Financial Accounting (Chapter 11)
Define: Paid-in capital
the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock [when a corporation has only 1 class of stock it is common stock]
After receipt of its charter, the corporation establishes By-Laws. What are by-laws?
they establish the internal rules and procedures for conducting the affairs of the corporation.
what is the purpose of a stock split?
to increase the marketability of the stock by lowering its market price per share.
Common Stock & Retained earnings have a normal _________ balance
Credit
Treasury stock has a normal _________ balance
Debit
what are the 2 classifications recognized within paid-in capital?
1) Capital Stock (preferred & common stock) 2) Additional paid-in capital (excess of amounts paid over par/stated value and paid-in capital from treasury stock)
Dividends can take 4 forms. What are they?
1) Cash 2) Property 3) Scrip (promissory note to pay cash) 4) Stock
what are some of the disadvantages experienced by a corporation?
1) Corporation management (separation of ownership and management) 2) Government regulations 3) Additional taxes (corporations are taxed as a separate legal entity)
what are the 2 ways that corporations can issue stock?
1) Directly to investors 2) Indirectly through an investment banking firm (specializes in bringing securities to the attention of prospective investors)
What are 3 reasons for possible retained earnings restrictions? [make part of the balance unavailable for dividends]
1) Legal Restrictions 2) Contractual restrictions (ex: long-term debt contracts may restrict retained earnings) 3) Voluntary restrictions [these restrictions are generally disclosed in the notes to financial statements]
What 4 things decrease Retained earnings?
1) Net Loss 2) prior period adjustments for overstatement of net income 3) Cash & Stock dividends 4) disposals of treasury stock
what 2 things increase retained earnings?
1) Net income 2) prior period adjustments for understatement of net income
The stockholders' equity section of a corporation's balance sheet consists of two parts: 1) ? & 2) ?
1) Paid-in (contributed) capital 2) Retained Earnings (earned capital)
For a company to distribute a cash dividend, it must have what 3 things?
1) Retained earnings 2) Adequate Cash 3) A declaration of dividends (a decision from the board of directors to distribute dividends)
what are some of the advantages experienced by a corporation?
1) Separate legal existence 2) Limited liability of stockholders 3) Transferable ownership rights 4) Ability to acquire capital 5) Continuous life 6) Corporation management (professional managers)
What are some of the rights shared by stockholders?
1) Vote in the election of the board & vote on actions that require stockholder approval 2) Share earnings through receipt of dividends 3) Keep same % ownership when new stock is issued (preemptive right) 4) Residual claim (share in assets upon liquidation in proportion to their holdings)
What is considered when corporations set the price for a new issue of stock?
1) company's anticipated future earnings 2) its expected dividend rate per share 3) its current financial position 4) current state of the economy 5) the current state of the securities market
why do we never record a gain on sale of treasury stock?
1) gains are when assets are sold, treasury is not an asset. it is a contra equity account. 2) corprations do not realize a gain/loss from stock transactions with its own stockholders
on what 2 dates in connection with dividends do companies make accounting entries?
1) the Declaration date 2) the Payment date
what are the 3 dates in connection with dividends?
1) the Declaration date 2) the record date 3) the payment date [companies make accounting entries on the declaration date and the payment date*****]
What are some reasons that corporations would want to acquire treasury stock?
1) to reissue shares to employees for bonuses/stock compensation plans 2) to signal to stock market that the stock is underpriced in hopes of enhancing market price 3) to have additional shares available for use in the acquisition of other companies 4) reduce # of shares outstanding and thereby increase earnings per share
A stock dividend results in a decrease in _______ and an increase in __________
A stock dividend results in a decrease in retained earnings and an increase in paid-in capital [unlike a cash dividend, stock dividends do not decrease total stockholders' equity or total assets]
****NOTE****
A stock split does not have any effect on total paid-in capital, retained earnings, or total stockholders equity --> so it is not necessary to journalize a stock split !! [# of shares outstanding increases & par value per share decreases]
When a company disposes of treasury stock shares, it credits the treasury stock account for what amount?
ALWAYS the same amount it paid to reacquire the shares in the first place [does not resell them at the market price]
****NOTE****
Companies cannot pay dividends to common stockholders until it pays the entire preferred dividend. [companies cannot pay dividends to common stockholders while any preferred dividends are in arrears]
****NOTE****
Companies do not debit net losses to paid-in capital accounts. To do so would destroy the distinction between paid-in and earned capital [they debit it to retained earnings]
Treasury Stock is a __________ account
Contra stockholder's equity account [it reduces stockholder's equity] [reduces stockholder claims on corporate assets]
When issuing common stock to pay for services, what cost should be recognized in the exchange transaction?
Cost = cash equivalent price [it is either the fair value of the consideration given up, or the fair value of the consideration received]
When preferred stock is cumulative, preferred dividends not declared in a given period are called ____________
dividends in arrears
On July 1, Mead sells for $10 per share 1,000 shares of its treasury stock, previously acquired at $8 per share. Journalize the transaction.
Dr. Cash (10,000) Cr. Treasury Stock (8000) Cr. Paid-in capital treasury stock (2000) [we always sell back treasury stock at the price we paid for it]
July 1, Mead, Inc. sells for $10 per share the 1,000 shares of its own treasury stock, previously acquired at $8 per share. What is the entry made?
Dr. Cash 10,000 Cr. Treasury Stock 8,000 Cr. paid-in capital from treasury stock 2,000
Hydro-Slide issues 1,000 shares of $1 par value common stock at $5 per share. What is the journal entry?
Dr. Cash 5,000 Cr. Common Stock 1,000 Cr. Paid-in Capital in excess of par 4,000
Media General declares a 50 cent per share cash dividend on 100,000 shares of $10 par value common stock. What is the entry to record this declaration?
Dr. Cash Dividends 50,000 Cr. Dividends Payable 50,000
When a company issues stock dividend shares, what is the accounting entry made?
Dr. Common Stock Dividends Distributable Cr. Common Stock
What is the accounting entry made on the Payment Date of dividends?
Dr. Dividends Payable Cr. Cash [payment of dividends reduces both current assets and current liabilities]
Doral Corporation has $750,000 of common stock and a net income of $122,000 at the end of its first year. What is the closing entry for net income? What is the total stockholder's equity?
Dr. Income Summary 122,000 Cr. Retained Earnings 122,000 [stockholder's equity = $872,000]
General Microwave discovers in 2014 that it understated depreciation expense on equipment in 2013 by $300,000. What is the entry for prior period adjustment?
Dr. Retained earnings 300,000 Cr. Accumulated depreciation 300,000
Company A declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. the fair market value is $15 per share. What is the entry to record the declaration of the stock dividend?
Dr. Stock Dividends 75,000 Cr. Common stock dividends distributable 50,000 Cr. Paid-in capital in excess of par - C.S. 25,000 [this records the declaration of 10% stock dividend]
what do we record when a company purchases treasury stock?
Dr. Treasury Stock Cr. Cash
If a company issues a small stock dividend (less than 20-25% of issued stock), the value assigned to the dividend is the _______ value per share
Faire value per share [b/c small stock dividend will have little effect on the market price of the shares previously outstanding]
True or False: The journal entry to record the authorization of capital stock includes a credit to the appropriate capital stock account
False [the authorization of capital stock does not result in a formal accounting entry]
On the balance sheet, we subtract __________ from stockholder's equity to get Total Stockholder's equity
Less: Treasury Stock
how do we compute net income available to common stockholders?
Net income - preferred stock dividends
Are dividends in arrears considered a liability?
No No payment obligation exists until the board of directors declares a dividend
If a company issues a large stock dividend (greater than 20-25%), the value assigned to the dividend is the _________ value
Par (or stated) value [note: small stock dividends are more popular]
Payment of dividends reduces both ________ and ________. The cumulative effect of the declaration and payment of a cash dividend decreases both _______ and ________
Payment of dividends reduces both current assets and current liabilities the cumulative effect of the declaration and payment of cash dividends decreases both Stockholder's equity and total assets
When a company fully depletes the credit balance in Paid-in Capital from Treasury stock, it debits ____________ any additional excess of cost over selling price
Retained Earnings [example on top of pg. 554]
Companies report prior period adjustments in the ____________
Retained Earnings Statement (b/c this is where the error is after end of year adjustments)
Sale of treasury stock increases both ________ and _________
Sale of treasury stock ALWAYS increases total assets and stockholder's equity
what affect does a) a Stock Split and b) a Stock Dividend have on Par value per share?
Stock Split --> decreases par value per share Stock Dividend --> no change in par value per share
what affect does a) a Stock Split and b) a Stock Dividend have on Total par value?
Stock Split --> no change in par value Stock Dividend --> increases par value
what affect does a) a Stock Split and b) a Stock Dividend have on Total stockholder's equity?
Stock Split --> no change in stockholder's equity Stock Dividend --> no change in stockholder's equity
What affect does a) a Stock Split and b) a Stock Dividend have on Total paid-in capital
Stock Split --> no change in total paid-in capital Stock dividend --> increases paid-in capital
what affect does a) a Stock Split and b) a Stock Dividend have on retained earnings?
Stock Split -->no change in total retained earnings Stock Dividend --> decreases retained earnings
what happens at the record date for dividends?
The company determines ownership of the outstanding shares for dividend purposes. Before this period it has to update its stock ownership records. [********no entry is required for this date********]
what does it mean when an investment banking firm "underwrites" the entire stock issue?
They buy all of the stock from the corporation at a discount, and then are in charge of reselling the stock to prospective investors
How do stock dividends affect stockholder's equity?
They change the composition of stockholder's equity [they transfer to paid-in capital a portion of retained earnings. but total stockholder's equity remains the same]
how do you calculate "return on common stockholder's equity?" what does it show?
This ratio shows how many dollars of net income the company earned for each dollar invested by the common stockholders Net income available to common stockholders / average common stockholder's equity
True or False: Cash dividends distributed from only the balance in common stock are illegal
True [they must come from retained earnings]
****NOTE****
When issuing stock to pay for services, land, etc., **the par value of the stock is never a factor in determining the cost of the assets received**
What type of account is Common Stock Dividends Distributable?
a Stockholder's Equity Account (debit balance) [it is not a liability account because assets will not be used to pay the dividend]
Define: Treasury Stock
a corporation's own stock that it has issued and subsequently reacquired from shareholders (but not retired).
A corporation is formed by grant of a state ________
charter [it is a document that describes the name and purpose of the corporation, the types and numbers of shares of stock that are authorized to be issued, the names of the individuals that formed the company, and the number of shares they agreed to purchase]
****NOTE****
in the stockholder's equity section of the balance sheet, companies list preferred stock first because of its dividend and liquidation preferences over common stock
what is a Stock Split?
like a stock dividend, it involves issuance of additional shares to stockholders according to their percentage ownership. [However, a stock split results in a reduction in the par or stated value per share] [the number of shares increases in the same proportion that par or stated value per share decreases]
****NOTE****
make sure to use "Paid-in capital in excess of stated value--common stock" when we are dealing with no-par common stock and a stated value instead
What is preferred stock?
preferred stock has contractual provisions that give it priority over common stock when it comes to... 1) distributions of earnings (dividends) 2) assets in the event of liquidation 3) Non-voting [common stock owners receive dividends/assets only after all of the preferred stock holders have been accounted for]
Explain the "cumulative dividend" feature associated with preferred stock?
preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders receive any dividends [preferred dividends not declared in a given period are called dividends in arrears]
Define: Outstanding Stock
the # of shares of issued stock that are being held by stockholders
****NOTE****
the authorization of capital stock does not result in a formal accounting entry [it has no effect on assets or stockholder's equity]