Exam 3

Common Stock Dividend

# shares outstanding X dividend amount per share

At what amount should PPE be recorded when it is purchased?

- Plant assets are recorded at cost (historical cost concept) - Cost is the purchase price plus all costs incurred in getting the asset ready for use

Why would a corporation reacquire its own stock?

- To reduce the shares outstanding and thus increase market value per share - because the market price is low - To remove shares from the market to avoid a hostile takeover - To use in employee stock option programs - To give cash back to existing shareholders - to increase the reported earnings per share

Loss on sale

- expense account - recorded on the income statement - decreases net income (and thus retained earnings)

Preferred Stock

- has dividend preference - set at a fixed percentage - stockholders do not have voting rights

Depreciation of the Leased Asset

- referred to as amortization - typically calculated on a straight-line basis

Gain on sale

- revenue account - recorded on the income statement - increases net income (and thus retained earnings)

Common Stock

- stockholders have voting rights (election of board of directors, vote on the significant activities of management) - dividend rates are determined by the board of directors based on the corporation's profitability - receive dividends after preferred stockholders

Treasury Stock

A corporation's own stock that it has reacquired

If cash received exceed the book value

A gain on sale is recorded

Discounting

The process of finding the present value of a cash flow or a series of cash flows; discounting is the reverse of compounding.

Which type of depreciation method will show more depreciation over the life of the asset? Why?

They show the exact same amount of depreciation over the life of the asset, the difference is a timing issue

At the beginning of a lease period, the lessee records

a leased asset (debit) and a leased liability (credit)- both equal to the present value of the lease payments

If cash received is less than book value

a loss on sale is recorded

Par Value

a monetary amount assigned to each class of stock for accounting purposes only- has no relationship to market value

Mortgage

a specific type of loan that is used to buy real estate

Capital expenditures are

capitalized (the capital expenditure is added to the cost if the asset that has been improved or bettered)

Book Value

cost - accumulated depreciation

Most preferred stock is...

cumulative- preferred stockholders must be paid both current and prior years unpaid dividends before common stockholders can receive any dividends

Depreciation

systematic allocation of the cost of the plant asset to expense over its useful life- 'using up' of buildings and equipment

What happens when the shares reacquired are reissued?

the accounting treatment depends on the relationship between the re-issue price and the reacquisition cost

Present Value of Lump Sum

we know the value of some amount in the future and we want to know the value today- how much is a dollar received in the future worth today?

Future Value of Lump Sum

we know the value of some amount today and we want to know the value at some point in the future- how much will today's dollar be worth in the future?

Future Value of an Annuity Due

we want to know the value of a series of equal cash flows occurring at the beginning of each period at some point in the future- how much is a dollar received at the beginning of every year for four years worth at the end of the 4 years?

Future Value of an Ordinary Annuity

we want to know the value of a series of equal cash flows occurring at the end of each period at some point in the future- how much is a dollar received at the end of every year for four years worth at the end of the four years?

Present Value of Annuity Due

we want to know the value today of a series of equal payments to be made or received in the future- how much is a series of future payments occurring at the beginning of each period worth today?

Present Value of Ordinary Annuity

we want to know the value today of a series of equal payments to be made or received in the future- how much is a series of future payments occurring at the end of each period worth today?

Long-Term Note Payable

when a company borrows money from the bank for longer than a year

Lump Sum

when a company purchases more than one asset for one, lump-sum amount

A debt-to-equity ratio of 0.80 indicates

equity is 20% larger than debt

Residual Value

estimate of the company thinks the asset can be sold for at the end of its useful life

Useful Life

estimate of the length of time in years the asset will be used in business operations

Sum of Years Digits Depreciation

example of accelerated depreciation method- records more depreciation in the early years of an assets life and less depreciation in the later years

Earnings per share information tells an individual stockholder

how much of a company's net income is associated with his or her ownership interest (how much of the company's net income for the year belongs to him or her)- higher is better

necessary adjustments to i and n

i / # of compounds per year n x # of compounds per year

Life

in the first year of depreciation, the numerator of the fraction is equal to the useful life of the asset; each subsequent year the numerator is reduced by one

A debt-to-equity ratio of 1.30 indicates liabilities

liabilities are 30% larger than equity

Property, Plant, and Equipment

long-term assets that have physical substance (land, building, equipment)

Price Earnings Ratio (P/E) Formula

market price per share / earnings per share

Buildings and equipment are depreciated because of the

matching concept

Return on Equity (ROE)

measure the amount of profit earned per dollar of invested capital

Times Interest Earned Ratio

measure the companies' ability to meet its interest payments as they come due

Price Earnings Ratio (P/E)

measures investors' expectations regarding the growth potential and earnings stability of a company

Earnings Per Share (EPS)

measures the amount of net income associated with each share of common stock

Debt to Equity Ratio

measures the percentage of funds being provided by creditors versus stockholders

Number of Periods

n

Transactions involving our own stock

never effect the income statement (net inocme)

ROE measures the amount

of profit earned for each dollar of stockholder investment- higher is better

Compound Interest

interest earned on both the principal amount and any interest already earned

Depreciation Income Statement Impact

Increase depreciation expense and decrease net income

The times interest earned ratio can be thought of as a

'margin of safety' provided to creditors- the higher the times interest earned ratio, the more income the company has to pay its interest and the less likely is to default on these payments

Future value factors can be calculated by

(1+I)^n

Units of Production Method

(Cost-Residual Value)/Total Estimated Usage = Usage Rate Usage Rate x Actual Usage for the Current Year = Depreciation Expense

Times Interest Earned Ratio Formula

(Net Income + Interest Expense + Income Tax Expense) / Interest Expense

Sum of the Years Digits Method

(cost-residual value) x (Life/SYD)

Straight-line depreciation expense per year

(cost-residual value)/life in years

Earnings Per Share (EPS) Formula

(net income - preferred dividends) / # of common shares outstanding

Characteristics of Cash Dividends

- Dividends must be declared by the board of directors before they can be paid - The corporation is not legally required to declare (and subsequently pay) dividends - Dividends are not classified as an expense and thus do not impact net income. Rather, dividends are paid out of net income - Dividends are classified as a contra-equity account because they reduce equity (specifically retained earnings) - Normal balance of dividends account is a debit - Once a dividend is declared, a liability is created

Lessee Accounting

- Lessee records a leased asset and a lease liability on their balance sheet equal to the present value of the lease payments - Leased asset is depreciated - lease liability is amortized (gradually reduced) over the lease term down to a zero balance

Debt Financing

-Loans; repay with interest -Liable for amount of loan -Relationship ends with repayment

Equity Financing

-no responsibility to repay -investor takes risk -investor rewarded by company's future success

Two Categories of Equity

1. Contributed Capital 2. Retained Earnings

Two Types of Capital Stock

1. Preferred Stock 2. Common Stock

Financial Statement Ratios relating to Stockholders' Equity

1. Return on Equity 2. Earnings per Share 3. Price Earnings Ratio

Four Common Depreciation Methods

1. Straight Line 2. Sum of the Years Digits 3. Double Declining Balance 4. Units of Production

Four Accountable Events in the Life Cycle of PPE

1. account for the acquisition of PPE 2. account for any capital expenditures made during the life of the asset 3. account for the depreciation of buildings and equipment 4. account for the sale of disposal of PPE

Expenditures during the life of the asset

1. capital expenditures 2. revenue expenditures

Financial Statement Ratios Relating to Debt

1. debt to equity ratio 2. times interest earned ratio

Four Time Value of Money Cases

1. future value of a lump sum 2. present value of a lump sum 3. future value of an annuity 4. present value of an annuity

Lessor

A party that has agreed contractually to let another party use its asset for a period at an agreed price.

Lessee

A party that has made contractual arrangements to use another party's asset for a period at an agreed price.

Annuity

A series of equal payments at fixed intervals for a specified number of periods

ASSUME: First year an asset is being depreciated Which method will give an income tax advantage? (Straight-line vs accelerated methods)

Accelerated Method: in the first year an asset is depreciated, accelerated methods will show a larger amount of depreciation expense than straight-line. By showing the larger expense, the accelerated method shows the smaller amount of net income. The smaller the net income, the less you have to pay in income taxes.

Annuity Due

An annuity that pays at the beginning of each period.

Units of Production

Based on actual usage of the asset

Loss/Gain on sale

Cost of asset - Accumulate Depreciation = Book Value at date of sale - Selling Price = Loss/Gain on Sale

Capital Expenditures

Costs incurred to increase the operating efficiency of the asset, productive capacity of the asset, or the expected useful life of the asset- are usually substantial in amount and occur infrequently during the period of ownership

Journal entry at end of lease (December 31)

Debit interest expense and lease liability and credit cash (payment)

Depreciation Balance Sheet Impact

Decrease Assets (by increasing contra-asset accumulated depreciation) and decrease retained earnings (decrease NI)

Amortization Table

Displays the interest and principal amounts for each payment of an installment loan

Revenue Expenditures

Expenditures made to keep an asset in good working order, ordinary repairs to an asset- are usually small in amount and they usually occur frequently throughout the life of the asset- have no effect on useful life of an asset

Revenue expenditures are

Expensed

Interest Rate

I

Dividend Preference

If a dividend is paid the preferred stockholders must be paid in full before common stockholders can receive a dividend

Ordinary Annuity

If the first payment occurs at the end of the period

As the compounding frequency increases, what happens to the present value?

It decreases because the more frequent the compounding, the more interest is earned on interest thus you need less money up front (today)

As the compounding frequency increases, what happens to the future value?

It increases because the more frequent the compounding, the more interest is earned on interest thus giving a higher future value

Time Value of Money

Measurement and recording of liabilities are based on this concept (compound interest)

earning before interest and taxes (EBIT)

Net Income + Interest Expense + Income Tax Expense

Return on Equity (ROE) Formula

Net Income / Average Stockholders' Equity

Depreciation Cash Flow Impact

None- depreciation is a non-cash expense

Preferred Stock Dividends

Par value x Dividend rate %

Present Value of Leased Payments

Present Value = Payments x PVAF

ASSUME: First year an asset is being depreciated Which method will show the highest total assets on the year-end balance sheet? (Straight-line vs accelerated methods)

Straight-line: By showing the lower depreciation expense, straight-line also shows the lower amount of accumulated depreciation. Remember, the accumulated depreciation is classified as a contra-asset because it reduces total assets. Thus, straight-line will show a lower reduction of assets in the first year and thus a higher amount of total assets.

ASSUME: First year an asset is being depreciated Which method will show the highest net income? (Straight-line vs accelerated methods)

Straight-line: in the first year an asset is depreciated, straight-line will always shows a smaller amount of depreciation expense than an accelerated method. By showing a smaller amount of expense, the net income will be higher.

To determine the new annual depreciation expense

The book value (cost - accumulated depreciation) of the asset at the date of the change less any salvage value is depreciated based on the number of years remaining in the useful life

Over time, what happens to the book value of an asset?

The book value will decrease each year because the amount of accumulated depreciation gets larger each year

Why is there no adjustment for units of production depreciation?

Units of production is NOT based on the passage of time. Rather, it is based on the actual usage of the asset. Therefore, the only thing that is relevant here is the usage of the asset (miles driven). The date of purchase does not impact the depreciation expense calculation.

Double-Declining Balance Depreciation

a accelerated method that allocates a higher depreciation in the earlier years of the asset's life and lower depreciation in later years

Lease

a contract granting use or occupation of property during a specified time for a specified payment

Cost

all expenditures necessary to acquire the asset and make it ready for intended use

Capitalization

all of the costs incurred in getting the asset ready for use are recorded on the balance sheet as part of the cost of the asset

Treasury stock is recorded

at its reacquisition cost (the amount paid to buy it back)

Double Declining Balance Method

book value at beginning of the year x 2/Life

to record the depreciation of the leased asset

debit amortization expense, credit leased asset

Treasury stock results in a

decrease to stockholders' equity on the balance sheet- contra-equity account

Land does not

depreciate since its usefulness and revenue producing ability generally remain intact

Simple Interest

interest paid on the principal alone (P x R x T)

Book Value at the beginning of the year

is the cost of the asset since the balance in accumulated depreciation at the beginning of the asset's life is zero- in subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year

Treasury stock is considered

issued stock but not outstanding stock (does not have voting rights, cannot receive dividends)

P/E ratio is different from other ratios

it is not the ratio of two financial statement numbers, it is the comparison of a financial statement number to a market value number- the higher is better because the ratio is associated with firms for which strong growth is predicted in the future

a cost is capitalized when

it is recorded as part of an asset on the balance sheet rather than as an expense on the income statement

Total Preferred Stock Dividend

par value per share x % x # shares outstanding

Dividends in Arrears

preferred dividends that were supposed to be declared but were not declared during a given period

It is always easiest to compare the different alternatives using

present values rather than future values

Long-Term Note Payable are liabilities typically repaid in equal installments, part of which are repayment of

principal and part of which are interest

Cost assigned to each asset:

purchase price/total price x lump-sum purchase amount

re-issue price > reacquisition cost

record excess in the equity account PAID-IN CAPITAL-TREASURY

re-issue price < reacquisition cost

reduce paid-in capital- treasury by debiting the account for the difference- if deficit still exists reduce retained earnings for the remaining deficit

What is the difference between issued and outstanding shares?

represents shares of stock issued by the company and then reacquired by the company (I.e., the company buys back the stock)

Once asset is fully depreciated its ending book value is equal to the

residual value

The debt-to-equity ratio provides a measure of

risk to creditors by considering the funds invested by creditors (debt) and investors (equity)

Costs incurred in getting asset ready for use include

sales tax, freight (shipping) costs, installation costs, repair costs incurred prior to use, assembly costs, fees such as closing costs and recording fees

Date of Payment

the date on which dividends are actually to be paid to stockholders

Date of Declaration

the date the directors vote to declare and pay a dividend

Date of Record

the date which a stockholder must own the stock in order to receive the declared dividend

paid-in capital

the excess of the selling price of the stock over the par value is recorded in the equity account called

Compounding

the frequency with which interest is added to the principal

if the lease agreement calls for ownership of the asset to be transferred to the lessee at the end of the lease

the lessee uses the economic life of the asset as the asset's life

if the lease agreement calls for the asset to be returned to the lessor at the end of the lease

the lessee uses the lease terms as the asset's life

UOP best adheres to

the matching concept because the recording of the expense is based on actual usage

Depreciation Expense

the portion of a plant asset's cost that is transferred to an expense account in each fiscal period during a plant asset's useful life- found on income statement- reduces net income

Depreciation expense is the same amount each year of the asset's life using

the straight-line method

SYD

the sum of the digits of the life

Accumulated Depreciation

the total amount of depreciation expense that has been recorded since the purchase of a plant asset- causes a decrease in assets (contra asset account)

Outstanding Shares

the total number of shares actually in the hands of stockholders

Authorized Shares

the total number of shares of stock that the company is allowed to set to the public

Issued Shares

the total number of shares that have been sold to the public

Contributed Capital

this is the amount that owners have contributed through the purchase of stock (capital stock)

Retained Earnings

this is the net income earned by the company not paid out as dividends

In the last year, the lease liability balance must be zero

to adjust make the reduction of principal equal to the lease balance and force out the interest

Debt to Equity Ratio Formula

total liabilities/total stockholders equity