๐Financial Accounting II Unit 4 โ Stockholders' Equity: Dividends & Stock Actions
Stockholders' equity is a crucial aspect of financial accounting, representing ownership interests in a company. This unit explores key components like common and preferred stock, paid-in capital, and retained earnings, as well as important transactions such as dividends and stock actions.
Understanding stockholders' equity is essential for assessing a company's financial health and shareholder value. The unit covers various types of dividends, stock issuance and repurchases, and their accounting treatments, providing insights into how these actions impact financial statements and shareholder returns.
Stockholders' equity represents the residual interest in a company's assets after deducting liabilities
Par value is the nominal or face value assigned to a share of stock, typically a small amount (e.g., 0.01or1.00)
Paid-in capital consists of the amount paid by investors for stock that exceeds its par value
Additional paid-in capital (APIC) is the excess amount paid over par value for common or preferred stock
Retained earnings are the cumulative net income earned by a company since its inception, less any dividends paid
Treasury stock refers to a company's own shares that have been repurchased from shareholders but not retired
Treasury stock is recorded at cost and reduces total stockholders' equity
Book value per share is calculated by dividing total stockholders' equity by the number of outstanding shares
Earnings per share (EPS) measures the portion of a company's profit allocated to each outstanding share of common stock
Types of Stock and Ownership
Common stock represents the basic ownership in a company and entitles holders to voting rights and residual claims on assets and earnings
Preferred stock provides certain preferences over common stock, such as priority in dividend payments and asset distribution during liquidation
Preferred stock may be cumulative (dividends accumulate if not paid) or non-cumulative
Preferred stock may be convertible into common stock at a predetermined ratio
Authorized shares are the maximum number of shares a company is permitted to issue, as stated in its corporate charter
Issued shares are the total number of shares sold to investors, including shares held by the company as treasury stock
Outstanding shares are the shares currently held by investors, excluding treasury stock
Restricted stock units (RSUs) are a form of equity compensation granted to employees, which vest over time and convert into common stock upon vesting
Dividends: Purpose and Types
Dividends are distributions of a company's earnings to its shareholders, typically in the form of cash or additional shares
Dividends provide a return to investors and signal a company's financial strength and growth prospects
Cash dividends are paid in cash and reduce the company's cash balance and retained earnings
Special dividends are non-recurring distributions, often larger than regular dividends, paid due to excess cash or significant events
Stock dividends are paid in the form of additional shares and transfer amounts from retained earnings to paid-in capital accounts
Small stock dividends (generally less than 20-25% of outstanding shares) are recorded at fair value
Large stock dividends (generally greater than 20-25% of outstanding shares) are recorded at par value
Property dividends involve the distribution of non-cash assets, such as securities or real estate, to shareholders
Scrip dividends are promissory notes to pay cash dividends at a future date, often due to temporary cash constraints
Stock Issuance and Repurchases
Companies issue stock to raise capital for various purposes, such as funding growth, acquisitions, or debt repayment
Initial public offering (IPO) is the first sale of a company's stock to the public, typically underwritten by investment banks
Seasoned equity offering (SEO) is the issuance of additional shares by a company that is already publicly traded
Stock splits increase the number of outstanding shares and proportionately reduce the par value and market price per share
Stock splits are often used to improve liquidity and affordability for investors (e.g., 2-for-1 or 3-for-1 splits)
Reverse stock splits reduce the number of outstanding shares and proportionately increase the par value and market price per share
Stock repurchases (buybacks) occur when a company buys back its own shares from the market, reducing outstanding shares
Repurchases may be motivated by undervaluation, excess cash, or a desire to boost earnings per share
Accounting for Stock Transactions
Stock issuance is recorded by debiting Cash (or other assets) and crediting Common Stock (par value) and Paid-in Capital in Excess of Par
Stock repurchases are recorded by debiting Treasury Stock and crediting Cash
Treasury stock is a contra-equity account that reduces total stockholders' equity
When treasury stock is resold, any difference between the selling price and the repurchase cost is recorded in Paid-in Capital from Treasury Stock
Stock dividends are recorded by debiting Retained Earnings and crediting Common Stock (par value) and Paid-in Capital in Excess of Par
The amount transferred from Retained Earnings is based on the fair value (small stock dividends) or par value (large stock dividends) of the shares issued
Cash dividends are recorded by debiting Retained Earnings and crediting Cash Dividends Payable
When paid, Cash Dividends Payable is debited, and Cash is credited
Financial Statement Impact
Stock issuance increases assets (e.g., cash) and stockholders' equity (common stock and paid-in capital)
Stock repurchases decrease assets (cash) and stockholders' equity (treasury stock)
Repurchases also reduce the number of outstanding shares, which can increase earnings per share
Stock dividends transfer amounts from retained earnings to paid-in capital accounts, with no net change in total stockholders' equity
Stock dividends increase the number of outstanding shares, which can improve liquidity and affordability for investors
Cash dividends reduce assets (cash) and retained earnings, decreasing total stockholders' equity
Dividends and stock repurchases provide returns to shareholders but reduce the company's resources for growth and investment
Stock splits and reverse splits change the number of outstanding shares and the par value per share but do not affect total stockholders' equity
Legal and Regulatory Considerations
State laws govern the issuance, dividends, and repurchase of stock, including restrictions on sources of distributions
Securities and Exchange Commission (SEC) regulates public companies and requires periodic financial reporting and disclosure
SEC rules mandate the fair and timely disclosure of material information, including stock transactions and dividend declarations
Stock exchanges (e.g., NYSE, NASDAQ) impose listing requirements and rules for member companies
Tax laws impact the treatment of dividends and stock transactions for both the company and its shareholders
Qualified dividends are taxed at preferential long-term capital gains rates for individual shareholders
Stock repurchases can provide tax advantages over dividends, as they are taxed as capital gains when shares are sold
Real-World Applications and Examples
Apple Inc. (AAPL) has a history of stock splits, with a 7-for-1 split in 2014 and a 4-for-1 split in 2020, making its shares more accessible to investors
Berkshire Hathaway Inc. (BRK.A) is known for its high-priced Class A shares, which have never split and traded at over $400,000 per share in 2021
Microsoft Corporation (MSFT) has consistently paid quarterly dividends since 2003 and has steadily increased its dividend payout over time
In 2013, Carl Icahn pushed for a $150 billion share buyback at Apple, arguing that the company was undervalued and had excess cash
During the 2008 financial crisis, many banks, such as JPMorgan Chase & Co. (JPM) and Wells Fargo & Company (WFC), cut or suspended dividends to conserve capital
In 2015, KKR & Co. Inc. (KKR) completed a $500 million share repurchase program, demonstrating its commitment to returning capital to shareholders