Understanding Stockholders' Equity: A Comprehensive Guide

Stockholders' Equity

Rights of stockholders to share proportionately in:

1. Profits
2. Management
3. Corporate assets upon liquidation
4. Any new issues of stock of the same class (preemptive right)

Preemptive Right: Protects an existing stockholder from involuntary dilution of ownership interest.

Key Concepts

Additional Paid-in Capital: Indicates any excess over par value paid in by stockholders in return for the shares issued to them.

Retained Earnings: Represents the earned capital of the company.

Lump-Sum Sales: When a corporation issues two or more classes of securities for a single payment.

• Incremental Method: Company cannot determine the fair value of all classes of securities.
• Proportional Method: Determining relative value is available for each class of security.

Types of Stock

Preferred Stock: Stock whose holders are guaranteed priority in the payment of dividends but whose holders have no voting rights. Preference over common stock to remaining corporate assets in the event of liquidation.

Common Stock: The residual corporate interest that bears the ultimate risks of loss and receives the benefits of success. No guarantee of dividends or assets upon dissolution.

Paid-in Capital vs. Retained Earnings: Dividends can be declared out of retained earnings, but cannot be declared out of paid-in capital. Look to earnings for the continued and growth of the corporation.

Capital Stock

Authorized Capital Stock: The total number of shares authorized by the Government of incorporation for issuance.

• Unissued: Shares authorized but not issued.
• Issued: Shares distributed to stockholders.
• Outstanding: Shares issued and still in the hands of stockholders.

Treasury stock: shares of stock issued and repurchased by the issuing corporation but not retired.

Par value: has no relationship to its fair value. At present, the par value .  associated with most capital stock issuances is very low. Low par values help companies avoid a contingent liability

purchasing own shares:(1) to provide tax-efficient distributions of excess cash to shareholders, (2) to increase earnings and return on equity, (3) to provide for employee  compensation or to meet potential merger needs, (4) to thwart takeover attempts or to reduce number of stockholders, (5) to make a market in the stock.

Features Preferred Stock:  -Preference as to dividends. -Preference as to assets in liquidation. -Convertible into common stock.  -Callable at the option of the corporation. -Nonvoting.

Cumulative: if corporation fails to pay a dividend, it must make it up in a later year before paying any dividends to common stockholders

Dividends in Arrears: Any passed dividend on cumulative preferred stock

Participating: Holders share ratably with the common stockholders in any profit distributions

Convertible: Allows stockholders (option) to exchange preferred shares for common stock at a predetermined ratio

Redeemable- Mandatory redemption period or a redemption feature that the issuer cannot control.

Callable: Permits the corporation (option) to call or redeem the outstanding preferred shares at specified future dates and at stipulated prices.

Preferred stock Reported : -at par value as the first item in the stockholders’ equity section of balance sheet.