity.
Lawry sold 100 shares of its treasury stock at $9 per share.
After demonstrating these entries, ask your students to record the following three transactions in their
notes:
Lawry sold 100 shares of its treasury stock at $14 per share.
Cash……………………………………………….. 1,400
Treasury Stock……………………………. 1,000
Paid-In Capital from Sale of Treasury Stock 400
Lawry sold 100 shares of its treasury stock at $8 per share.
WRITING EXERCISE—Treasury Stock
Ask your students to respond to the following (TM 11-8):
Name and explain two reasons that a corporation might choose to repurchase its own
stock.
Answers are found on TM 11–7.
Chapter 11 Corporations: Organization, Stock Transactions, and Dividends 221
OBJECTIVE 5
Describe and illustrate the reporting of stockholders’ equity.
SYNOPSIS
There are two methods to report stockholders equity on the balance sheet. In Method 1, each stock is
reported separately along with its related paid-in capital account. In Method 2, each stock is reported
separately but the paid-in capital account is combined for all classes of stock. Exhibit 6 illustrates both
and paid-in capital, a statement of stockholders’ equity is prepared.
Key Terms and Definitions
• Prior Period Adjustments – Corrections of material errors related to a prior period or periods,
excluded from the determination of net income.
Relevant Example Exercises and Exhibits
• Example Exercise 11-6 Reporting Stockholders’ Equity
SUGGESTED APPROACH
This objective covers paid-in capital, retained earnings, and treasury stock on the balance sheet. It also
illustrates the retained earnings statement, describes restrictions on retained earnings, and describes prior
period adjustments. Lecture Aids to cover each of these items are discussed below.
222 Chapter 11 Corporations: Organization, Stock Transactions, and Dividends
LECTURE AID—Paid-In Capital on the Balance Sheet
Paid-in capital and retained earnings are the two major sources of stockholders’ equity; therefore, they are
the two major sections on a corporation’s balance sheet.
You will probably need to remind your students that paid-in capital consists of the following accounts:
TM 11-11 lists the stockholders’ equity accounts that are reported in the paid-in capital section of the
balance sheet.
Refer your students to Exhibit 6 in the text to see two examples of how these accounts are reported. Stress
that the second format for Stockholder’s Equity summarizes all of the paid-in capital accounts as one
total, labeled “Additional Paid-In Capital.”
To make sure your students see the “big picture,” remind them that the Stockholders’ Equity section of
the balance sheet consists of the following:
DEMONSTRATION PROBLEM—Retained Earnings Statement
Begin by reviewing the concept of retained earnings. Retained earnings are profits that have been kept
(retained) by a corporation. They are profits that have not been returned to shareholders through
dividends. Therefore, a corporation’s retained earnings are increased by its net income and reduced by
dividends declared.
TM 11-12 presents a retained earnings statement for Parks Corporation.
LECTURE AID—Restrictions on Retained Earnings
Many students have the following misconception: Restricting retained earnings sets aside cash for a
specific purpose. You must work to dispel the notion that restricting retained earnings affects a
corporation’s cash.
Use the following story to introduce the concept of restricted retained earnings:
Let’s say that you have decided to treat yourself to a nice lunch off campus today. You have $30 in your
pocket. When you get to the restaurant where you plan to eat, you notice that your car’s gas tank is on
empty. You don’t have any credit cards with you, and you know you will have to purchase at least $10 in
gas. How much can you afford to spend on lunch? Of course, the answer is $20.
WRITING EXERCISE—Restriction of Retained Earnings
Ask your students to write a response to the following question (TM 11-13):
Technograph Corporation discovered that some hazardous material was buried on a parcel of land
currently owned by the corporation. A former owner of the property buried the material. It will cost
Technograph $1 million to remove the material and dispose of it properly.
224 Chapter 11 Corporations: Organization, Stock Transactions, and Dividends
Possible Response: Since it is possible that the EPA would require that such hazardous materials be
cleaned up, the board of directors could restrict retained earnings for the cleanup. This would be
categorized as a “legal” restriction. However, the restriction alone sets aside no cash for the future
cleanup.
DEMONSTRATION PROBLEM—Prior-Period Adjustments
When an error in a prior year’s net income is discovered, it is reported as a prior-period adjustment. Prior-
period adjustments are shown on the retained earnings statement as a correction to the beginning balance
of retained earnings.
The text does not illustrate a retained earnings statement with a prior-period adjustment. The following
example will help you give a brief practical example of this concept:
At the end of the current year, E & M Corporation discovered that several errors were made in the
physical inventory count taken at the end of last year. As a result, the cost of merchandise sold last year
was understated by $10,000, causing income before taxes to be overstated by the same amount. E & M
reported $100,000 as its ending retained earnings last year.
Chapter 11 Corporations: Organization, Stock Transactions, and Dividends 225
OBJECTIVE 6
Describe the effect of stock splits on corporate financial statements.
SYNOPSIS
A stock split is the process by which a corporation reduces the par of stated value of the common stock
and issues a proportionate number of additional shares. Exhibit 9 illustrates this process. Sometimes this
is done to make the stock more appealing in the open market. If the market value of a stock gets too high,
a limited number of investors can afford the stock. A stock split requires no journal entry, but the details
of the split should be disclosed in the notes to the financial statements.
Key Terms and Definitions
• Stock Split – A reduction in the par or stated value of a common stock and the issuance of a
proportionate number of additional shares.
SUGGESTED APPROACH
With a stock split, one share of stock is split into two or more shares. When this occurs, the par value of
the stock decreases, and the number of shares increases. The market value of the stock should also fall.
Under this objective, you will need to explain why a corporation would choose to split its stock. Also
illustrate the effect of a stock split on the number of shares and par value.
DEMONSTRATION PROBLEM—Stock Splits
Bravara Corporation has 10,000 shares of $20 par-value common stock selling at $100 per share.
Determine the new number of shares, par value, and market price under each of the following
independent assumptions.
226 Chapter 11 Corporations: Organization, Stock Transactions, and Dividends
The new market price is what the stock should sell for in theory after the stock split. However, many
factors other than the split may affect the price of the stock. For example, favorable news about the
economy may keep the price of the stock from dropping as low as it otherwise would in the event of a
split.
INTERNET ACTIVITY—Stock Splits
Since stock splits create excitement in the stock market, many investors track which companies have
announced stock splits. The following Web site provides a “Stock Split Calendar.”
http://investing.money.msn.com/investments/calendar/stock-splits
Have your students visit this site or perform a search on “stock splits” for more information.
WRITING EXERCISE—Stock Splits
Ask your students to answer the following question (TM 11-9):
OBJECTIVE 7
Describe and illustrate the use of earnings per share in evaluating a company’s profitability.
SYNOPSIS
The earnings per share ratio is used to evaluate the company’s profitability. Net income alone can be
difficult to compare across different size companies. This ratio is used to determine earnings per common
share sometimes called basic earnings per share. The ratio is calculated as: earnings per share = (net
income – preferred dividends)/average number of common shares outstanding.
Chapter 11 Corporations: Organization, Stock Transactions, and Dividends 227
Key Terms and Definitions
• Earnings per Common Share (EPS) – Net income per share of common stock outstanding
during a period.
Relevant Example Exercises and Exhibits
SUGGESTED APPROACH
Explain the significance of earnings per share data and present the formula for basic earnings per share.
LECTURE AID—Earnings per Share
Assume that two couples residing in the same city each have combined incomes of $70,000. Would you
expect both couples to have about the same lifestyle? If you knew that one of those couples had no
children and the other couple had seven children, would you still expect both couples to have the same
lifestyle? In this case, the per-person income of the two families is dramatically different.
Couple A—No Children Couple B—Seven Children
Earnings per Person =
$70,000 $35,000
2
=
Earnings per Person =
$70,000 $7,778
9
=
This same concept can be applied to corporations. Assume that two corporations both made $100,000 of
net income last year. Corporation A has 1,000 shares of stock, and Corporation B has 100,000 shares.
Would you rather have a share of stock in Corporation A or B? Corporation A has more income for each
share of stock.
228 Chapter 11 Corporations: Organization, Stock Transactions, and Dividends
Stress that earnings per share does not normally represent the amount that stockholders can expect to
receive in dividends. It would only represent this amount if the corporation paid out all its earnings in
dividends.
GROUP LEARNING ACTIVITY—Earnings per Share
Type Item Description LO(s) Difficulty
Time
Est
BUSPROG AICPA ACBSP – APC Bloom’s EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 2 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 2 2 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 3 3 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 4 3 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 5 3 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 6 4 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
DQ 10 6 Easy 5 min. Analytic Measurement Accounting for Corporations Knowledge
PE 1A Dividends per share 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 1B Dividends per share 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 2A Entries for issuing stock 2 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 2B Entries for issuing stock 2 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 3A Entries for cash dividends 3 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 3B Entries for cash dividends 3 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 4A Entries for stock dividends 3 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 4B Entries for stock dividends 3 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 5A Entries for treasury stock 4 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 5B Entries for treasury stock 4 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
PE 6A Reporting stockholders’ equity 5 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 6B Reporting stockholders’ equity 5 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 7A Retained earnings statement 5 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 7B Retained earnings statement 5 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
PE 8A Earnings per share 7 Easy 5 min. Analytic Measurement Accounting for Corporations Application x x
PE 8B Earnings per share 7 Easy 5 min. Analytic Measurement Accounting for Corporations Application x x
EX 1 Dividends per share 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x x
EX 2 Dividends per share 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application
EX 3 Entries for issuing par stock 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
EX 4 Entries for issuing no-par stock 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
EX 5 Issuing stock for assets other than cash 2 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
EX 6 Selected stock transactions 2 Easy 15 min. Analytic Measurement Accounting for Corporations Application
EX 7 Issuing stock 2 Moderate 10 min. Analytic Measurement Accounting for Corporations Application
EX 8 Issuing stock 2 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
EX 10 Entries for stock dividends 3 Moderate 15 min. Analytic Measurement Accounting for Corporations Application x
EX 11 Treasury stock transactions 4 Moderate 15 min. Analytic Measurement Accounting for Corporations Application x x
EX 12 Treasury stock transactions 4,5 Moderate 15 min. Analytic Measurement Accounting for Corporations Application x
EX 13 Treasury stock transactions 4,5 Moderate 15 min. Analytic Measurement Accounting for Corporations Application x
EX 14 Reporting paid-in capital 5 Easy 10 min. Analytic Measurement Accounting for Corporations Application
EX 15 Stockholders’ Equity section of balance sheet 5 Easy 10 min. Analytic Measurement Accounting for Corporations Application
EX 16 Stockholders’ Equity section of balance sheet 5 Easy 10 min. Analytic Measurement Accounting for Corporations Application
EX 17 Retained earnings statement 5 Easy 10 min. Analytic Measurement Accounting for Corporations Application x
EX 18 Stockholders’ Equity section of balance sheet 5 Moderate 15 min. Analytic Measurement Accounting for Corporations Application
EX 19 Statement of stockholders’ equity 5 Easy 15 min. Analytic Measurement Accounting for Corporations Application x
EX 20 Effect of stock split 6 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
EX 21 Effects of cash dividend and stock split 3,6 Easy 5 min. Analytic Measurement Accounting for Corporations Application
EX 22 Selected dividend transactions, stock split 3,6 Moderate 15 min. Analytic Measurement Accounting for Corporations Application
EX 23 EPS 7 Easy 5 min. Analytic Measurement Accounting for Corporations Application x
EX 24 EPS 7 Easy 10 min. Analytic Measurement Accounting for Corporations Application x x
EX 25 EPS 7 Moderate 10 min. Analytic Measurement Accounting for Corporations Application x x
CP 1 Board of directors’ actions 1 Easy 10 min. Ethics Industry Accounting for Corporations Comprehension x x x
CP 2 Ethics and professional conduct in business 2 Easy 10 min. Ethics Industry Accounting for Corporations Analysis x x
CP 3 Issuing stock 2 Moderate 20 min. Analytic Measurement Accounting for Corporations Analysis x
CP 4 Interpret stock exchange listing 1 Moderate 20 min. Analytic Industry Accounting for Corporations Evaluation x x
CP 5 Dividends 3 Moderate 20 min. Analytic Measurement Accounting for Corporations Analysis x
CP 6 Profiling a corporation 1 Moderate 30 min. Analytic Industry Accounting for Corporations Analysis x x
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