Chapter 13

Earnings per share (EPS)

Sometimes called earnings per common share or basic earnings per share, is the net income per share of common stock outstanding during a period

Three dates included in a dividend annoucement

1. Date of declaration 2. Date of record 3. Date of payment

Deficit

A debit balance in Retained Earnings

Contributed capital

Capital contributed to the corporation by stockholders

Paid-in capital

Capital contributed to the corporation by stockholders

CEO

Chief executive-officer

What are the primary classes of paid-in capital

Common stock Preferred stock

Contractual restrictions of retained earnings

Corporation may enter into contracts that require restrictions of retained earnings. Example: A bank loan may restrict retained earnings so that the amount for repaying the loan cannot be used for dividends.

Date of declaration

Date of board of directors formally authorizes the payment of dividend

(T/F) A corporation may not reacquire some of the stock that it has issued.

False A corporation may reacquire some of the stock that it has issued.

Discount

If the stock is issued (sold) for a price that is less than its par

Premium

If the stock is issued (sold) for a price that is more than its par

Costs may be incurred in organizing a corporation. These costs include:

Legal fees Taxes State incorporation fees License fees Promotional costs

Retained earnings

Net income retained in the business

If there is one class of stock the account is entitled _____ stock or ____ stock.

common; capital

Retained Earnings normally has a _____ balance.

credit

Deficit results from accumulated net _____.

losses

Stock

shares of ownership

Issue (corporations)

shares sold to the stockholders

Treasury stock

stock that a corporation has issued and then reacquired

Outstanding stock

the stock remaining in the hands of stockholders

Two closing entries to retained earnings for a period:

1. Debit each revenue account for its balance, credit each expense account for its balance, and credit (net income) or debit (net loss) the retained earnings account. 2. Debit the retained earnings account for the balance of each dividend account and credit each dividend account.

Discretionary restrictions of retained earnings

Corporation's board of directors may restrict retained earnings voluntarily. Example: The board may restrict retained earnings and, thus, limit dividend distributions so that earnings are available for expanding the business.

Corporation taxes

Corporations must pay federal income tax on their income Stockholder must pay income taxes on the dividends they receive.

Nonpublic or private corporations

Corporations whose shares are not traded publically are usually owned by a small group of investors

Prior period adjustment

Correction of error is reported in the retained earnings statement as an adjustment to the beginning balance of retained earnings.

In arrears

Cumulative preferred stock dividends that have not been paid in prior year

A corporation may reacquire its own stock for a variety of reasons, including the following:

To provide shares for resale to employees To reissue as bonuses to employees To support the market price of the stock

Major objective of a stock split

To reduce the market price per share of the stock. This attracts more investors and broadens the types and number of stockholders.

Since dividends are normally based on earnings, a corporation (can/cannot) guarantee dividends even to preferred stockholders.

cannot

Cash Dividend

cash distribution of earnings by a corporation to its stockholders

When stock is issued in exchange for assets other than ____, such as land, buildings, and equipment, the assets acquired are recorded at their ______ _____ value. If this value cannot be determined, the fair market value of the ____ issued is used.

cash; fair market; stock

No dividends (_____ or _____) are paid on the shares of _____ stock. To do so would result in the corporation earning dividend revenue from ______.

cash; stock; treasury; itself

Public corporation

corporations whose shares of stock are traded in public markets

To the extent that Paid-In Capital from Sale of Treasury stock has a _____ balance, it is _____ for any such decrease. Any remaining decrease is then ____ to the retained earnings account.

credit; debited; debited

When stock is issued at a premium, Cash is ______ for the amount received. Common Stock or Preferred Stock is ______ for the par amount. An account entitled __________ ________ _______ _______ _____ is credited for the excess of the amount paid over par.

debited; credited; Paid-In Capital in Excess of Par

When no-par stock is issued, Cash is ____ and Common stock is ____ for the proceeds. As no-par stock is issued over time, this entry is the same even if the ______ price varies.

debited; credited; issuing

Costs incurred in organizing a corporation are ______ to an _____ account entitled Organizational _______.

debited; expense; Expenses

Stock dividends normally are ____ only on common stock and _____ to common stockholders.

declared: issued

In the Stockholders' Equity section, a deficit is _____ from paid-in capital in determining total ______'s equity.

deducted; stockholder

Stock dividend

distribution of shares of stock to stockholders

Dividends

distributions of a corporation's earnings to stockholders.

The dividend rights of a preferred stock are stated either as ____ ___ _____ or as a percent of par _____ ____ _____.

dollars per share; percent of par

Stockholder's equity

owner's equity in a corporation

The stated value is recorded like a ____ _____. Any excess of the proceeds over the ____ value is credited to __________ ________ __ ______ __ _______ _______.

par value; stated; Paid-In Capital in Excess of State Value.

Stockholders or shareholders

people who own the stock own the coporation.

Net income increases ____ earnings, while a net loss and dividends decrease _____ earnings.

retained; retained

Stockholders of all corporations have limited liability, meaning:

that creditors usually may not go beyond the assets of the corporation to satisfy their claims. Thus, the financial loss that a stockholder may suffer is limited to the amount invested.

The net increase or decrease in retained earnings for a period is recorded by ____ closing entries.

two

Two main sources for stockholders' equity:

Paid-in capital Retained earnings

Stock split

Process by which a corporation reduces the par of stated value of its common stock and issues a proportionate number of additional shares. Applies to all common shares included in the unissued, issued, and treasury shares.

Par value

The stock certificate may also indicate a dollar amount assigned to each share of stock

Cumulative preferred stock

has a right to receive regular dividends that were not declared (paid) in prior years.

In some states, _______ stock may be assigned a stated value per share.

no-par

Stock dividend affected only _____'s equity. Specifically, the amount of the stock dividend is transferred from ___________ to __________. The amount transferred is normally the ________ (_______) of the shares issued in the stock dividend.

stockholder; Retained Earnings; Paid-in Capital; fair value; market price

____ gives corporations the ability to raise large amounts of capital.

Stock

Issuing stock

A separate account is used for recording the amount of each class of stock issued to investors to a corporation. Stock is often issued by a corporation at a price other than its par.

Corporation as a legal entity may

Acquire, own and dispose of property in its own name. May incur liabilities and enter into contracts. Most importantly, it can sell stock.

Date of record

Date the corporation uses to determine which stockholders will receive the dividend

Date of payment

Date the corporation will pay the dividend to the stockholders who owned the stock on the date of record

Board of directors of a corporation

This board meets periodically to establish corporate policies. It also selects a CEO and other major officers to manage the corporation's day-to-day affairs.

Earnings per share equiation

Earnings per share = (Net Income - Preferred Dividends) ÷ Average Number of Common Shares Outstanding

Advantages of the corporate forum: 1. Separate legal existence 2. Continuous life 3. Raising large amounts of capital 4. Ownership rights are easily transferrable 5. Limited liability

Explanation of advantages: 1. A corporation exists separately from its owners. 2. A corporations life is separate from its owners; therefore it exists indefinitely. 3. The corporate form is suite for raising large amounts of money from shareholders. 4. A corporation sells shares of ownership, called stock. The stockholders of a public company can transfer their shares of stock to other stockholders through stock markets such as the New York Stock Exchange. 5. A corporation's creditors usually may not go beyond the assets of the corporation to satisfy their claims. Thus, the financial loss that a stockholder may suffer is limited to the amount invested.

Disadvantages of the Corporate Form 1. Owner is separate from management 2. Double taxation of individuals 3. Regulatory costs

Explanation of disadvantages: 1. Stockholders control management through a board of directors. The board of directors shoulds represent shareholder interests: however, the board is often more closely tied to management than to shareholders. As a result, the board of directors and management may not always behave in the best interests of stockholders. 2. As a separate legal entity, a corporation is subject to taxation. Thus, net income distributed as dividends will be taxed once at the corporation level and then a gain at the individual level. 3. Corporations must satisfy many regulatory requirements, such as those required by the Sarbanes-Oxley Act.

(T/F) A stock dividend does change the assets, liabilities, or total stockholders' equity of a corporation.

False A stock dividend does not change the assets, liabilities, or total stockholders' equity of a corporation.

(T/F) Although dividends may be paid in other assets, additional stock dividends are most common.

False Although dividends may be paid in other assets, cash dividends are most common.

(T/F) Any dividends in arrears are normally not disclosed in notes to the financial statements.

False Any dividends in arrears are normally disclosed in notes to the financial statements.

(T/F) Noncumulative preferred stock does have the right to receive regular dividends

False Noncumulative preferred stock does not have the right to receive regular dividends.

(T/F) State incorporations laws are very similar, and corporations often organize in their founders' state.

False State incorporation laws differ, and corporations often organize in those states with the more favorable laws. For this reason, more than half of the largest companies are incorporated in Delaware.

Forming a corporation steps:

File an application of incorporation with the state 2. After application approved, the state grants a charter or articles of incorporation. 3. The corporate management and board of directors then prepare a set of bylaws, which are the rules and procedures for conducting the corporation's affairs

Cost method

Normally used for recording the purchase and resale of treasury stock. Using the cost method, Treasury Stock is debited for the cost (purchase price) of the stock. When the stock is resold, Treasury Stock is credited for its cost. Any difference between the cost and the selling price is debited for credited to Pain-In Capital from Sale of Treasury Stock.

Characteristics of a corporation

Legal entity, distinct and separate from the individuals who create and operate it. Stockholders can buy and sell stock without affecting the corporation's operations or continued existence. The stockholders of all corporations have limited liability. Stock holders control a corporation by electing a board of directors. As a separate entity, a corporation is subject to taxes.

What are the two methods that can be used for reporting stockholders; equity on the balance sheet?

Method 1: Each class of stock is reported, followed by its related pain-in capital accounts. Retained earnings is then reported, followed by a deduction for treasury stock. Method 2: The stock accounts are reported, followed by the paid-in capital reported as a single item, Additional paid-in capital. Retained earnings is then reported followed by a deduction for treasury stock.

Statement of stockers' equity

Normally prepared when a corporation also has changes in stock and paid-in capital accounts.

Legal restrictions of retained earnings

State laws may require a restriction of retained earnings Example: States may restrict retained earnings by the amount of treasury stock purchased. In this way, legal capital cannot be used for dividends.

The stock dividends distributable and pain-in capital in excess of par-- common stock accounts are reported in the _________ _______ section of the balance sheet.

Paid-in Capital

There must be a sufficient (large enough) balance in _________ to declare a cash dividend. That is, the balance of ____________ must be large enough so that the dividend does not create a _____ balance in the _______________ account. However, because the balances of Cash and Retained Earnings are often unrelated, a large Retained Earnings balance does not mean that there is ____ available to pay _____.

Retained Earnings; Retained Earnings; debit; retained earnings; cash; dividends

The stock dividends account is closed to _______ at the end of the accounting period. This closing entry ________ Retained Earnings and _____ Stock Dividends

Retained Earnings; debits; credits

Major rights that accompany ownership of a share of stock:

Right to vote in matters concerning the corporation. Right to share in distributions of earnings. Right to share in assets upon liquidation.

Changes in retained earnings may be reported using one of the following:

Separate retained earnings statement Combined income and retained earnings statement Statement of stockholders' equity

Other names for stockholders' equity

Shareholders' equity, shareholders' investment, or capital

The conditions for a cash dividends are:

Sufficient retained earnings Sufficient cash Formal action by the board of directors.

The price at which stock is sold depends on a variety of factors, such as the following:

The financial condition, earnings record, and dividend record of the corporation Investor expectations of the corporation's potential earning power General business and economic conditions and expectations

Legal capital

The minimum amount of pain-in capital to protect creditors. This usually includes the par or stated value of the shares issued.

Characteristics of Stock

The number of shares of stock that a corporation is authorized to issue is stated in its charter. Corporations may issue stock certificates to stockholders to documents their ownership Stock may be issued without par Some states require corporations to maintain a minimum amount of paid-in capital to protect creditors. Major rights that accompany ownership of a share of stock.

Restrictions (appropriations)

The use of retained earnings for payment of dividends may be restricted by action of a corporations' board of directors. Remain part of the retained earnings. They are usually disclosed in the notes to the financial statements.

(T/F) A sale of treasury stock may result in a decrease in pain-in capital.

True

(T/F) Any preferred dividends in arrears must be paid before any common stocks dividends are paid.

True

(T/F) Corporations whose stock is traded in a public market must report earnings per share on their income statements

True

(T/F) Errors may arise from a mathematical mistake or from a mistake in applying accounting principles. Such errors may not be discovered within the same period in which they occur. In such cases, the effect of the error should not affect the current period's net income.

True

(T/F) In some cases, a debit balance in Retained Earnings may occur.

True

(T/F) In some states, the board of directors of a corporation is required to assign a stated value to no-par stock

True

(T/F) Preferred stockholders have first rights (preference) to any dividends; thus, they have a greater chance of receiving dividends than common stockholders.

True

(T/F) Retained Earnings is unaffected by the investments, its balance does not represent cash or cash available from dividends.

True

(T/F) Retained earnings is a corporation's cumulative net income that has not been distributed as dividends.

True

(T/F) The articles of incorporation formally create the corporation.

True

(T/F) The pain-in capital contributed by the stockholders is recorded in separate accounts for each class of stock.

True

(T/F) When the only change to stockholders' equity is due to net income or net loss and dividends, a retained earnings statement is sufficient.

True

Preferred stock

When a corporation issues one or more classes of stock with various preference rights, such as preference to dividends.

Common stock

When only one class of stock is issued. Each share of common stock has equal rights.

On the _______, the stockholders' equity is reported by its _____ main sources.

balance sheet; two

When a separate Retained earnings Statement is prepared, the ______ balance of retained earnings is reported. The net income is then added (or net loss is subtracted) and any dividends are ______ to arrive at the ending retained earnings for the period.

beginning; subtracted

Payment of dividends is authorized by the corporations ____ __ _____. When authorized, the directors are said to have declared a _________.

board of directors; dividend