ACCT 2121 Chapter 11

preferred stockholders have a priority in relation to:

(1) dividends and (2) assets in the event of liquidation

The stockholders' equity section of a corporation's balance sheet consists of two parts:

(1) paid‐in (contributed) capital and (2) retained earnings (earned capital).

Three dates are important 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

The primary objectives in accounting for the issuance of common stock are:

(1) to identify the specific sources of paid‐in capital (2) to maintain the distinction between paid‐in capital and retained earnings

large stock dividend

(greater than 20%-25% of the corporation's issued stock) > normally use par or stated value per share to record small stock dividends

small stock dividend

(less than 20%-25% of the corporation's issued stock) > use the fair value per share to record small stock dividends

Within paid‐in capital, two classifications are recognized:

1.) Capital stock, which consists of preferred and common stock. Companies show preferred stock before common stock because of its preferential rights. They report information about the par value, shares authorized, shares issued, and shares outstanding for each class of stock. 2.) Additional paid‐in capital, which includes the excess of amounts paid in over par or stated value.

For a corporation to pay a cash dividend, it must have the following:

1.) Retained earnings 2.) Adequate cash 3.) Declared dividends

corporation advantages:

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

A corporation may acquire treasury stock for various reasons:

1.) To reissue the shares to officers and employees under bonus and stock compensation plans. 2.) To increase trading of the company's stock in the securities market. Companies expect that buying their own stock will signal that management believes the stock is underpriced, which they hope will enhance its market price. 3.) To have additional shares available for use in acquiring other companies. 4.) To reduce the number of shares outstanding and thereby increase earnings per share.

Corporations generally issue stock dividends for one of the following reasons:

1.) To satisfy stockholders' dividend expectations without spending cash. 2.) To increase the marketability of the stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes it easier for smaller investors to purchase the shares. 3.) To emphasize that the company has permanently reinvested in the business a portion of stockholders' equity, which therefore is unavailable for cash dividends.

Issuance of Stock

> A corporation can issue common stock directly to investors. > Direct issue is typical in closely held companies. > Alternatively, it can issue common stock indirectly through an investment banking firm that specializes in bringing securities to the attention of prospective investors. > Indirect issue is customary for a publicly held corporation

Corporation Management

> Although stockholders legally own the corporation, they manage it indirectly through a board of directors they elect > The board, in turn, formulates the operating policies for the company.

Transferable Ownership Rights

> Ownership of a corporation is held in shares of capital stock, which are transferable units. > Stockholders may dispose of part or all of their interest in a corporation simply by selling their stock.

common stock

> When a corporation has only one class of stock, it is identified as common stock. > Each share of common stock gives the stockholder the ownership rights

cost method

> companies increase (debit) Treasury Stock by the price paid to reacquire the shares. > Treasury Stock decreases (credit) by the same amount when the company later sells the shares

In closing entries, a company debits a net loss to ___. It does not debit net losses to ___.

> the Retained Earnings account > paid‐in capital accounts

Corporation

A company organized as a separate legal entity, with most of the rights and privileges of a person.

Government Regulations

A corporation is subject to numerous state and federal regulations. > state laws, SEC, Sarbanes-Oxley

by ownership

A corporation may be a nonprofit charitable, medical, or educational corporation (such as the Salvation Army or the American Cancer Society)

by purpose

A corporation may be organized for the purpose of making a profit (such as Facebook or General Motors)

Privately held corporation

A corporation that has only a few stockholders and whose stock is not available for sale to the general public.

Publicly held corporation

A corporation that may have thousands of stockholders and whose stock is traded on a national securities market.

Treasury stock

A corporation's own stock that has been reacquired by the corporation and is being held for future use.

Deficit

A debit balance in Retained Earnings.

Dividend

A distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis.

Charter

A document that describes a corporation's name and purpose, types of stock and number of shares authorized, names of individuals involved in the formation, and number of shares each individual has agreed to purchase.

Cumulative dividend

A feature of preferred stock entitling the stockholder to receive current and unpaid prior‐year dividends before common stockholders receive any dividends.

Return on common stockholders' equity (ROE)

A measure of profitability from the stockholders' point of view > computed by dividing net income available to common stockholders (which is Net income−Preferred dividends) by average common stockholders' equity

Payout ratio

A measure of the percentage of earnings a company distributes in the form of cash dividends to common stockholders. > computed by dividing total cash dividends declared to common shareholders by net income

Cash dividend

A pro rata (proportional to ownership) distribution of cash to stockholders.

Stock dividend

A pro rata (proportional to ownership) distribution of the corporation's own stock to stockholders. > You now own more shares of stock, but your ownership interest has not changed

Separate Legal Existence

As an entity separate and distinct from its owners, the corporation acts under its own name rather than in the name of its stockholders

Par value stock

Capital stock that has been assigned a value per share in the corporate charter.

Outstanding stock

Capital stock that has been issued and is being held by stockholders.

Preferred stock

Capital stock that has contractual preferences over common stock in certain areas.

No‐par value stock

Capital stock that has not been assigned a value in the corporate charter.

Retained earnings restrictions

Circumstances that make a portion of retained earnings currently unavailable for dividends.

Additional Taxes

Corporations, on the other hand, must pay federal and state income taxes as a separate legal entity. These taxes can be substantial. They can amount to as much as 40% of taxable income.

Ability to Acquire Capital

It is relatively easy for a corporation to obtain capital through the issuance of stock.

Retained earnings (definition)

Net income that a company retains in the business.

Retained earnings (cash dividend req.)

Payment of dividends from retained earnings is legal in all states. In addition, loan agreements frequently constrain companies to pay dividends only from retained earnings. Many states prohibit payment of dividends from legal capital. However, payment of dividends from paid‐in capital in excess of par value is legal in some states.

Dividends in arrears

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

Adequate cash (cash dividend req.)

Recently, Facebook had a balance in retained earnings of $6,099 million but a cash balance of only $4,315 million. If it had wanted to pay a dividend equal to its retained earnings, Facebook would have had to raise $1,784 million more in cash. It would have been unlikely to do this because it would not be able to pay this much in dividends in future years. In addition, such a dividend would completely deplete Facebook's balance in retained earnings, so it would not be able to pay a dividend in the next year unless it had positive net income.

Continuous Life

Since a corporation is a separate legal entity, its ability to continue is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer

Legal capital

The amount of capital that must be retained in the business for the protection of corporate creditors.

Authorized stock

The amount of stock that a corporation is authorized to sell as indicated in its charter.

Stated value

The amount per share assigned by the board of directors to no‐par stock.

Paid‐in capital

The amount stockholders paid in to the corporation in exchange for shares of ownership.

Declared dividends (cash dividend req.)

The board of directors has full authority to determine the amount of income to distribute in the form of dividends. Dividends are not a liability until they are declared.

Payment date

The date cash dividend payments are made to stockholders.

Declaration date

The date the board of directors formally authorizes the dividend and announces it to stockholders.

Record date

The date when the company determines ownership of outstanding shares for dividend purposes. > No entry is required on the record date

Stock split

The issuance of additional shares of stock to stockholders accompanied by a reduction in the par or stated value per share.

Accumulated Other Comprehensive Income

This account includes the cumulative amount of all previous items reported as other comprehensive income.

In general, as long as the return on assets rate exceeds the rate paid on debt ___

a company will increase the return on common stockholders' equity by the use of debt

A stock dividend results in ___

a decrease in retained earnings and an increase in paid‐in capital

dividends are generally reported quarterly as ___

a dollar amount per share

a stock split results in ___

a reduction in the par or stated value per share

S corporation

allows for legal treatment as a corporation but tax treatment as a partnership—that is, no double taxation

controller

chief accounting officer who: (1) maintains the accounting records, (2) ensures an adequate system of internal control, and (3) prepares financial statements, tax returns, and internal reports

The declaration of a cash dividend ___

commits the corporation to a binding legal obligation

noncumulative

company doesn't have to pay preferred stockholders for previous missed years Ex. (HW CH11 P9)

cumulative

company has to pay preferred stockholders for previous missed years Ex. two missed years turns 28280 into 84840 (HW CH11 P9)

Dividends in arrears are not ___

considered a liability. No obligation exists until the board of directors formally "declares" that the corporation will pay a dividend

entry to record issuance of shares after recording stock dividend:

credit Common Stock Dividends Distributable by the amount debited in the recording of stock dividend debit Common Stock by the amount debited in the recording of stock dividend

entry to record 10% stock dividend on 50,000 shares of $10 par value common stock, with the current value being $15 per share:

credit Stock Dividends $75,000 debit Common Stock Dividends Distributable $50,000 debit Paid-in Capital in Excess of Par Value by 25,000

Limited Liability of Stockholders

creditors ordinarily have recourse only to corporate assets to satisfy their claims, not the personal assets of stockholders, limiting a stockholder's loss to what they invested in the company

entry to record the declaration of dividends:

debit Cash Dividends by the dividend amount times the number of shares credit Dividends Payable by the dividend amount times the number of shares

entry to record issuance of par value common stock at par for cash:

debit Cash by par value credit Common Stock by par value

entry to record issuance of par value common stock above par for cash:

debit Cash by sell value credit Common Stock by par value credit Paid-in Capital in Excess of Par Value by sell value - par value

entry to record issuance of par value common stock above stated for cash:

debit Cash by sell value credit Common Stock by stated value credit Paid-in Capital in Excess of Stated Value by sell value - stated value Ex. (HW CH11 P11)

entry on payment date:

debit Dividends Payable by the dividend amount times the number of shares credit Cash by the dividend amount times the number of shares

entry for reacquisition of stock

debit Treasury Stock by the acquisition price credit Cash by the acquisition price

by‐laws

establish the internal rules and procedures for conducting the affairs of the corporation

The first claim to dividends does not, however, ___ dividends

guarantee

treasurer

has custody of the corporation's funds and oversees the company's cash position

Pro rata

if you own, say, 10% of the common shares, you will receive 10% of the dividend

If a company wants to increase its return on common stockholders' equity, it can either ___

increase its return on assets or increase its reliance on debt financing.

The effect of a split on market price is generally ___

inversely proportional to the size of the split

Because a stock split does not affect the balances in any stockholders' equity accounts, a company does not ___

need to journalize a stock split

the issuance of common stock affects only ___

paid‐in capital accounts

A stock split does not have any effect on ___

paid‐in capital, retained earnings, and total stockholders' equity

The authorization of common stock does not ___

result in a formal accounting entry

entry to record the issuance of preferred stocks:

same as normal stocks, just with altered account names

Preferred stockholders have the right to ___

share in the distribution of corporate income before common stockholders

stock certificate

shows the name of the corporation, the stockholder's name, the class and special features of the stock, the number of shares owned, and the signatures of authorized corporate officials

Debt reduces ___

solvency > The company locks in fixed payments that it must make in good times and bad > The company must pay interest on a periodic basis and must pay the principal (face value) of the bonds at maturity

taxed twice (double taxation)

stockholders are required to pay taxes on cash dividends, and corporations are required to also pay taxes as well

license

subjects the corporation's operating activities to the general corporation laws of the state

Common Stock, would not be affected in reacquisition because ___

the number of issued shares does not change

the cumulative effect of the declaration and payment of a cash dividend on a company's financial statements is

to decrease both stockholders' equity and total assets