IA Ch. 15 Stockholders' Equity

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Chapter 15 Intermediate Accounting by Kieso

Anyone who wishes to establish a corporation must __

submit articles of incorporation to the state in which incorporatino is desired. After fulfilling the requirements, thee state issues a corporation charter, thereby recognizing the company as a legal entity subject to statee law.

Only by __ can a company __

special contract; restrict these rights and privileges at the time it issues the shares.

Owners must __ to ascertain such restrictions on or variations from the standard rights and privileges.

examine the articles of incorporation, stock certificates, and other provisions of the state law

In the absence of restrictive provisions, each share carries the following rights:

(1) To share proportionately in profits and losses. (2) To share proportionately in management (the right to vote for directors). (3) To share proportionately in corporate assets upon liquidation. (4) To share proportionately in any new issues of stock of the same class - called the preemptive right.

The preemptive right __

protects an existing stockholder from involuntary dilution of ownership interest. Without this right, stockholders might find their interest reduced by the issuance of additional stock without their knowledge, and at prices unfavorable to them.

Many corporations have eliminated __

the preemptive right because this right makes it inconvenient for corporations to issue large amounts of additional stock, as they frequently do in acquiring other companies.

Circuit City simply maintains __

a list of subsidiary ledger of stockholders as a guide to dividend payments, issuance of stock rights, voting proxies, and the like.

The major exchanges require

ownership controls that the typical corporation finds uneconomic to provide. Thus, corporations often use registrars and transfer agents who specialize in providing services for recording and transferring stock. The Uniform Stock Transfer Act and the Uniform Commercial Code govern the negotiability of stock certificates.

In every corporation one class of stock __

must represent the basic ownership interest. That class is called common stock.

Common stock is the __

residual corporate interest that bears the ultimate risks of loss and receives the benefits of success. It is guaranteed neither dividends nor assets upon dissolution, but common stockholders generally control the management of the corporation and tend to profit most if the company is successful.

By special stock contracts between the corporation and its stockholders, however, __

the stockholders may sacrifice certain of these rights in return for other special rights or privileges.

Special classes of stock are usually called __

preferred stock.

In return for any special preference, __

the preferred stockholder always sacrifices some of the inherent rights of common stock ownership.

A common type of preference __

is to give the preferred stockholders a prior claim on earnings. The corporation thus assures them a dividend, usually at a stated rate, before it distributes any amount to the common stockholders. In return for this preference the preferred stockholders may sacrifice their right to a voice in management or their right to share in profits beyond the stated rate.

Owner's equity in a corporation is also called __

stockholders' equity, shareholders' equity, or corporate capital.

What three categories normally appear as part of stockholders' equity?

(1) Capital stock, (2) additional paid-in capital, and (3) retained earnings

__ constitute contributed (paid-in) capital.

Capital stock and additional paid-in capital

Contributed capital (paid-in capital) __

is the total amount paid in on capital stock - the amount provided by stockholders to the corporation for use in the business.

Contributed capital includes items such as __

the par value of all outstanding stock and premiums less discounts on issuance.

Stockholders' equity is not __

a claim to specific assets but a claim against a portion of the total assets. Its amount is not specified or fixed; it depends on the company's profitability.

In issuing stock, companies follow these procedures: __

First, the state must authorize the stock, generally in a certificate of incorporation or charter. Next, the corporation offers shares for sale, entering into contracts to sell stock. then, after receiving amounts for the stock, the corporation issues shares. The corporation generally makes no entry in the general ledger accounts when it receives its stock authorization from the state of incorporation.

What accounting topics are discussed in the issuance of stock?

Accounting for par value stock, accounting for no-par stock, accounting for stock issued in combination with other securities (lump-sum sales), accounting for stock issued in noncash transactions, and accounting for costs of issuing stock

The par value of stock has __

no relationship to its fair value.

Low par values help __

companies avoid the contingent liability associated with stock sold below par.

If issuing stock below par, __

the company records the discount as a debit to Additional Paid-in Capital. In addition, the corporation may call on the original purchaser the current holder of the shares issued below par to pay in the amount of the discount to prevent creditors from sustaining a loss upon liquidation of the corporation.

___, these two stock __

Preferred Stock and Common Stock; accounts reflect the par value of the corporation's issued shares. The company credits these accounts when it originally issues the shares. It makes no additional entries in these accounts unless it issues additional shares or retires them.

__ indicates any excess __.

Additional Paid-in Capital (also called Paid-in Capital in Excess of Par); over par value paid in by stockholders in return for the shares issued to them. Once paid in, the excess over par becomes a part of the corporation's additional paid-in capital. The individual stockholder has no greater claim on the excess paid in than all other holders of the same class of shares.

The reason for issuance of no-par stock are twofold:

First, issuance of no-par stock avoids the contingent liability that might occur if the corporation issued par value stock at a discount. Second, some confusion exists over the relationship (or rather the absence of a relationship) between the par value and fair value. If shares have no par value, the questionable treatment of using par value as a basis for fair value never arises. This is particularly advantageous whenever issuing stock for property items such as tangible or intangible fixed assets.

A major disadvantage of no-par stock __

is that some states levy a high tax on these issues. In addition, in some states the total issue price for no-par stock may be considered legal capital, which could reduce the flexibility in paying dividends.

Corporations sell no-par shares, like par value shares, __

for whatever price they will bring.

Unlike par value shares, corporations issue them (no-par value shares) __

without a premium or a discount. The exact amount received represents the credit to common or preferred stock.

True no-par stock __

should be carried in the accounts at issue price without any additional paid-in capital or discount reported. But some states require that no-par stock have a stated value. The stated value is a minimum value below which a company cannot issue it. Thus, instead of being no-par stock, such stated-value stock becomes, in effect, stock with a very low par value.

Most corporations account for no-par stock __

with a stated value as if it were par value stock with par equal to the stated value.

The accounting problem in such lump-sum sales __

is how to allocate the proceeds among the several classes of securities. Companies use one of two methods of allocation: (1) the proportional method and (2) the incremental method.

Generally, corporations sell classes of stock __

separately from one another to track the proceeds relative to each class, as well as relative to each lot.

If a company cannot determine fair value for any of the classes of stock involved __

in a lump-sum exchange, it may need to use other approaches. It may rely on an expert's appraisal. Or, if the company knows that one or more of the class of securities issued will have a determinable fair value in the near future, it may use a best estimate basis with the intent to adjust later, upon establishment of the future fair value.

What order should the financial statements be prepared?

IS, RE, BS, CFS

Accounting for the issuance of shares stock for property or services involves __. The general rule is: __

an issue of valuation; Companies should record stock issued for services or property other than cash at either the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.

If a company cannot readily determine either the fair value of the stock it issues or the property or services it receives, __. Depending on data available,

it should employ an appropriate valuation technique; the valuation may be based on market transactions involving comparable assets or the use of discounted expected future cash flows. Companies should avoid the use of the book, par, or stated values as a basis of valuations for these transactions.

A company may exchange unissued stock or treasury stock ___. If it uses treasury shares, __. Instead, __ .Otherwise,

(issued shares that it has acquired but not retired) for property or services; it should use the fair value of the treasury stock, if known, to value the property or services; if it does not know the fair value of the treasury stock, it should use the fair value of the property or services received, if determinable.

In corporate law, __

the board of directors has the power to set the value of noncash transactions.

watered stock

The overvaluation of the stockholders' equity resulting from inflated asset values. The board sometimes abuses their power to set the value of noncash transactions and overstate corporate capital through intentional overvaluation of the property or services received in noncash transactions.

The corporation should eliminate __

the "water" by simply writing down the overvalued assets.

secret reserves

This occurs when a corporation undervalues the recorded assets as a result of the issuance of stock for property or services in noncash transactions involving stock. An understated corporate structure (secret reserve) may also result from other methods: excessive depreciation or amortization charges, expensing capital expenditures, excessive write-downs of inventory or receivables, or any other understatement of assets or overstatement of liabilities.

An example of a liability overstatement is __

an excessive provision for estimated product warranties that ultimately results in an understatement of owners' equity, thereby creating a secret reserve.

When a company issues stock, __. The company therefore__. In effect,__. As such,

it should report direct costs incurred to sell stock, such underwriting costs, accounting and legal fees, printing costs, and taxes, as a reduction of the amount paid in; debits issue costs to Additional Paid-in Capital because they are unrelated to corporate operations; issue costs are a cost of financing; issue costs should reduce the proceeds received from the sale of stock.

A corporation should expense __. In addition, __.

management salaries and other indirect costs related to the stock issue because it is difficult to establish a relationship between these costs and sale proceeds; a corporation expenses recurring costs, primarily registrar and transfer agents' fees, as incurred

When a company issues stocks but doesn't receive cash in return, what is the accounting treatment?

Corporations cannot use a receivable account. The SEC settled this issue: It requires companies to use the contra-equity approach because the risk of collection in this type of transaction is often very high.

ToF, dividends now exceed share buybacks as a form of distribution to stockholders.

False, share buybacks now exceed dividends

What are the reasons that corporations purchase their outstanding stock?

to provide tax-efficient distributions of excess cash to shareholders; to increase earnings per share and return on equity; to provide stock for employee stock compensation contracts or to meet potential merger needs; to thwart takeover attempts or to reduce the number of stockholders; to make a market in the stock

Explain "to provide tax-efficient distributions of excess cash to shareholders".

Capital gain rates on sales of stock to the company by the stockholders have been approximately half the ordinary tax rate for many investors. This advantage has been someone diminished by recent changes in the tax law related to dividends.

Explain "to increase earnings per share and return on equity".

Reducing both shares outstanding and stockholders' equity often enhances certain performance ratios.

Explain "to provide stock for employee stock compensation contracts or to meet potential merger needs".

Companies may use part of its treasury stock for employee stock option contracts.

Explain "to thwart takeover attempts or to reduce the number of stockholders".

Reducing the number of shares held be the public increases the control of existing owners and stops "outsiders" from gaining control or significant influence. Companies may also use stock purchases to eliminate dissident stockholders.

Explain "to make a market in the stock".

Purchasing stock in the marketplace creates a demand and this may stabilize or even increase the stock price.

Some publicly held corporations have chosen to __

"go private" by eliminating public ownership entirely by purchasing all of their outstanding stock. Companies often accomplish such a procedure through a leveraged buyout (LBO), in which the company borrows money to finance the stock repurchases.

After reacquiring shares, a company may either __

retire them or hold them in the treasury for reissue.Such shares are referred to as treasury stock or treasure shares if not retired. Treasury is a corporation's own stock, reacquired after having been issued and fully paid.

Treasury stock is not an asset because __

it simply reduces common stock outstanding and a reduction in both assets and stockholders' equity takes place.

Can a corporation own a part of itself?

No, a corporation may sell treasury stock to obtain funds, but that does not make treasury stock a balance sheet asset.

What rights do treasury stocks give a corporation?

None, the possession of treasury stock does not give the corporation the right to vote, to exercise preemptive rights as a stockholder, to receive cash dividends, or to receive assets upon corporate liquidation.

Treasury stock is essentially __

the same as unissued capital stock.

No matter which method a company uses (in accounting for treasury stock purchase), __

most states consider the cost of the treasury shares acquired as a restriction on retained earnings.

What methods are used for the handling of treasure stock in the accounts?

Two methods are generally acceptable: the cost method and the par value method.

What is the cost method?

For purchase of treasury stock - debt the Treasury Stock account for the reacquisition cost and in reporting this account as a deduction from the total paid-in capital and retained earnings on the balance sheet. More commonly used.

What is the par value method?

For purchase of treasury stock - the par or stated value method records all transactions in treasury shares at their par value and reports the treasury stock as a deduction only from capital stock.

How does the retained earnings restriction for treasury stock work?

Many states require a corporation to restrict its retained earnings for the cost of treasury stock purchased to keep intact the corporation's legal capital that it temporarily holds as treasury stock. The restriction is lifted once the treasury stock is sold.

The term outstanding stock means __

the number of shares of issued stock that stockholders own.

What's disclosed in regards to the purchase of treasury stock?

Both the number of shares issued and the number in the treasury are disclosed, the difference between the two is the number of shares of stock outstanding.

How are total assets and stockholders' equity affected by the sale of treasury stock either above or below cost?

Both above and below cost selling of treasury stock would increase the two accounts.

How are sales of treasury stock accounted for?

The company records the sale of the shares by debiting Cash and crediting Treasury Stock if the sale price for treasure stock is the same as cost. The difference is credit to Paid-In Capital when the selling price of shares exceeds cost. It debits the excess of the cost over selling price to Paid-in Capital from Treasury Stock when a corporation sells treasury stock below its cost.

Why is the sale of Treasury Stock not recognized as a Gain on Sale?

(1) Gains on sales occur when selling assets. (2) A gain or loss should not be recognized from stock transactions with its own stockholders.

What observations can we make based both sale of treasury stock below and above cost (how are they the same or different)?

(1) The Corporation credits Treasury Stock at cost in each entry. (2) It uses Paid-in Capital from Treasury Stock for the difference between the cost and the resale price of the shares. (3) Neither entry affects the original paid-in capital account, Common Stock.

After eliminating the credit balance in Paid-in Capital from Treasury Stock, __

the corporation debits any additional excess of cost over selling price to Retained Earnings.

Who approves the retirement of treasury shares?

The board of directors.

What happens when treasury stock is retired?

Retiring treasury stock results in cancellation of the treasury stock and a reduction in the number of issued shares. They have the status of authorized and unissued shares. The accounting effects are the same to the sale of treasury stock except that corporations debit the paid-in capital accounts applicable to the retired shares instead of cash.

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