Quiz 3 Accounting

Common stock

held by individuals who are thought of as the owners because they have the right to vote and share in profitability of the business through dividends.

price of a share of stock

if a companies profitability improves so that it can pay higher dividends the present value of its common stock will increase.

investing activities include all remaining assets on the balance sheet include:

short-term investments, PP and E

Sale of stocks in secondary markets

while managers watch the stock price on a daily basis, transactions between investors do not directly affect the company's financial statements

Working Capital

firm's ability to generate cash internally through operations and its management of current assets and current liabilities

Initial public offering (IPO)

very first sale of a company's stock to the public (going public)

record journal entry or repurchase

-most companies record the purchase of treasury stock based on the cost of the shares that were purchased Treasury stock cash

both methods

alternative ways at arriving at the same answer

pro rata

each stockholder receives additional shares equal to the percentage of sales held.

Operating assets and liabilities include the following:

-most current assets (other than short-term investments and cash) -most current liabilities (other than amounts owed to investors) -retained earnings because it increases by the amount of net income, which is the starting point for the operating section (RE also decreases by dividends)

stockholder

-when you invest in a corporation -receive shares of stock

corporations issue 2 types of stock

-common stock -preferred stock

Ownership of a corporation

-corporation is the only business from the law recognizes as a separate entity -own assets, incur liabilities, expand and contract size, sue others, be sued, and enter into contracts independently of its stockholders -tightly regulated by law -state issues a charter -governed by a board of directors elected by stockholders

Debt

-less risky -less expensive -more restrictive through the lender -priority payment over equity holders

Equity

-more risky -more expensive -give up more control (voting rights) -residual claims to net assets after debt-holders are paid -holders may be paid dividends

Remember that

1. Cash flow from operating activities is always the same regardless of whether it is computed using the direct or indirect method 2. investing and financing sections are always presented in the same manner regardless of the format of the operating section

2 primary sources of stockholder's equity

1. Contributed capital: amount of money stockholder's invested through the purchase of shares (common stock + additional paid-in capital) 2. Retained earnings (NI-dividends)

Preliminary steps to prepare the cash flow statement

1. Determine the change in each balance sheet account. From the years ending balance, subtract this years beginning balance 2. Classify each change as relating to O,I, or F

2 steps in the operating method

1. adjust net income for depreciation and amortization expense and gains and losses on sale of investing assets (PP&E) -since depreciation and amortization are subtracted in computing Net Income but do not affect cash, we always add each back -gain on sales of PP&E are subtracted and losses are added 2, adjust net income for changes in assets and liabilities marked as operating (O) -add the change when an operating asset decreases or an operating liability increases -subtract the change when an operating asset increases or an operating liability decreases

To prepare the statement of cash flows they need the following data

1. comparative balance sheets-used in calculating the cash flows form all activities 2.complete income statement-used primarily from operating activities 3.additional details-concerning selected accounts where the total change amount in an account balance during the year does not reveal the underlying nature of the cash flows

Dividend announcement

1. declaration date: date on which the board of directors officially approves the dividend. as soon as it makes the declaration, it creates a dividend liability 2. record date: date on which the corporation prepares the list of current stockholders based on its records. the dividend is payable only to those names listed on the record date. no journal entry is made 3. payment date: cash is disbursed to pay the dividend liability.

3 categories of cash flows

1. operating 2.investing 3. financing

2 requirement for payment of cash dividend

1. sufficient retained earnings -corporation must have accumulated a sufficient amount of retained earnings to cover the amount of the dividend. 2. sufficient cash -corporation must have sufficient cash to pay the dividend and meet operating needs of the business. the cash generated in the past by earnings represented in RE may been expended. No necessary relationship between balance of RE and cash.

benefits of owners of stock

1. voice management: vote in the stockholders' meetings on major issues concerning management of the corporation (number of votes=number of shares owned) 2. dividends: receive a proportional share of the distribution or remaining assets upon liquidation of the company 3. residual claim: receive a proportional share of the distribution of remaining assets upon liquidation of the company

preferred stock differs from common stock based on a number of rights granted to the stockholders

1.preferred stock does not grant voting rights -increases equity capital without diluting common stockholder's control 2. less risky -holders receive priority payment of dividends and distribution of assets if the corporation goes out of business 3. fixed dividend rate -attractive to certain investors who want a stable income

dividend yield

=dividends per share / market price per share

assets can be split into cash and non cash assets

Cash+noncash assets=L + SE -any transaction that changes cash must be accompanied by a change in liabilities, stockholders equity, or non cash assets

reasons why a corporation may want to repurchase its stock from existing stockholders

Existence of employee bonus plan provides workers with shares of the companies stock as part of their compensation. because of SEC regulations, most companies find it less costly to give employees repurchased shares than issue new ones.

Earnings per share ratio

Net Income+Averages number of common shares outstanding

Cash flows from financing activities

exchanges of cash with creditors (debt holders) and owners (stockholders).

statement of cash flows

explains how the amount of cash on the balance sheet at the beginning of the period has become the amount of cash reported at the end of the period

small stock dividend

amount transferred should be the total market value of the shares issued, with the par value of the stock transferred to common stock and the excess transferred to the capital in excess of par value account

large stock dividend

amount transferred to common stock is based on the par value of additional shares issued

Issued shares

authorized shares sold to investors (=outstanding shares + treasury stock). stock that has been sold to the public

Outstanding shares

authorized shares that have been issued and currently held by investors

Treasury stock

authorized shares that have been issued but are no longer held by investors (contra-equity) account. they are being held by the corporation and have no voting, dividend, or other stockholder rights.

dividend policy is determined by the...

board of directors

stock options

buy stock at a fixed price -form of compensation risk-free investment

no-par value stock

capital stock that has no par value specified in the corporate charter

Journal entry for initial sale of stock

cash common stock capital in excess of par

stock price appreciation

companies that reinvest the majority of their earnings tend to increase their future earnings potential. capital gains are taxed at a lower rate than dividend income.

when a stock dividend occurs

company must transfer additional amount from RE account to common stock

common stock

credited for the number of shares times the par value per share and capital excess of par is credited for the remainder

stock dividend

distribution of additional shares of a corporation's own stock to its stockholder's on a pro rata basis at no cost to the stockholder.

why investors make so much money in stock market

dividends increase with a corporations profitability

dividends in arrears

dividends on cumulative preferred stock that have not been declared in prior years.

stock split

increase in the total number of authorized shares by a specified ratio. 2 for 1 plot each share held is called in and two new shares are issued in place. It reduces the par value of its stock from $1 to $0.5 and doubles the number of shares outstanding. In contrast, it does not result in the transfer of a dollar amount to the common stock account.

When a company sells a treasury stock

it does not report an accounting profit or loss on the transaction, even if it sells the stock for more than it paid. according to GAAP not considered a normal profit-making activity.

most stock dividends are classified as

large--more than 20-25% of currently outstanding shares (small is less than 20-25%)

Once the board of directors declares a dividend payable

legal obligation to pay the dividend

financing activities which include all remaining liabilities and SE

long-term debt, contributed capital, retained earnings for decreases from dividends

disadvantage of a corporation

management may not always act in the owner's best interest. how to fix: -compensation packages that reward managers for meeting goals that are important to stockholders -offer managers stock options, permit them to buy stock at a fixed price

indirect method starts with

net income and converts it to cash flows from operating activities

Par value

nominal value per share of capital stock as specified in the charter; serves as the basis for legal capital

seasoned new issues

once a company's stock has been traded on established markets, additional sales of new stock to the public

legal capital

permanent amount of capital defined by state law that must remain invested in the business; serves as a cushion for creditors by specifying an amount that owners could not withdraw before bankruptcy.

cumulative dividend preference

preferred stock feature that requires specified current dividends not paid in full to accumulate for every year in which they are not paid. these cumulative preferred dividends must be paid before any common dividends can be paid.

Cash flows from investing activities

purchase and disposal of long-lived productive assets and investments in the secruties of other companies.

Cash Flows from operating

relate directly to revenues and expenses reported on the income statement.

1. Direct method

reports the components of cash flows from operating activities as gross receipts and gross payments. -net cash inflow (outflow): difference between inflows and outflows -rarely used because it is more expensive than the indirect method

Current dividend preference

requires the current preferred dividend to be paid before any dividends are paid on the common stock.

advantages of a corporation

separate management of a business from its ownership

cash equivalents

short-term, highly liquid investments with original maturity of less than 3 months. they are both 1. readily convertible to known amounts of cash 2. so near to maturity there is little risk that their value will change if interest rates change examples: treasury bills, money market funds, commercial paper

corporate charter

specifies the maximum number of shares that can be sold to the public

2. Indirect method

starts with net income from the income statement and then eliminates non cash items to arrive at net cash inflow (outflow) from operating activities. -used by 99% of large US companies

dividends

steady income. utility stocks.

Return can come in 2 forms

stock price appreciation and dividends

treasury stock

stock that has been bought back

Treasury stock

stock that has been required and is held by the issuing corporation. these shares have no voting, dividend, or other stockholder rights while they are held as treasury stock. (contra-equity account)

Issued Shares

stock that has been sold to the public

preferred stock

stock that has specified rights over common stock

in both a stock dividend and stock split

stockholder receives more shares of stock without having to invest additional resources.

authorized number of shares

the maximum number of shares of common stock that can be issued as specified by the charter

if the corporate charter does not specify a par value...

the states value is used in the same manner. if there is no stated or par value the entire proceeds from the sale will be entered under the common stock account.

investors buy common stock because...

they expect return on investment

authorized shares

total number of shares board of directors allows the firm to sell as equity

Outstanding shares

total number of shares of stock that are owned by stockholders on any particular date (issued shares-treasury stock=outstanding shares)