Cpa Review- Far 7-1 (Stockholders' Equity)

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Stockholders' Equity

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-(or Shareholders' / Owners' Equity), is the owners' claim to the net assets of a corporation. Generally presented on the B/S as the last major section.

Hint 1

-Contains 5 major components on B/S: (1) Capital stock, (2) APIC, (3) R/E's or deficit, (4) AOCI, (5) Treasury stock. NCI may be shown when consolidated F/S's are presented.

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Capital Stock

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-(or legal capital) is the amount of capital that must be retained by the corporation for the protection of creditors. Includes preferred and common stock.
-Preferred stock generally issued w/ a par value but common stock may be issued w/ or w/out it. Any excess amount received over par goes to APIC.
-Corporations charter contains amount of each class of stock that it can legally issue, called "authorized" capital stock.
-When part or all authorized capital stock is issued it's called "issued" capital stock.

Hint 2

-Amount of capital stock in the hands of shareholders is called "outstanding" capital stock.
-Common stock is the basic ownership interest in a corporation. Common shareholders bear the ultimate risk of loss and receive the ultimate benefits of success, but they aren't guaranteed dividends or assets upon dissolution.
-Generally control management and have the right to vote and right to share in earnings of the corporation.
-May have preemptive rights to a proportionate share of any additional common stock issued.

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Common S/E Formula

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Total shareholders' equity - Preferred stock outstanding (at greater of call price or par value)

Hint 3

- Cumulative preferred dividends in arrears = Common shareholders' equity

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BV Per Common Share

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-Measures the amount the common shareholders would receive for each share if all assets were sold at their book (carrying) values and all creditors were paid.

Hint 4

Book Value Per Common Share = Common shareholders' equity (from above) ÷ Common shares outstanding

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Preferred Stock

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-Equity security w/ preferences and features not associated w/ common stock.
1. Cumulative PS: all or part of the preferred dividend not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders. Accumulated amount called dividends in arrears.
2. Convertible PS: may be exchanged for common stock (at option of stockholder) at a specified conversion rate.
3. Callable (Redeemable) PS: may be called (repurchased) at a specified price, at option of issuing corporation.

Hint 5

4. Mandatory Redeemable PS (Liability): issued w/ a maturity date. Similar to debt, must be bought back by company on maturity date. Classified as a liability.
5. Participating PS: preferred shareholders share (participate) w/ common shareholders in dividends in excess of a specific amount. Fully participating means preferred shareholders participate in excess dividends w/out limit, partially means participate to a limited extent.
6. PS may include a preference to assets upon liquidation of the entity.

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APIC

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-Generally contributed capital in excess of par or stated value. Can also arise from many different types of transactions*, may be aggregated and shown as one amount on the B/S.

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*Sale of treasury stock at a gain, quasi-reorganization, issuance of liquidating dividends, conversion of bonds, declaration of a small stock dividend.

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Retained Earnings

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-Accumulated earnings (or losses) during the life of the corporation that have not been paid out as dividends. Amount is reduced by distributions to stockholders and transfers to APIC for stock dividends. Doesn't include treasury stock or AOCI. If account has a negative balance, it's called a deficit.

Hint 7

Net income/loss - Dividends (FMV of cash, property, and stock*) declared ± Prior period adjustments** ± Accounting changes reported retrospectively + Adjustment from quasi-reorganization = Change in Retained Earnings
*Small vs. Large stock stock dividends
**Reported "net of tax"

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Classifications of R/E's (Appropriations)

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-May be classified as appropriated or unappropriated. Purpose is to disclose to shareholders that some of the R/E's aren't available to pay dividends b/c they have been restricted for legal or contractual reasons or as a discretionary act of management for contingency purposes.

Hint 8

-Appropriation may not be used to absorb costs or losses and may not be transferred to income. J/E:
DR. R/E's (unappropriated)*
CR. R/E's Appropriated for [purpose]*
*decrease / increase, no change in total R/E's

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Quasi-Reorganization

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-(corporate readjustment) accounting adjustment that revises the capital structure as though a corporation had been legally reorganized. Allows a corp. with significant deficit in R/E's to eliminate that deficit and have a "fresh start." Requires approval from shareholders.
1. Purpose: to restate overvalued assets to their lower FV's (thus reduce future depreciation) and to eliminate a R/E's deficit (thus facilitate the declaration of dividends).

Hint 9

2. Procedures: (1) Revalue assets and liabilities to their current FV's and present values, (2) Bring R/E's to zero (eliminate deficit) against APIC. If APIC is insufficient to absorb deficit, more APIC can be created by reducing par or stated value of stock, thus reducing capital stock. (3) Following reorganization, B/S must be dated to show the date of adjustment and must continue to be disclosed (usually for 3-10 years).

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AOCI (PUFER)

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-Include pension adjustments, unrealized gains and losses on AFS securities, foreign currency translation adjustments, deferred gains and losses on the effective portion of CF hedges, and revalution surpluses (IFRS only).

Hint 10

-Don't enter into R/E's, are recognized in period incurred and combined w/ net income to determine comprehensive income. Total AOCI must be shown in the S/E section separate from capital stock, APCI, and R/E's.

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Treasury Stock

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-Corporation's own stock that has been issued to shareholders and subsequently reacquired (but not retired). Treasury stockholders aren't entitled to any of the rights of ownership given to common shareholders.
-Portion of R/E's equal to cost of treasury stock may be restricted and may not be used as basis for declaration and payment of dividends (depending on state law).

Hint 11

-2 methods of accounting for are permitted: (1) Cost Method, (2) Legal or (Par / Stated Value) Method. Primary difference is the timing of the recognition of gain or loss on treasury stock transactions.
-Under both methods, gains and losses are recorded as a direct adjustment to S/E and aren't included in the determination of net income. Also shares held as treasury stock aren't considered outstanding.

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Cost Method

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-Required by IFRS and used by GAAP companies approximately 95% of time.
-Treasury shares are recorded at carried at their reacquisition cost. Gain or loss determined when stock is reissued or retired and the original issue price and BV of the stock don't enter into accounting.

Hint 12

-"APIC- treasury stock" is credited for gains and debited for losses when treasury stock is reissued at prices that differ from original selling price.
-Losses may also decrease R/E's if APIC- T/S account doesn't have a balance large enough to absorb the loss. Net income and R/E's are never increased through treasury stock transactions.

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Legal (or Par / Stated Value) Method

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-Prohibited by IFRS, used by GAAP companies approximately 5% of the time.
-Treasury shares are recorded by reducing the amounts of par (or stated) value and APIC received at the time of original sale. Treasury stock is debited for its par (or stated) value. APIC - Common Stock is debited (reduced) for the pro rata share of the original issue price attributable to the reacquired shares.

Hint 13

-R/E's is debited (reduced) for any excess of treasury stock cost over the original issue price. APIC - T/S is credited (increased) for any excess of the original issue price over the treasury stock cost. Under this method, the sources of capital associated w/ the original issue are maintained.
-Comparison of methods below

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Retirement of Treasury Stock

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-When T/S is acquired w/ the intent of retiring the stock and the price paid is in excess of the par or stated value, the excess may be charged against either (1) all PIC arising from past transactions in the same class of stock or (2) R/E's.

Hint 14

-When the price paid for the acquired T/S is less than par or stated value, the difference must be credited to PIC.
-Ex: of J/E's below

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Donated Stock

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-A company's own stock received as a donation from a shareholder. No change in total S/E as a result of donation but the # of shares outstanding decreases, resulting in higher BV per common share. Should record donated stock at FV.*

Hint 15

*DR. Donated T/S (@ FMV)
CR. APIC (@ FMV)
-If sold J/E is:
DR. Cash (@ sales price)
DR. APIC (if SP < Original FMV)
CR. APIC (if SP > Original FMV)
CR. Donated T/S (@ BV or Original FMV)

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Accounting for a Stock Issuance (to Non-Employees)

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1. Stock Issued Above Par Value: cash debited for proceeds, common / preferred stock credited for par or stated value and APIC credited for excess over par value.
2. Stock Issued Below Par Value: APIC is debited to reflect a discount on the stock. Discount represents a contingent liability to the original owners.

Hint 16

3. Stock Subscriptions: means that a contractual agreement to sell a specified number of shares at an agreed-upon price on credit is entered into. Upon full payment of the subscription, a stock certificate evidencing ownership in the corporation is issued.

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Subscriptions

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1. Sale: "subscriptions receivable" is debited and "capital stock subscribed" is credited as is APIC. Subscriptions not paid for at year-end are treated as a contra-equity item, offsetting the amount of par (or stated) value and APIC related to subscriptions not paid for at year-end.
2. Collection: subscription receivable is credited and cash or other assets are debited.

Hint 17

3. Issuance of Stock Previously Subscribed: capital stock subscribed account is debited and the regular capital stock account is credited.
4. Default / Forfeiture: if all or part of subscription isn't collected, terms of agreement will determine treatment. Generally, you reverse applicable portion of original entry and either (1) issue stock in proportion to amount paid, (2) refund the partial payment, (3) or retain partial payment by a credit to APIC.

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Stock Rights

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-Provides an existing shareholder w/ the opportunity to buy additional shares. Right usually carries a price below the stock's market price on the date the rights are granted.
-Issuance of stock rights requires a memorandum entry only.

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-Is possible that the right may subsequently be redeemed by the company, which will decrease S/E in the amount of the redemption price. J/E for exercise of stock rights:
DR. Cash (amount received)
CR. Common Stock (par value)
CR. APIC (residual)

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Other Stock Valuation Issues

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-Stock issued for outside services should be recorded at the FV of the stock.

Hint 19

-Stock issued in a "basket sale" w/ other securities (ex: bonds) should be allocated a portion of the sales proceeds based on the relative FMV's of the different securities.

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Distributions to Shareholders

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1. Dividend: pro rata distribution by a corporation based on the shares of a particular class of stock and usually represents a distribution of earnings.
2. Date of Declaration: the date the board of directors formally approves a dividend. Liability is created (dividends payable), and R/E's is reduced (debited).

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3. Date of Record: date the board specifies as the date the names of shareholders to receive the dividend are determined (no J/E).
4. Date of Payment: date the dividend is actually disbursed by the corporation or its paying agent.

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Types of Dividends

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1. Cash: distribute cash to shareholders and may be declared common or preferred stock. Paid from R/E's and only to authorized, issued, and outstanding shares.
2. Property (In-Kind): distribute noncash assets to shareholders. Non-reciprocal transfers of nonmonetary assets. On date of declaration, property given should be restated to FV and any gain or loss should be recognized in income. Dividend liability and related debit to R/E's should be recorded at FV of the assets transferred.

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3. Scrip: special form of N/P where a company commits to paying a dividend at a later date. May be used when there's a cash shortage. On date of declaration, R/E's is debited and N/P is credited. Some scrip dividends even bear interest.
4. Liquidating: occur when dividends to shareholders exceed R/E's. Dividends in excess of R/E's would be charged (debited) first to APIC and then to common or preferred stock. Reduce total PIC.

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IFRS vs. GAAP- Dividends

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-IFRS and SEC require public entities to present dividends per share and in total for each class of shares.

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-Reported in the statement of changes in equity or in the notes to the F/S's.

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Stock Dividends

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-Distribute additional shares of a company's own stock to its shareholders. Treatment depends on percentage (no dividend income reported by shareholder, cost basis goes down).
1. Small Stock Dividend (< 20-25%): Issuance isn't expected to affect market price of stock. FMV of stock dividend at declaration date is transferred from R/E's to capital stock and APIC. No effect on total S/E, as APIC is substituted for R/E's.
DR. R/E's (# of shares x FMV)
CR. C/S (# of shares x Par Value)
CR. PIC (for difference, plug #)

Hint 23

2. Large Stock Dividend (> 20-25%): may be expected to reduce the market price of the stock (similar to a stock split). The par (or stated) value of the stock dividend is normally transferred from R/E's to capital stock in order to meet legal requirements. Amount transferred is the number of shares issued x the par (or stated) value of the stock (reduces R/E's by par amount of stock). Declaration J/E:
DR. R/E's (# of shares x Par Value)
CR. C/S Distributable
-Distribution of stock dividend J/E (same amounts as above):
DR. C/S Distributable
CR. Capital Stock

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Stock Dividends on T/S

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-Generally not distributed b/c not considered outstanding. Exception is made when state law requires that T/S be protected from dilution or*

Hint 24

*The company is maintaining a ratio of treasury shares to shares outstanding in order to meet stock option or other contractual commitments.

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Stock Splits

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-Occur when a corporation issues additional shares of its own stock (w/ out charge) to current shareholders and reduces the par value per share proportionately. No change in the total BV of the shares outstanding and usually doesn't affect R/E's or total S/E.
-Reverse stock split would reduce the number of shares outstanding and increases the par value proportionately. One way to do is to recall outstanding stock certificates and issue new ones.

Hint 25

-Stock splits usually aren't applied on T/S b/c they aren't considered outstanding. Exception is made is company is trying to maintain a ratio of T/S to shares outstanding in order to meet stock or other contractual commitments or if state law requires that T/S be protected from dilution.

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Disclosure Info About Capital Structure- GAAP

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-Required for all entities that have issued securities.
-Must disclose rights and privileges of various securities outstanding and number of shares.
-Amount of redemption requirements (for next 5 years)

Hint 26

-Have to disclose the liquidation preference of preferred stock and the aggregate or per-share amounts at which preferred stock may be called or is subject to redemption through sinking-fund operations. Also amounts of arrearages in cumulative preferred dividends.

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Disclosure Info About Capital Structure- IFRS

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-For each class of stock: number of shares authorized, number issued and fully paid and issued and not fully paid, per value per share, reconciliation of # of shares outstanding at beginning and end of the period.

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-Rights, preferences, and restrictions. Shares of the entity held by entity or subsidiaries. Shares reserved for issuance under options or contracts for the sale of shares. Description of the nature and purpose or each reserve w/in equity.

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Accounting for Stock Issued to Employees

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-Employer corporation grants options to purchase shares of its stock, often at a price lower than the prevailing market, making it possible for the individual exercising the option to have a potential profit at the moment of acquisition.

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-Most state that purchaser must retain the stock for a minimum period, eliminating the possibility of speculation. Cost of compensation is measured by the FV based on option pricing model (2 types, below).

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Noncompensatory Stock Option / Purchase Plans

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-Used to raise capital or diversify ownership among employees or officers. Under GAAP, employee stock purchase plan is noncompensatory if all of following are met:
1. Substantially all full-time employees meeting limited requirements may participate. Officers and employees owning a specific amount of outstanding shares of the corporation are excluded.
2. Stock is offered to eligible employees equally.

Hint 29

3. Time permitted to exercise the rights is limited to a reasonable period.
4. Any discount from the market price is no greater than would be reasonable offer of stock to shareholders or others.
-If plan meets these criteria, don't require recognition of compensation expense (no J/E until purchased and then regular entry).
-Under IFRS, employee stock purchase plans are generally considered to be compensatory.

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Compensatory Stock Option / Purchase Plans

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-Valued at the FV of the options issued.
1. Option (Exercise) Price: price at which the underling stock can be purchased pursuant to the option contract.
2. Exercise Date: date by which the option holder must use the option to purchase underlying stock.
3. FV: determined by an economic pricing model such as the Black-Scholes method.*
4. Grant Date: date option is issued (no J/E).
5. Vesting Period: period over which the employee has to perform services in order to earn the right to exercise the options. Compensation is recognized over the service period and this is generally the vesting period.*
*Expense to the issuer.

Hint 30

6. Compensation Expense: under FV method, total compensation expense is measured by applying an acceptable FV pricing model (Black-Scholes Option Pricing Model). Allocated over the service period in accordance w/ the matching principle. Service period is vesting period (time between grant date and vesting date).
7. Compensation Cost: should be recognized as an expense over the periods of employment attributable to the option.
8. Expiration of Options: requires a reclassification of the remaining balance in APIC - Stock Options account. DR. APIC - Stock Options, CR. APIC - Expired Stock Options (compensation expense not affected by expiration).

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Statement of Changes in S/E

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-Provides specific info about changes in an entity's primary equity components, including capital transactions and distributions to shareholders, reconciliation of R/E's.

Hint 31

-Reconciliation to carrying amount of each class of equity capital, PIC, and AOCI.
-Under GAAP, comprehensive income may be presented as a separate category in the statement of equity (prohibited under IFRS).

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IFRS vs. GAAP

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-GAAP permits the presentation of the statement of changes in S/E either as a primary F/S or w/in the notes to the F/S's.

Hint 32

-IFRS and SEC require the statement of changes in S/E to be presented as a primary F/S.