Chapter 18 IRM

Overview
CHAPTER 18
Shareholders Equity
We turn our attention in this chapter from liabilities, which represent the creditors interests in the
assets of a corporation, to the shareholders residual interest in those assets. The discussions
distinguish between the two basic sources of shareholders equity (1) invested capital and (2)
earned capital. These two sources are the subjects of Parts B and C of this chapter paid-in capital
and retained earnings. We explore the expansion of corporate capital through the issuance of shares
as well as the contraction caused by the retirement of shares or the purchase of treasury shares.
Within the context of our discussions of retained earnings, we examine cash dividends, property
dividends, stock dividends, and stock splits.
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
After studying this chapter, you should be able to:
LO18-1 Describe the components of shareholders equity and explain how they are reported in
a statement of shareholders' equity.
LO18-2 Describe comprehensive income and its components.
LO18-3 Understand the corporate form of organization and the nature of stock.
LO18-4 Record the issuance of shares when sold for cash and noncash consideration.
LO18-5 Distinguish between accounting for retired shares and treasury shares.
LO18-6 Describe retained earnings and distinguish it from paid-in capital.
LO18-7 Explain the basis of corporate dividends, including the similarities and differences
between cash and property dividends.
LO18-8 Explain stock dividends and stock splits and we account for them.
LO18-9 Discuss the primary differences between U.S. GAAP and IFRS with respect to
accounting for shareholders equity.
Lecture Outline
Part A: The Nature of Shareholders Equity
I.
Sources of Shareholders Equity

A. A company can raise money externally to fund operations in either of two ways:
1. Debt financing.
a.
Takes the form of notes, bonds, leases, and other liabilities.
b. Creates creditors interest in the assets of the business.
Instructors Resource Manual

Copyright 2015 McGraw-Hill Education. All rights reserved.
18-1
2.
Equity financing.
a.
Creates ownership interests in the assets of the business.
b. Owners of a corporation are its shareholders.
c.
Shareholders equity is a residual amount, the amount that remains
after creditor claims have been subtracted from assets. (T18-1)
B.
II.
Shareholders equity is created mainly by:

1. Amounts invested by shareholders paid-in capital.
2. Amounts earned by the firm on behalf of its shareholders retained earnings.
Shareholders Equity in Financial Statements
A. The balance sheet reports balances of shareholders equity accounts. (T18-2)
B. Comprehensive income, a more expansive view of the change in shareholders equity than
traditional net income, is the total nonowner change in equity for a reporting period.
Transactions between the corporation and its shareholders primarily include dividends and
the sale or purchase of shares of the companys stock. Nonowner changes other than those
that are part of traditional net income are the ones reported as other comprehensive
income. Other comprehensive income is reported in two places.
1. Components of comprehensive income created during the reporting period - can be
reported either (a) as an additional section of the income statement, (b) as part of the
statement of shareholders equity, or (c) as a separate statement, often included in the
financial statements in a disclosure note. Each component is reported net of its related
income tax expense or income tax benefit. (T18-3)
2. The comprehensive income accumulated over the current and prior periods is
reported as a separate component of shareholders equity.
C. The statement of shareholders equity discloses transactions that cause changes in
shareholders equity account balances. (T18-4)
Part B: Paid-In Capital

I.
Fundamental Share Rights

A. Usually ownership rights held by common shareholders include the right to:
1.
Vote.
2.
Share in profits when dividends are declared.
3.
Share in the distribution of assets if the company is liquidated.
B. Usually the special rights of preferred shareholders include a preference:
1.
To a specified amount of dividends so that if the board of directors declares
dividends, preferred shareholders receive the designated dividend before any
dividends are paid to common shareholders.
2.
Over common shareholders as to the distribution of assets in the event the
corporation is dissolved.
C. Dividends on cumulative preferred shares that are not declared in any given year must be
paid the next time dividends are paid before any can be paid to common shareholders.
D. When preferred shares are not participating, shareholders are entitled to no more than
the designated dividend preference.
18-2
Intermediate Accounting, 8/e
II.
The Concept of Par Value

A. Par value has little significance other than historical.
B. Par value originally indicated the actual value of shares, but this is no longer the case.
C. Companies usually assign shares a nominal par value to elude elaborate statutory rules
pertaining to par value shares.
D. When shares are issued, we record the par amount in common stock and the remainder of
the proceeds in additional paid-in capital.
III. Accounting for the Issuance of Shares
A. When shares are sold for cash, shareholders investment is allocated between stated capital
and additional paid-in capital. (T18-5)
B. At times, shares are sold for noncash consideration like a service or a noncash asset.
(T18-6)
1.
The transaction should be recorded at the fair value of either the shares or the
noncash consideration, whichever seems more clearly evident.
2.
This is consistent with the general rule for accounting for any noncash transaction.
C. More than one security might be sold for a single price.
1.
The cash received usually is the sum of the separate market values of the two
securities. Each is then recorded at its market value.
2.
If only one securitys value is known, the second securitys market value is inferred
from the total selling price. (T18-7)
3.
If the total selling price is not equal to the sum of the two market prices, the total
selling price is allocated between the two securities in proportion to their relative
market values.
E. Share issue costs are the costs of the legal, promotional, and accounting services
necessary to effect the sale of shares.
1.
The costs reduce the net cash proceeds from selling the shares and thus paid-in
capital excess of par.
2.
Share issue costs are not recorded separately.
F. U.S. GAAP and IFRS are generally compatible with respect to accounting for
shareholders' equity. Some differences exist in presentation format and terminology and in
choices regarding reporting comprehensive income. (T18-8)
IV.
Reacquired Shares
A. Companies sometimes reacquire shares previously sold.
1.
The most common motivation is to support the market price of the shares.
2.
All share repurchases are functionally the same.
3.
Accounting treatment depends on whether the company states that it is formally
retiring the shares or purchasing treasury shares. (T18-9) (T18-10) (T18-11)
B. When a corporation formally retires previously issued shares, those shares assume the
same status as authorized but unissued shares just the same as if they never had been
issued.
1.
Payments to retire shares are viewed as a distribution of corporate assets to
shareholders.
2.
We decrease precisely the same accounts that previously were increased when the
shares were sold namely, common (or preferred) stock and paid-in capital excess
of par.

18-3
3.
C.
The difference between the cash paid to buy the shares and the amount the shares
originally sold for are treated differently depending on whether that difference is
positive (credit) or negative (debit):
a. If a credit difference is created, we credit paid in capital share repurchase.
b. If a debit difference is created, we debit retained earnings unless a credit balance
already exists in paid in capital share repurchase, in which case we debit that
account.
Corporations often view a share buyback as a purchase of treasury stock.
1.
The cost of acquiring the shares is temporarily debited to the treasury stock
account.
2.
We delay recording the effects on specific shareholders equity accounts until later
when the shares are reissued.
3.
Essentially, we view the purchase of treasury stock as a temporary reduction of
shareholders' equity, reversed later when the treasury stock is resold.
4.
When the treasury shares are resold, we treat the difference between the cash
received and the amount the shares originally cost differently depending on whether
that difference is positive (credit) or negative (debit):
a. If a credit difference is created, we credit paid-in capital share repurchase.
b. If a debit difference is created, we debit retained earnings unless a credit balance
already exists in paid-in capital share repurchase, in which case we debit that
account.
Part C: Retained Earnings

I.
The Nature of Retained Earnings

A. In Part B, we studied invested capital. In Part C, we consider earned capital, usually
referred to as retained earnings. (T18-12)
B. In general, retained earnings represents a corporation's accumulated, undistributed or
reinvested net income (or net loss).
C. Distributions of earned assets are dividends.
D. We refer to a debit balance in retained earnings as a deficit.
II.
Dividends
A. Most corporate dividends are paid in cash. At the declaration date, retained earnings is
reduced and a liability is recorded. Registered owners of shares on the date of record are
entitled to receive the dividend. (T18-13)
B. Occasionally, a noncash asset is distributed. In that case it is referred to as a property
dividend. The fair market value of the assets to be distributed is the amount recorded for a
property dividend. Before recording the property dividend, the asset may need to be
written up or down to fair market value. This would create a gain or loss. (T18-14)
III. Stock Distributions

A. In a stock dividend, additional shares of stock are distributed to existing shareholders.
1.
A stock dividend affects neither the assets nor the liabilities of the firm.
2.
Because each shareholder receives the same percentage increase in shares, each
shareholders percentage ownership of the firm remains the same.
3.
For a "small" stock dividend (25% or less), the fair value of the additional shares
distributed is transferred from retained earnings to paid-in capital. (T18-15)
18-4
B.
A stock distribution of 25% or higher is a stock split. (T18-16)

1.
If referred to merely as a stock split, no journal entry is recorded.
2.
If referred to as a "stock split effected in the form of a stock dividend," the par value
of the additional shares is reclassified within shareholders equity.
Decision-Makers Perspective
A. Profitability is vital to a company's long run survival.
B. The return on shareholders' equity is a popular summary measure of profitability.
1.
The return on shareholders' equity is calculated by dividing net income by average
shareholders' equity
2.
The return on shareholders' equity measures the ability of company management to
generate net income from the resources that owners provide.
C. Analysts often supplement the return on shareholders equity ratio with the earnings-price
ratio.
1.
This ratio relates earnings to the market value of equity rather than the book value of
equity.
2.
It is calculated as the earnings per share divided by the market price per share.
3.
A common variation is the inverse the price-earnings ratio.
D. Shareholders equity transactions can affect the return to shareholders.
1.
When a company buys back some of its shares, the return on shareholders equity
goes up.
2.
On the other hand, the buyback of shares uses assets, which decreases the resources
available to earn net income in the future.
E. Analysts should evaluate dividend decisions with consideration for prevailing
circumstances. Management must decide whether shareholders are better off receiving
cash dividends or having funds reinvested in the firm.
Appendix 18: Quasi-Reorganizations
A. A quasi-reorganization aids a company that experiences financial difficulties, and yet has
favorable future prospects.
1.
Inflated asset values are written down.
2.
The accumulated deficit (debit balance in retained earnings) is eliminated.
B. Assets (and liabilities if necessary) are written up or down to reflect fair values.
1.
Corresponding credits or debits are made to retained earnings.
2.
The deficit usually is temporarily increased by this step.
C. The deficit in retained earnings (debit balance) is eliminated.
1.
Retained earnings is credited; additional paid-in capital is debited.
2.
If additional paid-in capital is not sufficient to absorb the entire deficit, common
stock is debited also.
D. Retained earnings is dated to indicate the date the deficit was eliminated and when the
new accumulation of earnings began.

18-5
PowerPoint Slides
A PowerPoint presentation of the chapter is available at the textbook website.
An alternate version of the PowerPoint presentation also is available.
Teaching Transparency Masters
The following can be reproduced on transparency film as they appear here, or

you can use the disk version of this manual and first modify them to suit your
particular needs or preferences.
18-6
SHAREHOLDERS EQUITY
Shareholders equity accounts represent the ownership

interests of shareholders. Shareholders equity is a residual
amount whats left over after creditor claims have been
subtracted from assets (in other words, net assets).
Assets Liabilities = Shareholders equity
Net Assets
Ownership interests of shareholders arise primarily from

two sources (1) amounts invested by shareholders in the
corporation and (2) amounts earned by the corporation on
behalf of its shareholders. These two sources are reported
as (1) paid-in capital and (2) retained earnings.
A third source is Accumulated Other Comprehensive

Income
T18-1

18-7
Exposition Corporation
Balance Sheet ($ in millions)
December 31, 2016
Assets
[$3,000]
Liabilities
[$1,000]
Shareholders equity
PAID-IN CAPITAL:
Capital stock (par):
Preferred stock, 10%, $10 par,
cumulative, nonparticipating
Common stock, $1 par
Common stock dividends distributable
Additional Paid-in Capital:
Paid-in capital excess of par, common
Paid-in capital excess of par, preferred
Paid-in capital share repurchase
Paid-in capital conversion of bonds
Paid-in capital stock options
Paid-in capital stock award plan
Paid-in capital lapse of stock options
Total paid-in capital
$100
55
5
260
50
8
7
9
5
1
$
RETAINED EARNINGS
500
1,670
ACCUMULATED COMPONENTS OF COMPREHENSIVE INCOME:
Unrealized gains (losses) on investment securities

Unrealized net loss on pensions
Deferred gains (losses) on derivatives
Foreign currency translation adjustments
TREASURY STOCK (at cost)
Total shareholders equity
(85)
(75)
(4)
-0-
(164)
(6)
$2,000
T18-2
18-8
COMPREHENSIVE INCOME
Encompasses all changes in equity other than from transactions with
owners.
Nonowner changes other than those that are part of traditional net
income are the ones reported as other comprehensive income.
Comprehensive income accumulated over the current and prior
periods is reported in the shareholders equity section of the balance
sheet.
Components of comprehensive income created during the reporting
period can be reported either (a) as an additional section of the
income statement, (b) as part of the statement of shareholders equity,
or (c) as a separate statement in a disclosure note:
($ in millions)
Net income
$xxx
Other comprehensive income:
Net unrealized holding gains (losses) on investments (net of tax)
$x
Gains (losses) from and amendments to postretirement plans (net of tax) (x)
Deferred gains (losses) from derivatives (net of tax)
(x)
Gains (losses) from foreign currency translation (net of tax)*
x
xx
Comprehensive income
$xxx
Changes in the fair value of some securities.

Gains and losses due to revising assumptions or market returns differing from expectations and
prior service cost from amending the plan (described in Chapter 17).
When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is
deferred as a component of comprehensive income and included in earnings later, at the same
time as earnings are affected by the hedged transaction (described in the Derivatives Appendix
to the text).
Gains or losses from changes in foreign currency exchange rates. The amount could be an
addition to or reduction in shareholders equity. (This item is discussed elsewhere in your
accounting curriculum.)
T18-3

18-9
STATEMENT OF SHAREHOLDERS' EQUITY

Wal-Mart
Retained
Earnings
Accum.
Other
Compr.
Income
Total
Walmart
Sh/Hdrs
Equity
(In millions, except per share amounts)
Shares
Common
Stock
Capital in
Excess of
Par Value
Balances February 1, 2011

Consolidated net income
Other comprehensive income
Cash dividends ($1.46 per share)
Purchase of Company stock
Other
3,516
(113)
15
$352
(11)
1
$3,577
(229)
344
$63,967
15,699
(5,048)
(5,930)
3
$646
(2,056)
$68,542
15,699
(2,056)
(5,048)
(6,170)
348
Balances January 31, 2012

Other
3,418
342
3,692
68,691
16,999
(115)
11
(11)
1
(357)
285
(5,361)
(7,341)
(10)
(1,410)
823
71,315
16,999
823
(5,361)
(7,709)
276

Other
3,314
(87)
6
332
(9)
3,620
(294)
55
72,978
16,022
(6,139)
(6,254)
(41)
(587)
(2,409)
76,343
16,022
(2,409)
(6,139)
(6,557)
14
3,233
$323
$2,362
$76,566
$(2,996)
$76,255
T18-4
18-10
SHARES SOLD FOR CASH
When shares are sold for cash, the capital stock account
(usually common or preferred) is credited for the amount
representing stated capital. When shares have a designated
par value, that amount denotes stated capital and is credited to
the stock account. Proceeds in excess of this amount are
credited to paid-in capital excess of par.
Dow Industrial sells 100,000 of its common shares, $1 par per

share, for $10 per share:
($ in 000s)
Cash (100,000 shares at $10 price per share)....................... 1,000

Common stock (100,000 shares at $1 par )...................
Paid-in capital excess of par (remainder)..............
100
900
The entire proceeds from the sale of nopar stock are deemed
stated capital and recorded in the stock account.
If the shares are nopar, the entry is as follows:

Cash (100,000 shares at $10 price per share)....................... 1,000
Common stock ....................................................
1,000
T18-5

18-11
SHARES SOLD FOR NONCASH CONSIDERATION
Occasionally, a company might issue its shares for

consideration other than cash. It is not uncommon for a new
company, yet to establish a reliable cash flow, to pay for
promotional and legal services with shares rather than with
cash. Similarly, shares might be given in payment for land, or
for equipment, or for some other noncash asset.
Shares should be issued at whichever evidence of fair market

value seems more clearly evident.
DuMont Chemicals issues 1 million of its common shares, $1

par per share, in exchange for a custom-built factory for which
no cash price is available. Todays issue of the Wall Street
Journal lists DuMonts stock at $10 per share:
($ in millions)
Property, plant, and equipment (1 million shares at $10)....

Common stock (1 million shares at $1 par ).....................
Paid-in capital excess of par (remainder).................
10
1
9
T18-6
18-12
MORE THAN ONE SECURITY

SOLD FOR A SINGLE PRICE
More than one security might be sold for a single price. The
cash received usually is the sum of the separate market values
of the two securities. Each is then recorded at its market
value.
If only one securitys value is known, the second securitys

market value is inferred from the total selling price.
AP&P issues 4 million of its common shares, $1 par per share,

and 4 million of its preferred shares, $10 par, for $100 million.
Todays issue of the Wall Street Journal lists AP&Ps common at
$10 per share. There is no established market for the preferred
shares:
($ in millions)
Cash...........................................................................
Common stock (4 million shares x $1 par) ......................
Paid-in capital excess of par, common.................
Preferred stock (4 million shares x $10 par).....................
Paid-in capital excess of par, preferred................
100
4
36
40
20
If the total selling price is not equal to the sum of the two
market prices, the total selling price is allocated between the
two securities in proportion to their relative market values.
T18-7

18-13
INTERNATIONAL FINANCIAL REPORTING STANDARDS

Use of the term reserves and other terminology differences. Shareholders equity
is classified under IFRS into two categories: Share capital and reserves. The term
reserves is considered misleading and thus is discouraged under U.S. GAAP. Here are
some other differences in equity terminology:
U.S. GAAP
IFRS
Capital stock:
Share capital:
Common stock
Ordinary shares
Preferred stock
Preference shares
Paid-in capitalexcess of par, common
Share premium, ordinary
shares
Paid-in capitalexcess of par, preferred
Share premium, preference
shares
Accumulated other comprehensive income: Reserves:
Net gains (losses) on investmentsAOCI
Investment revaluation
reserve
Net gains (losses) currency translation AOCI
Translation
reserve
{N/A: adjusting P,P, & E to fair value not permitted}
Revaluation
reserve
Retained earnings
Retained earnings
Total equity
Presented after Liabilities
Liabilities
Often presented before
T18-8
18-14
COMPARISON OF SHARE RETIREMENT AND

TREASURY STOCK ACCOUNTING
SHARE BUYBACKS
American Semiconductors balance sheet included the following:
Shareholders' Equity ($ in millions)
Common stock, 100 million shares at $1 par .............
Paid-in capital excess of par.....................................
Paid-in capital share repurchase...............................
Retained earnings........................................................
$ 100
900
2
2,000
Retirement
Treasury Stock
Reacquired 1 million of its common shares
Case 1: Shares repurchased at $7 per share
Common stock ($1 par x 1 million sh). 1
Treasury stock (cost).............. 7
PIC excess of par ($9 per sh)......... 9
PIC share repurchase (difference)
3
Cash............................................
7
Cash...................................
7
OR
Case 2: Shares repurchased at $13 per share
Common stock ($1 par x 1 million sh). 1
Treasury stock (cost)............... 13
PIC excess of par ($9 per sh)......... 9
PIC share repurchase .................. 2*
Retained earnings (difference)........... 1
Cash............................................
13
Cash...................................
13
*Because there is a $2 million credit balance.
T18-9

18-15
COMPARISON OF SHARE RETIREMENT AND

TREASURY STOCK ACCOUNTING
SUBSEQUENT SALE OF SHARES
American Semiconductor sold 1 million shares after reacquiring shares at $13 per share
(Case 2 in Illustration 18-10)
Retirement
Case A: Shares sold at $14 per share
Cash................................... 14
Common stock (par)........
1
PIC excess of par........
13
Treasury Stock
Cash............................................ 14
Treasury stock (cost) ..............
13
PIC share repurchase..........
1
OR
Case B: Shares sold at $10 per share
Cash................................... 10
Common stock (par)........
1
PIC excess of par .........
9
Cash............................................ 10
Retained earnings (to balance)....... 1
PIC share repurchase .............. 2*
Treasury stock (cost)..............
13
*Because there is a $2 million credit balance.
T18-10
18-16
REPORTING SHARE BUYBACKS IN THE

BALANCE SHEET
Formally retiring shares restores the balances in both the Common
stock account and Paid-in capital excess of par to what those
balances would have been if the shares never had been issued at
all.
o Any net increase in assets resulting from the sale and
subsequent repurchase is reflected as Paid-in capital
share repurchase.
o Any net decrease in assets resulting from the sale and
subsequent repurchase is reflected as a reduction in
retained earnings.
When a share repurchase is viewed as treasury stock, the cost of

the treasury stock is simply reported as a reduction in total
shareholders equity.
Shares Treasury
Retired
Stock
Shareholders Equity
Paid-in capital:
Common stock, 100 million shares at $1 par
Paid-in capital excess of par
Paid-in capital share repurchase
Retained earnings
Less: Treasury stock, 1 million shares (at cost)
($ in millions)
99
891
1,999
$2,989
$ 100
900
2
2,000
(13)
$2,989
T18-11
18-17
RETAINED EARNINGS
In general, retained earnings represents a corporation's

accumulated, undistributed, or reinvested net income (or net
loss). It also is called reinvested capital or earned capital.
Distributions of earned assets are dividends.

A debit balance in retained earnings is referred to as a deficit.
A restriction of retained earnings communicates
managements intention to withhold assets represented by a
specified portion of the retained earnings balance (normally
indicated by a disclosure note).
T18-12
18-18
CASH DIVIDENDS
On June 1, the board of directors of Craft Industries declares a
cash dividend of $2 per share on its 100 million shares, payable
to shareholders of record June 15, to be paid July 1:
($ in millions)
June 1 declaration date

Retained earnings...............................................
Cash dividends payable
(100 million shares at $2/share) ............................
200
200
June 13 ex-dividend date

no entry
June 15 date of record
no entry
July 1 payment date
Cash dividends payable ....................................
Cash .............................................................
200
200
T18-13

18-19
PROPERTY DIVIDENDS
Before recording a property dividend, the asset first must be

written up to fair market value.
On October 1, the board of directors of Craft Industries
declares a property dividend of 2 million shares of Beaman
Corporations preferred stock that Craft had purchased in
March as an investment (book value: $9 million).
The investment shares have a fair market value of $5 per
share and are payable to shareholders of record October 15,
to be distributed November 1:
October 1 declaration date

Investment in Beaman Corporation
preferred stock ..........................................
Gain on appreciation of investment ($10 $9)
Retained earnings (2 million shares at $5 per share)
Property dividends payable ...................
($ in millions)
1
10
1
10
October 15 date of record

no entry
November 1 payment date
Property dividends payable ..........................
Investment in Beaman Corporation
preferred stock ....................................
10
10
T18-14
18-20
STOCK DIVIDENDS
A stock dividend is the distribution of additional shares of

stock to current shareholders of the corporation.
Because each shareholder receives the same percentage

increase in shares, shareholders' proportional interest in
(percentage ownership of) the firm remains unchanged.
For a "small" stock dividend (less than 25%), the fair market
value of the additional shares distributed is transferred from
retained earnings to paid-in capital.
Craft declares and distributes a 10% common stock dividend

(10 million shares) when the market value of the $1 par common
stock is $12 per share:
($ in millions)
Retained earnings (10 million shares at $12 per share).....

Common stock (10 million shares at $1 par per share) . .
Paid-in capital excess of par (remainder)............
120
10
110
T18-15

18-21
STOCK SPLITS
A stock distribution of 25% or higher is referred to as a stock

split.
A frequent reason for issuing a stock split is to reduce the

market price per share (by half in a 2 for 1 split, for example).
The proper accounting treatment of stock split is to make no

journal entry, unless the stock distribution is referred to as a
"stock split effected in the form of a stock dividend."
Craft declares and distributes a 2 for 1 stock split effected
in the form of a 100% stock dividend (100 million shares)
when the market value of the $1 par common stock is $12
per share:
($ in millions)
Paid-in capital excess of par..........................

Common stock (100 million shares at $1 par) ........
100
100
Some companies choose to debit retained earnings instead:
Retained earnings..............................................
Common stock (100 million shares at $1 par) ........
100
100
T18-16
18-22
Suggestions for Class Activities

1.
Research Activity
Ask students to look up three companies in the Money & Investing section of the Wall Street Journal,
the financial pages of another newspaper, or on the Internet. Have them find the price-earnings ratio
of each company. Using those data, have them determine the rate of return on the market value of
shareholders' equity.
Suggestions:
Pose these questions:
1. What information does the rate of return provide?
2. How is the information different from that provided by the rate of return of shareholders' equity
as commonly calculated from financial statements?
Points to note:
The rate of return on the market value of shareholders' equity is the inverse of the price-earnings
ratio, i.e., the earnings-price ratio. The rate of return on the market value of shareholders' equity is a
summary measure of profitability. It measures the ability of management to generate earnings from
the resources that owners provide. Like other ratios, analysts must be careful not to view it in
isolation Thats why its useful to supplement the return on shareholders equity ratio as commonly
calculated from financial statements (net income divided by average shareholders' equity) with this
market-based ratio. This ratio is simply the earnings per share divided by the market price per share.
2.
Real World Scenario
Hormel Foods Corp., which makes Spam and other prepared foods, distributed a two-for-one stock
split in March 2011. At the time the split was announced, the company's stock price was $49.
Suggestions:
Ask students to:
1.
Speculate as to why Hormel declared the stock split.
2.
Consider what the share price would be at the time of the distribution, other things being equal.
Points to note:
Normally, as in this case, a split is made to reduce the per share price and thus enhance the
marketability of the stock by making it affordable to a larger number of potential investors. It also
might signal favorable performance. Other things equal, the new share price would be $24.50 after
the split. Of course, quite a few circumstances and events can cause the price to vary.

18-23
3.
Real World Scenario

Following is a news release from General Electric:
FAIRFIELD, Conn.--(BUSINESS WIRE)--Dec. 10, 2004--The Board of Directors of GE today

raised the Company's quarterly dividend 10% to $0.22 per outstanding share of its common stock and
authorized the repurchase of up to $15 billion of its common stock over the next three years.
"GE has tremendous prospects for growth in earnings and cash flow," said GE Chairman and CEO
Jeff Immelt.
"We have been executing a clear strategy to build a capital-efficient portfolio of faster-growth
industrial businesses and higher-returning financial services businesses," Immelt said. "That work is
now largely behind us, and we have the best set of GE businesses we've had in many years. We're
confident that in 2005 we will return to solid double-digit earnings growth with expanding
incremental returns on capital and increasing cash flow from operating activities. As a result we fully
expect to have the flexibility to invest in technology and innovation while returning value to
shareowners through a substantial dividend and a share repurchase program."
The dividend increase, from $0.20 per share, marks the 29th consecutive year in which GE has
raised its dividend. GE has paid a dividend every year since 1899. The dividend is payable January 25,
2005, to shareowners of record on December 27, 2004. The ex-dividend date is December 22.
The new share repurchase program replaces a program first authorized in 1994. Since 1994, GE
has returned more than $75 billion to shareowners through dividends and the repurchase of more than
1.1 billion shares.
Suggestions:
Ask students to consider the statement that GE has the flexibility to invest in technology and
innovation while returning value to shareowners through a substantial dividend and a share
repurchase program. This implies a choice. What are the choices? How do the choices return value
to shareholders?
Points to note:
Companies have choices regarding the disposition of earnings. One choice is to reinvest in profitmaking activities, hopefully benefiting shareholders through higher future earnings and therefore
future capital gains and dividends. Another choice is to distribute the earnings currently as dividends.
Another is to buy back shares. This supports the market price of stock and reduces dilution that
occurs when new shares are issued.
18-24
4.
Real World Scenario

Following is a news release from Northeast Community Bancorp:
Northeast Community Bancorp, Inc. (NASDAQ: NECB) today announced that its Board of
Directors declared an initial quarterly cash dividend of $0.03 per common share. The dividend
will be paid on or about November 15 to stockholders of record as of the close of business on
October 12.
Suggestions:
Ask students to:
1.
Consider the effect on the share price on the ex-date, other things being equal.
2.
Consider the ongoing effect of the decision on company assets, other things being equal.
3.
Speculate as to why Northeast Community Bancorp declared the dividend after not
previously paying dividends.
Points to note:
Normally, the stock price declines by the amount of a cash dividend, $.03 in this case, the first
day the stock trades after the recipients of the dividend are determined. Dividends use cash that
otherwise would be available for reinvestment in company growth or other activities.
Companies typically pay cash dividends when they feel that is a better return to shareholders
than would be reinvesting with the expectation of higher future stock prices. Dividend decisions
reflect managerial strategy concerning the mix of internal versus external financing, alternative
investment opportunities, and industry conditions. High dividends often are found in mature
industries and low dividends in growth industries. Microsoft, for instance, like FedEx
previously, for years paid no dividends, focusing instead on plowing available cash into growth
opportunities.

18-25
5.
Professional Skills Development Activities
The following are suggested assignments from the end-of-chapter material that will help your
students develop their communication, research, analysis, and judgment skills.
Communication Skills. Analysis Case 18-2, Exercise 18-23, and Problem 18-6 are suitable for
student presentation(s). In addition to Communication Cases 18-3 and 18-6, Research Case 184 can be adapted to ask students to prepare a memo to the Controller outlining the findings of
the research. Communication Cases 18-3 and 18-10 requires group interaction. Problem 18-12
and Analysis Case 18-7 do well as group assignments. Questions 18-11, 18-21, Exercise 18-14,
and Research Case 18-10 create good class discussions.
Research Skills. In their professional lives, our graduates will be required to locate and extract
relevant information from available resource material to determine the correct accounting
practice, perhaps identifying the appropriate authoritative literature to support a decision. In
addition to Research Case 18-4, Communication Cases 18-3 and 18-10 provide an excellent
opportunity to help students develop this skill. In addition, Judgment Case 18-5 can be adapted
to require students to research the authoritative literature on accounting for stock splits.
Analysis Skills. The Broaden Your Perspective section includes Analysis Cases that direct
students to gather, assemble, organize, process, or interpret date to provide options for making
business and investment decisions. In addition to Analysis Cases 18-2 and 18-7, Exercise 18-1,
Problem 18-7, and Real World 18-11 also provide opportunities to develop analysis skills.
Judgment Skills. The Broaden Your Perspective section includes Judgment Cases that require
students to critically analyze issues to apply concepts learned to business situations in order to
evaluate options for decision-making and provide an appropriate conclusion. In addition to
Judgment Case 18-5, Communication Case 18-3 also requires students to exercise judgment.
18-26
6.
Ethical Dilemma
The chapter includes the following ethical dilemma.
ETHICAL DILEMMA
Interworld Distributors has paid quarterly cash dividends since 1985. The dividends have
steadily increased from $.25 per share to the latest dividend declaration of $2.00 per share. The
board of directors is eager to continue this trend despite the fact that revenues fell significantly
during recent months as a result of worsening economic conditions and increased competition. The
company founder and member of the board proposes a solution. He suggests a 5% stock dividend
in lieu of a cash dividend to be accompanied by the following press announcement:
"In lieu of our regular $2.00 per share cash dividend, Interworld will distribute a 5% stock
dividend on its common shares, currently trading at $40 per share. Changing the form of the
dividend will permit the Company to direct available cash resources to the modernization of
physical facilities in preparation for competing in the 21st century."
What do you think?
You may wish to discuss this in class. If so, discussion should include these elements:
Step 1 - The Facts:
The founder of Interworld Distributors suggests distributing a 5% stock dividend in lieu of its
regular $2.00 per share cash dividend. The board of directors wants to continue providing dividends
to shareholders despite the fact that revenues have recently declined. The stock dividend will permit
Interworld to conserve cash and reinvest cash resources in modernization of physical facilities.
Shareholder percentage of ownership in the company does not change as a result of a small stock
dividend. Distribution of a small stock dividend results in a reclassification of retained earnings to
paid-in capital. Retained earnings are reduced just as if a cash dividend had been paid. Per share
stock prices usually decline after a company issues a small stock dividend in order to maintain the
same overall value of investment in the company. The company founder is attempting to produce the
illusion that current shareholders will be receiving a real dividend and camouflage the fact that
revenues have declined.
Step 2 - The Ethical Issue and the Stakeholders:
The ethical issue or dilemma is whether the boards obligation to protect the companys image
(and perhaps their jobs) is greater than its obligation to protect investors and creditors interests by
providing full disclosure of relevant information.
Stakeholders include the founder of Interworld, other members of the board of directors,
company management, employees, current and future creditors, and current and future investors.
Step 3 - Values:
Values include honesty, integrity, objectivity, loyalty to the company, loyalty to shareholders, and
responsibility to users of financial statements.
18-27
Step 4 - Alternatives:
1. Distribute and record a 5% stock dividend to current holders of common stock.
2. Do not declare a stock dividend.
Step 5 - Evaluation of Alternatives in Terms of Values:
1. Alternative 1 illustrates loyalty to protecting the company image to current shareholders.
2, Alternative 2 reflects values of honesty, integrity, objectivity, and responsibility for fair
reporting to current shareholders and to other users of the financial statements.
Step 6 - Consequences:
Alternative 1
Positive consequences: The company and its management may look better in the eyes of some
shareholders. The company reserves cash to invest in the future modernization of plant facilities.
Negative consequences: Some shareholders may falsely believe they are receiving a distribution of
value from the company. Users of the financial statements would be misinformed. The founder and
the board may lose the respect of some shareholders and the financial community.
Alternative 2
Positive consequences: The founder and board members maintain self-respect and gain the
respect of the financial community. Users of the financial statements are better informed regarding
the true financial position of the company.
Negative consequences: Shareholders become displeased about the lack of dividend distribution
and reinvest elsewhere. The stock price per share may decline due to the lack of a dividend
distribution. Some managers jobs may be in jeopardy.
Step 7 - Decision:
Student(s) must decide their course of action.
18-28
Assignment Chart
Questions
Learning
Objective(s)
18-1
18-2
18-3
18-4
18-5
18-6
18-7
18-8
18-9
18-10
18-11
18-12
18-13
18-14
18-15
18-16
18-17
18-18
18-19
18-20
18-21
18-22
18-23
18-24
1
1
1
1
1
1
1
1
1
1
1
2
2
3
4
4
4
5
5
8
8
8
8
A
Topic
Sources of shareholders equity
Statement of shareholders' equity
Shares sold for consideration other than cash
More than one security sold for a single price
Share issue costs
When shares are retired
Treasury shares
Stock dividends
Stock splits
Reverse stock split
Stock dividends
Quasi-reorganization

Est. time
(min.)
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
18-29
Brief
Exercises
Learning
Objective(s)
18-1
18-2
18-3
18-4
18-5
18-6
18-7
18-8
18-9
18-10
18-11
18-12
18-13
18-14
18-15
18-16
2
4
4
4
4
5
5
5
5
5
7
7
8
8
8
9
Est. time
(min.)
Topic
Stock issued
Stock issued
Stock issued
Effect of preferred stock on dividends
Retirement of shares
Treasury stock
Treasury stock
Treasury stock
Cash dividend
Property dividend
Stock dividend
Stock split
Stock split
IFRS; reporting shareholders equity
18-30
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
Exercises
18-1
18-2
Learning
Objective(s)
2
2
Topic
Est. time
(min.)
FASB codification research; reporting other
comprehensive income in shareholders equity
Earnings or OCI?
Stock issued for cash; Wright Medical Group
Issuance of shares; noncash consideration
Redeemable shares
Share issue costs; issuance
Reporting preferred shares
New equity issues; offerings announcements
Effect of cumulative, nonparticipating preferred
stock on dividends 3 years
Treasury stock
Treasury stock weighted average and FIFO cost
Reporting shareholders equity
Change from treasury stock to retired stock
Stock buyback; press release; Ford
Transactions affecting retained earnings
Stock dividend
Stock split; Hamni Financial
Cash in lieu of fractional share rights
FASB codification research
Profitability ratio
IFRS; equity terminology
25
15
15
15
20
15
15
15
15
18-3
18-4
18-5
18-6
18-7
18-8
18-9
18-10
2
4
4
4
4
4
4
4
18-11
18-12
18-13
18-14
18-15
18-16
18-17
18-18
18-19
18-20
18-21
18-22
18-23
18-24
18-25
5
5
5
5
5
5
5
6, 7
8
8
8
1, 5, 8
6, 7, 8
1
9
CPA/CMA
Exam Questions
Learning
Objective(s)
Topic
Est. time
(min.)
CPA-1
CPA-2
CPA-3
CPA-4
CPA-5
CPA-6
CPA-7
CPA-8
CMA-1
CMA-2
CMA-3
5
5
7
7
8
8
9
9
1
1
8
Treasury stock
Property dividend
Stock dividend
Stock dividend
Stock split
IFRS
IFRS
Common stock
Common stock
Stock dividend
3
3
3
3
3
3
3
3
3
3
3

15
15
20
15
20
20
20
15
25
10
15
15
15
35
15
15
18-31
Problems
Learning
Objective(s)
18-1
18-2
18-3
5
5
18-4
5, 7
18-5
6, 7, 8
18-6
1, 3-8
18-7
1-4
18-8
18-9
3,
4, 7
7
18-10
18-11
4-8
8
18-12
1, 4-8
18-13
Est. time
(min.)
Topic
Various stock transactions; correction of journal

entries
Share buyback comparison of methods
Reacquired shares comparison of retired
shares and treasury shares
Statement of retained earnings
Shareholders equity transactions; statement of

shareholders' equity
Reporting shareholders' equity: comprehensive
income; Cisco Systems
Share issue costs; issuance; dividends; early
retirement
Effect of preferred stock characteristics on
dividends
Investment in debt securities; integrative
problem
Various shareholders equity topics;

comprehensive
Quasi-reorganization
[based on Appendix 18]
25
35
30
25
50
35
35
15
15
20
20
65
25
Star Problems
18-32
Cases
Real World Case 18-1
Analysis Case 18-2
Communication Case 18-3
Learning
Objective(s)
4
1, 3, 6, 7
1
Research Case 18-4
Judgment Case 18-5

5-8
4
Analysis Case 18-7
Ethics Case 18-8
Research Case 18-9

Air France/KLM Case
CPA Simulation 18-1
1, 6
1
Topic
Est. time
(min.)
IPO; Dolby Labs

Is preferred stock debt or equity? group
interaction
Codification research; comprehensive income;
research; integrative; Cisco
Treasury stock; stock split; dividends; Alcoa
Issuance of shares; share issue costs; prepare a
report
Analyzing financial statements; price-earnings
ratio; dividend payout ratio
The Swiss label maker; value of shares issued
for equipment
Researching the way shareholders equity
transactions are reported; retrieving financial
statements from the Internet
Should the present two-category distinction
between liabilities and equity be retained? group
interaction
IFRS; reporting shareholders equity; Air
France/KLM
10
35
30
20
15
45
30
25
50
30
30
Judgment; stock dividends and splits;

dividends on preferred stock; treasury stock;
manditorily redeemable preferred stock

18-33

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Chapter 18 IRM

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Overview

Sources of Shareholders Equity

Instructors Resource Manual

Shareholders equity is created mainly by:

Part B: Paid-In Capital

Fundamental Share Rights

Intermediate Accounting, 8/e

The Concept of Par Value

Instructors Resource Manual

Part C: Retained Earnings

The Nature of Retained Earnings

III. Stock Distributions

Intermediate Accounting, 8/e

A stock distribution of 25% or higher is a stock split. (T18-16)

Instructors Resource Manual

Teaching Transparency Masters

The following can be reproduced on transparency film as they appear here, or

Intermediate Accounting, 8/e

Shareholders equity accounts represent the ownership

Ownership interests of shareholders arise primarily from

A third source is Accumulated Other Comprehensive

Instructors Resource Manual

ACCUMULATED COMPONENTS OF COMPREHENSIVE INCOME:

Unrealized gains (losses) on investment securities

Intermediate Accounting, 8/e

Changes in the fair value of some securities.

Instructors Resource Manual

STATEMENT OF SHAREHOLDERS' EQUITY

(In millions, except per share amounts)

Balances February 1, 2011

Balances January 31, 2012

Balances January 31, 2013

Balances January 31, 2014

Intermediate Accounting, 8/e

SHARES SOLD FOR CASH

Dow Industrial sells 100,000 of its common shares, $1 par per

Cash (100,000 shares at $10 price per share)....................... 1,000

If the shares are nopar, the entry is as follows:

Instructors Resource Manual

SHARES SOLD FOR NONCASH CONSIDERATION

Occasionally, a company might issue its shares for

Shares should be issued at whichever evidence of fair market

DuMont Chemicals issues 1 million of its common shares, $1

Property, plant, and equipment (1 million shares at $10)....

Intermediate Accounting, 8/e

MORE THAN ONE SECURITY

If only one securitys value is known, the second securitys

AP&P issues 4 million of its common shares, $1 par per share,

Instructors Resource Manual

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Often presented before

Intermediate Accounting, 8/e

COMPARISON OF SHARE RETIREMENT AND

*Because there is a $2 million credit balance.

Instructors Resource Manual

COMPARISON OF SHARE RETIREMENT AND

*Because there is a $2 million credit balance.

Intermediate Accounting, 8/e

REPORTING SHARE BUYBACKS IN THE

When a share repurchase is viewed as treasury stock, the cost of

In general, retained earnings represents a corporation's

Distributions of earned assets are dividends.

Intermediate Accounting, 8/e

June 1 declaration date