Source: Chapter 18, Intermediate Financial Accounting II
Difficulty: Intermediate to Advanced | Prerequisites: Parts 1 and 2 of these notes. Comfort with journal entries (debits and credits), par value, and the equity section of the balance sheet.
This section covers the mechanics of how equity changes hands: issuing shares for cash or noncash consideration, buying shares back (and whether to retire them or hold them as treasury stock), and distributing dividends. These transactions are where the theory from Parts 1 and 2 turns into journal entries. The journal-entry patterns here, particularly for treasury stock and dividend accounting, are heavily tested. If you can write out the entries from memory for each scenario, you are in strong shape for the exam.
When a company issues shares, it splits the proceeds between the common stock account (at par) and additional paid-in capital (the excess). No-par shares go entirely into the common stock account. Treasury stock is recorded at cost and reduces equity; retirement reverses the original issuance entries. Cash dividends create a liability on the declaration date and reduce retained earnings, with no entry on the date of record.
Par value
A nominal, per-share amount stated in the corporate charter. It sets the minimum legal capital the company must maintain. Par value determines how the proceeds of a share issuance are split between the common stock account and APIC.
Think of it as an arbitrary baseline number, not the market price.
No-par stock
Shares issued without a stated par value. The entire issue price is credited to the common stock account, with no APIC entry needed.
Additional paid-in capital (APIC) / paid-in capital in excess of par
The amount shareholders paid above the par value of the shares. For a $1 par share sold at $10, the APIC is $9 per share.
Fair value (fair market value / FMV)
The price at which shares would trade in an arm's-length transaction. When shares are issued for noncash consideration (land, equipment, services), the transaction is recorded at fair value.
Noncash consideration
Anything other than cash received in exchange for shares: land, equipment, legal services, promotional services. Recorded at the fair value of the shares or the noncash item, whichever is more clearly determinable.
Authorized shares
The maximum number of shares a corporation is permitted to issue, as stated in its charter. Authorized = issued + unissued.
Issued shares
Shares that have been sold to shareholders at some point. Issued = outstanding + treasury stock.
Outstanding shares
Shares currently held by investors outside the corporation. These are the shares that vote and receive dividends.
Treasury stock
Previously issued shares the corporation has repurchased and is holding. They are issued but not outstanding. Recorded at cost as a contra-equity account.
Share retirement
When a company buys back shares and formally cancels them, returning them to the pool of authorised but unissued shares. The original issuance entries (common stock and APIC) are reversed.
Cash dividend
A distribution of cash to shareholders, declared by the board of directors. Creates a liability on the declaration date and reduces retained earnings.
Liquidating dividend
A dividend that exceeds the balance in retained earnings. The excess portion is debited to additional paid-in capital, effectively returning contributed capital to shareholders.
Declaration date
The date the board of directors votes to declare a dividend. A liability (dividends payable) is recorded and retained earnings is reduced.
Date of record
The date used to determine which shareholders are entitled to receive the dividend. No journal entry is required.
Ex-dividend date
Typically two business days before the date of record. Shares purchased on or after this date do not carry the right to the declared dividend.
Payment date
The date the dividend is paid. The liability (dividends payable) is debited and cash is credited.
Issuing par-value shares for cash
Example: Dow Industrial sells 100,000 common shares, $1 par, at $10 per share.
Debit Cash: 100,000 x $10 = $1,000,000
Credit Common Stock: 100,000 x $1 = $100,000
Credit Paid-in Capital in Excess of Par: ($10 - $1) x 100,000 = $900,000
The pattern: cash is debited for total proceeds, common stock is credited at par, and the excess goes to APIC.
Issuing no-par shares for cash
Example: Same facts, but shares have no par value.
Debit Cash: $1,000,000
Credit Common Stock: $1,000,000
With no par value, the entire proceeds are credited to common stock. There is no APIC entry.
A company may issue shares in exchange for land, equipment, services, or other noncash assets. The transaction is recorded at fair value.
Example: A company issues 1,000,000 common shares ($1 par) for a custom-built factory. The stock trades at $10 per share; no cash price is available for the factory.
Debit Property, Plant and Equipment: 1,000,000 x $10 = $10,000,000
Credit Common Stock: 1,000,000 x $1 = $1,000,000
Credit Paid-in Capital in Excess of Par: $9,000,000
The journal entry follows the same par/APIC split. The noncash asset is recorded at the fair value of the shares given.
When two securities (e.g. common and preferred) are sold together for a lump sum:
If both have known market values, allocate the total proceeds based on relative market value.
If only one has a known market value, the other's value is inferred from the total selling price.
Example: AP&P issues 4,000,000 common shares ($1 par) and 4,000,000 preferred shares ($10 par) for $100,000,000. Common trades at $10/share. No market exists for the preferred.
Common stock value: 4,000,000 x $10 = $40,000,000
Preferred stock value (inferred): $100,000,000 - $40,000,000 = $60,000,000
Journal entry:
Debit Cash: $100,000,000
Credit Common Stock: $4,000,000 (4M x $1 par)
Credit APIC, Common: $36,000,000 ($40M - $4M)
Credit Preferred Stock: $40,000,000 (4M x $10 par)
Credit APIC, Preferred: $20,000,000 ($60M - $40M)
Companies buy back their own shares to distribute profits without paying dividends, to support the share price by reducing supply, or for employee compensation plans.
Buying back shares does not create an asset.
Key share count relationships
Authorised = Issued + Unissued
Issued = Outstanding + Treasury stock
Outstanding shares are held by external investors (these vote and receive dividends)
Treasury stock shares are issued but not outstanding
Two methods of accounting for buybacks
Method 1: Retirement
The shares are formally cancelled and return to the unissued pool. The original issuance entries are reversed.
Example: A company reacquires 1,000,000 shares originally issued at $10 (par $1) for $7 per share.
Debit Common Stock: $1,000,000 (par x shares)
Debit APIC: $9,000,000 (($10 - $1) x 1,000,000)
Credit PIC, Share Repurchase: $3,000,000 (FMV difference, i.e. ($10 - $7) x 1M)
Credit Cash: $7,000,000
If the repurchase price exceeds the original issue price, the excess is debited to PIC, Share Repurchase (if a credit balance exists) and then to Retained Earnings.
Method 2: Treasury stock
Shares are held by the company. The entry is simple:
Debit Treasury Stock: at cost ($7,000,000)
Credit Cash: at cost ($7,000,000)
Treasury stock is a contra-equity account. It reduces total shareholders' equity.
Subsequent sale of treasury stock
Recorded like any share sale. If sold above cost, the excess goes to PIC, Share Repurchase. If sold below cost, PIC, Share Repurchase is debited first (up to its balance), then Retained Earnings absorbs any remaining shortfall.
Subsequent sale after retirement
Treated as a new issuance: debit cash, credit common stock at par, credit APIC for the excess.
General principles
Dividends are distributions of assets the company has earned on behalf of its shareholders. If dividends paid exceed assets earned, management is returning a portion of the shareholders' original investment.
Liquidating dividend: When a dividend exceeds the balance in retained earnings, the excess is debited to additional paid-in capital rather than retained earnings. This signals a return of contributed capital, not earned capital.
Cash dividends: the three key dates
There is no legal obligation to pay dividends. A liability arises only when the board of directors declares one.
1. Declaration date
The board votes to declare the dividend. A liability is created.
Debit Retained Earnings
Credit Dividends Payable
A listing of eligible shareholders must be assembled before payment.
2. Date of record
The cutoff date for determining which shareholders receive the dividend. Registered owners on this date are entitled to the payment.
No journal entry is required.
The ex-dividend date is typically two business days before the date of record. Shares purchased on or after the ex-dividend date do not carry the right to the declared dividend.
3. Payment date
Cash is paid to shareholders.
Debit Dividends Payable
Credit Cash
Worked example: Craft Industries
June 1: Board declares $2/share dividend on 100,000,000 shares, payable July 1 to shareholders of record June 15.
Declaration (June 1):
Debit Retained Earnings: $200,000,000
Credit Dividends Payable: $200,000,000
Date of Record (June 15): No entry.
Payment (July 1):
Debit Dividends Payable: $200,000,000
Credit Cash: $200,000,000
Students often think a dividend liability exists before the board declares one. It does not. There is no legal obligation until the declaration date.
Students sometimes record a journal entry on the date of record. No entry is needed; it is purely an administrative cutoff.
Treasury stock is frequently mistaken for an asset. It is a contra-equity account that reduces shareholders' equity.
When shares are issued for noncash consideration, students sometimes record the asset at par value instead of fair value. Always use fair value.
Students confuse share retirement with treasury stock. Retirement cancels the shares (they become unissued). Treasury stock holds them as issued but not outstanding.
⚠️ Be able to write the journal entries for stock issuance (par and no-par), noncash issuance, and lump-sum issuance from memory.
⚠️ Know the difference between the retirement method and the treasury stock method for buybacks, including journal entries for both.
⚠️ The three dividend dates (declaration, record, payment) and which require a journal entry is a frequently tested point.
⚠️ Understand the relationship: Authorised = Issued + Unissued, and Issued = Outstanding + Treasury Stock.
⚠️ Be ready to explain what a liquidating dividend is and how it differs from a normal cash dividend in the journal entry.
True or False: A journal entry is required on the date of record. (False. No entry is needed.)
Fill in the blank: When shares have no par value, the entire issue price is credited to ________. (Common Stock.)
True or False: Treasury stock is an asset on the balance sheet. (False. It is a contra-equity account.)
Fill in the blank: Authorised shares = ________ + Unissued shares. (Issued shares.)
True or False: A liquidating dividend is debited entirely to retained earnings. (False. The excess beyond retained earnings is debited to additional paid-in capital.)
Q: A company sells 50,000 shares of $2 par common stock at $15 per share. Write the journal entry.
A: Debit Cash $750,000. Credit Common Stock $100,000 (50,000 x $2). Credit APIC $650,000 ($750,000 - $100,000).
Q: What is the journal entry to record the purchase of 10,000 shares of treasury stock at $12 per share?
A: Debit Treasury Stock $120,000. Credit Cash $120,000.
Q: A board of directors declares a $1.50/share dividend on 2,000,000 outstanding shares. Write the declaration-date entry.
A: Debit Retained Earnings $3,000,000. Credit Dividends Payable $3,000,000.
Q: Explain the difference between share retirement and the treasury stock method.
A: Retirement formally cancels the shares, reversing the original common stock and APIC entries. The shares return to the unissued pool. The treasury stock method records the repurchase at cost in a contra-equity account; the shares remain issued but are not outstanding.
Q: A company issues 200,000 shares ($5 par) in exchange for land. The stock trades at $20 per share. What is the journal entry?
A: Debit Land $4,000,000 (200,000 x $20). Credit Common Stock $1,000,000 (200,000 x $5). Credit APIC $3,000,000 ($4M - $1M). The asset is recorded at the fair value of the shares given.
This material builds directly on Parts 1 and 2. The share-count relationships (authorised, issued, outstanding, treasury) matter for earnings per share (EPS) calculations in later chapters.
Treasury stock and share retirement connect to the statement of changes in shareholders' equity, which tracks every movement in the equity section across the period. The dividend entries here also lay the groundwork for stock dividends and stock splits, which are covered later in the course.
stock issuance, share issuance, par value, no-par stock, APIC, additional paid-in capital, paid-in capital in excess of par, noncash consideration, fair value, lump-sum issuance, relative market value allocation, share buyback, share repurchase, treasury stock, treasury stock method, share retirement, authorised shares, issued shares, outstanding shares, unissued shares, contra equity, cash dividend, liquidating dividend, declaration date, date of record, record date, ex-dividend date, payment date, dividends payable, retained earnings, journal entries equity, ACCTG 471 Chapter 18