Lesson 15:

Stockholders’ Equity

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- Malala
 Today’s Topics
- Common stock
Types of Stock - Preferred stock
- Treasury stock

- Retained earnings
Other Equity Accounts - AOCI
- Noncontrolling interest

- Earnings per share

Earnings Per Share - P/E ratio
 Today’s Topics
- Common stock
Types of Stock - Preferred stock
- Treasury stock

- Retained earnings
Other Equity Accounts - AOCI
- Noncontrolling interest

- Earnings per share

Earnings Per Share - P/E ratio
What is Stockholders’ Equity?

Stockholders’ equity

These names are

Shareholders’ equity interchangeable

Owners’ equity

If the company was a partnership (instead of a corporation)

the equity section would be called “partners’ capital.”
EXAMPLES OF EQUITY ACCOUNTS

Additional paid-in
Common stock capital – common Preferred stock
stock

Additional paid-in Treasury stock

capital – preferred Retained earnings
stock (contra-equity)

Accumulated other
Noncontrolling
comprehensive
interest
income
 Types of Stock
 Basic voting stock issued by the
Common Stock corporation
 The “owners” of the corporation

 Stock (usually nonvoting) that has

Preferred Stock specific privileges

 The corporation’s own stock that has

Treasury Stock been issued but repurchased by the
corporation
 Stock Terminology
• Authorized shares
– The maximum number of shares a corporation can
legally sell to investors (this is determined by its board
of directors)
• Issued shares
– The total number of shares a corporation has sold to
investors
• Outstanding shares
– The total number of shares currently held by investors
If a corporation repurchases shares from investors,
the shares are still issued but not outstanding
Apple’s Balance Sheet
 Common Stock
• Common shareholders:
– Share proportionately in profits and losses
– Can vote for the board of directors
– Have a residual claim on the company’s assets
– Can share proportionately in new stock issues
of the same class (the pre-emptive right)

The pre-emptive right prevents shareholders from having their

ownership stake reduced without the chance to invest more capital.
*Some companies have eliminated the pre-emptive right.
 Preferred Stock
• Preferred stock differs from common stock in that:
– It has no voting rights
– It has priority regarding dividends
• Cumulative (must pay “dividends in arrears”)
– It has priority if the company is liquidated
• In a bankruptcy, creditors get paid first, then preferred
shareholders, then common shareholders (if there is anything left)
– In some cases, it is convertible into common stock
• E.g., you can exchange 1 preferred share for 15 common shares
– In some cases, it is callable by the corporation
• The corporation gets the capital when it needs it, but can
repurchase the shares later when the capital is no longer needed
Preferred stock is usually described as
“4% preferred stock, par value $100 per share”
 Treasury Stock
• Treasury stock is when a firm repurchases
its stock
– The stock is still “issued” but no longer
“outstanding”

If the company chooses to “retire”

the shares it has repurchased, those
shares would NOT be considered
outstanding or issued. However, the
act of retiring shares doesn’t affect
the number of shares authorized
 Stock Buybacks
• Companies
repurchase stock:
– To signal that the
company is undervalued
– To provide shares of
stock for an employee
bonus plan
– To distribute money to
shareholders
You will discuss this more in
Corporate Finance
 Accounting for Treasury Stock
• Treasury stock is recorded based on the price paid to
repurchase the shares and is recorded with the following
journal entry
Account Debit Credit
Treasury Stock XX
Cash XX

This is a contra-equity
account, NOT an asset

repurchase price * # shares repurchased

Accounting for Treasury Stock

• Companies NEVER recognize a gain or loss dealing

in their own stock.
– If treasury stock is resold for more than the repurchase price, a
gain is NOT recorded. This is the journal entry that would be
made:
Account Debit Credit sales price × shares resold
Cash aa
Treasury Stock bb repurchase price × shares resold
Additional paid-in capital cc
difference between aa and bb

– If treasury stock is resold for less than the repurchase price, a loss
is NOT recorded. This is the journal entry that would be made:
Account Debit Credit sales price × shares resold
Cash aa
Additional paid-in capital cc difference between aa and bb
Treasury stock bb
repurchase price × shares resold
Treasury Stock – Example
On December 12, 2012, Aston Martin decides repurchase 1,000
shares of stock from investors for $80/share. What is the
journal entry to record the repurchase of the shares?
Account
Treasury stock Debit Credit
Treasury Stock Cash
80,000 80,000
Cash 80,000 $80 × 1,000
80,000

On December 22, 2012, Aston Martin decides to re-sell all of the shares previously
repurchased on Dec 12 for $95/share.
Account Debit Credit $95 × 1,000
Cash 95,000
Treasury Stock 80,000 $80 × 1,000
Additional paid -in capital 15,000
Leftover
Alternative Scenario
On December 22, 2012, Aston Martin decides to re-sell all of the shares previously
repurchased on Dec 12 for $60/share.
Account Debit Credit $60 × 1,000
Cash 60,000
Additional paid -in capital 20,000 Leftover
Treasury stock 80,000
$80 × 1,000
 Quiz A
1. On 1/1, Olio City has 10,000 common shares of stock
authorized, issued, and outstanding. On 1/5, its board of
directors approves the issuance of up to additional
20,000 common shares as part of an IPO. When the IPO
takes place on 8/15, Olio City issues 8,000 common
shares. On 10/31, Olio City repurchases 3,000 of those
shares. As of 11/1, how many of Olio City’s common
shares are:
a) Authorized?
b) Issued?
c) Outstanding?
 Quiz A
2. What benefits does preferred stock typically provide?
3. Why would anyone choose to buy common stock
instead of preferred stock?
4. If Costco were to do a special one-time dividend
where it paid $5 billion cash to its common
shareholders, how would this affect Costco’s balance
sheet?
 Today’s Topics
- Common stock
Types of Stock - Preferred stock
- Treasury stock

- Retained earnings
Other Equity Accounts - AOCI
- Noncontrolling interest

- Earnings per share

Earnings Per Share - P/E ratio
 Retained Earnings
• Retaining earnings is the accumulated
profits (and losses) of the corporation
since its inception, minus any dividends
– When retained earnings is negative (when it has a
debit balance) we call it “accumulated deficit”
 Accumulated Other Comprehensive Income
(AOCI)

• There are several types of gains and losses that

bypass the income statement
– Instead of affecting net income, these gains and
losses are recorded as other comprehensive income
– At the end of each period, other comprehensive
income is closed out to a permanent equity account
called accumulated other comprehensive income
Accumulated Other Comprehensive Income
• OCI is closed out to AOCI at year-end just as
revenues and expenses are closed out to retained
earnings

Net Income
CLOSED Retained Earnings
(from the income statement)
OUT TO (equity on the balance sheet)

Other Comprehensive Income

CLOSED Accumulated OCI
(bypasses income statement)
OUT TO (equity on the balance sheet)
 Noncontrolling Interest
• When a company acquires more than 50% but less
than 100% of another firm, the investor consolidates
100% of the investee’s assets and liabilities
– However, the investor doesn’t own 100% of the investee;
thus, the investor must recognize that the investee’s minority
shareholders have claims against the investee’s assets and
liabilities
– The interest of the minority shareholders is called
noncontrolling interest
 Example
• Your investment firm acquires 90% of Blizzard Games
– Because your firm acquired more than 50% of Blizzard, your firm
must consolidate Blizzard’s financial information
• This means the two companies are treated as a single entity
for financial reporting
• However, other shareholders still own 10% of Blizzard
– To acknowledge the equity of those shareholders in Blizzard,
your company’s financial statements will show a line item for
noncontrolling interest
Accounting for noncontrolling interests is part of consolidation
accounting, which is covered in an Advanced Accounting course.
Example
 Quiz B
1. What is…
a) Accumulated other
comprehensive income?
b) Noncontrolling interest?
c) Treasury stock?
2. What is OCI? How does it relate
to AOCI?
 Today’s Topics
- Common stock
Types of Stock - Preferred stock
- Treasury stock

- Retained earnings
Other Equity Accounts - AOCI
- Noncontrolling interest

- Earnings per share

Earnings Per Share - P/E ratio
 Earnings Per Share
• We can divide a company’s net income by the
number of common shares to find the
company’s earnings per share (EPS)

Net Income – Preferred Dividends

Earnings Per Share =
Average # of Common Shares Outstanding
 Example
• Chapul makes cricket bars
– Net income = $165,000
– Preferred dividends = $25,000
– Shares outstanding, Jan. 1 = 10,000
– 2,000 additional shares issued on October 1
• Weighted average shares = (10,000 * ) + (12,000 * ) = 10,500
– Alternative way to compute the average shares:
(10,000 * ) + (2,000 * ) = 10,500

• EPS =

• EPS = $13.33
• People frequently refer to earning per share as “earnings”
and it is the most closely watched accounting metric in the
stock market
 Stock Market Lingo
• When a company’s earnings exceed the amount predicted by
analysts, this is called an earnings beat. It usually leads to an
increase in the company’s stock price.

If the company’s earnings don’t meet or exceed the amount forecasted by analysts,
this is called an earnings miss and usually leads to a drop in the stock price.
 Price-to-earnings Ratio
• A related concept is the Price-to-earnings
Ratio (P/E Ratio)

P/E Ratio =
– Example: share price of $40, EPS of $2.00
• We would say that the firm trades at “twenty
times earnings”
• If a competitor trades at thirty-five times
earnings, it might have more growth options
• We can use the P/E ratio to
compare firms
– Investors use this to look for
companies that are undervalued
 Quiz C
• On 1/1/18, Hatchbuck had 300,000 common shares outstanding. On
7/1/18, the company issued another 200,000 common shares. For the
year ended 12/31/18, the company posted a Net Income of $60,000.
The company also declared and paid $10,000 of dividends to preferred
shareholders and $20,000 of dividends to common shareholders.

1. What was Hatchbuck’s Earnings Per Share?

2. If Hatchbuck was a publicly-traded company and had a stock

price of $22/share, what would be Hatchbuck’s P/E Ratio?