Page 496 - Accounting Principles (A Business Perspective)

12. Stockholders' equity: Classes of capital stock

An accounting perspective:

Business insight

In the early 1970s, only about 10 per cent of undergraduate degrees in accounting were awarded to
women. This percentage increased steadily, and by the mid-1980s approximately half of all
undergraduate accounting degrees were earned by women. By 1996, the rate increased to slightly
more than half. This rate is more than twice the rate in the medical and legal professions. For more
information see "Accounting's Big Gender Switch," Business Week, January 20, 1997, p. 20.

Most preferred stocks are callable at the option of the issuing corporation. Callable preferred stock means
that the corporation can inform nonconvertible preferred stockholders that they must surrender their stock to the
company. Also, convertible preferred stockholders must either surrender their stock or convert it to common

shares.
Preferred shares are usually callable at par value plus a small premium of 3 or 4 per cent of the par value of the
stock. This call premium is the difference between the amount at which a corporation calls its preferred stock for
redemption and the par value of the stock.
An issuing corporation may force conversion of convertible preferred stock by calling in the preferred stock for
redemption. Stockholders who do not want to surrender their stock have to convert it to common shares. When
preferred stockholders surrender their stock, the corporation pays these stockholders par value plus the call

premium, any dividends in arrears from past years, and a prorated portion of the current period's dividend. If the
market value of common shares into which the preferred stock could be converted is higher than the amount the
stockholders would receive in redemption, they should convert their preferred shares to common shares. For
instance, assume that a stockholder owns 1,000 shares of convertible preferred stock. Each share is callable at USD
104 per share, convertible to two common shares (currently selling at USD 62 per share), and entitled to USD 10 of
unpaid dividends. If the issuing corporation calls in its preferred stock, it would give the stockholder either (1) USD
114,000 [(USD 104 + USD 10) X 1,000] if the shares are surrendered or (2) common shares worth USD 124,000
(USD 62 X 2,000) if the shares are converted. Obviously, the stockholder should convert these preferred shares to
common shares.

Why would a corporation call in its preferred stock? Corporations call in preferred stock for many reasons: (1)
the outstanding preferred stock may require a 12 per cent annual dividend at a time when the company can secure
capital to retire the stock by issuing a new 8 per cent preferred stock; (2) the issuing company may have been
sufficiently profitable to retire the preferred stock out of earnings; or (3) the company may wish to force conversion
of its convertible preferred stock because the cash dividend on the equivalent common shares is less than the
dividend on the preferred shares.

Balance sheet presentation of stock
The stockholders' equity section of a corporation's balance sheet contains two main elements: paid-in capital
and retained earnings. Paid-in capital is the part of stockholders' equity that normally results from cash or other
assets invested by owners. Paid-in capital also results from services performed for the corporation in exchange for

497