ACCT 314 Exam 2 University of Nebraska-Lincoln

How should mandatorily redeemable PSs be reported?

*Mandatorily redeemable preferred shares must be reported in the balance sheet as a liability, not as shareholders' equity

What are temporary differences?

- Are differences between the amount of an asset or liability that is reported in the financial statements and the equivalent amount that is included in the company's tax records. - Arise when pretax accounting income and taxable income are recognized in different periods

What are the consequences of temporary differences?

- Deffered Tax Liability - Deffered Taz asset

How do permanent differences affect DTA or DTL or Tax expense?

- They will not be accounted for in the taxable income, therefore not affecting any of them

What are reasons for share buybacks?

-Directly boost share prices. The main goal of any share repurchase program is to deliver a higher share price. -Tax efficiency. Dividend payments are taxed as income whereas rising share values aren't taxed at all. ... -More flexibility than dividends. ... -Offset dilution.

What are the examples of permanent differences?

-Interest income on tax-exempt securities (municipal bonds) -Fines and penalties paid to governments for violation of the law -Non-deductible portion of business meals and entertainment expenses -Premiums paid (and subsequent proceeds) on life insurance policies for key management employees when held until death of the insured -Non tax-deductible goodwill amortization or impairment

What are components of shareholders' equity?

-Paid-in-capital -Retained earnings -Treasury stock -Accumulated Other Comprehensive Income

Stock option plan vesting period

-Record compensation expense over the service period for which employees receive the options with a credit to paid-in capital-stock options. o The vesting period goes from the date of grant to the first date the options canbe exercised. o Compensation is measured as the fair value of the stock options at the grantdate. The fair value is estimated by employing a recognized option pricingmodel.

What are the implications of dividends and stock splits on financial statements

-Stock splits will ultimately not cahnge the overall dollar amount reported on the Stockholders equity -Dividends: a decrease in reatained earnings and cash

How are permanent differences calculated?

-They are accounted before in the pretax computation

What is the DTA of stock options?

-is the portion of the options' intrinsic value earned to date times the tax rate?

What is shareholders' equity?

-the amount that the owners of a company have invested in their business. This includes the money they've directly invested and the accumulation of income the company has earned and that has been reinvested since inception.

Why PSs are sometimes called hybrid securities?

A cross between equity and debt o Equity because preferred shareholders receive dividends each year thecompany pays dividends. o Debt because the company is obligated to pay cash (or other assets) at a fixedor determinable rate in the future makes.

What are net operating losses (NOL)?

A net operating loss is negative taxable income which happens when tax-deductibleexpenses exceed taxable revenues

Do you know what authorized/issued/outstanding/retired shares are?

A. Authorized shares are the maximum number of shares of stock that a corporation islegally permitted to issue and sell to the public as specified in its articles ofincorporation. The number of authorized shares is determined at the company'screation but can be increased by vote of the shareholders. B. Issued shares are shares of stock that have been sold to investors at some point.Issued shares can be classified as either outstanding shares or treasury shares. C. Outstanding shares are shares that have been issued and are currently owned bystockholders. Treasury shares are shares that have been issued to stockholders, buthave since been repurchased by the corporation

What is par value?

A. Most shares continue to bear arbitrarily designated par amounts B. Shares with nominal par amounts became common to dodge elaborate statutory rulespertaining to par value shares. C. Like the designations of common and preferred shares, the concepts of par value andlegal capital have been eliminated entirely from the Model Business Corporation Act

What are stock splits?

A. Objective: To induce the per share market price decline that follows. The motivation for reducing the per share market price is to increase the stock's marketability by making it attractive to a larger number of potential investors

What are retained earnings?

A. Retained earnings represents a corporation's accumulated, undistributed net income(or net loss)

Do share buybacks create an asset?

Acquisition of a company's own shares does not create an asset

What is an employee share purchase plan (ESPP)?

An employee stock purchase plan permits all employees to buy shares directly from theircompany at favorable terms.

What affect retained earnings

B. The most frequent changes to retained earnings are increases due to income and decreases due to distributions to owners such as dividends. So a credit balance in retained earnings account means prior years' accumulated earnings exceed dividends paid to shareholders. Debit balance means the company accumulated losses and is referred to as a deficit.

Do you know howbasic EPS and dilutive EPS should be reported when the income statement includesdiscontinued operations?

Basic EPS and diluted EPS must be reported separately for income from continuingoperations and net income on the face of the income statement when the incomestatement includes discontinued operations

What are share buybacks?

Companies sometimes reacquire shares of its stock that were previously sold, we callit share buybacks.

When will permanent differences be created?

Created when an income item is included in taxable income or accounting income butwill never be included in the computation of the other

When will a deferred tax Asset (DTA) be created?

DTA - If tax laws require the company to wait until a future period to take a tax deduction that reduces taxable income, the company reports a deferred tax asset reflecting the benefit of that future deductible amount - Accounting income < Taxable income

When will a deferred tax liability (DTL) be created?

DTL - f tax laws allow a company to postpone paying taxes on activities reported in the current period's income statement, the company must report a deferred tax liability because the company anticipates those activities will lead to future taxable amounts. - AKA Accouniting Income > Taxable Income

When will a deferred tax liability (DTL) be created?

DTL - If tax laws allow a company to postpone paying taxes on activities reported in thecurrent period's income statement, the company must report a deferred tax liabilitybecause the company anticipates those activities will lead to future taxable amounts.

What are different types of temporary differences? Liabiilities

Deferred Tax Liabilities - Revenues - Installment sales of property (installment method for taxes). - Unrealized gain from recording investments at fair value (taxable when the asset is sold) - Expenses - Accelerated depreciation on these tax returns over straight-line depreciation in the income statement - Prepaid expenses ( tax-deductible when paid)

What are different types of temporary differences? Assets

Deferred Tax liabilities - Revenues - Rent collected in advance - Subscriptions collected in advance - Other revenue collected in advance - Expenses - Estimated expenses and losses (tax-deductible when paid) - Unrealized loss from recording investments at fair value or inventory at LCM (tax-deductible when asset is sold)

Do you know how to compute a basic EPS?

Earnings available to common shareholders/weighted average number of common stocks outstanding

What is the key issue of temporary differences?

For temporary differences, the issue is not whether an amount is taxable or deductible, but when.

If there is a change in a tax rate due to a change in a tax law, how should DTA or DTL be adjusted?

If a change in a tax law occurs and the new rate is different, the deferred taxliability or asset is adjusted to reflect the change in the amount to be paid orrecovered. The effect of the adjustment is reported in operating income as part oftax expense in the year the tax law change is enacted.

When do we say a security is antidilutive?

If the effect of the conversion or exercise of potential common shares would be toincrease, rather than decrease, EPS, these securities are referred to as antidilutivesecurities. Such securities are ignored when calculating both basic and diluted EPS

How should share value be determined when stocks are issued for noncash assets?

Issuance of shares should be recorded at fair value

Note that knowing the journal entries implies that not only you know the accounts but alsoyou know the amounts and the implications on financial statements.

Make sure to know how each debit and credit affect each other after making the journal entries

Will permanent differences be reversed like temporary differences?

No

Is tax payable in the year an NOL occurs?

No tax is payable in the year an NOL occurs

Do you know the differences between invested capital and earned capital?

Paid-in Capital a. invested by shareholders when they purchase shares of stock from the corporation. b. Arising from the company buying back some of those shares or c. Arising from share-based compensation activities. Earned Capital Represents what is arened by the company

What are preferred shares (PSs)?

Preferred Shares: Shares with certain preferences or features that distinguish themfrom common shares

What are the consequences of stock issuance costs?

Share issue costs reduce net proceeds from selling shares, resulting in a lower amountof additional paid-in capital

Treasury Stock

Shares previously sold to shareholders that are bought back by the corporation

What is a stock option plan?

Stock option plans give employees the option to buy a specified number of shares of thecompany's stock at a specified exercise price during a specified period of time.

What arethe tax laws regarding NOLs, e.g., can a company use tax NOLs to offset future taxableincome, will NOLs expire?

Tax laws a. NOL carryforward creates a deferred tax asset b. The NOL tax benefit should be recognized in the year the loss occurs c. NOLs do not expire - Companies are limited to offsetting a maximum of 80% of taxable incomewith NOL carryforwards in any given year.

How will a deferred tax assets be reported in a balance sheetwhen there is a valuation allowance?

The deferred tax asset is then reported at its estimated net realizable value, similar to themanner that accounts receivable are reduced by the allowance for uncollectible accounts.

Under IFRS, when will a deferred tax asset (DTA) be created for stock options?

The deferred tax asset isn't created until the award 'is in the money', that is has intrinsic value.

Are TSs considered to be issued or outstanding?

The stock is considered issued but not outstanding

Restricted Stock Award and Units or plans: are their journal entries on the grant date?

There are no journal entries

How are the purchase of treasury stocks and it subsequent resale treated?

They are treated as one singular transaction

What are the four common types of OCI?

a. Components of comprehensive income created during the reporting period in the statement of comprehensive income b. The comprehensive income accumulated (AOCI) over the current and priorperiods in the balance sheet. 1. Unrealized holding gains or holding losses on investments that are classified as available for sale. 2. Foreign currency translation gains or losses. 3. Pension plan gains or losses. 4. Pension prior service costs or credits.

Why are there differences in revenues and expenses (and gains and losses) between the taxreturn and the income statement?

a. Financial accounting standards (GAAP) are established to provide usefulinformation to investors and creditors b. Congress establishes tax rules (IRS codes) to i. allow it to raise funds in a socially acceptable mannerii. influence the behavior of taxpayer

Paid-in Capital

a. invested by shareholders when they purchase shares of stock from the corporation. b. Arising from the company buying back some of those shares or c. Arising from share-based compensation activities.

What is valuation allowance?

deferred tax asset is then reduced by a valuation allowance if it is "more likely than not"that some portion or all of the deferred tax asset will not be realized

For example, what is the effect on earningsin the year after the share-based compensations are granted?

increase the expenses, reduce the net income, and increase the number of outstanding shares, all of which results in a smaller EPS.

For stock dividends, do you know theaccounting treatments depending on whether large or small stock dividends are issued?

o A small stock dividend is a distribution of stock that is less than 25 percent of the outstanding shares. Small stock dividends are recorded at the market value of the stock. Retained earnings account is reduced for the small stock dividend. o A large stock dividend is a distribution of stock that is equal to or greater than 25 percent of the outstanding shares. Large stock dividends are recorded at the par value of the stock. Retained earnings account, or alternatively paid-in capital excess of par account, is reduced for the large stock dividend.

What are the differences between cumulative and noncumulative PSs?

o Cumulative: Dividends in arrears accumulate and must be made up in a later dividend year before any dividends are paid on common shares Noncumlative: previous dividends do not have to be made up

What are the differences between participating and nonparticipating PSs?

o Participating: Allows preferred shareholders to receive additional dividendsbeyond the stated amount

Where is EPS recorded?

on the face of income statement?

Do you know examples of share-based compensation?

stock award plans, stock option plans, stockappreciation rights (SARs), or one of the several similar plans

For example, a debit in DTL means a decrease of

the liability in the balance sheet

In the event there are multiple temporary differences, what do we do?

we still follow the four-step approach for accounting purpose?

What are the differences in stock option plans with graded vesting and cliff vesting?

• Cliff vesting: The stock option plans vest (become exercisable) on one single date. • Graded-Vesting: Option recipients gradually become eligible to exercise their optionsrather than all at once.

What are the important dates for dividends?

• Declaration date - the date the board of directors declares the dividend. Onthe declaration date a liability for dividend payable is recorded and retainedearnings are reduced for the amount of the dividend declared. • Ex-dividend date - the date that serves as the ownership cut-off point for thereceipt of the most recent declared dividend. (No journal entry is required onthe ex-dividend date) • Date of Record- the date recipients of the dividends are determined, usuallyone business day after the ex-dividend date. The company prepares a list ofregistered owners who will receive the dividend. To be a registered owner ofshares, an investor must purchase shares before the ex-dividend date. (Nojournal entry) • Payment date- the date the corporation pays the dividend to the stockholdersand removes the dividend payable.

What are dividends?

• Distributions of assets the company has earned on behalf of its shareholders • All dividends, except for stock dividends, reduce the total stockholders' equity in the corporation

What is a restricted stock unit?

• Is a right to receive a specified number of shares of company stock. Only after the vesting requirements are satisfied, the company issues and distributes the shares. • The recipient benefits by the value of the shares at the end of the vesting period. • Terms of RSUs vary o The recipient sometimes is given the cash equivalent of the number of shares used to value the RSUs or o The terms might stipulate that either the recipient or the company is allowed o choose whether to settle in stock or cash

What are reverse stock splits?

• Occurs when a company decreases its outstanding shares. • No journal entry is necessary.

What are the impact of reverse stock splits on outstanding shares, share price, and par value?

• Occurs when a company decreases its outstanding shares. • No journal entry is necessary. • Market price per share theoretically would increase • Often done by struggling companies trying to increase the stock price. • Example: After a 1-for-4 reverse stock split, 100 million shares, $1 par pershare, would become 25 million shares, $4 par per share.

Restricted Stock Award and Units vesting period

• Record compensation expense over the service period for which participants receive the shares with a credit to paid-in capital-restricted stock. o The vesting period goes from the date of grant to when restrictions are lifted. o The compensation expense is computed using with the market price of unrestricted shares of the same stock at the date of grant. Any market pricechanges that might occur after that do not affect the total compensation.

What rights do preferred shareholders have?

• Right of conversion: allows preferred shareholders to exchange shares ofpreferred stock for common stock at a specified conversion ratio • Redemption privilege: allow preferred shareholders the option, under specifiedconditions, to return their shares for a predetermined redemption price • Preferred shareholders have preference over common stockholders in dividendsand liquidation rights

What is a restricted stock (award)?

• Shares are awarded in the name of the employee. • The company might retain physical possession of the shares. • The employee has all rights of a shareholder, subject to certain restrictions. o Usually not free to sell the shares during the restriction period

weighted average number of common stocks outstanding

• Start with the number of common shares outstanding at the beginning of the period. • Add the number of new common shares issued during this period, time-weighted for the fraction of the period they were outstanding. • Subtract the number of common shares reacquired (as treasury stock or to be retired) during this period, time-weighted for the fraction of the period they were not outstanding. • Add the number of treasure stock sold during this period, time-weighted for the fraction of the period they were outstanding. • Add the increase in the number of common shares due to a stock distribution(e.g., stock dividend or stock split), NOT time-weighted.

What are the three conditions that determine the accounting for ESPP?

• Substantially all full-time employees may participate on an equitable basis • The discount from market is small (no greater than 5%). • Employees have no longer than one month after price is fixed to decide whether toparticipate.

What rights do common shareholders have?

• The right to vote on matters that come before the shareholders, including theelection of corporate directors. • The right to share in profits when dividends are declared. • The right to share in the distribution of assets if the company is liquidated B. Preemptive right (sometimes given to common shareholders) • the right to maintain one's percentage share of ownership when new shares areissued

What is liquidating dividend?

• When dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend

What are the impact of stock splits on outstanding shares, share price, and par value?

• an increase in the number of shares outstanding. • a decrease in the par per share. • no change in the total par value. • a decrease in the market value of stock. • no change in retained earnings and total stockholders' equity. • no journal entry required.

Accumulated Other Comprehensive Income

• extends our view of income beyond net income reported in an income statementto include four types of gains and losses not included in income statements :a. Net holding gains (losses) on investments. b. Gains (losses) from and amendments to post retirement benefit plans. c. Deferred gains (losses) on derivatives. d. Adjustments from foreign currency translation