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CHAPTER 11 STOCKHOLDERS’ EQUITY
• Expertise, talents.
◼ Can use a number of formulas to distribute income, including:
• Distribute everything equally.
If no mention made in agreement, profits and losses will be divided equally among
partners.
INSTRUCTOR’S MANUAL
11-16
Lecture Suggestions
Module 1
LO 2
Discuss how different characteristics of stock can be advantageous to the preferred stockholders.
These characteristics will increase the market price of the preferred stock. Cumulative preferred
stock will have a higher price than non-cumulative preferred. However, the more favorable
characteristics the preferred stock has, the less desirable the common stock may be.
Module 2
LO 5
Also stress that Treasury Stock is the only stock account that is not recorded at par value.
Treasury Stock is recorded at the cost the company pays for it. When the treasury stock is resold, it
is removed from the books at the amount the company paid for it.
Students often find it difficult to understand why dividends in arrears are not recorded as a liability
since the company owes the shareholders a dividend. Explain that the corporation has no legal
liability to ever declare a dividend. So if the Board of Directors does not declare a dividend, there
is no obligation to pay the dividend. The liability arises when the dividends are declared by the
Board of Directors. Even though dividends in arrears are not recorded in the financial statements,
the amount of dividends in arrears must be disclosed in the footnotes to the financial statements.
Module 2
LO 7
Add a stock split to the comparison from the previous suggestion. Prepare another stockholders’
equity section showing the effect of a 2:1 stock split instead of a 100% stock dividend.
CHAPTER 11 STOCKHOLDERS’ EQUITY
11-17
Projects and Activities
Module 1
LO 1
Identifying the Components of the Stockholders’ Equity Section of
the Balance Sheet
In-class discussion: Workout Wonders Stockholders’ Equity
Study the Stockholders’ Equity section of the balance sheet of Workout Wonders (Exhibit 11-5) in your
textbook.
◼ How many classes of stock does the company have? What are they? Do they have a par value?
◼ How many shares of common stock are issued as of December 31, 2016?
◼ Did Workout Wonders hold any Treasury stock at December 31, 2016? What class of stock was
the Treasury stock? How many shares of Treasury stock were held?
◼ What is the $618 million in Capital in excess of par value? From which class of stock was it
contributed?
Solution
◼ Workout Wonders has two classes of stock: common and preferred stock. Preferred stock is a no
par stock and common stock has a par value of $1 2/3 per share.
Module 1
LO 2
Preferred Stock
In-class discussion: Bank of America Corporation
Preferred Stock
Per Footnote 13 of Bank of America’s 2014 financial statements:1
”At the Corporation’s annual meeting of stockholders on May 7, 2014, the stockholders approved an
amendment to the Series T Preferred Stock such that it qualifies as Tier 1 capital, and the amendment
INSTRUCTOR’S MANUAL
11-18
Also included in Footnote 13 is a Preferred Stock Summary schedule. Bank of America has several
different series of preferred stock, including2:
Series B preferred stock, 7%, cumulative, redeemable
Series D preferred stock, 6.204%, noncumulative
◼ Explain the following terms as it relates to preferred stock: cumulative, arrears, and redemption.
◼ Will the balance sheet report the dividends in arrears as a current liability?
◼ The Series T preferred stock is no longer cumulative. What does this mean to the shareholders?
◼ Explain the terms used in the description for the Series B and Series D stock.
Solution
◼ Cumulative – the right to receive any dividends that were not paid in the past along with the
current year’s dividend before the common shareholders receive any dividends
Arrears – dividends on preferred stock that are not paid
Redemption – company has the right to buy back the stock at a predetermined price.
Module 1
LO 3
Stock Issued for Cash
In-class discussion: Noodles & Co.
“Noodles & Company is a high growth, fast casual restaurant concept offering lunch and dinner within a
fast growing segment of the restaurant industry. We opened our first location in 1995, offering noodles and
pasta dishes, staples of many cuisines, with the goal of delivering fresh ingredients and flavors from
around the world under one roof—from Pad Thai to Mac & Cheese.”3
In June of 2013, Noodles & Co., a privately held company, “went public” by offering 5,357,143 shares of
their stock to the public at $18.00 per share.4 This is known as an IPO, or initial public offering.
◼ How do you suppose Noodles & Co., or any company, determines the price at which they will
initially offer their stock for public sale? Is this an arbitrary number?
CHAPTER 11 STOCKHOLDERS’ EQUITY
11-19
◼ Does the offering of shares guarantee that the company will receive approximately $96.4 million?
What happens if no one buys at $18.00?
◼ What advantage is there for the current owners of the company to dilute their share of the
company by offering a stake to outsiders?
◼ Based on what you have studied about companies thus far, what are the two most likely uses to
which Noodles & Co. might put the proceeds of the offering?
◼ As a potential investor, what information would you want from Noodles & Co. to enable you to
make a decision about whether you want to own their stock, how many shares you want, and what
price you are willing to pay? Is the product important?
Solution
◼ The initial offering price is based on a company’s balance sheet position, and its operating results,
in comparison with similar companies already publicly traded. The price is usually developed with
◼ Most companies either want to retire debt or expand the company. According to the information
Noodles & Co. had in their IPO, “The net proceeds we receive from this offering will be
approximately$87.0 million based on the initial public offering price of $18.00 per share, after
deducting the underwriting discounts and commissions and estimated offering expenses payable
by us. If the underwriters' option to purchase additional shares in this offering from us is
exercised, our net proceeds will be approximately $100.4 million after deducting the underwriting
discounts and commissions and estimated offering expenses payable by us.
INSTRUCTOR’S MANUAL
11-20
Outside assignment: What does stock cost?
How much can a company expect to receive if it issues additional stock? What would it cost you to buy a
share of Apple Inc., General Mills or the Gap? How do these prices change over time? Let’s put together a
◼ What is the highest price their common stock has reached during the past 52 weeks? What was the
lowest price?
◼ What is the current market price of each company’s common stock?
◼ Compare the high and the low, for the last 52 weeks for each company, given to you by your
instructor. What do you think is the reason for the changes in price? Were the changes large or
small? Were they up or down? Are they closer today to the high or low? Think about the
economy, the respective industries, and events you may have heard about through the media that
happened to a particular company.
◼ What general characteristics of companies seem to influence stock price? You are not expected to
be an expert. Be an informed, careful observer. Try to develop a list of factors that appear to
influence stock price.
Solution:
Students can work on this together in teams, or even as a class. Divide them into “work groups” to gather,
collate, and analyze the information. Expand the assignment if time permits by asking students, in
Ethical discussion: Insider trading
There have been many “insider trading” scandals in the news. Do you really understand what the term
means, and what was wrong with the actions taken by these individuals?
◼ What do you personally believe “insider trading” is? Define it as completely as possible in your
own words, without going to reference materials just now.
CHAPTER 11 STOCKHOLDERS’ EQUITY
11-21
◼ Look through the periodical index and find two articles that describe cases of insider trading.
Summarize what happened in each. What did the people involved do? Why was it considered
wrong? Were there mitigating circumstances? Did the parties involved argue that they were not
wrong? If so, what justification did they offer?
◼ In light of your limited research into the question, comment on your observations on insider
trading investigations and prosecutions in terms of the:
• size of the trades involved,
• position (occupation) of the person involved, and
• number of people in the same company involved, and the communication between them.
◼ Suppose you are an employee of a company who is negotiating with another, larger company.
Your company is going to sell one of its subsidiaries, based upon the discovery of a new
technology, to the larger company, which is in a better position to manufacture and market the
product. These negotiations have not as yet been made public. Everyone in your office is talking
about buying as many shares in the subsidiary as they can because, when the sale takes place, the
stockholders in the subsidiary will be bought out by the larger company at a very advantageous
price. Is this insider trading? Why or why not?
Solution
◼ Students’ own definitions will vary. Many have little idea what the term means. Ask this question
in class before students research the remainder of the exercise, and note down their responses.
INSTRUCTOR’S MANUAL
11-22
the Complaint, ImClone and the market were awaiting an imminent decision from the U.S. Food
and Drug Administration on one of ImClone's key products, a cancer treatment called "Erbitux."
The Commission alleges that information about the Waksals' efforts to sell signaled insider
pessimism about the FDA decision, the prospects for Erbitux, and the future of ImClone. The
Commission alleges that, based on this conduct, Stewart and Bacanovic violated Section 17(a) of
the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule
10b-5 there under.
Specifically, the Commission's complaint alleges as follows:
Early in the morning on December 27, 2001, the day before ImClone publicly disclosed the FDA
decision, Waksal and his daughter placed orders with Douglas Faneuil (Bacanovic's assistant) to
sell all of their ImClone shares at Merrill Lynch. Faneuil spent that morning talking to Bacanovic
by telephone (Bacanovic was vacationing in Florida) and others at Merrill Lynch about Waksal's
and his daughter's instructions to sell and whether Waksal could sell his shares, either directly or
through his daughter's account.
On several subsequent occasions, Stewart and Bacanovic lied to the Commission, the U.S.
Attorney's Office for the Southern District of New York, and the Federal Bureau of Investigation
about the events of December 27, 2001 and the facts surrounding Stewart's sale of ImClone stock.
For example, the Defendants fabricated a false alibi for Stewart's trades, stating that she sold her
ImClone stock because she and Bacanovic had decided earlier that she would sell if ImClone's
stock price fell below $60 per share. In addition, Stewart told the government that she did not
recall anyone telling her that day that any of the Waksals were selling their ImClone stock.
CHAPTER 11 STOCKHOLDERS’ EQUITY
watched more closely than those more removed from the regular buying and selling of stocks. If
too many shares change hands and the trades all seem to center around a related group of people,
such as people who all work for the same company, they draw attention to themselves. However,
the legal actions focus on the effect the trading has on the market price, so that it is only the larger
operations that stand out. The smaller cases profit individually (this does not justify the practice)
but have little measurable effect on the market, even for the individual stock in question.
Module 1
LO 4
Treasury Stock
In-class discussion: Treasury Stock
Intuit Inc. is a leading provider of innovative business and financial management solutions for small
businesses, consumers, accounting professionals and financial institutions. Their flagship products and
services include QuickBooks, TurboTax and Quicken. 9
Our treasury shares are repurchased at the market price on the trade date; accordingly, all amounts paid to
reacquire these shares have been recorded as treasury stock on our balance sheets. Repurchased shares of
our common stock are held as treasury shares until they are reissued or retired. When we reissue treasury
stock, if the proceeds from the sale are more than the average price we paid to acquire the shares we record
an increase in additional paid-in capital. Conversely, if the proceeds from the sale are less than the average
price we paid to acquire the shares, we record a decrease in additional paid-in capital to the extent of
increases previously recorded for similar transactions and a decrease in retained earnings for any remaining
amount.
◼ Why would a company buy back its own stock?
INSTRUCTOR’S MANUAL
11-24
◼ What conditions must be present in the company to make a large buyback possible?
◼ What would Intuit do with all this stock? What future benefit might it have?
◼ How do they account for treasury stock?
Solution
◼ A company may want to buy back its stock for several reasons including, (1) to have stock
available to distribute to employees for bonuses or to make available as part of an employee
Module 2
LO 5
Cash Dividends for Preferred and Common Stock
In-class exercise: Preferred stock and dividends
A company has preferred stock which is cumulative, convertible preferred stock.
◼ What does this mean? Does it create a liability for the company? Explain why or why not.
Solution
◼ The stock’s cumulative feature means that in a year in which no dividend is paid, the preferred
CHAPTER 11 STOCKHOLDERS’ EQUITY
11-25
Module 2
LO 6
Stock Dividends
In-class discussion: Stock dividends and taxes
◼ You have learned that stock dividends are not taxable for the recipient (the shareholder). Why do
you think this is true? Is it because they have no value?
◼ If a stock dividend is not taxable, and a cash dividend is, could you avoid taxes by asking the
company you own shares in to pay you your dividend in stock instead of cash, even though they
intended to send you cash? Why or why not? What is the difference between this situation and a
declared stock dividend?
Solution
◼ Stock dividends certainly have value. The stockholder who receives a small stock dividend hopes
(probably correctly) that the stock will recover its market price before the dividend, or close to it,
Module 2
LO 7
Stock Splits
In-class discussion: Reverse split
You have learned about stock splits, their purposes, and their results. Now consider a “reverse split.” What
do you think this might be? Why do you think a company might consider one? Look for a recent example
of a company activating a reverse split. Explain what happened, and why.
Solution
A reverse split occurs when a company reduces, rather than increases, the number of shares outstanding.
INSTRUCTOR’S MANUAL
11-26
Module 3
LO 10
How Changes in Stockholders’ Equity Affect the Statement of Cash
Flows
In-class exercise: Treasury Stock versus Retirement
Review the Stockholders’ Equity section of Southwest Airline’s 201412 balance sheet.
Stockholders’ Equity
Common stock ($1 par value, 200 million shares authorized) $ 808
◼ What types of stock does Southwest Airline’s have?
◼ Southwest does not show an “Additional paid-in capital” account. What do they show instead?
Does it mean the same thing?
◼ What does the Treasury stock represent? How is this different than when stock is retired?
Solution
◼ In 2014, Southwest had only one class of stock, their $1 par value common stock.
Module 4
Appendix
LO 11
Sole Proprietorships and Partnerships
In-class discussion: Public accounting firms
◼ You may recall from earlier in this course that public accounting firms are organized as
partnerships. Explain why.
◼ Discuss the advantages and disadvantages of allowing partnerships some of the benefits of the
corporate form.
Solution
◼ A key issue is independence. Accountants provide an unbiased opinion of a company’s operating
CHAPTER 11 STOCKHOLDERS’ EQUITY
11-27
In-class discussion: Partnership ethics
Al and Ed, friends since childhood, decided to go into business together. They entered into a partnership in
a hot tub spa and tanning parlor, with a retail store selling hot tubs for home use. Al was concerned about
Before they actually drew up the partnership agreement, Al solved his perceived problem by having his
attorney transfer the title to his house from him and his wife to his wife and children. He felt this was only
fair to protect his family from a potential problem with the business.
◼ Do you think Al was right to be concerned?
◼ In personal terms, was this a reasonable solution?
◼ Is anyone potentially harmed by his act?
◼ Do you consider what he did to be ethical?
Note: You are not expected to know what the law says about these events. Consider the situation on
common-sense ethical grounds.
Solution
Many partners in large as well as small partnerships use whatever legal maneuvers they can to protect
INSTRUCTOR’S MANUAL
