Chapter 16 Contributed Capital Intermediate Accounting 10 th edition Nikolai Bazley Jones An electronic presentation by Norman Sunderman Angelo State University COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
2 Types of Corporations 1. Private Owned by governmental units (FDIC) Corporations (stock and nonstock; open and closed) 2. Public corporations 3. Domestic corporations Incorporated in the state that it is operating in 4. Foreign Available for universities, purchase by corporations hospitals, Incorporated in the public churches another state
3 Stockholders’ Rights v. The right to share in the profits when a dividend is declared. v. The right to elect directors and to establish corporate policies. v. The right (called a preemptive right) to maintain a proportionate interest. v. The right to share in the distribution of the assets of the corporation if it is liquidated.
Advantages of the Corporate Form v. Limited liability v. Capital accumulation v. Ease of transferability 4
Disadvantages of the Corporate Form v. Increased taxation v. Difficulties of control v. Regulation 5
6 Basic Terminology Outstanding Authorized capital stock-The number of stock--The number of shares of capital stock that a corporation has issued to its may issue as stockholders and stated in its that are still charter. being held by them on a specific date. Issued capital stock--The number of shares of capital stock that a corporation has issued to its stockholders as of a specific date.
7 Basic Terminology Outstanding Issued capital Authorized capital stock-The number of stock--The Treasury stock-Subscribed capital of capital number of shares The stock--The stock that a number of stock of capital stock shares of capital number of shares that a corporation has that a corporation stock that a of capital stock issued to its has issued to its may issue as corporation has thatin corporation a its stockholders and stockholders as of stated issued to its will issue using an are still that a specific date. charter. stockholders and installment being held by has purchase plan. them on a reacquired but not retired. specific date.
8 Basic Terminology Authorized Capital Stock Issued Capital Stock * Outstanding capital stock * Treasury stock Unissued Capital Stock * Subscribed capital stock
9 Legal Capital Legal capital is the amount of stockholders’ equity that the corporation cannot distribute to stockholders.
10 Issuance of Capital Stock When only one class of stock is issued, it is referred to as common stock.
11 Issuance of Capital Stock A corporation issues 500 shares of its $10 par common stock for $18. Cash Common Stock, $10 par Additional Paid-in Capital on Common Stock 9, 000 5, 000 4, 000
12 Issuance of Capital Stock A corporation issues 500 shares of its no -par stock common stock with a stated value of $10 for $18 per share. Cash 9, 000 Common Stock, $10 stated value Additional Paid-in Capital on Common Stock 5, 000 4, 000
13 Issuance of Capital Stock A corporation issues 500 shares of its no -par, no-stated value common stock for $18 per share. Cash 9, 000 Common Stock, no-par (500 shares) 9, 000
14 Stock Issuance Costs The FASB is planning to change GAAP so that all stock issuance costs are expensed as incurred.
15 Stock Subscriptions A corporation enters into a subscription contract with several subscribers that calls for the purchase of 1, 000 shares of $6 par common stock at a price of $13 per share. A $3 per share down payment is required, with the remaining $10 due in one month. Cash 3, 000 $6 x 1, 000 Subscription Receivable: Common Stock 10, 000 Common Stock Subscribed 6, 000 Additional Paid-in Capital on Common Stock 7, 000
16 Stock Subscriptions The $10 per share final payment was received from subscribers to 950 of the 1, 000 shares. Cash Subscription Receivable: Common Stock 9, 500 Common Stock Subscribed Common Stock, $6 par 5, 700 9, 500 5, 700 950 x $6
17 Stock Subscriptions When a default occurs, the accounting is determined by the relevant contract provisions, such as-1. Return to the subscriber the entire amount paid in. 2. Return to the subscriber the entire amount paid in, less any costs incurred to reissue the stock. 3. Issue to the subscriber a lesser number of shares based upon the total amount of payment received. 4. Require the forfeiture of all amounts paid in.
18 Stock Subscriptions The subscriber to the 50 remaining shares defaults on the contract. The contract requires the forfeiture of all amounts paid in. Common Stock Subscribed 300 Additional Paid-in Capital on Common Stock 350 Subscription Receivable: 50 X $10 Common Stock Additional Paid-in Capital from Subscription Default 50 X $6 50 X $7 500 150
19 Combined Sales of Stock A corporation issues 100 packages of securities for $82. 80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share). Common Stock: $16 x 2 shares x 100 Preferred Stock: $60 x 1 share x 100 Total market value = $ 3, 200 = 6, 000 $9, 200
20 Combined Sales of Stock A corporation issues 100 packages of securities for $82. 80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share). $3, 200 Common Stock: x $8, 280 $9, 200 $6, 000 Preferred Stock: x $8, 280 $9, 200 = $2, 880 = 5, 400 $8, 280
21 Combined Sales of Stock A corporation issues 100 packages of securities for $82. 80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share). Cash 8, 280 Common Stock 2, 000 Additional Paid-in Capital on Com. Stock 880 Preferred Stock, $50 par 5, 000 Additional Paid-in Capital on Pref. Stock 400
22 Stock Splits A stock split results in a decrease in the par value per share of stock accompanied by a proportional increase in the number of shares issued. A stock split ordinarily is recorded by a memorandum entry.
Noncompensatory Stock Option Plans An employee stock purchase plan is designed to raise capital or obtain more widespread ownership of the corporate stock. Three criteria must be met for a share option plan to qualify as noncompensatory. 23
24 Noncompensatory Stock Option Plans 1. Substantially all full-time employees who meet limited employment qualifications may participate in the plan on an equitable basis. 2. The discount from the market price does not exceed the per-share amount of stock issuance costs avoided by not issuing the stock to the public. A purchase discount of 5% automatically complies with this criterion.
25 Noncompensatory Stock Option Plans 3. The plan has no option features other than the following: Employees are allowed a short time from the date the purchase price is set to decide whether to enroll in the plan (no longer than 31 days), and. . . The purchase price is based solely on the market price of the stock on the purchase date, and employees are permitted to cancel their participation before the purchase date and receive a refund of any amounts previously paid.
26 Compensatory Stock Option Plans A share option plan that does not possess ALL three of the criterion for a noncompensatory plan is a compensatory plan.
27 Compensatory Stock Option Plans A corporation must use the fair value method to account for its compensatory share option plan.
28 Recognition of Compensation Expense On January 1, 2007, Fox Corporation adopts a compensatory stock option plan and grants 9, 000 stock options to 30 selected employees. The $50 exercise price is equal to the fair market price of the stock on this grant date. Turnover is about 3%. Using an option pricing model in accordance with FASB 123 R, Fox values each option at $17. 15 on the grant date. Page 785 Continued
29 Fixed Stock Option Plan with Cliff Vesting Fox multiplies the fair value per stock option times the estimated stock options that will become vested [$17. 15 x (9, 000 x 0. 97)] = $140, 871. Memorandum entry: On January 1, 2007, the company granted a compensatory stock option plan to 30 employees. The plan allows each employee to exercise 300 stock options to acquire the same number of shares of the company’s common stock at an exercise price of $50 per share. The option vest at the end of 3 years and expire at the end of 10 years. The estimated value of the stock options expected to be exercised is $140, 871. Page 785 Continued
30 Fixed Stock Option Plan with Cliff Vesting v. At the end of 2008, Fox changes the estimated forfeiture rate to 6%. v. At the end of 2009, a total of 7, 500 stock options for 25 employees actually vest and the other 1, 500 are forfeited.
31 Fixed Compensatory Stock Option Plan 2007 Estimated (actual) total compensation cost $140, 871 Fraction of service period expired x 1/3 Est. compensation expense to date$46, 957 Previously recognized com. exp. (0) Current compensation expense $46, 957 2008 2009 $128, 201 128, 625 x 2/3 x 3/3 $85, 467 $128, 625 (46, 957) (85, 467) $38, 510 $43, 158 300 x (30 employees x 0. 97 x 300 x 25 x $17. 15 0. 97 x 0. 97) x $17. 15 300 x (30 employees x 0. 94 x (fair value per option) 0. 94 x 0. 94) x $17. 15 (fair value per option)
32 Fixed Compensatory Stock Option Plan On December 31, 2007, Fox Corporation records the compensation expense by multiplying the $140, 871 by the fraction of the service period that expired. Compensation Expense Common Stock Option Warrants (Additional Paid-in-Capital) 46, 957 $140, 871 x 1/3 Continued
33 Fixed Compensatory Stock Option Plan Based on new estimations, at the end of 2008 Fox Corporation revises total compensation cost to $128, 201 [$17. 15 x (9, 000 x 0. 94)]. Twothirds of $128, 201, or $85, 467, has expired. Fox previously recorded $46, 957 in 2004, so a “catch-up” entry is needed ($85, 467 - $46, 957 = $38, 510). Compensation Expense Common Stock Option Warrants Continued 38, 510
34 Fixed Compensatory Stock Option Plan On January 5, 2010, one employee exercises options to purchase 300 shares of Fox Corporation’s $10 par common stock. On this date the stock is selling for $70 per share. Fair market value of warrants, $17. 15. Cash 15, 000 Common Stock Option Warrants 5, 145 Common Stock, $10 par 3, 000 Additional Paid-in Capital on Common Stock 17, 145 300 x $17. 15
35 Performance-Based Stock Option Plan A performance-based plan is set up so that the terms will vary depending on how well the selected employee performs. In other words, the better the employee manages the corporation, the better the terms.
36 Performance-Based Stock Option Plan Assume the option plan depends on the increase in market share of stock option plan are the same The terms for the. Fox’s products over the 3 -year service period. Fox grants each follows selected as before except The terms are asof the 30 for each employee: employees a maximum of 300 stock options. 1. If the market share has increased 5 percent, at least 100 stock options will vest on that date. 2. If the market share has increased by at least 10 percent, another 100 stock options will vest. 3. If the market share has increased by more than 20%, all 300 stock options will vest.
37 Performance-Based Stock Option Plans On the grant date, Fox estimates that its market share will increase between 10 and 20 %, so it assumes that 200 options will vest per employee. Based on new estimations, at the end of 2008 Fox Corporation changes the employee forfeiture rate to 6%. At the end of 2009, 25 employees vest 7, 500 stock options. Continued
38 Performance-Based Stock Option Plan 2007 Estimated (actual) total compensation cost $93, 914 Fraction of service period expired x 1/3 Est. compensation expense to date$31, 305 Previously recognized com. exp. (0) Current compensation expense $31, 305 200 x (30 employees x 0. 97) x $17. 15 (fair value per option) 2008 2009 $85, 467 128, 625 x 2/3 x 3/3 $56, 978 $128, 625 (31, 305) (56, 978) $25, 673 $ 71, 647 300 x 25 x $17. 15 200 x (30 employees x 0. 94) x $17. 15 (fair value per option)
39 Share Appreciation Rights Although compensatory stock option plans provide selected employees with the opportunity to acquire shares of stock with a market value in excess of the option price, these plans have some disadvantages. At the time of the exercise, the employee must have sufficient cash to pay the option price and any income taxes. In certain situations, this places a significant cash flow burden on the employee. Share appreciation rights enable the employee to receive cash, stock or a combination of both for the excess of the market value over a stated price.
40 Share Appreciation Rights A company accounts for share appreciation rights using the fair value method. Because the fair value can only be determined on the exercise date, the company must estimate the compensation cost at the end of each year based on the fair value of the SARs at that time. Additional changes to expense are made each year until the rights are exercised.
41 Share Appreciation Rights v. Assume that on January 1, 2006, when the market price is $60 per share, Wolf Corporation grants 1, 000 share appreciation rights to one employee. The employee will receive cash for the excess between $60 and the quoted price on the date of exercise. The service period is four years and the rights must be exercised within ten years. The SARs are valued at $19 on the date of the grant.
Various Preferred Stock Characteristics ü Preference as to dividends. ü Accumulation of dividends. ü Participation in excess dividends. ü Convertibility into common stock. ü Attachment of stock warrants (rights). ü Callability by the corporation. ü Redemption at a future maturity date. ü Preference as to assets upon liquidation of the corporation. (no journal entry) ü Lack of voting rights. 42
43 Cumulative Preferred Stock On cumulative preferred stock, if a corporation fails to declare adequate dividends at the usual date, the amount of passed dividends becomes dividends in arrears. These dividends accumulate and dividends cannot be paid to common shareholders until all preferred dividends in arrears are paid.
44 Cumulative Preferred Stock Dividends in arrears are not a liability because they have not been declared, but must be disclosed in the footnotes to the financial statements.
45 Cumulative Preferred Stock Richland Corporation has outstanding 1, 000 shares of 10%, $100 par cumulative preferred stock. The dividends are two years in arrears when a $30, 000 dividend is declared. Preferred stockholders would receive all of it. 1, 000 shares x $100 x 0. 10 x 3 years = $30, 000
46 Cumulative Preferred Stock Assume total dividends of $5, 000, $11, 000, $30, 000 and $30, 000 on the 10% cumulative preferred stock with a par of $100, 000. Total Preferred Common Year Dividends Arrears 1 $5, 000 0 $5, 000 2 $11, 000 0 $4, 000 3 $30, 000 $14, 000 $16, 000 0 4 $30, 000 $10, 000 $20, 000 0
47 Convertible Preferred Stock Convertible preferred stock allows stockholders to convert preferred stock into another security, usually common stock.
48 Convertible Preferred Stock No value is assigned to the convertible feature. Since corporations may not show a gain or loss by trading in their own stock, the book value method must be used.
49 Convertible Preferred Stock Ness Corporation originally issued 500 shares of $100 par convertible preferred stock at $120 per share. Each share of preferred stock may be converted into four shares of $20 par common stock. Preferred Stock, $100 par 50, 000 Additional Paid-in Capital on Preferred Stock 10, 000 Common Stock, $20 par 40, 000 Additional Paid-in Capital from Preferred Stock Conversion 20, 000 Continued
50 Convertible Preferred Stock Alternatively, assume each preferred share may be converted into seven shares of common stock. Preferred Stock, $100 par 50, 000 Additional Paid-in Capital on Preferred Stock 10, 000 Retained Earnings 10, 000 Common Stock, $20 par 70, 000
51 Preferred Stock with Stock Warrants A corporation may attach warrants to preferred stock to enhance their attractiveness. These warrants represent rights to purchase additional common shares at a specified price in the future.
52 Preferred Stock with Stock Warrants The corporation is actually selling two different securities, preferred stock and warrants. Therefore, the proceeds must be allocated to the two securities based upon their fair values.
Preferred Stock with Stock Warrants (Rights) Ponce Corporation issues 1, 000 shares of $100 par value preferred stock at a price of $121 per share. It attaches a warrant to each share of stock that allows the holder to purchase one share of $10 par common stock at $40 per share. Immediately after the issuance, the preferred stock begins selling ex rights for $119 per share and the warrants for $6 each. Preferred Stock: $119, 000 x $121, 000 = $115, 192 $119, 000 + $6, 000 Common Stock $6, 000 x $121, 000 = 5, 808 Warrants: Continued $119, 000 + $6, 000 53
54 Preferred Stock with Stock Warrants (Rights) When issued Cash ($121 x 1, 000) 121, 000 Preferred Stock, $100 par 100, 000 Additional Paid-in-Capital on Preferred Stock 15, 192 Common Stock Warrants (equity) 5, 808
55 Preferred Stock with Stock Warrants (Rights) All warrants are exercised. Cash ($40 x 1, 000) Common Stock Warrants Common Stock, $10 par Additional Paid-in Capital on Common Stock 40, 000 5, 808 10, 000 35, 808
56 Callable Preferred Stock Callable preferred stock may be retired under specified conditions by a corporation at its option.
57 Callable Preferred Stock Li Corporation has outstanding 1, 000 shares of $100 par callable preferred stock that were issued at $110 per share and no dividends are in arrears. The call price is $112 per share. Preferred Stock, $100 par Additional Paid-in Capital on Preferred Stock Retained Earnings Cash 100, 000 10, 000 2, 000 112, 000
58 Callable Preferred Stock Li Corporation has outstanding 1, 000 shares of $100 par callable preferred stock that were issued at $110 per share and no dividends are in arrears. The call price is $105 per share. Preferred Stock, $100 par 100, 000 Additional Paid-in Capital on Preferred Stock 10, 000 Cash 105, 000 Additional Paid-in Capital from Recall of Preferred Stock 5, 000
59 Treasury Stock Treasury stock is a corporation’s own capital stock that. . . v has been fully paid for by stockholders, v has been legally issued, v is reacquired by the corporation, and v is being held by the corporation for future reissuance.
60 Reasons for Treasury Stock v To use for stock options, bonuses, and employee purchase plans v To use for convertible bonds and preferred stock v To use excess cash instead of paying dividends v To use in acquiring other companies v To reduce outstanding shares and increase EPS v To buy out hostile shareholders v To use for stock dividends
61 Treasury Stock Cost Method Ball issues 6, 000 shares of $10 par common stock for $12 per share: Cash 72, 000 Common Stock $10 par 60, 000 Additional Paid-in Capital on Common Stock 12, 000
62 Treasury Stock Cost Method Reacquisition of 1, 000 shares of common stock at $13 per share: Treasury Stock Cash 13, 000
63 Treasury Stock Cost Method Reissuance of 600 shares of treasury stock at $15 per share: Cash 9, 000 Treasury Stock 7, 800 Additional Paid-in Capital from Treasury Stock 1, 200
64 Treasury Stock Cost Method Reissuance of another 200 shares of treasury stock at $8 per share: Cash 1, 600 Additional Paid-in Capital from Treasury Stock 1, 000 Treasury Stock 2, 600
65 Treasury Stock Cost Method Reissuance of another 100 shares of treasury stock at $10 per share: Cash 1, 000 Additional Paid-in Capital from Treasury Stock 200 Retained Earnings 100 Treasury Stock 1, 300
66 Treasury Stock Par Value Method Issuance of 6, 000 shares of $10 par common stock for $12 per share: Cash 72, 000 Common Stock $10 par 60, 000 Additional Paid-in Capital on Common Stock 12, 000
67 Treasury Stock Par Value Method Reacquisition of 1, 000 shares of common stock at $13 per share: Treasury Stock Additional Paid-in Capital on Common Stock Retained Earnings Cash 10, 000 2, 000 13, 000
68 Treasury Stock Par Value Method Reissuance of 600 shares of treasury stock at $15 per share: Cash 9, 000 Treasury Stock 6, 000 Additional Paid-in Capital on Common Stock 3, 000
69 Treasury Stock Par Value Method Reissuance of another 200 shares of treasury stock at $8 per share: Cash Additional Paid-in Capital on Common Stock Treasury Stock 1, 600 400 2, 000
70 Treasury Stock Par Value Method Reissuance of another 100 shares of treasury stock at $10 per share: Cash Treasury Stock 1, 000
71 Conceptual Overview of Treasury Stock 1. Treasury stock is not an asset. 2. Treasury stock does not vote, has no preemptive rights, ordinarily does not share in dividends, or participate in the company’s liquidation assets, but does participate in stock splits. 3. Treasury stock transactions do not result in gains or losses. Continued
72 Conceptual Overview of Treasury Stock 4. Treasury stock transactions may reduce retained earnings, but may never increase it. 5. Retained earnings usually must be restricted regarding dividends when treasury stock is held. 6. Total corporate stockholders’ equity is not affected by whether cost or par value method is used.
73 Retirement of Treasury Stock Occasionally, a board of directors may decide to retire treasury stock and reduce the legal capital
74 Retirement of Treasury Stock Ball Corporation decides to retire the remaining 100 shares of stock. Cost Method Common Stock, $10 par 1, 000 Additional Paid-in-Capital($2 per share) 200 Retained Earnings (plug) 100 Treasury Stock 1, 300 Par Value Method Common Stock, $10 par Treasury Stock 1, 000
75 Chapter 16 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.
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