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Overview
We turn our attention in this chapter from liabilities, which represent the creditors’ interests in
the assets of a corporation, to the shareholders’ residual interest in those assets. The discussions
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
After studying this chapter, you should be able to:
LO18-1 Describe the components of shareholders’ equity and explain how they are reported in a
statement of shareholders’ equity.
LO18-2 Describe comprehensive income and its components.
accounting for shareholders’ equity.
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Part A: The Nature of Shareholders’ Equity
I. Sources of Shareholders’ Equity
A. A company can raise money externally to fund operations in either of two ways:
1. Debt financing.
18-2 Intermediate Accounting, 8/e
2. Equity financing.
a. Creates ownership interests in the assets of the business.
B. Shareholders’ equity is created mainly by:
1. Amounts invested by shareholders – paid-in capital.
2. Amounts earned by the firm on behalf of its shareholders – retained earnings.
II. Shareholders’ Equity in Financial Statements
A. The balance sheet reports balances of shareholders’ equity accounts. (T18-2)
B. Comprehensive income, a more expansive view of the change in shareholders’ equity than
traditional net income, is the total nonowner change in equity for a reporting period.
Transactions between the corporation and its shareholders primarily include dividends and
the sale or purchase of shares of the company’s stock. Nonowner changes other than those
Part B: Paid-In Capital
I. Fundamental Share Rights
A. Usually ownership rights held by common shareholders include the right to:
1. Vote.
2. Share in profits when dividends are declared.
II. The Concept of Par Value
A. Par value has little significance other than historical.
III. Accounting for the Issuance of Shares
A. When shares are sold for cash, shareholders’ investment is allocated between stated
capital and additional paid-in capital. (T18-5)
B. At times, shares are sold for noncash consideration like a service or a noncash asset.
(T18-6)
1. The transaction should be recorded at the fair value of either the shares or the
E. Share issue costs are the costs of the legal, promotional, and accounting services
necessary to effect the sale of shares.
1. The costs reduce the net cash proceeds from selling the shares and thus paid-in
capital – excess of par.
2. Share issue costs are not recorded separately.
IV. Reacquired Shares
A. Companies sometimes reacquire shares previously sold.
1. The most common motivation is to support the market price of the shares.
2. All share repurchases are functionally the same.
3. The difference between the cash paid to buy the shares and the amount the shares
originally sold for are treated differently depending on whether that difference is
positive (credit) or negative (debit):
C. Corporations often view a share buyback as a purchase of treasury stock.
1. The cost of acquiring the shares is “temporarily” debited to the treasury stock
account.
2. We delay recording the effects on specific shareholders’ equity accounts until later
Part C: Retained Earnings
I. The Nature of Retained Earnings
A. In Part B, we studied invested capital. In Part C, we consider earned capital, usually
referred to as retained earnings. (T18-12)
II. Dividends
A. Most corporate dividends are paid in cash. At the declaration date, retained earnings is
reduced and a liability is recorded. Registered owners of shares on the date of record are
III. Stock Distributions
A. In a stock dividend, additional shares of stock are distributed to existing shareholders.
1. A stock dividend affects neither the assets nor the liabilities of the firm.
B. A stock distribution of 25% or higher is a stock split. (T18-16)
Decision-Makers’ Perspective
A. Profitability is vital to a company’s long run survival.
B. The return on shareholders’ equity is a popular summary measure of profitability.
1. The return on shareholders’ equity is calculated by dividing net income by average
3. A common variation is the inverse – the price-earnings ratio.
D. Shareholders’ equity transactions can affect the return to shareholders.
1. When a company buys back some of its shares, the return on shareholders’ equity
goes up.
2. On the other hand, the buyback of shares uses assets, which decreases the resources
available to earn net income in the future.
E. Analysts should evaluate dividend decisions with consideration for prevailing
circumstances. Management must decide whether shareholders are better off receiving
cash dividends or having funds reinvested in the firm.
Appendix 18: Quasi-Reorganizations
A. A quasi-reorganization aids a company that experiences financial difficulties, and yet has
favorable future prospects.
1. Inflated asset values are written down.
18-6 Intermediate Accounting, 8/e
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A PowerPoint presentation of the chapter is available at the textbook website.
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The following can be reproduced on transparency film as they appear here, or
SHAREHOLDERS’ EQUITY
❖ Shareholders’ equity accounts represent the ownership
interests of shareholders. Shareholders’ equity is a residual
❖ Ownership interests of shareholders arise primarily from
two sources – (1) amounts invested by shareholders in the
T18-1
18-8 Intermediate Accounting, 8/e
Exposition Corporation
Balance Sheet ($ in millions)
December 31, 2016
Assets
[$3,000]
Liabilities
[$1,000]
Shareholders’ equity
PAID–IN CAPITAL:
Capital stock (par):
Preferred stock, 10%, $10 par,
Additional Paid-in Capital:
Paid-in capital – excess of par, common 260
Paid-in capital – excess of par, preferred 50
RETAINED EARNINGS 1,670
ACCUMULATED COMPONENTS OF COMPREHENSIVE INCOME:
Unrealized gains (losses) on investment securities (85)
Unrealized net loss on pensions (75)
COMPREHENSIVE INCOME
❖ Encompasses all changes in equity other than from transactions with
owners.
• Components of comprehensive income created during the reporting
period can be reported either (a) as an additional section of the
income statement, (b) as part of the statement of shareholders’ equity,
or (c) as a separate statement in a disclosure note:
($ in millions)
Net income $xxx
Other comprehensive income:
Net unrealized holding gains (losses) on investments (net of tax)† $ x
† Changes in the fair value of some securities.
‡ Gains and losses due to revising assumptions or market returns differing from expectations
and prior service cost from amending the plan (described in Chapter 17).
§ When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is
T18-3
18-10 Intermediate Accounting, 8/e
STATEMENT OF SHAREHOLDERS’ EQUITY
T18-4
SHARES SOLD FOR CASH
❖ When shares are sold for cash, the capital stock account
(usually common or preferred) is credited for the amount
Wal-Mart Accum. Total
Capital in Other Walmart
Common Excess of Retained Compr. Sh/Hdrs’
(In millions, except per share amounts) Shares Stock Par Value Earnings Income Equity
Balances – February 1, 2011 3,516 $352 $3,577 $63,967 $646 $68,542
Consolidated net income — — — 15,699 — 15,699
Other comprehensive income — — — — (2,056) (2,056)
Cash dividends ($1.46 per share) — — — (5,048) — (5,048)
Purchase of Company stock (113) (11) (229) (5,930) — (6,170)
Other 15 1 344 3 — 348
❖ The entire proceeds from the sale of nopar stock are deemed
stated capital and recorded in the stock account.
T18-5
18-12 Intermediate Accounting, 8/e
SHARES SOLD FOR NONCASH CONSIDERATION
❖ Occasionally, a company might issue its shares for
consideration other than cash. It is not uncommon for a new
DuMont Chemicals issues 1 million of its common shares, $1
par per share, in exchange for a custom-built factory for which
no cash price is available. Today’s issue of the Wall Street
Journal lists DuMont’s stock at $10 per share:
($ in millions)
T18-6
MORE THAN ONE SECURITY
SOLD FOR A SINGLE PRICE
❖ More than one security might be sold for a single price. The
cash received usually is the sum of the separate market values
AP&P issues 4 million of its common shares, $1 par per share,
and 4 million of its preferred shares, $10 par, for $100 million.
Today’s issue of the Wall Street Journal lists AP&P’s common
at $10 per share. There is no established market for the preferred
shares:
($ in millions)
Cash ………………………………………………………………. 100
❖ If the total selling price is not equal to the sum of the two
T18-7
18-14 Intermediate Accounting, 8/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Use of the term “reserves” and other terminology differences. Shareholders’
equity is classified under IFRS into two categories: Share capital and “reserves.” The
term reserves is considered misleading and thus is discouraged under U.S. GAAP.
Here are some other differences in equity terminology:
U.S. GAAP IFRS
Capital stock: Share capital:
Common stock Ordinary shares
Preferred stock Preference shares
COMPARISON OF SHARE RETIREMENT AND
TREASURY STOCK ACCOUNTING
– SHARE BUYBACKS
American Semiconductor’s balance sheet included the following:
Shareholders’ Equity ($ in millions)
Common stock, 100 million shares at $1 par ………… $ 100
Retirement Treasury Stock
Reacquired 1 million of its common shares
Case 1: Shares repurchased at $7 per share
Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) …………. 7
OR
Case 2: Shares repurchased at $13 per share
Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) ………….. 13
T18-9
18-16 Intermediate Accounting, 8/e
COMPARISON OF SHARE RETIREMENT AND
TREASURY STOCK ACCOUNTING
– SUBSEQUENT SALE OF SHARES
American Semiconductor sold 1 million shares after reacquiring shares at $13 per
share (Case 2 in Illustration 18–10)
Retirement Treasury Stock
Case A: Shares sold at $14 per share
Cash …………………………….. 14 Cash …………………………………….. 14
OR
Case B: Shares sold at $10 per share
Cash …………………………….. 10 Cash …………………………………….. 10
T18–10
REPORTING SHARE BUYBACKS IN THE
BALANCE SHEET
❖ Formally retiring shares restores the balances in both the Common
stock account and Paid-in capital – excess of par to what those
balances would have been if the shares never had been issued at all.
o Any net increase in assets resulting from the sale and
Shares Treasury
Retired Stock
Shareholders’ Equity ($ in millions)
Paid-in capital:
Common stock, 100 million shares at $1 par $ 99 $ 100