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Let's continue our quick review of the discussion on equity.
Again, we talked about how equity interests are
the residual interests that there may be multiple classes of stock with different rights.
There is a separate accounting that remains for par values,
although today, par is often a token amount,
often just a fraction of a cent.
We talked about retained earnings.
That's the cumulative amount of net income that's been closed into earnings.
It's reduced by ordinary dividends.
Sometimes, it's adjusted for the cumulative effects of changes in accounting standards.
Dividends reduce retained earnings or debit to retained earnings.
They're not an expense.
Dividends do become a liability when they're declared.
We talked about stock dividends.
This is when a company issues their own common shares instead of cash.
So, you get 10 percent more shares,
15 percent more shares.
It's a way of capitalizing some of your retained earnings into stock, into par values.
And as a result, signaling to the marketplace that this is a permanent reinvestment.
It does give the shareholder something in that they have an additional number of shares,
they could sell some of them and still have the same amount as they had before.
But of course, they may have a smaller percentage if they were to do that.
And then we talked about a stock split.
A stock split is usually where you get two shares for
each share you have today or three shares for each share you have today.
It's often done because the stock price may have risen,
and in some people on the management,
on the board, or others, analysts,
may feel that the stock is losing liquidity because the shares are
too expensive and you could then get
more activity in the stock if you were to decrease the price with
a stock split and maybe get wider ownership, wider distribution.
The stock split is accounted for differently
in that because it really just changes the par value of the stock.
And then, we talked about a stock split in the form of a dividend.
This is where the number of shares issued may be so great
that even though it was in the form of a dividend,
it's really accomplishing the same thing as a split,
and these dividends are considered to be a stock split.
There's a threshold for deciding when exactly that occurs.
But it will change the accounting when the stock dividend is large
enough to be considered de facto a stock split.
Now, we talked about a reverse split.
Sometimes, the company will decide to enter into a reverse split to
raise the fair value per share of the stock.
And this sometimes, can be necessary to comply with exchange requirements.
Some exchanges won't let you list the stock if it falls below a certain price.
You see this sometimes with startups that may have issued
too many shares and they risk becoming a pending stock.
But it's not a real common procedure but it does occur.
We also talked about accumulated other comprehensive income, AOCI.
Recall that that's net of tax,
it's usually recognized net of tax and there is
an associated deferred tax asset and liability,
and then that net amount, it gets closed
into accumulated other comprehensive income at the end of the accounting period.
Now, these amounts in accumulated other comprehensive income,
some of them are are reclassified into net income,
some of them are offset in future periods by future re-measurements.
Sometimes, if you have
a amount that was recognized in other comprehensive income, say, for an available,
for sale debt security,
if you sell the security,
you would then reclassify the amount that's in other comprehensive income into earnings.
Other amounts that are in AOCI
will just be offset in future periods by future measurements,
think pension plans with the actuarial amounts that are within a normal range.
You would expect that if it's a gain this period,
it'll be offset by a loss in a future period.
Also, the unwinding of a discount on available for sale securities,
if you hold that security to maturity,
the amounts will offset so that at the end,
there's nothing left to reclassify as the bonds mature.
So, reclassification entries also go through OCI and are
not a direct debit or credit to AOCI, a common mistake.
One other category of equity is preferred stock.
It's a financial instruments that has characteristics of both debt and equity,
and often has a fixed return,
a stated rate of return like interest in terms of a dividend,
but the shareholders are considered to be at risk for
their investment or subordinate to bond holders and liquidation.
Some vocabulary that's unique to preferred stock, participation rights.
That's when the security holders are able to receive
dividends from the security issuers profits,
cash flows, or returns on investment.
That's usually in addition to the stated rate that you have on the preferred stock.
Not cumulative dividends or dividends
that if they're not declared in a particular year, they're lost.
They don't roll forward. They're never paid.
Cumulative dividends, if they're not paid in the previous year,
they have to be paid in a subsequent year according to the terms of the preferred stock.
Usually, that has to be paid before the company can either pay dividends on
the common stock or engage in
a repurchase of common stock or other similar types of transactions.
Speaking of repurchasing stock,
stock repurchases are accounted for,
generally, as a treasury stock.
They're held in stock and they may be issued again as stock.
They may be sold or they may be retired in the future.
Treasury stock is a contra-equity account.
It will reduce the amount of equity of the company overall.
Do not account for these as an asset on the financial statements.
They're considered to be still issued but no longer outstanding.
It's a unique form of accounting.
Remember, you can't have a gain or loss from dealing in your own stock.
And that's a quick summary of equity.
I encourage you to look at some of the transactions if you feel
you need a more comprehensive review. Thank you.
John HeppClinical Assistant Professor of Accountancy
