📈Financial Accounting II Unit 3 – Stockholders' Equity: Stock Issuance & Buyback
Stockholders' equity is a crucial aspect of a company's financial structure, representing ownership interests and claims on assets. This unit explores the intricacies of stock issuance and buybacks, including the types of stock, accounting procedures, and their impact on financial statements.
Understanding these concepts is essential for grasping how companies manage their capital structure and return value to shareholders. The unit covers regulatory considerations, real-world examples, and the effects of stock transactions on key financial metrics like earnings per share and return on equity.
Stockholders' equity represents the residual interest in a company's assets after deducting liabilities
Consists of contributed capital (amounts received from issuing stock) and retained earnings (cumulative net income less dividends)
Stock issuance increases contributed capital and total stockholders' equity
Stock buybacks decrease outstanding shares and total stockholders' equity
Par value is the nominal or face value assigned to a share of stock
Additional paid-in capital is the amount received from issuing stock in excess of par value
Retained earnings are not directly affected by stock issuance or buybacks
Types of Stock
Common stock represents the residual ownership in a company and typically carries voting rights
Dividends on common stock are not guaranteed and are paid at the discretion of the board of directors
Preferred stock provides a higher claim on assets and earnings compared to common stock
Often carries a fixed dividend rate and may have priority over common stockholders in receiving dividends and assets during liquidation
Treasury stock is previously issued stock that has been repurchased by the company
Treated as a contra-equity account and reduces total stockholders' equity
Callable preferred stock allows the issuer to redeem the shares at a predetermined price after a specified date
Stock Issuance Process
Board of directors approves the issuance of new shares
Company determines the number of shares to be issued and the offering price
Prospectus is prepared, detailing the terms of the offering and the company's financial information
Investment bank may be engaged to underwrite the offering and assist with pricing and distribution
Shares are offered to the public through an initial public offering (IPO) or to existing shareholders through a rights offering
Investors purchase the newly issued shares, and the company receives the proceeds
Transfer agent records the ownership of the new shares and distributes stock certificates to investors
Accounting for Stock Issuance
When stock is issued, the company records the par value of the shares in the common stock account
Any amount received in excess of par value is recorded in the additional paid-in capital account
For example, if a company issues 1,000 shares with a par value of 1atapriceof10 per share, common stock would be credited for 1,000(1,000shares×1 par value), and additional paid-in capital would be credited for 9,000(1,000shares×9 excess over par value)
If stock is issued in exchange for assets or services, the transaction is recorded at the fair value of the shares issued or the fair value of the assets or services received, whichever is more reliably measurable
Stock issuance costs, such as underwriting fees and legal expenses, are recorded as a reduction of additional paid-in capital
Preferred stock issuance is accounted for similarly to common stock issuance, with the par value recorded in a separate preferred stock account
Stock Buybacks
Stock buybacks, also known as share repurchases, occur when a company buys back its own shares from shareholders
Reasons for stock buybacks include returning excess cash to shareholders, increasing earnings per share, and providing a tax-efficient alternative to dividends
When shares are repurchased, they are recorded as treasury stock, a contra-equity account that reduces total stockholders' equity
For example, if a company repurchases 500 shares at 20pershare,treasurystockwouldbedebitedfor10,000 (500 shares × 20pershare),andcashwouldbecreditedfor10,000
Repurchased shares may be retired (cancelled) or held as treasury stock for future reissuance
Stock buybacks can be executed through open market purchases, tender offers, or privately negotiated transactions
Financial Statement Impact
Stock issuance increases assets (cash) and stockholders' equity (common stock and additional paid-in capital)
Stock buybacks decrease assets (cash) and stockholders' equity (treasury stock)
Earnings per share (EPS) is calculated by dividing net income by the weighted average number of common shares outstanding
Stock issuance increases the number of shares outstanding and may dilute EPS if the newly issued shares do not generate a proportionate increase in net income
Stock buybacks reduce the number of shares outstanding and may increase EPS if net income remains constant or grows
Return on equity (ROE) measures a company's profitability relative to stockholders' equity
Stock issuance and buybacks can impact ROE by changing the balance of stockholders' equity
Regulatory Considerations
Public companies must comply with securities laws and regulations when issuing or repurchasing stock
Securities and Exchange Commission (SEC) requires registration of securities offerings and disclosure of material information to investors
Sarbanes-Oxley Act of 2002 (SOX) imposes strict financial reporting and internal control requirements on public companies
Insider trading laws prohibit company insiders from trading on material, non-public information
Stock buybacks are subject to SEC Rule 10b-18, which provides a safe harbor for companies repurchasing their shares
Rule 10b-18 specifies manner, timing, price, and volume conditions that must be met to avoid liability for market manipulation
Real-World Examples
In 2020, Tesla, Inc. (TSLA) conducted a $5 billion at-the-market stock offering to raise capital for general corporate purposes and to strengthen its balance sheet
Apple Inc. (AAPL) has an ongoing share repurchase program, buying back $81.7 billion of its common stock in fiscal year 2021 to return cash to shareholders
Berkshire Hathaway Inc. (BRK.A, BRK.B) has two classes of common stock, with Class A shares carrying more voting rights than Class B shares
In 2018, General Electric Company (GE) issued $5 billion of perpetual preferred stock with a fixed dividend rate to raise capital and improve its liquidity position
Many companies, such as Microsoft Corporation (MSFT) and Johnson & Johnson (JNJ), have dividend reinvestment plans (DRIPs) that allow shareholders to reinvest their dividends in additional shares of stock, effectively increasing the number of shares outstanding over time