Mastering Accounting for Equity Under U.S. GAAP for the FAR CPA Exam

Introduction

Equity is the ownership interest in a company, and its accounting is fundamental in assessing a firm’s financial health. Equity transactions include the issuance of stock, dividend payouts, and stock splits. This article provides an in-depth analysis of these transactions under U.S. Generally Accepted Accounting Principles (U.S. GAAP).

Accounting for Stock Issuance

When a company issues stock, it increases its equity.

Example 1: Common Stock Issuance

Suppose Company A issues 1,000 shares at a price of $10 per share. The journal entry would be:

• Debit Cash $10,000

• Credit Common Stock $10,000

Accounting for Cash Dividends

Cash dividends are direct payouts to shareholders.

Example 2: Cash Dividends

Company A declares a $1 dividend per share on its 1,000 outstanding shares. The journal entries would be:

1. To record the declaration of the dividend:

• Debit Retained Earnings $1,000

• Credit Dividends Payable $1,000

2. To record the payment of the dividend:

• Debit Dividends Payable $1,000

• Credit Cash $1,000

Accounting for Property Dividends

Property dividends involve the distribution of non-cash assets to shareholders.

Example 3: Property Dividends

If Company A declares a property dividend of land valued at $2,000:

1. To adjust the land to fair value:

• Debit Land $200 (Assume carrying value was $1,800)

• Credit Gain on Revaluation $200

2. To record the declaration of the dividend:

• Debit Retained Earnings $2,000

• Credit Dividends Payable $2,000

3. To record the distribution of the land:

• Debit Dividends Payable $2,000

• Credit Land $2,000

Accounting for Stock Splits

Stock splits increase the number of shares and reduce the price without affecting the total market capitalization.

Example 4: 2-for-1 Stock Split

For Company A with 1,000 shares at $10 per share:

1. Before the split: 1,000 shares × $10/share = $10,000

2. After the split: 2,000 shares × $5/share = $10,000

No journal entry is required for a stock split under U.S. GAAP.

Disclosures

Disclosures surrounding equity transactions are essential. This information is often included in the notes to the financial statements and may consist of the types of stock, outstanding shares, dividends declared, and other related activities.