PART A: INVESTED CAPITAL

LO10-1 Identify the advantages and disadvantages of the corporate form of ownership

● Invested capital = paid-in capital: amount of money paid into a company by its owners, the amount
stockholders invest when they purchase a company’s stock
● Earned capital = retained earnings: the amount the company has earned back for the stockholders
and has been retained in the business
● Company formed as
○ Sole proprietorship: business owned by one person
■ Most common form of business
○ Partnership: business owned by two or more persons
○ Corporation: entity that is legally separate from its owners and pays its own income taxes
■ Most are owned by many stockholders
■ Some are owned entirely by one individual
■ Dominate in terms of total sales, assets, earnings and employees
Corporations
● Formed in accordance with the laws of individual states
● Guided by the state incorporation laws as they write their articles of incorporation:
○ Sometimes called the corporate charter
○ Describe:
■ The nature of the firm’s business activities
■ The shares of stock to be issued
■ The initial board of directors
● Establishes corporate policies and appoints officers who manage the
corporation

● Stockholders control company (owners): by voting their shares, determine

the makeup of the BOD—which appoints the management to run the
company
STAGES OF EQUITY FINANCING
1. Raise money by selling stock to the founders of the business and to their friends and families
2. As the equity financing needs of the corporation grow, prepare a business plan & seek outside
investment from “angel” investors & venture capital firms
● Angel investors: wealthy individuals in the business community (e.g. Shark Tank), willing to
risk investment funds on a promising business venture
○ May invest from a few thousand to millions of dollars
● Venture capital firms: provide additional financing, often in the millions, for a percentage
ownership in the company
○ Many look to invest in promising companies to which they can add value through
business contacts, financial expertise or marketing channels
3. Corporation issues stock to the public: initial public offering (IPO)
● Most do not consider issuing stock to the public (“going public”) until their equity financing
exceeds $20 million
● Major event requiring the assistance of an investment banking firm (underwriter), lawyers
and public accountants
○ Major investment bankers (e.g. Citigroup, Morgan Stanley, Goldman Sachs) charge
up to 6% of the issue proceeds for their services
○ Legal & accounting fees are not cheap, costing several hundred dollars per hour for
services performed in preparation for a public stock offering

PUBLIC OR PRIVATE
● Publicly held corporation
○ trades on the:
■ New York Stock Exchange (NYSE),
● Many large companies (e.g. Walmart, ExxonMobil, General Electric) are
traded here
■ National Association of Securities Dealers Automated Quotations (NASDAQ), or
● Home to many of the largest high-tech companies (Apple, Microsoft, Intel)
■ By over-the-counter (OTC) trading
● Takes place outside one of the major stock exchanges
○ Are regulated by the Securities and Exchange Commission (SEC), resulting in significant
additional reporting and filing requirements
● Privately held corporation
○ Does not allow investment by the general public
○ Normally has fewer stockholders than public corporation
○ Generally do not need to file financial statements with the SEC
○ E.g. Cargill (agricultural commodities), Koch Industries (oil and gas), Mars (food and candy)
● Frequently, companies begin as smaller, privately held corporations. Then, as success broadens
opportunities for expansion, the corporation goes public
STOCKHOLDER RIGHTS
● Whether going public or private, stockholders are the owners of the corporation and have certain
rights:
○ The right to vote (including electing the BOD)
○ The right to receive dividends
○ The right to share in the distribution of assets if the company is dissolved

ADVANTAGES OF A CORPORATION
A corporation offers 2 primary advantages over sole proprietorships & partnerships:
● Limited Liability
○ Guarantees that stockholders in a corporation can lose no more than the amount they
invested in the company, even in the event of bankruptcy
■ Sole proprietorship/partnership: can be held personally liable for debts the
company has incurred, above and beyond the investment they have made
● Ability to Raise Capital and Transfer Ownership
○ Ownership rights are easily transferred
■ Corporations sell ownership interest in the form of shares of stock
■ An investor can sell their ownership interest (shares of stock) at any time & without
affecting the structure of the corporation/its operations
○ Attracting outside investment is therefore easier for a corporation

DISADVANTAGES OF A CORPORATION
A corporation has 2 primary disadvantages relative to sole proprietorships & partnerships:
● Additional Taxes
○ Corporation have double taxation:
■ As a legal entity separate from its owners, a corporation pays income taxes on its
earnings
■ When it distributes the earnings to stockholders in dividends, stockholders pay
taxes a second time on the corporate dividends they receive
■ In short: corporate earnings are taxed once upon earnings at the corporate level &
again on dividends at the individual level
● More paperwork
○ The federal & state governments impose extensive reporting requirements on the company
■ To protect rights of those who buy a corporation’s stock/who lend money to a
corporation
■ To ensure adequate disclosure of the information investors and creditors need
Limited Liability and Beneficial Tax Treatment
● S corporation: allows a company to enjoy limited liability as a corporation, but tax treatment as a
partnership
○ Major restriction: cannot have more than 100 stockholders, so S corporation appeals more to
smaller, less widely held businesses
● Limited liability companies (LLCs) and Limited liability partnerships (LLPs): offer limited liability and
avoid double taxation, with no limits of the number of owners/stockholders
○ These forms evolves in response to liability issues and tax treatment
○ Most accounting firms in US adopt one of these 2 business forms

LO10-2 Record the issuance of common stock

Common Stock
● Common stockholders = “true owners” of business
● Each share of common stock represents one unit of ownership (most cases)

AUTHORIZED, ISSUED, OUTSTANDING, AND TREASURY STOCK

The different number of shares:
● Authorized stock: total number of shares available to sell, stated in the company’s articles of
incorporation
● Issued stock: number of shares that have been sold to investors (a company usually doesn’t issue all
its authorised stock)
○ Outstanding stock: number of issued shares held by investors (only these receive dividends)
○ Treasury stock: number of issued shares repurchased by the company

PAR VALUE
● The legal capital per share of stock that’s assigned when the corporation is first established
● Originally indicated the real value of a company’s shares of stock
● Has no relationship to the market value of the common stock
○ Market value per share: the current share price (mostly far exceed the par value)
 ○ E.g. Facebook’s common stock traded above $100/share since 2015, but its par value is
$0.000006/share
● Laws in many states permit corporations to issue no-par stock
○ No-par value stock: common stock that has not been assigned a par value
● In some cases, a corporation assigns a stated value (treated and recorded in the same manner as par
value shares) to the shares

ACCOUNTING FOR COMMON STOCK ISSUES

● A company receives cash from issuing common stock, it debits Cash
○ If it issues a no-par value stock, it credits the equity account entitled Common Stock
■ E.g. Canadian Falcon issues 1,000 shares of no-par value common stock at
$30/share

○ If it issues par value stock, it credits 2 equity accounts:

■ Common Stock account for the number of shares issued x the par value/share
■ Additional Paid-in Capital [=paid-in capital in excess of par (the amount of stock over
par value)] for the portion of the cash proceeds above par value
● E.g. Canadian Falcon issues 1,000 shares of $0.01 par value common stock
share at $30 per share

● If common stock had stated value of $0.01, we would record the same entry as in the par value
example (for accounting purposes, stated value is treated in the same manner as par value)
● If company issues shares of stock in exchange for noncash goods/services (e.g. issue $30,000 stock to
attorney in payment for legal services), we would record the transaction the same way as above,
except we debit Legal Fees Expense, rather than Cash, for $30,000

LO10-3 Understand unique features and recording of preferred stock

Preferred Stock
● In order to attract wider investment, some corporations issue preferred stock in addition to common
stock
○ IBM has been authorized to issue 150 million shares of $0.01 par value preferred stock, but is
yet to issue any of it
● Preferred stock is “preferred” over common stock in 2 ways:
○ Preferred stockholders usually have first rights to a specified amount of dividends (a stated
dollar amount per share/a percentage of par value per share). If the board of directors
declares dividends, preferred shareholders will receive the designated dividend before
common shareholders receive any.
○ Preferred stockholders receive preference over common stockholders in the distribution of
assets in the event the corporation is dissolved.
FEATURES OF PREFERRED STOCK
● Preferred stock is interesting due to the flexibility allowed in its contractual provisions, it might be:
○ Convertible: shares can be converted into common stock
■ Allows the stockholder to exchange shares of preferred stock for common stock at a
specified conversion ratio
○ Redeemable: shares can be returned to (or redeemed by) the corporation at a fixed price
■ At the option of either stockholders or the corporation
■ A redemption privilege might allow preferred stockholders the option, under
specified conditions, to return their shares for a predetermined redemption price
■ Shares may be redeemable at the option of the issuing corporation
○ Cumulative: shares receive priority for future dividends, if dividends are not declared in the
given year
■ If the specified dividends are not declared in a given year, they become dividends in
arrears, and they accumulate until the company does declare dividends

● Attributes between common stock (equity) and long-term debt (liability)

○ Investors in common stock: owners of the corporation because they have voting rights, and
some preferred stock may be convertible to common stock
○ Investors in long-term debt, such as bonds, are creditors who have loaned money to the
corporation. They have the right to interest payments each year and then the face amount of
the bond at maturity. This financing arrangement is similar to preferred stock that pays
cumulative dividends and is redeemable by stockholders.

SHOULD PREFERRED STOCK BE CLASSIFIED AS DEBT RATHER THAN EQUITY?

Under U.S. accounting rules, we usually record preferred stock in the stockholders’ equity section of the
balance sheet just above common stock. However, sometimes preferred stock shares features with debt.
Redeemable preferred stock with a fixed redemption date (called mandatorily redeemable) is reported, like
bonds payable, in the liability section of the balance sheet.
● Under IFRS, most preferred stock is reported as debt, with the dividends reported in the income
statement as interest expense.
● Under U.S. GAAP, that’s the case only for “mandatorily redeemable” preferred stock.

ACCOUNTING FOR PREFERRED STOCK ISSUES

● Similar to the issue of common stock
○ Canadian Falcon issues 1,000 shares of $30 par value preferred stock for $40 per share
DIVIDENDS FOR PREFERRED STOCK
● Cumulative preferred stock (usually):
○ If dividends aren’t declared in a given year, they accumulate until the company declares
○ Common stockholders: not entitled to dividends in any year until stockholders of cumulative
preferred stock are attributed all dividends to which they are entitled
● A company issues 1,000 shares of 8%, $30 par value preferred stock & 1,000 shares of $1 par value
common stock at the beginning of 2019
○ If the preferred stock is cumulative, the company owes a dividend on the preferred stock of
$2,400 each year (= 1,000 shares × 8% × $30 par value). If the preferred dividend is not
declared in 2019 or 2020, dividends in arrears for the two years will total $4,800, and this
amount is expected to be paid in some future year.
○ If the preferred stock is noncumulative, then there will not be any dividends in arrears for
2019 and 2020.
● Let's say in 2021 the company declares a total dividend of $10,000. Dividends divided between
preferred and common stockholders:

● Because dividends are not an actual liability until they are declared by the board of directors,
dividends in arrears for cumulative preferred stockholders are not reported as a liability in the
balance sheet. However, information regarding any dividends in arrears is disclosed in the notes to
the financial statements.

LO10-4 Account for Treasury Stock

Treasury Stock
● Definition: a company’s own issued stock that it has purchased
● Purchases of treasury stock: referred to as buybacks, acquisitions, or repurchases of treasury stock

Decision Maker’s Perspective: Why Corporations Purchase Their Stock

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 of its outstanding shares
triggered a public buying spree that pushed the stock price up by more than 3%.
 2. To distribute surplus cash without paying dividends. While dividends usually are a good thing,
investors do pay personal income tax on them. Another way for a firm to distribute surplus cash to
shareholders without giving them taxable dividend income is to use the excess cash to purchase its
own stock. Under a stock purchase, only shareholders selling back their stock to the company at a
profit incur taxable income.
3. To boost earnings per share. Earnings per share is calculated as earnings divided by the number of
shares outstanding. Stock purchases reduce the number of shares outstanding, thereby increasing
earnings per share. However, with less cash in the company, it’s more difficult for companies to
maintain the same level of earnings following a share purchase.
4. To satisfy employee stock ownership plans. Another motivation for stock purchases is to acquire
shares used in employee stock awards and stock option compensation programs. → Microsoft,
reported that its board of directors had approved a program to purchase shares of its common stock
to offset the increase in shares from stock option and stock purchase plans.

ACCOUNTING FOR TREASURY STOCK

● Issuing shares increases stockholders’ equity → buying back those shares decreases stockholders’
equity
○ Rather than reducing the stock accounts directly, we record treasury stock as a separate
“negative” or “contra” account
○ Stockholders’ equity accounts normally have credit balances → treasury stock is included in
the stockholders’ equity section of the balance sheet with an opposite, or debit, balance
○ When a corporation purchases its own stock, it increases (debits) Treasury Stock, while it
decreases (credits) Cash.
○ Note: NOT an asset (not equity investment because company cannot invest in itself)
● Canadian Falcon purchases 100 shares of its own $0.01 par value common stock at $30 per share

○ Record at the cost to purchase the shares in the market ($30 per share)
○ The stock’s par value has no effect on the entry to record treasury stock
○ The debit to Treasury Stock reduces stockholders’ equity
○ The stockholders’ equity section of the balance sheet before and after the purchase of
treasury stock:

○ Treasury stock is reported as a contra equity, or negative amount, because treasury stock
reduces total stockholders’ equity.
● Canadian Falcon resells the 100 shares of treasury stock for $35.
○ Recall that these shares originally were purchased for $30 per share, so the $35 resale price
represents a $5 per share increase in additional paid-in capital. It’s not recorded as a $5 per
share gain in the income statement, as we would for the sale of an investment in another
company, since the company is reselling its own stock.
○ We record this transaction as follows:
 ○ When resell, reduce the treasury stock at the same $30 per share
○ $500 difference in APIC
○ stockholders’ equity section of the balance sheet before and immediately after the sale of
treasury stock:

● If stock price goes down, and we resell treasury stock for less than $30 per share → Canadian Falcon
resells the 100 shares of treasury stock for only $25

○ Canadian Falcon experienced a decrease in additional paid-in capital.

■ Reflected in the entry as a debit to the Additional Paid-in Capital account
■ Not recorded as a $5 per share loss in the income statement, as we would for the
sale of an investment in another company, because the company is reselling its own
stock

PART B: EARNED CAPITAL

● Equity that represents the net assets of the company that have been earned for the stockholders
rather than invested by the stockholders
● Some is distributed back to stockholders in the form of dividends → we end up with a component of
equity that represents earned capital that has been retained in the company (Retained Earnings)

LO10-5 Describe retained earnings and record cash dividends

Retained Earnings
● Definition: the earnings retained in a company, not distributed to stockholders over the life of the
company

All net income since company All dividends since

Retained Earnings = -
bagan company began
● E.g. table showing how net income & dividends impact balance in retained earnings over a 4-year
period
 ○ Y1: company reports net loss of $1,000; results in a balance of -$1,000 in retained earnings
○ Y2: company reports net income of $3,000; retained earnings ($2,000) = all net income (-
$1,000+$3,000) - all dividends ($0)
○ Y3: difference between net income and dividends ($4,000-$1,000=$3,000) adds to
cumulative balance of retained earnings
○ Y4: same with Y3
○ This process of adding net income and subtracting dividends each year to calculate
cumulative balance of retained earnings continues over the life of a company
○ retained earnings =/= cash!!
● Has a normal credit balance, consistent with other stockholders’ equity accounts; However, if losses
exceed income since the company began, Retained Earnings will have a debit balance
○ A debit balance in Retained Earnings is called an accumulated deficit (Y1)
○ Subtract accumulated deficit from total paid-in capital in the balance sheet to arrive at total
stockholders’ equity

Cash Dividends
● Dividends: distributions by a corporation to its stockholders
● Investors pay careful attention to this, a change in quarterly/annual cash dividend paid by company
can provide useful information about its future prospects
○ Increase in dividends → company doing well and bright future

Decision Maker’s Perspective: Why Don’t Some Companies Pay Dividends

● Unprofitable → choose not to; cash for strategic purposes to keep from bankruptcy
● Profitable → can also choose not to; growth companies (with large expansion plans) reinvest earnings
in growth of companies rather than distributing dividends
○ Investors invest even if no dividend hoping the company’s share price increases and they can
sell the stock for a profit
● As companies mature and their growth opportunities diminish, they tend to pay out more dividends

● Companies that pay dividends

○ Declaration date: date the BODs announce the next dividend to be paid → creates binding
legal obligation; on that date:
■ Increase Dividends, a temporary account that is closed into Retained Earnings at the
end of each period
■ Increase Dividends Payable, a liability account
○ Record date: specific date the BODs indicate on which the company looks at its records to
determine who the stockholders of the company are
■ Investor must be stockholder on record date to have right to receive dividend
○ Payment date: date of actual distribution
■ Dividends are paid only on shares outstanding, not treasury shares
● To illustrate the payment of a cash dividend, assume that on March 15 Canadian Falcon declares a
$0.25 per share dividend on its 2,000 outstanding shares—1,000 shares of common stock and 1,000
shares of preferred stock. We record the declaration of cash dividends as follows:
 ○ Dividends payable credited (classified as current liability in balance sheet because once
declared, company must pay in near future)
○ Calculate based on number of outstanding shares, not issued shares, because dividends are
not paid on treasury stock
● The dividend declared by Canadian Falcon is paid on April 15 to stockholders of record on March 31.
We make no entry on March 31, the record date (or on March 29, the ex-dividend date). We record
the payment of cash dividends on April 15 as follows:

● Cash is the asset most easily distributed to stockholders → most corporate dividends are cash
dividends
● In concept, though, any asset can be distributed to stockholders as a dividend.
● Property dividend: a noncash asset distributed to stockholders
○ Securities held as investments → most often distributed in a property dividend
○ The actual recording of property dividends is covered in intermediate accounting

LO10-6 Explain the effect of stock dividends and stock splits

Stock Dividends and Stock Splits
● Stock Dividends/Stock splits (depends on size of stock distribution): distributed additional shares of
their own stock to shareholders rather than cash
○ Suppose you own 100 shares:
■ Assuming a 10% stock dividend, you’ll get 10 additional shares.
■ A 100% stock dividend, equivalent to a 2-for-1 stock split, means 100 more shares.
● Large stock dividends (>=25% of shares outstanding) & stock splits → declared primarily due to the
effect they have on stock prices
○ Before the 100% stock dividend → shares trading at $40, so your 100 shares are worth
$4,000
○ After the 100% stock dividend → company value still the same → each share trades at $20,
so your 200 shares are still worth $4,000
○ Total assets, total liabilities, and total stockholders’ equity do not change as a result of a
stock dividend.

Decision Maker’s Perspective: Why Declare a Stock Split?

● Primary reason: to lower trading price of stock to a more acceptable trading range, making it
attractive to a larger number of potential investors
● Some companies keep trading price high to make it accessible only to wealthy investors

STOCK SPLITS/LARGE STOCK DIVIDENDS

● When a company declares a stock split → do not record a transaction
● After 2-for-1 stock split, Common Stock account balance (total par value) represents twice as many
shares
○ Canadian Falcon declares a 2-for-1 stock split on its 1,000 shares of $0.01 par value common
stock
■ Balance in Common Stock account → 1,000 shares x $0.01 par value = $10
 ■ Without journal entry, balance remains $10 despite the number of shares doubling
■ Result: par value per share is reduced into $0.005 (200 shares x $0.005 = $10)
● Note: all records, printed or electronic, that refer to the previous amount must be changed to reflect
new amount when stock split
● To avoid changing the par value per share, most companies report stock splits in the same way as a
large stock dividend
● We account for a large stock dividend by recording an increase in the Common Stock account in the
amount of the par value of the additional shares distributed, as presented below:

○ Stock Dividends account: temporary stakeholders’ equity account that’s closed to Retained
Earnings (similar to cash dividends)
○ Debit to Stock Dividends reduces Retained Earnings
○ Stock dividend entry → decreases Retained Earnings (equity account) & increases Common
Stock (another equity account)
○ The above entry does not change total assets, total liabilities, or total stockholders’ equity
● Balance sheet

● Disclosure of American Eagle’s 3-for-2 stock split

SMALL STOCK DIVIDENDS

● Large stock dividends → recorded at par value per share
● Small stock dividends → recorded at market value
● E.g. The market value of Canadian Falcon common stock is $30/share when they declare a 10%
dividend on its 1,000 shares outstanding of $0.01 par value common stock. After the 10% stock
 dividend, they will have an additional 100 shares outstanding. They record this small stock dividend as
follows:

○ Why large & small stock dividends are recorded differently → Some believe that a small stock
dividend will have little impact on the market price of shares currently outstanding, arguing
for the recording of small stock dividends at market value.
■ However, this reasoning is contrary to research evidence, which finds the market
price adjusts for both large and small stock dividends.
■ A 10% stock dividend will result in 10% more shares, but each share will be worth
10% less, so the investor is no better off.
■ Note that the above entry still does not change total assets, total liabilities, or
total stockholders’ equity.
■ The debit to Stock Dividends simply decreases Retained Earnings (equity account),
the credits increase Common Stock and APIC (two other equity accounts)

PART C: REPORTING STOCKHOLDERS’ EQUITY

LO10-7 Prepare and analyze the stockholders’ equity section of a balance sheet and the statement of
stockholders’ equity
Stockholders’ Equity in the Balance Sheet
● Stockholders’ equity section of the balance sheet for Nvidia Corporation (designs graphics processing
units (GPUs) for the gaming, cryptocurrency, and professional markets)

○ Preferred stock → listed before common stock, given its preference over common stock
○ $ amounts shown for common and preferred stock → number of shares issued x par value
■ Nvidia hasn’t issued preferred shares → $0
■ Issued 868 million shares common stock with par value $0.001/share → rounds to
common stock balance of 1 million
○ APIC → amounts above par value that have been received from investors
○ Retained earnings
■ When a company is started, most of the equity is in the paid-in capital section
because that’s the amount invested by stockholders. But if a company is profitable,
like Nvidia, and pays little in dividends, the retained earnings section of equity grows
and often exceeds the amount invested by stockholders.
■ For Nvidia, the balance in retained earnings is so large that it actually exceeds total
stockholders’ equity. How? Nvidia has used a portion of cash generated from
earnings to buy back treasury shares, which decreases stockholders’ equity. Nvidia
has applied this strategy to such an extent that the balance in treasury stock
(representing the cost of shares purchased by the company) now exceeds total paid-
in capital (representing the total cost of shares originally issued).
Decision Maker’s Perspective: Why Doesn’t Stockholders’ Equity Equal the Market Value of Equity?
● Market value of equity → price investors are willing to pay for a company’s stock
○ Equals stock price x number of shares outstanding
● Book value of equity → total stockholders’ equity reported in the balance sheet
● These 2 are generally not the same, often are vastly different (e.g. Nvidia reported total stockholders’
equity of about $6 billion, yet market value was over $63 billion
● Why?
○ Stockholders’ equity = assets - liabilities
○ An asset’s book value = its market value on date it’s purchased; can differ after that
■ E.g. buildings increase in value over time, but continues to be reported in balance
sheet at historical cost - accumulated depreciation; causing true value of assets and
stockholders’ equity > amount recorded
○ Even when investors see the increase in a company’s value and its stock price moves higher,
common stock in the company’s balance sheet continues to be reported at its original issue
price rather than its higher market value.

Statement of Stockholders’ Equity

● Stockholders’ equity section of balance sheet → shows the balance in each equity account at a point
in time
● Statement of stockholders’ equity → summarizes changes in the balance in each stockholders’ equity
account over time
● Comparison:

○ Beginning balances are 0 because first year of operations (balance of Jan 1, 2022 is same with
balance of Dec 31, 2021)
○ Statement of stockholders’ equity reports how each equity account changed during the year
■ Common Stock account increased because Canadian Falcon issued common stock
and declared a 100% stock dividend
■ APIC account increased from the issuance of common stock, the issuance of
preferred stock, and the sale of treasury stock for more than its original cost
■ Retained Earnings increased due to net income and decreased due to cash and stock
dividends
 ● retained earnings column → sometimes shown separately & referred to as
a statement of retained earnings
■ Purchase of treasury stock → reduction; because treasury stock reduces total
stockholders’ equity
● ending balance in Treasury Stock = 0, since all the treasury stock purchased
was resold by the end of the year
○ Ending balance of each stockholders’ equity account is shown in the stockholders’ equity
section of the balance sheet

(LO10-8 pg. 514)