ACCY 200 Module 7
Firm A (with no financial leverage) earns an ROI of 10%. Firm B also earns an ROI of 10%, but its assets are partially financed with liabilities bearing an interest rate of 15%
- Firms A and B are equally risky - Firm B has negative financial leverage - Firm B's ROE will be less than Firm A's ROE
the financial statement effects of a declaration of a cash dividend (on the date of declaration) include:
- a decrease in total stockholders' equity - an increase in current liabilities - a decrease in retained earnings - expenses are not affected (dividends directly reduce retained earnings) - net income is not affected - total assets is not affected on the date of declaration, but are decreased on the date of payment
the effects on the financial statements of the purchase of treasury stock include:
- a decrease to total assets - no effect on total liabilities - no effect on net income - a decrease to total stockholders' equity - a decrease to cash
the effects on the financial statements of the sale of treasury stock for a price greater than the treasury shares were purchased for include:
- an increase to cash - an increase to total stockholders' equity
gain contingencies
- are not recognized in the financial statements because of accounting conservatism - are sometimes disclosed in the notes to the financial statements, but only when the gain i highly likely to occur
deferred tax liabilities
- are provided for temporary differences between income tax and financial statement recognition of revenues and expenses - are normally long-term and represent income taxes that are expected to be paid more than a year from the balance sheet date - are one of the most significant liabilities shown on the balance sheet for many firms
deferred tax assets
- are recorded when warranty expense is reported in the year a sale is made, but the tax deduction is not allowed until a warranty claim is paid - result when an expense is recognized for financial accounting purposes before it is deductible for tax purposes - are recorded to recognize temporary differences that will cause taxable income to be lower in future years
what financial statement effects occurs when a bond interest payment is made
- current assets are decreased - current liabilities are decreased
common stockholders
- do not have any personal liability for corporate debts, and thus cannot be forced by creditors to invest additional amounts to make up for losses - have a claim to all assets that remain in the entity after all liabilities and preferred stock claims have been satisfied - are no entitled to receive any specific dividend amount - are the ultimate owners of the corporation they have a residual ownership claim to the corporation's asset - experience no upper limit to the value of their ownership interests
effects of the payment of a cash dividend
- does not have an effect on total stockholders' equity; retained earnings is decreased on the date of declaration when the dividend becomes a legal liability to the firm, not on the date of payment - decreases current and total liabilities - decreases cash - decrease in total assets
what financial statement effects occur when bond interest is accrued
- expenses are increased and net income is decreased - current liabilities are increased
bond discount
- is a deferred charge (debit) that is amortized to interest expense over the life of a bond - amortization increases interest expense over the amount actually paid to bondholders - is classified in the balance sheet as a contra account to the Bonds Payable account
stockholders' equity captions usually seen in a balance sheet include
- preferred stock - accumulated other comprehensive income (loss) - retained earnings
bond premium
- represents a reduction in interest expense to be recognized over the life of the bond - has the opposite effect on the bond's carrying value than does a bond discount
facts about convertible bonds
- the bondholder has the option of converting the bonds into common stock before the scheduled maturity date - if the common stock price has risen substantially since the bonds were issued, it is more likely that the conversion option will be exercised - the conversion feature may not become effective for several years after the bonds are issued
requirements that must be met for a corporation to pay a cash dividend include:
- the declaration of a cash dividend must not result in a violation of any existing contractual agreements such bond covenants - the board of directors must declare the dividend
the requirements that must be met for a corporation to pay a cash dividend
- the firm must have a sufficient balance in the Retained Earnings account to absorb the dividend - the firm must have enough cash to be able to pay the dividend
what financial statement effects occur when a bond premium is amortized
- the net carrying value of Bonds Payable is decreased - expenses are decreased and net income is increased
what financial statement effect occurs when a bond discount is amortized
- the net carrying value of bonds payable is increased - expenses are increased and net income is decreased
the financial statement effects of an early retirement of bonds usually include
- the recognition of a loss (or possibly a gain) on the retirement of bonds - a decrease to noncurrent liabilities - a decrease to assets --> cash is normally used to retire bonds - also retiring (removing) any unamortized premium or discount associated with the retired bonds
stockholders' equity captions usually seen in a balance sheet
- treasury stock - common stock - additional paid-in capital - not bonds payable (this is a liability)
if a firm has an average income tax rate of 25% and issues long-term debt with an interest rate of 8%, then the after-tax cost of debt is
8% * (1-25%)=6%
The journal entry that would normally be made by an issuing company upon the early retirement of bonds (with unamortized bond discount remaining)
DR: Bonds Payable DR: Loss on Retirement of Bonds CR: Cash CR: Discount on Bonds Payable
the entry to record the purchase of treasury stock
DR: Treasury Stock CR: Cash
the entry to record the purchase of treasury stock is
DR: Treasury Stock CR: Cash
the entry to record the retirement of fully amortized bonds payable at maturity is
Dr: Bonds Payable Cr: Cash
term bond
a lump-sum repayment of the face amount of this bond is made at the maturity date
the cumulative foreign currency translation adjustment is reported as a component of
accumulated other comprehensive income (loss) within stockholders' equity on the balance sheet
the stated interest rate
adjusted for compounding frequency, this interest rate is used to calculate the amount of interest paid for each payment period of a bond's life
the number of ____ shares is stated in the corporate charter that is filed with the state of incorporation
authorized
Bonds will be called when the market interest rate is sufficiently ____ the stated rate being paid on the bonds
below
under ____ voting, if 3 directors are to be elected, the owner of 50 shares of common stock is entitled to 150 votes
cumulative
preferred stock issues usually provide a ____ dividend, which means that any dividends that have been missed and are in ____ must be paid subsequently before any dividends can be paid to the common stockholders
cumulative; arrears
immediately after the issuance of a stock dividend, the market value per share of common stock for the company should normally:
decrease because more shares of stock are now outstanding but the total market value of all shares remains the same
if the retained earnings account has a negative balance, it is referred to as an accumulated ____
deficit
retained earnings is sometimes referred to as
earned capital
the difference between the rate of return on assets (ROI) and the rate of return on stockholders' equity (ROE) is referred to as ____ leverage
financial
key advantage to a corporation of issuing debt as opposed to common stock to raise additional funds needed for capital investment projects
interest expense is deductible in calculating taxable income, whereas dividends are not tax deductible
the number of ____ shares is the number of shares of stock that have actually been transferred from the corporation to the stockholders
issued
when bonds are called, the ____ usually has to pay a call ____
issuer; premium
the income statement is not affected by stock dividends because the transaction is between the corporation and
its stockholders (who are the corporation); no gain or loss can result from a capital transaction
cash is debited for the ____ value per share of common stock issued
market
bonds are often issued at a premium or discount, largely because of
market interest rate fluctuations that occur form the time the stated interest rate is established until the bonds are issued
stockholders' equity is sometimes referred to as
net assets
dividends decrease retained earnings directly, and thus do not affect ____
net income (loss)
the number of ____ shares will be less than the number of issued shares if the firm has ____ stock
outstanding; treasury
additional paid-in capital is a stockholders' equity category that reflects the excess of the amount received from the sale of preferred or common stock over the ____ value per share
par
in most states, the ____ value per share represents the legal capital on the corporation
par
preferred stock issues that provide for ____ dividends may result in the preferred stockholders receiving additional dividends beyond the annual preferred dividend requirement
participating
the stockholder of record is the person to whom the dividend check is made payable and mailed to on the ____ date
payment
contingent liabilites
potential claims on a company's resources arising from such things as pending litigation, environmental hazards, casualty losses to property, and product warranties
most bonds in existence today and all bonds issued in recent years are ____ bonds
registered
effective method
results in more amortization in later years
____ represents the cumulative earnings the corporation has retained for use in the business
retained earnings
dividends declared during the period decrease ____
retained earnings
net income for the period increases ____
retained earnings
net loss for the period decreases ____
retained earnings
as market interest rates fall, bond prices ____
rise
a reverse stock split
sometimes occurs when the market price of a company's common stock has settled in a lower level than management thinks is appropriate
the issuance of additional shares of common stock to stockholders in proportion to the number of shares each currently owns is referred to as a ____
stock dividend
straight-line method
the amount of discount or premium amortization on bonds is the same each year
retained earnings
the entity's cumulative earnings less any dividends paid over the life of the entity
serial bond
the face amount of this bond is repaid in installments over time
adjusted for compounding frequency, this is the discount rate used in the present value calculations for bond pricing
the market interest rate