Chapter 11 Reporting and Interpreting

Stockholders’ Equity

Financial Accounting
10e
Libby • Libby • Hodge
Benefits of Stock Ownership

Owners of common stock (known as stockholders or

shareholders) receive a number of benefits:

 A voice in management.

 Dividends: Proportional share of

the distribution of profits.

 Residual claim: Proportional share

of the distribution of remaining assets
upon the liquidation of the company.

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Authorized, Issued, and Outstanding Shares (3 of 3)

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Common Stock Transactions (1 of 2)

Common stock is held by investors who are the owners of a corporation.

Stockholders have the right to:

• Vote
• Share in profits of the business
• Elect the board of directors who hire and monitor the executives who
manage a company’s activities on a day-to-day basis

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Repurchase of Stock
• A corporation repurchase its stock from existing stockholders for a number
of reasons:
1) Undervalue of the stock
2) Retain controls
3) Change capital structure (issue debts for cash to repurchase stock)
• Stock that has been repurchased and is held by the issuing corporation is
called treasury stock.
• Treasury shares have no voting, dividend, or other stockholder rights while
they are held as treasury stock.

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Repurchase and Reissuance of Stock (1 of 2)

IBM reacquired 100,000 shares of its

common stock when it was selling for $140 per share.

Treasury Stock is a contra-equity account, not an asset!

IBM reissued 10,000 shares

of treasury stock at $150 per share.

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Repurchase and Reissuance of Stock (2 of 2)

IBM reissued 10,000 shares

of treasury stock at $130 per share.

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Dividends on Common Stock

• The return from investing in a company’s common stock can come from
two sources: stock price appreciation and dividends.
• Some investors prefer to buy stocks that pay little or no dividends.
• Companies that reinvest the majority of their earnings back into
their operations tend to increase their future earnings potential
and their stock price.
• Other investors, such as retired people who need a steady income,
prefer to receive their return in the form of dividends.
• Retirees seek stocks that will pay relatively high dividends, such as
utility stocks.

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Key Dividend Dates

Date of Declaration: Date on which the board of directors approves the

dividend. Assume IBM declared a $1,387 million dividend on 10/31.

Date of Record: Stockholders who own shares on this date will receive the
dividend. (No journal entry)

Date of Payment: The date the cash is disbursed to stockholders.

Note: The corporation must have sufficient retained earnings and

cash to cover the amount of the dividend.

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Dividend Yield
KEY RATIO ANALYSIS

Dividend
=
Dividends per Share $$$
Yield Market Price per Share

In 2017, IBM paid a dividend of $5.90 per share, and the

market price of a share of IBM stock was $153.42.

Dividend $5.90 per share

= = 3.85%
Yield $153.42 per share

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Nature of Stock Dividends (1 of 2)

• Stock dividends represent a distribution of additional shares of

stock to shareholders.
• Stock is distributed pro rata; stockholders retain the same
percentage ownership after stock dividends are distributed.
• A stock dividend has no economic value!
• Stock dividends do not change the stock’s par value or total
stockholders’ equity.
• The stock market reacts immediately when a stock dividend is
issued.
• The stock price falls.
• The lower market price may make the stock more attractive
to new investors.

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Nature of Stock Dividends (2 of 2)

Small Large

Stock
Stockdividend
dividend<<20–25%
20–25% Stock
Stockdividend
dividend>>20–25%
20–25%

Record
Recordat
atcurrent
currentmarket
marketvalue
value Record
Recordatatpar
parvalue
value
of
ofstock.
stock. of
ofstock.
stock.

The entry for a stock dividend is a transfer from the Retained

Earnings account to the Common Stock account (and Additional
Paid-in Capital account for small stock dividends).

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Stock Dividends

Large Stock Dividend: Assume IBM issued 50 million shares of its $0.20 par
value stock. On the date of declaration the following journal entry is made:

Small Stock Dividend: Assume IBM issued 5 million shares of its $0.20 par
value stock when it was trading for $150 per share.
On the date of declaration the following journal entry is made:

NOTE: Regardless of whether a stock dividend is classified as large or

small, there is no change in the total amount of stockholders’ equity
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Stock Splits

Unlike stock dividends, companies do not make journal entries to record

stock splits. Stock splits change the par value per share, but the total par
value is unchanged. Assume that a corporation had 3,000 shares of $2
par value common stock outstanding before a two-for-one stock split.

Before
Split After Split
Common Stock Shares 3,000 6,000 Increase

Par Value per Share $ 0.02 $ 0.01 Decrease

Total Par Value $ 60 $ 60 No Change

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Dividends on Preferred Stock (1 of 2)

Preferred stock offers a dividend preference:

Current dividend preference: Requires a company to pay current
dividends to preferred stockholders before paying dividends to common
stockholders. After this is met then dividends can be paid to common
stockholders.

Cumulative dividend preference: Requires any unpaid dividends on

preferred stock to accumulate. This amount, called dividends in arrears,
must be paid before common dividends are paid.
If preferred stock is noncumulative, any dividends not declared in previous
years are permanently lost and will never be paid.
Note: Dividends in arrears are disclosed in the notes to the financial
statements. They are not a liability until the board of directors declares
them.

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Dividends on Preferred Stock (2 of 2)
Wally Company has the following stock outstanding:
Preferred stock: 6%, $20 par value, 2,000 shares outstanding. Assume
current dividend preference
Common stock: $10 par value, 5,000 shares outstanding

(1) If Wally issues a $3,000 current dividend, the dividends would be

allocated as follows:
Preferred: $20 par value × 6% × 2,000 shares = $2,400
Common: $3,000 − $2,400 = $600

(2) If Wally issues a $30,000 dividend and the dividends were in arrears
for two years (assume cumulative dividend preference) the allocation
would be as follows:
Preferred: $2,400 current + ($2,400 in arrears × 2 years) = $7,200
Common: $30,000 − $7,200 = $22,800

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