Financial Accounting final exam
A company would repurchase its own stock for all of the following reasons EXCEPT:
it believes the stock is overvalued
Authorized stock represents the:
maximum number of shares that can be issued
Finance Lease:
requires recording an obligation along with the right-of-use asset. Essentially it is a non-cancelable agreement that is in form and substance a purchase of the leased asset. Over time, the lessee recognizes the right-of-use asset and separately recognizes interest on the lease liability.
Operating Lease:
requires recording an obligation along with the right-of-use asset. The the lessor (legal owner of asset) retains substantially all of the risks and obligations of ownership while the lessee uses the asset during the term of the lease. Lease expense is recognized on a straight-line basis over the lease term.
Which of the following should be considered when a company decides to declare a cash dividend on common stock?
the cash available and the retained earnings balance
When a company purchases treasury stock, which of the following statements is true?
the cost of treasury stock reduces stockholders' equity
Authorized Shares:
the maximum number of shares allowed to be sold -Identified in the corporate charter -No entry; disclosed on the F/S or in the notes
When bonds are issued by a company, the accounting entry typically shows an
increase in assets and an increase in liabilities
In 2019, Drew Company issued $200,000 of bonds for $189,640. If the stated rate of interest was 6% and the yield was 6.73%, how would Drew calculate the interest expense for the first year on the bonds using the effective interest method?
$189,640 x 6.73%
RVR Enterprises shows net income of $100,000 for 2023 and retained earnings of $500,000 on its December 31, 2023 balance sheet. During the year, RVR declared and paid $60,000 in dividends. What was RVR's retained earnings balance at December 31, 2022?
$460,000 Explanation: $460,000 + 100,000 - 60,000 = $500,000
Bonds in the amount of $100,000 with a life of 10 years were issued by the Round Company. If the stated rate is 6% and interest is paid semiannually, what would be the total amount of interest paid over the life of the bonds?
$60,000 Explanation: Semi-Annual Bond Interest Payments = Face x Rate x Time 100,000 x .06 x 6/12 = $3,000 $2,000 x 2 X 10 years = $60,000
Corporations
-Organized under the laws of a particular state -Corporate Charter or Articles of Incorporation -Separate legal entity or "person" -Rights and privileges of a person -Classified by purpose and ownership (publicly or privately held)
STOCK REPURCHASES- Treasury Stock
-Repurchase of company stock previously issued -Why? -Buy out the ownership of one or more stockholders -Reduce size of corporate operations -Reduce # of shares; increase EPS and market value per share -Acquire shares for employees- stock bonus, option or purchase plans -Satisfy terms of a business combination -Reduce vulnerability to a hostile takeover -Cost method is used: Treasury Stock XXX Cash XXX
Options (stock)
-Rights to buy stock at a set price - compensation for employees and executives -These "rights" are called stock options -Exercise or Strike Price : price at which stock can be bought. Compensation expense depends on the strike price and market value on the date of the grant. -Why? For 2 primary reasons: -Allows cash-poor companies to compete for top talent in the employee market -Better aligns the incentives of the employee with owners
Corporations distinguishing characteristics:
-Separate legal "person" -Limited liability of stockholders -Transferable ownership rights -Ability to raise capital -Continuous life -Corporation management -Government regulations -Double taxation (corporate tax and tax on distributions to owners)
Warrants
-Stock Warrant: right to purchase a specified number of shares of common stock at a stated price within a stated time period -2 situations: -Give an "equity kicker" to make the bonds or preferred stock more attractive. Typical duration of 5+ years -Give existing stockholders who have a legal right to purchase a specified share of a new stock issue, in order to maintain their relative level of ownership in the corporation. Typical duration of less than six months.
preffered stock
-Stock certificate -Separate class of stock—different account -Less risky than common stock -Par value x # of shares = preferred stock -Sale above par = additional paid in capital -Preference as to dividends and liquidation over common stockholders -Generally pays regular dividend - typically expressed in terms of % of par -Cumulative dividends feature: dividends in arrears plus current dividends must be paid -Dividends in arrears is NOT a liability since there is no obligation until dividends are declared
Common Stock
-Stock certificate: proof of ownership -Legal Capital Account= (Par Value X number of shares) -Sale above par= additional paid in capital -Ownership rights: -Voting -Pro rata participation in dividends -Pro rata participation in residual assets -Preemption—maintaining ownership percentage -Financial gain from a profitable company -Stock appreciation (capital gain) -Dividends
A company would repurchase its own stock for which reasons?
-it wishes to prevent unwanted takeover attempts -it wishes to increase the earnings per share -it needs the stock for employee bonuses
Kinsella Corporation's balance sheet showed the following amounts: current liabilities, $75,000; total liabilities, $100,000; total assets, $200,000. What is the long-term debt to equity ratio?
0.25 -Explanation: Total long-term debt/Total equity Total long-term debt = 100,000 -75,000; 25,000 Total equity = 200,000 - 100,000; 100,000 25,000/100,000= 0.25
McLaughlin Corporations's balance sheet showed the following amounts: current liabilities, $75,000; total liabilities, $100,000; total assets, $200,000. What is the debt to total assets ratio?
0.50 -Explanation: Debt to Total Assets = Total liabilities /total assets = 100,000/200,00 = .50
Market Value of Bonds
1. A bond's selling price (present value) is dictated by its market value 2. Process of finding Present Value is called "discounting" the future cash flows 3. Time value of money -1,000,000 today vs. $1,000,000 in 20 years 4. Current Market Value (Present Value) -$$ to be received at bond issue -Length of time until it is received -Market rate of interest 5. Selling price is often different than its face value
Debt Load Analysis Ratios Formulas:
1. Debt to Equity = Total Liabilities / Total Equity 2. Debt to Total Assets = Total Liabilities / Total Assets 3. Long-Term Debt to Equity = Long-Term Debt / Total Equity
Discounts and Premiums
1. Face Value * Stated Rate = Interest PAID 2. Market Rate (yield/effective rate) = rate investors demand 3. Stated Rate = Market Rate -Bonds sold at face value 4. Discounts/Premiums happen when the stated and market rates are different 5. Stated Rate > Market Rate -Premium 6. Stated Rate < Market Rate -Discount
For a corporation, most common sources of stockholder's equity are:
1. Paid-in capital -Common stock -Preferred stock -Additional paid-in capital 2. Retained Earnings or deficit 3. Accumulated other comprehensive income 4. Treasury stock
Bond Discounts
1. Receive less than face value at issuance 2. Discount on Bonds Payable: contra liability account 3. Bonds Payable - Discount = Carrying Value 4. Discount is an additional cost of borrowing 5. Bond discount is amortized and causes interest expense to be greater than the interest paid in each period 6. Bond discount amortization increases the carrying value of bonds until maturity (when CV = Face Value)
Bond Premiums
1. Receive more than face value at issuance 2. Premium on Bonds Payable: contra account 3. Bonds Payable + Premium = Carrying Value 4. Premium reduces the cost of borrowing 5. Bond premium is amortized and causes the amount of interest expense reported in each period to be less than the actual interest paid 6. Bond premium amortization decreases the carrying value of bonds until maturity (CV = Face Value)
Amortization Methods for Premiums & Discounts
1. Straight-Line Method (discount or premium) -Allocates the same amount of interest expense in each period 2. Effective Interest Method -Interest expense equals a constant percentage of the carrying value 3. Both methods result in the same total interest expense over the term of the bonds 4. GAAP requires Effective Interest Method if difference is material
Coverage Analysis Ratios:
1. Times Interest Earned (Accrual Basis) = Operating Income / Interest Expense 2. Times Interest Earned (Cash Basis) = (Cash Flows from Operations + Taxes Paid + Interest Paid) / Interest Payments
Bonds Payable Transactions and Interest Price
1. Transactions are recorded by the corporation (issuer/borrower): -Issuance -Buy Back -Bondholder (lender/investor) converts bonds to common stock !!NO entry when bondholder sells to another investor 2. Issue Price: -Face value -Discount (below face) -Premium (above face) -Prices are quoted at a percentage of face value (i.e. 102) 3. Bonds Payable: long-term 4. Bond Interest Payable: short-term
Willow Corporation's balance sheet showed the following amounts: current liabilities, $5,000; bonds payable, $1,500; lease obligations, $2,300. Total stockholders' equity was $6,000. The debt to equity ratios is
1.47 -Explanation: Debt to Equity= Total liabilities/total equity Total liabilities= 5,000 + 1,500 + 2,300 = 8,800 Debt to equity= 8,800/6,000 = 1.467
McKean Corporation authorizes 500,000 shares of common stock in its articles of incorporation. On May 1, 100,000 shares were sold to the company's founders. However, on October 15, McKean repurchased 20,000 shares to settle a dispute among the founders. At this date. how many shares were issued and outstanding, respectively?
100,000 and 80,000
Harvey Corporation shows the following the stockholders' equity section of its balance sheet: The par value of its common stock is $0.25 and the total balance in the Common Stock account is $50,000. Also noted is that 15,000 shares are currently designated as treasury stock. The number of shares outstanding is:
185,000
Effective Interest Method
3 Steps: 1. Compute bond interest expense (Carrying Value * Effective Interest Rate) 2. Compute bond interest paid (Face Value * Stated Rate) 3. Compute amortization amount (Bond interest expense - Bond interest paid) -Bond Premium: interest expense less than interest paid -Bond Discount: interest expense more than interest paid
What best describes the discount on bonds payable account?
A Contra Liability
When a company purchases treasury stock for $6,000 and then reissues it for $5,000, the difference of $1,000 is:
A decrease in stockholder's equity
Leases
Accounting for leased assets reflects the concept of whether you obtain the risks and benefits of ownership. Therefore, any lease that extends beyond one year are fundamentally like that of a purchase.
Straight-Line Method
Amortization Amount= Bond Discount or Premium / # of Interest Payments
Serenity Company issued $100,000 of 6%, 10-year bonds when the market rate of interest was 5%. The proceeds from this bond issue were $107,732. Using the effective interest method of amortization, which of the following statements is true? Assume interest is paid annually
Amortization of the premium for the first interest period will be $613
Face Value/Par Value/Principal
Amount of money the borrower agrees to repay at maturity.
Callable Bonds
Bonds that give the borrower the option to pay off the debt prior to maturity. Borrowers typically exercise this option when the interest being paid on the debt is substantially greater than the current market rate of interest.
Convertible Bonds
Bonds that give the lender the option to convert the bond into other securities- typically shares of common stock. Lenders will typically exercise this option when the value of the shares of common stock is more attractive than the interest and principal payments supplied by the debt instrument.
Maturity Date
Date on which the borrower agrees to pay the creditor the face (or par) value.
Notes/Bonds
Debt instruments that require borrowers to pay the lender the face value and usually to make periodic interest payments
Unsecured/Debenture Bonds
Debt that does not have collateral is unsecured. Unsecured bonds typically are called debenture bonds.
When a company declares a cash dividend, which of the following is true?
Liabilities are increased
Ratio Analysis
Long-Term liabilities are analyzed with solvency in mind -Debt load -Ability to cover interest payments (coverage)
Market/Yield Rate
Market rate of interest demanded by creditors. This is a function of economic factors and the creditworthiness of the borrower. It may differ from the stated rate.
Stated/Coupon/Contract Rate
Rate of interest paid on the face (or par) value. The borrower pays the interest to the creditor each period until maturity.
Stockholder's Equity
Represents the owners' claims against the assets of the corporation Assets = Liabilities + Stockholders' Equity
Which of the following is a component of stockholders' equity?
Retained Earnings
Entries: Stock Issuance
Sale at par value: Cash XXX Common Stock XXX Sale above par value: Cash XXX Common Stock XXX Paid-In Capital XXX
Secured Bonds
Secured debt provides collateral (such as real estate or another asset) for the lender. If the borrower fails to make the payments required by the debt, the leader can take steps to "repossess" the collateral.
The balance of the $2.50 per value Common Stock account for Patriot Company was $240,000,000 before its recent 2-for-1 stock split. The market price of the stock was $50 per share before the stock split. What occurred as a result of the stock split?
The market price of the stock dropped to approximately $25 per share -Explanation: The total value of a company does not change just because of a stock split. The market value of the company is determines the stock price, and since the number of shares are doubled, the market value of each share is cut in half.
Which of the following statements is true?
The shares that are in the hands of the stockholders are said to be outstanding.
Junk Bonds
Unsecured bonds that are relatively risky and, therefore, pay a high rate of interest to compensate the lender for the added risk.
The result of using the effective interest method of amortization of the discount on bonds is that
a constant interest rate is charged against the debt carrying value -Explanation: the constant interest rate, which is the market interest rate or yield is multiplied by the carrying value to calculate bond interest expense
The premium on bonds payable account is shown on the balance sheet as
an addition to a long-term liability
Outstanding Shares:
the number of issued shares actually in the hands of stockholders -Considers shares bought back by the company "Treasury Stock" -Difference between Issued and Outstanding shares is the reacquired shares
Issued Shares:
the number of shares actually sold to stockholders -Formation of corporation -Ongoing
What is the effect of a stock dividend on stockholders' equity?
total stockholders' equity stays the same
When a company declares a 3-for 1 stock split, the number of shares:
triples and par value is reduced by one-third
