ACC 201 Ch 11. Reporting and Analyzing Stockholders' Equity

Return on Common Stockholders' Equity (ROE) =

(net income - preferred dividends) / average common stockholders' equity

List three reasons why buying stock in a corporation is often attractive to an investor

-limited liability -shares are readily transferable -can invest in relatively small amounts

Suppose a company splits its shares of common stock that currently have a par value of $10 on a 2 for 1 basis. This means that _______ share(s) of $______ par value stock is exchanged for ________share(s) of $__________ par value stock.

1, 10 2, 5

List the two classifications of Paid-in capital as well as the items listed in each.

1. Capital stock -preferred stock -common stock 2. Additional paid-in capital -Paid-in capital in excess of par value- preferred stock -Paid-in capital in excess of par value- common stock

Describe the cumulative effect of the declaration and payment of a cash dividend on assets, liabilities, and stockholders equity on financial statements.

1. Decrease in stockholders' equity (due to the increase in Cash Dividends at the declaration date) 2. Decrease in total assets (due to decrease in Cash at payment date) no cumulative effect on total liabilities, since Dividends Payable increases at declaration date, then decreases by that same amount at payment date

List three possible causes for retained earnings restrictions.

1. Legal: States may require the corporations restrict RE for the cost of treasury stock purchased. 2. Contractual long term debt contracts may restrict RE as a condition for loan. 3. Voluntary the board of directors may voluntarily restrict RE for specific purposes such as future plant expansion.

List the four main items listed in the stockholders' equity section of the balance sheet.

1. Paid-in capital 2. Retained earnings 3. Accumulated other comprehensive income 4. treasury stock

In terms of obtaining long-term capital, the issuance of bonds has three primary advantages relative to the sale of common stock:

1. Stockholder control is not affected (current stockholders retain full control of the company) 2. Tax savings results 3. ROE may be higher

Three dates are important in connection with dividends:

1. The declaration date 2. The record date 3. The payment date

List four reasons why a corporation may acquire treasury stock

1. To reissue the shares to officers and employees under bonus and stock compensation plans. 2. To increase trading of the company's stock in the securities market. Companies expect that buying their own stock will signal that management believes the stock is underpriced, which they hope will enhance the market price. 3.To have additional shares available for use in acquiring other companies. 4.To reduce the number of shares outstanding and thereby increase earnings per share.

List three reasons why a company might issue stock dividends.

1. To satisfy stockholders' dividend expectations without spending cash. 2. To increase the marketability of its stock 3. To emphasize that a portion of stockholders' equity has been permanently reinvested in the business and is, therefore, unavailable for cash dividends.

List two ways to classify corporations

1. by purpose: for-profit not-for-profit 2: by ownership publicly held corporation privately held corporation

Dividends can take four forms:

1. cash 2. property 3. scrip (promissory note to pay cash) 4. stock

list three examples of comprehensive income items

1. certain adjustments to pension plan assets 2. types of foreign currency gains and losses 3. some gains and losses on investments

List 3 disadvantages of existing as a corporation rather than existing as a partnership/proprietorship.

1. corporation management- separation of ownership and management 2. government regulations 3. additional taxes

preferred stockholders have priority over common stockholders in relation to

1. dividends 2. assets in the event of liquidation

Once an organization has been incorporated (through the state charter), it must

1. establish by-laws 2. obtain a license from each state in which they do business

list two responsibilities of the board of directors

1. formulates operating policies 2. selects officers to execute policy and to perform daily management functions.

List the two ways in which a company can increase its ROE

1. increase ROA 2. increase reliance on debt financing (issue more bonds)

Suppose a company declares a 10% stock dividend on its $10 par common stock when 50,000 shares are outstanding. The market price at the declaration date is $15 per share. Describe the effects that this has on the stockholders' equity section of the balance sheet.

1. increase total paid in capital by $75,000 (50,000 shares x 10% x $15); Common Stock increase by $50,000 and Paid-in Capital in Excess of Par increases by $25,000 2. decreases Retained Earnings by $75,000

For corporations, state regulations prescribe requirements for:

1. issuing stock, 2. distributions of earnings permitted to stockholders, and 3. the acceptable methods of buying back and retiring stock.

List two responsibilities of the treasurer

1. maintain custody if the corporation's funds 2. maintain the corporations cash position

List three responsibilities of the controller

1. maintaining the accounting records 2. ensuring an adequate system of internal control 3. preparing financial statements, tax returns, and internal reports

Transfer of ownership rights among stockholders has no effect on

1. operating activities of the corporation 2. corporation's assets, liabilities, and total stockholders' equity.

When capital stock is listed on the balance sheet, information is reported about which four things?

1. par value 2. shares authorized 3. shares issued 3. shares outstanding

For a corporation to pay a cash dividend, it must have the following:

1. retained earnings 2. adequate cash 3. declared dividends

For corporations, federal securities laws govern

1. sale of capital stock to general public 2. disclosure of financial affairs to SEC through quarterly and annual reports, and 3. the reporting requirements of the various securities markets.

list the two ways to obtain long-term capital

1. sell common stock (equity financing) 2. issue bonds (debt financing)

List 6 advantages of existing as a corporation over existing as a partnership/proprietorship.

1. separate legal existence 2. limited liability of shareholders 3. transferable ownership rights 4. ability to acquire capital 5. continuous life 6. corporation management- professional managers

List 8 important characteristics that distinguish a corporation from proprietorships and partnerships

1. separate legal existence 2. limited liability of stockholders 3. transferable ownership rights 4. ability to acquire capital 5. continuous life 6. corporation management 7. government regulations 8. additional taxes

Describe the delegation of responsibiity in the management of a corporation.

1. stockholders elect chairman and board of directors 2. chairman and board of directors select president and CEO 3. President and CEO delegate responsibility to other officers, including VP of finance/CFO 4. VP of finance/CFO delegates responsibility to the treasurer and to the controller

List three names for owners equity

1. stockholders' equity 2. shareholders' equity 3. corporate capital

List the two primary objectives in accounting for the issuance of common stock

1. to identify the specific sources of paid-in-capital 2. to maintain the distinction between paid-in-capital and retained earnings.

The stockholders' equity section of a corporation's balance sheet includes: (list the two parts)

1.paid-in (contributed) capital 2. retained earnings (earned capital).

Pro rata means that if you own 10% of the common shares, you will receive

10% of the dividend

In order for an organization to exist as an S corporation, there must be no more than _________________ shareholders.

100

What is the main difference between the issuance of stock dividends and stock splits?

A stock split results in a reduction in the par or stated value per share, a stock dividend does not.

comprehensive income items are closed each year to the _________________________________ account.

Accumulated Other Comprehensive Income

describe how a deficit appears on the balance sheet.

Accumulated deficit is deducted from Total paid-in capital to get Total paid-in capital and retained earnings

If a balance sheet is prepared before the issuance of stock dividends that have been declared, describe how the declared dividends appear on the sheet.

Common Stock Dividends DIstributable are listed under Paid-in capital, added to Common Stock to get Total paid-in capital

Describe the difference between a corporation and a partnership in terms of legal existence

Corporation: -Acts under its own name rather than name of stockholders. -Acts of owners (stockholders) are not binding unless owners are agents of the corporation. Partnership: -Acts of owners (partners) are binding

Describe what it means to say that owners of a corporation (stockholders) have limited liability.

Creditors of the corporation have no legal claim on personal assets of owners unless fraud has occurred

A debit balance in retained earnings is identified as a ________________.

Deficit

T or F: No-par stock is capital stock that has a market value of zero.

F

T or F: Par value stock has been assigned a value per share that is equal to its market value.

F

T or F: The amount of stock that a corporation is authorized to sell is established through various organized U.S securities exchanges.

F

T or F: cash dividends are payed on all issued shares, including treasury shares.

F; Cash dividends are not paid on treasury shares.

T or F: The payment of the cash dividend reduces stockholders' equity.

F; Payment of the dividend REDUCES both current assets and current liabilities but has no effect on stockholders' equity.

T or F: Proof of stock ownership is evidence by the charter.

F; Proof of stock ownership is evidence by a stock certificate

T or F: Unlike par value, the stated value corresponds to the market value of the stock.

F; Stated value, like par value, does not indicate or correspond to the market value of the stock. The stated value of no-par stock may be changed at any time by action of the directors.

T or F: Stock dividends are not journalized, but stock splits are.

F; Stock splits are not journalized, but stock dividends are.

T or F: a $100,000 balance in Retained Earnings means that there is $100,000 in cash

F; The balance in Retained Earnings does not represent any specific asset

T or F: Because preferred stockholders have the first claim to dividends, they are garunteed dividends.

F; The first claim to dividends does not guarantee dividends.

T or F: The issuance of common stock affects both Paid-in capital and Retained Earnings accounts.

F; The issuance of common stock affects ONLY PAID IN CAPITAL ACCOUNTS

T or F: Today, most states require a par value.

F; Today, many states do not require a par value. Instead, they use other means to protect creditors.

T or F: Dividends in arrears are listed on the balance sheet as a liability.

F; dividends in arrears are not a liability because no obligation exists until the board of directors declares a dividend. The amount of dividends in arrears should be disclosed in the notes to the financial statements.

Some states have laws favorable to the corporate form of business organization, and thus many organizations choose to incorporate in these states. Provide one example

In the state of Delaware, defense tactics against takeovers can be approved by the board of directors without a vote by shareholders

describe the entry made when a company declares a cash dividend.

Increase (debit) Cash Dividends Increase (credit) Dividends Payable

Paid-in Capital in Excess of Par Value _____________ (increases/decreases) stockholders equity.

Increases

Explain why a company does not incur any liabilities in the issuance of stock dividends.

Issuance of additional shares of stock does not change the total amount of the dividend that the company owes to shareholders, it just changes the amount by which the dividend is divided

describe the entry made at the record date of a cash dividend.

No entry is required on the record date.

____________________ stock is capital stock that has not been assigned a value per share in the corporate charter.

No-par value

__________________stock is capital stock that has been assigned a value per share in the corporate charter. The value may be any amount selected by the corporation.

Par value

In general, as long as the _____________________ exceeds the _____________________________, a company will increase ROE by the use of debt.

ROA Rate, interest rate paid on bonds

___________is net income that is retained in the business.

Retained Earnings

List one tool used to evaluate a companys earnings performance

Return on Common Stockholders' Equity (ROE)

List four types of hybrid organizations

S corporations limited partnerships limited liability partnerships limited liability corporations

T or F: Although a corporation may have operating divisions in a number of states, it will be incorporated in only one state.

T

T or F: Corporation does not participate in transfer of ownership rights after original sale of capital stock.

T

T or F: If all authorized stock is sold, a corporation must obtain consent of the state to amend its charter before issuing additional shares.

T

T or F: The issuance of the common stock affects only paid-in capital accounts.

T

T or F: declaration of stock dividends does not result in distribution of assets.

T

T or F: the original Paid-in capital account is not affected when a company acquires treasury stock.

T (because the number of total issued shares does not change)

Describe how the issuance of no-par common stock with a stated value is accounted for.

The Stated value is treated same as par value Paid-in Capital in Excess of Stated Value account is used if necessary

Explain what it means for an investment banking firm to underwrite an entire stock issue.

The bank buys the stock from the issuer at a certain percentage less than full price, the resells it to investors at full price.

Describe taxation of partnerships/proprietorships

The owners each report their share of earnings on their personal income tax returns, then each individual owner pays taxes on the amount that they reported

Describe how Treasury Stock appears on the balance sheet.

Treasury Stock is deducted from Total paid-in capital and retained earnings to get Total stockholders equity

A stock dividend results in _____________________(an increase in/a decrease in/no change to) retained earnings, _____________________(an increase in/a decrease in/no change to) Paid-in capital, and ____________________ (an increase in/a decrease in/no change to) total stockholders equity.

a decrease in, an increase in, no change to

Corporations typically record small stock dividends at fair/market value per share because of the assumption that

a small stock dividend will have little effect on the market price of shares previously outstanding (since in the issuance of a small stock dividend, the total number of issued shares increases by a small amount, and the market price per share decreases by a small amount).

Explain how Paid-in capital in excess of par value appears on the balance sheet.

added to Common Stock to get Total paid-in capital

a charter is also known as

articles of incorporation

Why is Common Stock Dividends Distributable a stockholders' equity account rather than a liability account?

because the dividends will not be paid with assets

Why might an organization choose to exist as an S corporation?

because while S corporations still receive legal treatment as corporations, they receive tax treatment as partnerships (no double taxation)

The _____________________ has full authority to determine the amount of income to be distributed in the form of dividends and the amount to be retained in the business.

board of directors

Stockholders manage corporation indirectly through a

board of directors, which they elect

How is a corporation formed?

by grant of a state charter

How does issuance of stock dividends increase the marketability of the companys stock?

by increasing the number of shares outstanding and thereby decreasing the market price per share to make it easier for smaller investors to purchase the shares.

The issuance of stock dividends is also referred to as

capitalizing retained earnings

Paid-in capital is the total amount of

cash and other assets paid in to the corporation by stockholders in exchange for capital stock.

payout ratio =

cash dividends declared on common stock/net income

Life of corporation is stated in the _________________ and may be _____________ or __________________________________________-.

charter, perpetual, limited to specific number of years

a privately held corporation is often referred to as a(n)

closely held corporation

The declaration of a cash dividend

commits the corporation to a binding legal obligation that cannot be rescinded.

When a corporation has only one class of stock, it is identified as

common stock

Declaration of stock dividends changes the ______________ not the __________________ of total stockholders equity.

composition, amount

Treasury Stock is a(n) _____________________________ account, and thus has a normal _______________ (debit/credit) balance.

contra stockholders' equity, debit

Paid-in capital is sometimes called

contributed capital.

In a corporation, the chief accounting officer is referred to as the

controller

The amount of stock a corporation is authorized to sell is indicated in the

corporate charter

an entity created by law that is separate and distinct from its owners.

corporation

Describe the concept of double taxation

corporations are taxed 1. once at the corporate level (the corporation must pay federal and state income taxes as a separate legal entity), and 2. once at the individual level (stockholders must pay taxes on cash dividends)

The purchase of treasury stock is generally accounted for by the __________method.

cost

Common Stock has a normal _________ balance.

credit

Paid-in Capital in Excess of Par Value has a normal ________________ balance.

credit

Describe how the issuance of no-par common stock without a stated value is accounted for.

credit common stock by the full amount of cash received

Preferred stock contracts often contain a _________________________-feature.

cumulative dividend feature

If preferred stock is cumulative, preferred stockholders must be paid both_______________________ and any_______________________ before common stockholders receive dividends.

current-year dividends, dividends in arrears

Cash Dividends has a normal ____________ balance.

debit

If cumulative net losses exceed cumulative income over a company's life, there is a __________ (debit/credit) balance in Retained Earnings results.

debit

Net income is recorded in Retained Earnings by a closing entry. Describe this entry

debit (decrease) Income Summary credit (increase) Retained Earnings

Describe the journal entry made when the issuance of preferred stock for cash is recorded, and the par value of the shares is NOT the same as the cash price

debit Cash credit Preferred Stock credit Paid-in Capital in Excess of Par Value- Preferred Stock

describe the entry made when a company acquires shares of its own stock (purchases treasury stock)

debit Treasury Stock credit Cash

describe the journal entry made when a company issues par value common stock at par for cash.

debit cash by par value credit (increase) Common Stock by par value

Describe the journal entry made when the issuance of common stock for cash is recorded, and the par value of the shares is NOT the same as the cash price

debit cash for total amount of cash received credit common stock by total par value of the shares credit Paid-in Capital in Excess of Par Value by difference

Dividends are not a liability until they are

declared

describe the entry made to record the issuance of stock dividends

decrease (debit) Common Stock Dividends Distributable increase (credit) Common Stock

describe the entry made at the payment date of a cash dividend.

decrease (debit) Dividends Payable decrease (credit) Cash

An increase in Cash Dividends ________________ (increases/decreases) stockholders' equity.

decreases

Though the acquisition of treasury stock does not affect the original paid-in capital account, it ________________ (increases/decreases) total stockholders' equity.

decreases

Stock Dividends _______________ (increases/decreases) stockholders' equity and thus has a normal _______________ (debit/credit) balance.

decreases, debit

A net loss _______________ (increases/decreases) retained earnings, and thus in closing entries, a company ___________ (debits/credits) a net loss to the Retained Earnings account

decreases, debits

A corporation can issue common stock ____________________which is typically the case for closely held companies, or it can issue common stock ___________________________________which is customary for a publicly held corporation.

directly to investors, indirectly through an investment banking firm

a distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis.

dividend

Investors are interested in both a company's _______________________ and its _____________________.

dividend record earnings performance

When preferred stock is cumulative, preferred dividends not declared in a given period are called

dividends in arrears

The Return on Common Stockholders' Equity (ROE) ratios shows how many _______________________________were earned for each ________________________________.

dollars of net income, dollar invested by common stockholders

When recording the declaration of stock dividends, the amount debited to Stock Dividends uses the total ___________________ (fair/par) value of the shares issued.

fair

What does the bank gain from allowing investment banking firms to underwrite an entire stock issue?

gives away the risk

A large stock dividend is _________________________ of the corporations stock and is recorded at _____________________ per share.

greater than 20% - 25% par or stated value

describe the entry made at the declaration date of stock dividends (assuming the current fair value is greater than the par value)

increase (debit) Stock Dividends increase (Credit) Common Stock Dividends Distributable increase (credit) Paid-in Capital in Excess of Par Value

Describe how to account for the purchase of treasury stock under the cost method

increase (debit) treasury stock by the price paid to reacquire the shares decrease (credit) treasury stock by that same amount when later selling the shares

The purpose of a stock split is to

increase the marketability of the stock by lowering its market prices per share.

How does the issuance of stock dividends affect the number of outstanding shares and the par value per share?

increases number of outstanding shares NO CHANGE IN PAR VALUE, this is only changed if the company manually changes it

The effect of a stock split on market price is generally _____________ (directly/inversely) proportional to the size of the split.

inversely

List the main disadvantage of the issuance of bonds to obtain long-term capital

it reduces solvency (because the company must pay interest regardless of whether they are in a period of low earnings or high earnings)

Years ago, par value determined

legal capital per share that a company must retain in the business for the protection of corporate creditors. That amount was not available for withdrawal by stockholders.

A small stock dividend is _________________________ of the corporations stock and is recorded at _____________________ per share.

less than 20% - 25%, fair value (market price)

describe how Preferred Stock appears on the balance sheet

listed before Common Stock because it is more liquid

Companies that have high growth rates are characterized by ________________(high/low) payout ratios because they reinvest most of their net income in the business.

low

Why might a low payout ratio be concerning?

low dividend payments might signal that a company has liquidity or solvency problems

Explain why increasing reliance on debt financing (issue more bonds) results in a higher ROE than if the company were to issue additional stock.

net income is spread over a smaller amount of common stockholders equity

Retained earnings is

net income that a corporation retains for future use.

A stock split results in _____________________(an increase in/a decrease in/no change to) retained earnings, _____________________(an increase in/a decrease in/no change to) Paid-in capital, and ____________________ (an increase in/a decrease in/no change to) total stockholders equity.

no change to, no change to, no change to

number of shares issued - number of shares in treasury =

number of shares oustanding

Costs incurred in the formation of a corporation are called ______________________ and are _______________________.

organization costs, expensed as incurred

What does the company determine at the record date?

ownership of the outstanding shares for dividend purposes; the dividend to be paid to each stockholder

Many states prohibit payment of dividends from legal capital. However, payment of dividends from _______________________________ is legal in some states.

paid-in capital in excess of par

If the corporation fails, most preferred stocks have a preference to the corporations assets for the _________________ value of the shares or for a ___________________ value.

par, specified liquidating

List one tool used to evaluate a companys dividend record

payout ratio

Stockholders' right to maintain their proportionate interest in a corporation with any additional shares issued.

preemptive right

Return on Common Stockholders' Equity (ROE) measures

profitability from the common stockholders' view point.

A ______________________corporation may have thousands of stockholders and its stock is traded on a national exchange. A __________________ corporation usually has only a few stockholders and does not offer its stock for sale to the general public.

publicly held, privately held

Dividends are typically reported ___________________ as a(n) _________________________.

quarterly, dollar amount per share **i.e. "quarterly dividend rate of 24 cents per shares"

If the life of a corporation is stated in the charter as limited, the corporations period of existence can be extended through ________________________________.

renewal of charter.

Because the acquisition of treasury stock reduces stockholders equity, what do many states do to protect creditors (stockholders)?

require that a portion of Retained Earnings equal to the cost of the treasury stock purchased by restricted from being paid out as dividends

stockholders are the last in line of all those who have a claim on the assets and income of the corporation

residual claim

Loan agreements frequently constrain companies to pay dividends only from

retained earnings

Payment of dividends from ____________________ is legal in all states.

retained earnings

Corporations can legally declare dividends out of ___________________in all states, but in many states corporations can not legally declare dividends out of ________________.

retained earnings, paid-in capital

Since a corporation is a ________________________, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer.

separate legal entity

In many states the board of directors assigns a _________________________ to no-par shares.

stated value

A _________________, like a stock dividend, involves the issuance of additional shares of stock to stockholders according to their percentage ownership.

stock split

Common Stock Dividend Distributable is a(n) ____________________ account, and thus has a normal __________________ (debit/credit) balance.

stockholders' equity, credit

Liability of stockholders limited to

the amount they invested in the corporation

The authorization of common stock does not result in a formal accounting entry because

the event has no immediate effect on either corporate assets or stockholders' equity.

outstanding stock refers to

the number of shares of issued stock that are currently being held by stockholders

The payout ratio measures the

the percentage of earnings distributed in the form of cash dividends to common stockholders

List four rights of stockholders

the right to: 1. Vote in election of board of directors at annual meeting and vote on actions that require stockholder approval 2. share the corporate earnings through receipt of dividends 3. keep the same percentage ownership when new shares are issued (preemptive right) 4. share in assets upon liquidation in proportion to their holdings (residual claim)

Although the authorization of common stock does not result in a formal accounting entry, the number of authorized shares is often reported in

the stockholders equity section of the balance sheet (as a description of the Paid-In capital account)

comprehensive income consists of

the unrealized gains and losses are not included in net income

What is one reason why a company would purchase many treasury shares, thereby depleting its Cash?

to avoid being targeted for acquisition

In some cases there may be retained earnings restrictions. These make a portion of the balance currently

unavailable for dividends.

preferred stockholders sometimes do not have

voting rights