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Chapter 12 - Stockholders’ equity. In this chapter students will be able to: List the three forms of financing and distinguish debt from equity, define and distinguish contributed capital from earned capital, define and distinguish preferred stock from common stock. | 2 Chapter 12: Shareholders’ Equity 2 3 Learning Objective 1 List the three forms of financing and distinguish debt from equity. 4 Shareholders’ Equity How to Finance a Corporation: Borrow (focus of chapter 11) Notes, Bonds, Leases The debt holders are legally entitled to repayment of their principal and interest claims Issue Equity Common and Preferred Stock The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets Contributed capital Retained Earnings (profitable operations) Earned capital 5 The Relative Importance of Liabilities, Contributed Capital, and Earned Capital Figure 12-2 The relative importance of liabilities, contributed capital, and retained earnings (percentage of total assets) 6 Debt and Equity Distinguished – Characteristics 1. Formal legal contract 1. No legal contract 2. Fixed maturity date 2. No fixed maturity date 3. Fixed periodic payments 3. Discretionary dividend 4. Security in case of default payments | 2 Chapter 12: Shareholders’ Equity 2 3 Learning Objective 1 List the three forms of financing and distinguish debt from equity. 4 Shareholders’ Equity How to Finance a Corporation: Borrow (focus of chapter 11) Notes, Bonds, Leases The debt holders are legally entitled to repayment of their principal and interest claims Issue Equity Common and Preferred Stock The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets Contributed capital Retained Earnings (profitable operations) Earned capital 5 The Relative Importance of Liabilities, Contributed Capital, and Earned Capital Figure 12-2 The relative importance of liabilities, contributed capital, and retained earnings (percentage of total assets) 6 Debt and Equity Distinguished – Characteristics 1. Formal legal contract 1. No legal contract 2. Fixed maturity date 2. No fixed maturity date 3. Fixed periodic payments 3. Discretionary dividend 4. Security in case of default payments 5. No direct voice in 4. Residual asset interest management – influence 5. Vote for board of directors through debt covenants 6. Dividends are not an expense 6. Interest is an expense but a distribution of retained earnings Debt Equity 7 Distinctions Between Debt and Equity Interested Party Debt Equity Investors / Creditors Lower investment risk Higher investment risk Contractual future cash payments Dividends are discretionary Effects on credit rating Effects of dilution/ takeover Interest is tax deductible Dividends are not tax deductible Liabilities section of the balance sheet Shareholders’ equity of the balance sheet Income statement effects from debt No income statement effects from equity Fixed cash receipts Variable cash receipts Management Accountants/ Auditors 8 Concept Practice 1 9 Learning Objective 2 Define and distinguish contributed capital from earned capital. 10 Accounting for Shareholders’ Equity The Shareholders’ equity section of a corporate balance sheet .
