ACC 201 Ch 11. Reporting and Analyzing Stockholders' Equity
Return on Common Stockholders' Equity (ROE) =
(net income - preferred dividends) / average common stockholders' equity
List three reasons why buying stock in a corporation is often attractive to an investor
-limited liability -shares are readily transferable -can invest in relatively small amounts
Suppose a company splits its shares of common stock that currently have a par value of $10 on a 2 for 1 basis. This means that _______ share(s) of $______ par value stock is exchanged for ________share(s) of $__________ par value stock.
1, 10 2, 5
List the two classifications of Paid-in capital as well as the items listed in each.
1. Capital stock -preferred stock -common stock 2. Additional paid-in capital -Paid-in capital in excess of par value- preferred stock -Paid-in capital in excess of par value- common stock
Describe the cumulative effect of the declaration and payment of a cash dividend on assets, liabilities, and stockholders equity on financial statements.
1. Decrease in stockholders' equity (due to the increase in Cash Dividends at the declaration date) 2. Decrease in total assets (due to decrease in Cash at payment date) no cumulative effect on total liabilities, since Dividends Payable increases at declaration date, then decreases by that same amount at payment date
List three possible causes for retained earnings restrictions.
1. Legal: States may require the corporations restrict RE for the cost of treasury stock purchased. 2. Contractual long term debt contracts may restrict RE as a condition for loan. 3. Voluntary the board of directors may voluntarily restrict RE for specific purposes such as future plant expansion.
List the four main items listed in the stockholders' equity section of the balance sheet.
1. Paid-in capital 2. Retained earnings 3. Accumulated other comprehensive income 4. treasury stock
In terms of obtaining long-term capital, the issuance of bonds has three primary advantages relative to the sale of common stock:
1. Stockholder control is not affected (current stockholders retain full control of the company) 2. Tax savings results 3. ROE may be higher
Three dates are important in connection with dividends:
1. The declaration date 2. The record date 3. The payment date
List four reasons why a corporation may acquire treasury stock
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 the 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.
List three reasons why a company might issue stock dividends.
1. To satisfy stockholders' dividend expectations without spending cash. 2. To increase the marketability of its stock 3. To emphasize that a portion of stockholders' equity has been permanently reinvested in the business and is, therefore, unavailable for cash dividends.
List two ways to classify corporations
1. by purpose: for-profit not-for-profit 2: by ownership publicly held corporation privately held corporation
Dividends can take four forms:
1. cash 2. property 3. scrip (promissory note to pay cash) 4. stock
list three examples of comprehensive income items
1. certain adjustments to pension plan assets 2. types of foreign currency gains and losses 3. some gains and losses on investments
List 3 disadvantages of existing as a corporation rather than existing as a partnership/proprietorship.
1. corporation management- separation of ownership and management 2. government regulations 3. additional taxes
preferred stockholders have priority over common stockholders in relation to
1. dividends 2. assets in the event of liquidation
Once an organization has been incorporated (through the state charter), it must
1. establish by-laws 2. obtain a license from each state in which they do business
list two responsibilities of the board of directors
1. formulates operating policies 2. selects officers to execute policy and to perform daily management functions.
List the two ways in which a company can increase its ROE
1. increase ROA 2. increase reliance on debt financing (issue more bonds)
Suppose a company declares a 10% stock dividend on its $10 par common stock when 50,000 shares are outstanding. The market price at the declaration date is $15 per share. Describe the effects that this has on the stockholders' equity section of the balance sheet.
1. increase total paid in capital by $75,000 (50,000 shares x 10% x $15); Common Stock increase by $50,000 and Paid-in Capital in Excess of Par increases by $25,000 2. decreases Retained Earnings by $75,000
For corporations, state regulations prescribe requirements for:
1. issuing stock, 2. distributions of earnings permitted to stockholders, and 3. the acceptable methods of buying back and retiring stock.
List two responsibilities of the treasurer
1. maintain custody if the corporation's funds 2. maintain the corporations cash position
List three responsibilities of the controller
1. maintaining the accounting records 2. ensuring an adequate system of internal control 3. preparing financial statements, tax returns, and internal reports
Transfer of ownership rights among stockholders has no effect on
1. operating activities of the corporation 2. corporation's assets, liabilities, and total stockholders' equity.
When capital stock is listed on the balance sheet, information is reported about which four things?
1. par value 2. shares authorized 3. shares issued 3. shares outstanding
For a corporation to pay a cash dividend, it must have the following:
1. retained earnings 2. adequate cash 3. declared dividends
For corporations, federal securities laws govern
1. sale of capital stock to general public 2. disclosure of financial affairs to SEC through quarterly and annual reports, and 3. the reporting requirements of the various securities markets.
list the two ways to obtain long-term capital
1. sell common stock (equity financing) 2. issue bonds (debt financing)
List 6 advantages of existing as a corporation over existing as a partnership/proprietorship.
1. separate legal existence 2. limited liability of shareholders 3. transferable ownership rights 4. ability to acquire capital 5. continuous life 6. corporation management- professional managers
List 8 important characteristics that distinguish a corporation from proprietorships and partnerships
1. separate legal existence 2. limited liability of stockholders 3. transferable ownership rights 4. ability to acquire capital 5. continuous life 6. corporation management 7. government regulations 8. additional taxes
Describe the delegation of responsibiity in the management of a corporation.
1. stockholders elect chairman and board of directors 2. chairman and board of directors select president and CEO 3. President and CEO delegate responsibility to other officers, including VP of finance/CFO 4. VP of finance/CFO delegates responsibility to the treasurer and to the controller
List three names for owners equity
1. stockholders' equity 2. shareholders' equity 3. corporate capital
List the two primary objectives in accounting for the issuance of common stock
1. to identify the specific sources of paid-in-capital 2. to maintain the distinction between paid-in-capital and retained earnings.
The stockholders' equity section of a corporation's balance sheet includes: (list the two parts)
1.paid-in (contributed) capital 2. retained earnings (earned capital).
Pro rata means that if you own 10% of the common shares, you will receive
10% of the dividend
In order for an organization to exist as an S corporation, there must be no more than _________________ shareholders.
100
What is the main difference between the issuance of stock dividends and stock splits?
A stock split results in a reduction in the par or stated value per share, a stock dividend does not.
comprehensive income items are closed each year to the _________________________________ account.
Accumulated Other Comprehensive Income
describe how a deficit appears on the balance sheet.
Accumulated deficit is deducted from Total paid-in capital to get Total paid-in capital and retained earnings
If a balance sheet is prepared before the issuance of stock dividends that have been declared, describe how the declared dividends appear on the sheet.
Common Stock Dividends DIstributable are listed under Paid-in capital, added to Common Stock to get Total paid-in capital
Describe the difference between a corporation and a partnership in terms of legal existence
Corporation: -Acts under its own name rather than name of stockholders. -Acts of owners (stockholders) are not binding unless owners are agents of the corporation. Partnership: -Acts of owners (partners) are binding
Describe what it means to say that owners of a corporation (stockholders) have limited liability.
Creditors of the corporation have no legal claim on personal assets of owners unless fraud has occurred
A debit balance in retained earnings is identified as a ________________.
Deficit
T or F: No-par stock is capital stock that has a market value of zero.
F
T or F: Par value stock has been assigned a value per share that is equal to its market value.
F
T or F: The amount of stock that a corporation is authorized to sell is established through various organized U.S securities exchanges.
F
T or F: cash dividends are payed on all issued shares, including treasury shares.
F; Cash dividends are not paid on treasury shares.
T or F: The payment of the cash dividend reduces stockholders' equity.
F; Payment of the dividend REDUCES both current assets and current liabilities but has no effect on stockholders' equity.
T or F: Proof of stock ownership is evidence by the charter.
F; Proof of stock ownership is evidence by a stock certificate
T or F: Unlike par value, the stated value corresponds to the market value of the stock.
F; Stated value, like par value, does not indicate or correspond to the market value of the stock. The stated value of no-par stock may be changed at any time by action of the directors.
T or F: Stock dividends are not journalized, but stock splits are.
F; Stock splits are not journalized, but stock dividends are.
T or F: a $100,000 balance in Retained Earnings means that there is $100,000 in cash
F; The balance in Retained Earnings does not represent any specific asset
T or F: Because preferred stockholders have the first claim to dividends, they are garunteed dividends.
F; The first claim to dividends does not guarantee dividends.
T or F: The issuance of common stock affects both Paid-in capital and Retained Earnings accounts.
F; The issuance of common stock affects ONLY PAID IN CAPITAL ACCOUNTS
T or F: Today, most states require a par value.
F; Today, many states do not require a par value. Instead, they use other means to protect creditors.
T or F: Dividends in arrears are listed on the balance sheet as a liability.
F; dividends in arrears are not a liability because no obligation exists until the board of directors declares a dividend. The amount of dividends in arrears should be disclosed in the notes to the financial statements.
Some states have laws favorable to the corporate form of business organization, and thus many organizations choose to incorporate in these states. Provide one example
In the state of Delaware, defense tactics against takeovers can be approved by the board of directors without a vote by shareholders
describe the entry made when a company declares a cash dividend.
Increase (debit) Cash Dividends Increase (credit) Dividends Payable
Paid-in Capital in Excess of Par Value _____________ (increases/decreases) stockholders equity.
Increases
Explain why a company does not incur any liabilities in the issuance of stock dividends.
Issuance of additional shares of stock does not change the total amount of the dividend that the company owes to shareholders, it just changes the amount by which the dividend is divided
describe the entry made at the record date of a cash dividend.
No entry is required on the record date.
____________________ stock is capital stock that has not been assigned a value per share in the corporate charter.
No-par value
__________________stock is capital stock that has been assigned a value per share in the corporate charter. The value may be any amount selected by the corporation.
Par value
In general, as long as the _____________________ exceeds the _____________________________, a company will increase ROE by the use of debt.
ROA Rate, interest rate paid on bonds
___________is net income that is retained in the business.
Retained Earnings
List one tool used to evaluate a companys earnings performance
Return on Common Stockholders' Equity (ROE)
List four types of hybrid organizations
S corporations limited partnerships limited liability partnerships limited liability corporations
T or F: Although a corporation may have operating divisions in a number of states, it will be incorporated in only one state.
T
T or F: Corporation does not participate in transfer of ownership rights after original sale of capital stock.
T
T or F: If all authorized stock is sold, a corporation must obtain consent of the state to amend its charter before issuing additional shares.
T
T or F: The issuance of the common stock affects only paid-in capital accounts.
T
T or F: declaration of stock dividends does not result in distribution of assets.
T
T or F: the original Paid-in capital account is not affected when a company acquires treasury stock.
T (because the number of total issued shares does not change)
Describe how the issuance of no-par common stock with a stated value is accounted for.
The Stated value is treated same as par value Paid-in Capital in Excess of Stated Value account is used if necessary
Explain what it means for an investment banking firm to underwrite an entire stock issue.
The bank buys the stock from the issuer at a certain percentage less than full price, the resells it to investors at full price.
Describe taxation of partnerships/proprietorships
The owners each report their share of earnings on their personal income tax returns, then each individual owner pays taxes on the amount that they reported
Describe how Treasury Stock appears on the balance sheet.
Treasury Stock is deducted from Total paid-in capital and retained earnings to get Total stockholders equity
A stock dividend results in _____________________(an increase in/a decrease in/no change to) retained earnings, _____________________(an increase in/a decrease in/no change to) Paid-in capital, and ____________________ (an increase in/a decrease in/no change to) total stockholders equity.
a decrease in, an increase in, no change to
Corporations typically record small stock dividends at fair/market value per share because of the assumption that
a small stock dividend will have little effect on the market price of shares previously outstanding (since in the issuance of a small stock dividend, the total number of issued shares increases by a small amount, and the market price per share decreases by a small amount).
Explain how Paid-in capital in excess of par value appears on the balance sheet.
added to Common Stock to get Total paid-in capital
a charter is also known as
articles of incorporation
Why is Common Stock Dividends Distributable a stockholders' equity account rather than a liability account?
because the dividends will not be paid with assets
Why might an organization choose to exist as an S corporation?
because while S corporations still receive legal treatment as corporations, they receive tax treatment as partnerships (no double taxation)
The _____________________ has full authority to determine the amount of income to be distributed in the form of dividends and the amount to be retained in the business.
board of directors
Stockholders manage corporation indirectly through a
board of directors, which they elect
How is a corporation formed?
by grant of a state charter
How does issuance of stock dividends increase the marketability of the companys stock?
by increasing the number of shares outstanding and thereby decreasing the market price per share to make it easier for smaller investors to purchase the shares.
The issuance of stock dividends is also referred to as
capitalizing retained earnings
Paid-in capital is the total amount of
cash and other assets paid in to the corporation by stockholders in exchange for capital stock.
payout ratio =
cash dividends declared on common stock/net income
Life of corporation is stated in the _________________ and may be _____________ or __________________________________________-.
charter, perpetual, limited to specific number of years
a privately held corporation is often referred to as a(n)
closely held corporation
The declaration of a cash dividend
commits the corporation to a binding legal obligation that cannot be rescinded.
When a corporation has only one class of stock, it is identified as
common stock
Declaration of stock dividends changes the ______________ not the __________________ of total stockholders equity.
composition, amount
Treasury Stock is a(n) _____________________________ account, and thus has a normal _______________ (debit/credit) balance.
contra stockholders' equity, debit
Paid-in capital is sometimes called
contributed capital.
In a corporation, the chief accounting officer is referred to as the
controller
The amount of stock a corporation is authorized to sell is indicated in the
corporate charter
an entity created by law that is separate and distinct from its owners.
corporation
Describe the concept of double taxation
corporations are taxed 1. once at the corporate level (the corporation must pay federal and state income taxes as a separate legal entity), and 2. once at the individual level (stockholders must pay taxes on cash dividends)
The purchase of treasury stock is generally accounted for by the __________method.
cost
Common Stock has a normal _________ balance.
credit
Paid-in Capital in Excess of Par Value has a normal ________________ balance.
credit
Describe how the issuance of no-par common stock without a stated value is accounted for.
credit common stock by the full amount of cash received
Preferred stock contracts often contain a _________________________-feature.
cumulative dividend feature
If preferred stock is cumulative, preferred stockholders must be paid both_______________________ and any_______________________ before common stockholders receive dividends.
current-year dividends, dividends in arrears
Cash Dividends has a normal ____________ balance.
debit
If cumulative net losses exceed cumulative income over a company's life, there is a __________ (debit/credit) balance in Retained Earnings results.
debit
Net income is recorded in Retained Earnings by a closing entry. Describe this entry
debit (decrease) Income Summary credit (increase) Retained Earnings
Describe the journal entry made when the issuance of preferred stock for cash is recorded, and the par value of the shares is NOT the same as the cash price
debit Cash credit Preferred Stock credit Paid-in Capital in Excess of Par Value- Preferred Stock
describe the entry made when a company acquires shares of its own stock (purchases treasury stock)
debit Treasury Stock credit Cash
describe the journal entry made when a company issues par value common stock at par for cash.
debit cash by par value credit (increase) Common Stock by par value
Describe the journal entry made when the issuance of common stock for cash is recorded, and the par value of the shares is NOT the same as the cash price
debit cash for total amount of cash received credit common stock by total par value of the shares credit Paid-in Capital in Excess of Par Value by difference
Dividends are not a liability until they are
declared
describe the entry made to record the issuance of stock dividends
decrease (debit) Common Stock Dividends Distributable increase (credit) Common Stock
describe the entry made at the payment date of a cash dividend.
decrease (debit) Dividends Payable decrease (credit) Cash
An increase in Cash Dividends ________________ (increases/decreases) stockholders' equity.
decreases
Though the acquisition of treasury stock does not affect the original paid-in capital account, it ________________ (increases/decreases) total stockholders' equity.
decreases
Stock Dividends _______________ (increases/decreases) stockholders' equity and thus has a normal _______________ (debit/credit) balance.
decreases, debit
A net loss _______________ (increases/decreases) retained earnings, and thus in closing entries, a company ___________ (debits/credits) a net loss to the Retained Earnings account
decreases, debits
A corporation can issue common stock ____________________which is typically the case for closely held companies, or it can issue common stock ___________________________________which is customary for a publicly held corporation.
directly to investors, indirectly through an investment banking firm
a distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis.
dividend
Investors are interested in both a company's _______________________ and its _____________________.
dividend record earnings performance
When preferred stock is cumulative, preferred dividends not declared in a given period are called
dividends in arrears
The Return on Common Stockholders' Equity (ROE) ratios shows how many _______________________________were earned for each ________________________________.
dollars of net income, dollar invested by common stockholders
When recording the declaration of stock dividends, the amount debited to Stock Dividends uses the total ___________________ (fair/par) value of the shares issued.
fair
What does the bank gain from allowing investment banking firms to underwrite an entire stock issue?
gives away the risk
A large stock dividend is _________________________ of the corporations stock and is recorded at _____________________ per share.
greater than 20% - 25% par or stated value
describe the entry made at the declaration date of stock dividends (assuming the current fair value is greater than the par value)
increase (debit) Stock Dividends increase (Credit) Common Stock Dividends Distributable increase (credit) Paid-in Capital in Excess of Par Value
Describe how to account for the purchase of treasury stock under the cost method
increase (debit) treasury stock by the price paid to reacquire the shares decrease (credit) treasury stock by that same amount when later selling the shares
The purpose of a stock split is to
increase the marketability of the stock by lowering its market prices per share.
How does the issuance of stock dividends affect the number of outstanding shares and the par value per share?
increases number of outstanding shares NO CHANGE IN PAR VALUE, this is only changed if the company manually changes it
The effect of a stock split on market price is generally _____________ (directly/inversely) proportional to the size of the split.
inversely
List the main disadvantage of the issuance of bonds to obtain long-term capital
it reduces solvency (because the company must pay interest regardless of whether they are in a period of low earnings or high earnings)
Years ago, par value determined
legal capital per share that a company must retain in the business for the protection of corporate creditors. That amount was not available for withdrawal by stockholders.
A small stock dividend is _________________________ of the corporations stock and is recorded at _____________________ per share.
less than 20% - 25%, fair value (market price)
describe how Preferred Stock appears on the balance sheet
listed before Common Stock because it is more liquid
Companies that have high growth rates are characterized by ________________(high/low) payout ratios because they reinvest most of their net income in the business.
low
Why might a low payout ratio be concerning?
low dividend payments might signal that a company has liquidity or solvency problems
Explain why increasing reliance on debt financing (issue more bonds) results in a higher ROE than if the company were to issue additional stock.
net income is spread over a smaller amount of common stockholders equity
Retained earnings is
net income that a corporation retains for future use.
A stock split results in _____________________(an increase in/a decrease in/no change to) retained earnings, _____________________(an increase in/a decrease in/no change to) Paid-in capital, and ____________________ (an increase in/a decrease in/no change to) total stockholders equity.
no change to, no change to, no change to
number of shares issued - number of shares in treasury =
number of shares oustanding
Costs incurred in the formation of a corporation are called ______________________ and are _______________________.
organization costs, expensed as incurred
What does the company determine at the record date?
ownership of the outstanding shares for dividend purposes; the dividend to be paid to each stockholder
Many states prohibit payment of dividends from legal capital. However, payment of dividends from _______________________________ is legal in some states.
paid-in capital in excess of par
If the corporation fails, most preferred stocks have a preference to the corporations assets for the _________________ value of the shares or for a ___________________ value.
par, specified liquidating
List one tool used to evaluate a companys dividend record
payout ratio
Stockholders' right to maintain their proportionate interest in a corporation with any additional shares issued.
preemptive right
Return on Common Stockholders' Equity (ROE) measures
profitability from the common stockholders' view point.
A ______________________corporation may have thousands of stockholders and its stock is traded on a national exchange. A __________________ corporation usually has only a few stockholders and does not offer its stock for sale to the general public.
publicly held, privately held
Dividends are typically reported ___________________ as a(n) _________________________.
quarterly, dollar amount per share **i.e. "quarterly dividend rate of 24 cents per shares"
If the life of a corporation is stated in the charter as limited, the corporations period of existence can be extended through ________________________________.
renewal of charter.
Because the acquisition of treasury stock reduces stockholders equity, what do many states do to protect creditors (stockholders)?
require that a portion of Retained Earnings equal to the cost of the treasury stock purchased by restricted from being paid out as dividends
stockholders are the last in line of all those who have a claim on the assets and income of the corporation
residual claim
Loan agreements frequently constrain companies to pay dividends only from
retained earnings
Payment of dividends from ____________________ is legal in all states.
retained earnings
Corporations can legally declare dividends out of ___________________in all states, but in many states corporations can not legally declare dividends out of ________________.
retained earnings, paid-in capital
Since a corporation is a ________________________, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer.
separate legal entity
In many states the board of directors assigns a _________________________ to no-par shares.
stated value
A _________________, like a stock dividend, involves the issuance of additional shares of stock to stockholders according to their percentage ownership.
stock split
Common Stock Dividend Distributable is a(n) ____________________ account, and thus has a normal __________________ (debit/credit) balance.
stockholders' equity, credit
Liability of stockholders limited to
the amount they invested in the corporation
The authorization of common stock does not result in a formal accounting entry because
the event has no immediate effect on either corporate assets or stockholders' equity.
outstanding stock refers to
the number of shares of issued stock that are currently being held by stockholders
The payout ratio measures the
the percentage of earnings distributed in the form of cash dividends to common stockholders
List four rights of stockholders
the right to: 1. Vote in election of board of directors at annual meeting and vote on actions that require stockholder approval 2. share the corporate earnings through receipt of dividends 3. keep the same percentage ownership when new shares are issued (preemptive right) 4. share in assets upon liquidation in proportion to their holdings (residual claim)
Although the authorization of common stock does not result in a formal accounting entry, the number of authorized shares is often reported in
the stockholders equity section of the balance sheet (as a description of the Paid-In capital account)
comprehensive income consists of
the unrealized gains and losses are not included in net income
What is one reason why a company would purchase many treasury shares, thereby depleting its Cash?
to avoid being targeted for acquisition
In some cases there may be retained earnings restrictions. These make a portion of the balance currently
unavailable for dividends.
preferred stockholders sometimes do not have
voting rights