accounting test 4

authorized stock

is the number of shares that a corporation's charter allows it to sell. The number of authorized shares usually exceeds the number of shares issued (and outstanding), often by a large amount

The bond issuer

pays the interest rate specified in the indenture, the contract rate (also referred to as the coupon rate, stated rate, or nominal rate).

Indicate whether the company in each separate case 1 through 3 has entered into an operating lease or a capital lease. 2. The title is transferred to the lessee, the lessee can purchase the asset for $1 at the end of the lease, and the lease term is five years. The leased asset has an expected useful life of six years.

capital lease

Indicate whether the company in each separate case 1 through 3 has entered into an operating lease or a capital lease. 3. The present value of the lease payments is 95% of the leased asset's market value, and the lease term is 70% of the leased asset's useful life.

capital lease

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Paid cash dividends.

financing

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Issued common stock for cash.

financing

Holders of the stock can receive dividends exceeding the stated rate under certain conditions.

Participating

Holders of this stock can exchange it for shares of common stock.

Convertible

When the contract rate and market rate are equal

a bond will sell at par value.

On December 31, 2015, Wintergreen, Inc., issued $150,000 of 7 percent, 10-year bonds for cash of $139,875. The total cost of borrowing equals _____. $105,000 $139,875 $115,125 $255,000

$155,125 -total bond interest expense = Total amount repaid - Amount borrowed Amount repaid = Interest payments of $105,000 (or 20 x ($150,000 x 7% x ½)) + Par value paid at maturity of $150,000 = $255,000 Total bond interest expense = Amount repaid of $255,000 - Amount borrowed of $139,875 = $115,125

Disadvantages of Corporate Form

*Government regulation*: A corporation must meet requirements of a state's incorporation laws, which subject the corporation to state regulation and control. Proprietorships and partnerships avoid many of these regulations and governmental reports. *Corporate taxation*: Corporations are subject to the same property and payroll taxes as proprietorships and partnerships plus additional taxes. The most burdensome of these are federal and state income taxes that together can take 40% or more of corporate pretax income. Moreover, corporate income is usually taxed a second time as part of stockholders' personal income when they receive cash distributed as dividends. This is called double taxation. (Dividends are normally taxed at the individual's income tax rate; for "qualified" dividends, the tax rate is 0%, 15%, or 20%, depending on the individual's tax bracket.)

Advantages of Corporate Form

*Separate legal entity*: A corporation conducts its affairs with the same rights, duties, and responsibilities of a person. It takes actions through its agents, who are its officers and managers. *Limited liability of stockholders*: Stockholders are liable for neither corporate acts nor corporate debt. *Transferable ownership rights*: The transfer of shares from one stockholder to another usually has no effect on the corporation or its operations except when this causes a change in the directors who control or manage the corporation. *Continuous life*: A corporation's life continues indefinitely because it is not tied to the physical lives of its owners. *Lack of mutual agency for stockholders*: A corporation acts through its agents, who are its officers and managers. Stockholders, who are not its officers and managers, do not have the power to bind the corporation to contracts—referred to as lack of mutual agency. *Ease of capital accumulation*: Buying stock is attractive to investors because (1) stockholders are not liable for the corporation's acts and debts, (2) stocks usually are transferred easily, (3) the life of the corporation is unlimited, and (4) stockholders are not corporate agents. These advantages enable corporations to accumulate large amounts of capital from the combined investments of many stockholders.

What is true for the corporate form of organization

- Capital is more easily accumulated then with most other forms of organization - corporate income that is distributed to shareholders is usually taxed twice - it is a separate legal entity - owners are not agents of the corporation

Purpose of the Statement of Cash Flows

- How does a company receive its cash? - Where does a company spend its cash? - What explains the change in the cash balance?

Importance of Cash Flows

- What explains the change in the cash balance? - Where does a company spend its cash? - How does a company receive its cash? - Why do income and cash flows differ?

Corporation

- an entity created by law - existence is seperate from owners - has rights and priveledges - ownership can be privately held or publicly held

disadvantages of bond financing

- bonds can decrease return on equity (This downside risk of financial leverage is more likely to arise when a company has periods of low income or net losses.) - bonds require payment of both periodic interest and the par value at maturity (Bond payments can be especially burdensome when income and cash flow are low.)

preferred stock

- has special rights that give it priority (or senior status) over common stock in one or more areas. Special rights typically include a preference for receiving dividends and for the distribution of assets if the corporation is liquidated. - Preferred stock carries all rights of common stock unless the corporate charter nullifies them. Most preferred stock, for instance, does not confer the right to vote. - A separate class of stock, typically having priority over common shares in . . . --Dividend distributions --Distribution of assets in case of liquidation

A bond is the issuer's written promise to pay an amount identified as the ___ ________ of the bond with interest.

par value

Cash equivalents are...

- short-term, highly liquid investments. - readily convertible into cash. - sufficiently close to maturity so that market value is unaffected by interest rate changes

bond indenture

-The legal document identifying the rights and obligations of both the bondholders and the issuer is called -the legal contract between the issuer and the bondholders.

carrying value

par value less unamortized discount

bond certificate

A bondholder might also receive a __________ _______________ as evidence of the company's debt. - includes specifics such as the issuer's name, the par value, the contract interest rate, and the maturity date. - As a cost-saving measure, many companies no longer issue paper ______________ to bondholders.

advantages of bond financing

Bonds do not affect owner control interest on bonds is tax deductible bonds can increase return on equity (return on assets > interest borrowed fund = increased return on equity)

The issuing corporation can retire the stock by paying a prespecified price.

Callable

Operating Activities: Cash inflows and outflows

Cash Inflows: - From cash sales customers, receipt of dividend revenue, sale of trading securities, collections on credit sales, and from receipt of interest revenue Cash Outflows: - To pay salaries and wages, pay operating expenses, pay suppliers, pay interest and owed, pay taxes and fines, and buy trading and securities

Financing Activities: Cash inflows and outflows

Cash Inflows: - From issuing its commonstock and preferred stock, issuing its short- and long-term debt (notes payable and bonds payable), contributions by owners, and reissuing its treasury stock Cash Outflows: - To pay dividends to shareholders, purchase treasury stock, pay withdrawals by owners, pay off its short- and long-term debt(notes payable and bonds payable)

Investing Activities: Cash inflows and outflows

Cash Inflows: - from selling property, plant, and equipment, selling long term investments, selling short-term investments(except trading), selling (discounting) of notes receivable, selling intangible assets, collecting principles on notes receivable Cash Outflows: - to buy property, plant, and equipment, buy intangible assets, buy long-term investments(exept trading), and loan money in return for notes receivable

Indirect method statement of cash flow - set up

Cash flows from ----- activities Net income Adjustments to reconcile net income to ----- cash flow - Net cash provided(or used) by ------- activities Things to remember: -Add: Noncash expenses and losses -Subtract: Noncash revenues and gains -current assets: opposite direction (add the decreases, subtract the increases) -current liabilities: same direction (add the increases. subtract the decreases)

Direct method statement of cash flows

Cash flows from ------ activities cash received cash paid Net cash provided(or used) by -------- activities Things to remember: - Add: cash receipts from sale of long-term assets - Less: cash paid to acquire long-term assets

Holders of the stock are entitled to receive current and all past dividends before common stockholders receive any dividends.

Cumulative

less than par value

If the contract rate is less than the market rate, the bond will sell at this amount

more than par value

If the contract rate is more than the market rate, the bond will sell at this amount.

Holders of the stock lose any dividends that are not declared in the current year.

Noncumulative

Holders of the stock are not entitled to receive dividends in excess of the stated rate.

Nonparticipating

contract rate

The interest paid on a bond is determined by multiplying this rate by bond par value by the time period (if the interest payment is made more often than annually).

par value

When the contract rate and market rate are equal, a bond will sell at this amount.

straight-line bond amortization method

allocates an equal portion of the total bond interest expense to each interest period.

cash basis

an accounting method in which revenue is recorded when payment is received and an expense is recorded when cash is paid - Revenue is recorded when cash is received from customers, and expenses are recorded when cash is paid to suppliers and employees.

The interest that is paid by the issuer to the bondholders is based on the __________ rate

contract

Investing activities

generally include those transactions and events that affect long-term assets—namely, the purchase and sale of long-term assets. They also include (1) the purchase and sale of short-term investments in the securities of other entities, except trading securities, and (2) lending and collecting money for notes receivable. This slide lists examples of cash flows from investing activities. Cash from collecting the principal amounts of notes that result from a loan to another party are classified as investing. However, the FASB requires that the collection of interest on notes be reported as an operating activity; also, if a note results from sales to customers, it is classified as operating.

Financing activities

include those transactions and events that affect long-term liabilities and equity. Examples are (1) obtaining cash from issuing debt and repaying the amounts borrowed and (2) receiving cash from or distributing cash to owners. These activities involve transactions with a company's owners and creditors. They also involve borrowing and repaying principal amounts relating to both short- and long-term debt. GAAP requires that payments of interest expense be classified as operating activities. This slide lists examples of cash flows from financing activities.

Operating activities

include those transactions and events that determine net income. Examples are the production and purchase of inventory, the sale of goods and services to customers, and the expenditures to operate the business. Not all items in income, such as unusual gains and losses, are operating activities (we discuss these exceptions later). This slide lists the more common cash inflows and outflows from operating activities.

The legal document identifying the rights and obligations of both the bondholders and the issuer is called the bond ______________

indenture

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Received cash from sale of land at a loss.

investing

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Sold long-term investments for cash.

investing activities

bond

is its issuer's written promise to pay an amount identified as the par value of the bond with interest

The par value is paid at a specified future date known as the bond's ___________ ___________

maturity date

discount on bonds payable

occurs when a company issues bonds with a contract rate less than the market rate. This means that the issue price is less than par value.

bonds with longer maturities

often have higher market rates because of the risk of adverse events occurring over those longer time periods.

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Paid cash for property taxes on building

operating

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Paid cash interest on outstanding notes.

operating

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Received cash interest on a note.

operating

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Paid cash for wages and salaries.

operating activities

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Purchased inventories for cash.

operating activities

Classify the following cash flows as either operating, investing, or financing activities. (Assume indirect method) Received cash payments from customers

operating activities

Indicate whether the company in each separate case 1 through 3 has entered into an operating lease or a capital lease. 1. The lessor retains title to the asset, and the lease term is three years on an asset that has a five-year useful life.

operating lease

outstanding stock

refers to issued stock held by stockholders

indirect method

reports net income and then adjusts it for items necessary to obtain net cash provided or used by operating activities. - It does not report individual items of cash inflows and cash outflows from operating activities. Instead, the indirect method reports the necessary adjustments to reconcile net income to net cash provided or used by operating activities. - The net cash amount provided by operating activities is identical under both the direct and indirect methods. This equality always exists. The difference in these methods is with the computation and presentation of this amount. The FASB recommends the direct method, but because it is not required and the indirect method is arguably easier to compute, nearly all companies report operating cash flows using the indirect method.

Accrual basis

revenues are recognized when earned and expenses are recognized when incurred

direct method

separately lists each major item of operating cash receipts (such as cash received from customers) and each major item of operating cash payments (such as cash paid for inventory). The cash payments are subtracted from cash receipts to determine the net cash provided (used) by operating activities.

contract rate

sets the amount of interest the issuer pays in cash.

if the contract rate is less than the market rate

the bond will sell at a discount. - That is, a purchaser of this bond will pay less than the par value to purchase the bond. Why? If a bond is only paying interest of 5 percent annually and other equally risky bonds are paying 10 percent and selling at par, you surely wouldn't be willing to pay par for the 5 percent bond

If the contract rate is more than the market rate

the bond will sell at a premium -That is, a purchaser of this bond will be willing to pay more than the par value to purchase the bond. Wouldn't you be willing to pay more for a bond that will pay you 10 percent interest per year than an equally risky bond that will pay only 5 percent?

As the risk level increases

the market rate increases to compensate purchasers for the bonds' increased risk

market rate of interest

the rate that borrowers are willing to pay and lenders are willing to accept for a particular bond and its risk level.

issued stock

the total number of a company's shares that have been sold and are held by shareholders