Accounting - Module 6 - Huang

Investing activities include

(a) cash transactions that involve the purchase or disposal of investments and property, plant, and equipment, and (b) lending money and collecting the notes receivable

What are two types of dividends that companies can issue?

- Cash dividend - stock dividend

Provide an example of a persistent earning:

- Gross profit, Operating income, income before tax ( found at the top of the income statement)

What are the three types of Common Stock ?

1. Authorized Stock 2. Issued Stock 3. Outstanding Stock

What are three features of Preferred stock ?

1. Convertibile 2. Redeemable 3. Cumulative

What are three dates associated with dividends?

1. Declaration Date 2. Record Date 3. Payment Date

What are two ways to prepare a cash flow statement ?

1. Direct Method ( Use receipts) 2. Indirect Method ( Use Income Statement & Balance Sheet )

Which two accounts will have journal entries when a dividend is declared ? Which account is debited / credited ?

1. Dividend ( Debit) 2. Dividends Payable ( Credit)

Which two accounts will have journal entries when a dividend is paid ? Which account is debited / credited ?

1. Dividends Payable- Debit 2. Cash- Credit

What are three disadvantages of income statements ?

1. Measurement error 2. Discretion of Management 3. Bias ( example - premature revenue recognition )

What are three reasons a firm would manage their earnings?

1. Meet or Beat Market Expectations ( ex EPS) 2. Debt Covenant ( contract- maintain ROE / ROA) 3. Manager compensation

High quality generally has two qualities ( factors)

1. Persistence- current earnings are repeatable 2. Conservative- tendency to understate Net Income & Assets

What are three ratios to evaluate equity ?

1. ROE- Return on Equity 2. Earnings per share 3. Price earnings ratio

What are three stockholders rights ? ( common and preferred)

1. Right to vote ( business decisions/ board of directors) 2. Receive dividends 3. Share in distribution of assets ( after creditors)

Low quality generally has two qualities ( factors)

1. Transitory earnings are included 2. Aggressive- tendency to overstate Net Income & Assets

Weighted- average of common shares is used when:

A company issues stock during a year.

Treasury Stock

A corporation's own stock that it has issued and later reacquired.

preferred stock

A special type of stock whose owners, though not generally having a say in running the company,( may have limited voting rights) have a claim to profits before other stockholders do.

If investors have an expectation that a firm is growing and the firm will be profitable in the future.

A stock with a lower P/E ratio could still drive a higher stock price. Price is based on expected earnings, instead of actual earnings.

Additional Paid in Capital (APIC)

An equity account that reflects the difference at the time of issue between the par value and the issuance price (less underwriting costs) of any new stock sold by a company.

Accrual accounting is the reason that we need the Cash Flow statement. However, what does the cash flow statement help us do ?

Assess the firm's access to cash.

Company repurchases 100 shares of its own stock for $30 per share. What accounts are impacted ?

Cash & Treasure Stock

Financing Activities

Cash flow activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

Why do we need Cash Flow Statements ?

Cash flow statements are needed due to accrual accounting practices.

What are the differences between common stock and preferred stock ?

Common stock and Preferred stock have slightly different rights and dividend policies.

Payment Date of Dividend

Date of the actual cash distribution

Record Date of Dividend

Date that the company will determine who will receive the dividend. ( registered owners of stock)

What would be the accounting treatment for below issue of common stock ? - 1,000 shares, $.01 par value, $20 per share which accounts are impacted ? - Debit / Credit ?

Debit- Cash - $20,000 Credit- Common Stock- $10 ($.01 x 1000) Credit - Additional paid in Capital- 19,900 ( 20,000 - 10)

What would be the accounting treatment for below issue of common stock ? - 1,000 shares ( No par value), $20 per share which accounts are impacted ? - Debit / Credit ?

Debit- Cash- $20,000 Credit - Common Stock - $20,000

What would be the journal entries for the below transaction ? Company repurchases 100 shares of its own stock for $30 per share, $.01 par value. - Which accounts? - Debit / Credit ? ( what amount?)

Debit- Treasure Stock- 3000 ( Contra Equity- opposite of "DEALOR" rules. Credit- Cash - 3,000 *ignore par value for treasury stock

Journal entries are required on the which two dividend dates?

Declaration date and Payment Date

When treasury stock is acquired, what is the effect on total stockholders' equity? a. Decrease b. Increase c. No effect

Decrease - Treasury stock is a contra equity account. This action reduces the amount of stock that is available for purchase.

Treasury stock is an equity account ? ( True or False)

False

2,000 shares were issued at $40 per share. ( no par) You Should Debit Common Stock for $80,000 and Credit Cash for $80,000. True or False

False - (DEALOR) - Equity Increased - Credit, Cash Increased - Debit

Common stockholders usually receive asset distribution after creditors ( True or False).

False- After creditors, preferred stock holders would receive distribution of the company's assets ( due to bankruptcy )

A conservative accounting practice could include recording a high estimate of bad debt. ( True or False) ( Why?)

False- a higher bad debt estimation would increase the bad debt expense account; increased expenses reduce Net Income.

A cash flow statement is easily manipulated. ( True or False)

False- cash outflow and inflow must align with the date that the cash was earned or spent ( advantage of cash flow statement)

You record a journal entry for a stock split. True or False

False- journal entry is not required for stock split.

A stock split increases an stockholders percentage of ownership. True or False

False. Their percentage of ownership remains the same. Their number of holdings increased, but so did other stockholders, therefore their % of ownership remains the same.

Issuance of bonds or notes payable would be categorized as a ______________ activity on the CFS?

Financing Activity- Cash Inflow

Acquisition of treasury stock by a firm would be categorized as a ______________ activity on the CFS?

Financing Activity- Cash Outflow

By calculating the P/E ratio we are able to see:

How much investors are willing to pay for each dollar of a companies earnings

When treasury stock is reissued, what is the effect on total stockholders equity? a. Decrease b. Increase c. No effect

Increase- treasury stock is a contra equity account. This action increases the amount of stock that is available for purchase.

How does a stock split impact the number of shares ?

Increases the number of shares

Which method to prepare an income statement is most commonly used by public companies ?

Indirect method

Sale of an investment would be categorized as a ______________ activity on the CFS?

Investing Activity- Cash Inflow

Purchase of Long term assets would be categorized as a ______________ activity on the CFS?

Investing Activity- Cash Outflow

Dividends payable is what type of account ?

Liability

Return on Equity (ROE)

Net Income / Average Stockholders' Equity

Earnings Per Share (EPS) ( formula)

Net Income- Preferred Dividends / AVG shares of Common Stock computed as net income minus preferred dividends divided by the average number of common shares outstanding during the year.

Stock Dividends

New shares of stock distributed to existing stockholders as a supplement to or substitute for cash dividends.

Sale of good or services would be categorized as a ___________________ activity on the CFS?

Operating

Collection of Dividends (US), would be categorized as a ______________ activity on the CFS?

Operating Activity - Cash Inflow

Collection of interest would be categorized as a ______________ activity on the CFS? ( US GAAP)

Operating Activity - Cash Inflow

Paying interest ( interest expense ) would be categorized as a ______________ activity on the CFS? ( US GAAP)

Operating Activity - Cash Outflow

The purchase of inventory would be categorized as a ______________ activity on the CFS?

Operating Activity - Cash Outflow

par value stock

Par value for a share refers to the stock value stated in the corporate charter. Shares usually have no par value or very low par value, such as one cent per share. In the case of equity, the par value has very little relation to the shares' market price. Par value is also known as nominal value or face value

cumulative preferred stock

Preferred stock on which undeclared dividends accumulate until paid; common stockholders cannot receive dividends until cumulative dividends are paid.

convertible preferred stock

Preferred stock with an option to exchange it for common stock at a specified rate.

Price/Earnings (P/E) Ratio ( formula)

Price Per Share / Earnings Per Share

Why is assessing a firm's access to cash important ?

Provides insight on the firm's ability to pay its liabilities ( claims). A profitable firm could be driven into bankruptcy if it does not have sufficient cash ( or liquid assets) to satisfy claims.

When a stock dividend ( issue of stock as a dividend), occurs, how are retained earnings and equity impacted ?

Retained Earnings- Decrease Common Stock - Increase

stock dilution ( provide example)

Stock dilution refers to the issuance of additional stock by a company, for any purpose. - Company stock options - employee stock issue

paid-in capital

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

outstanding stock

The number of shares held by investors; excludes treasury shares

How do you calculate retained earnings?

Total New Income - Total Dividends ( Since establishment of the firm)

Earnings management is allowed by GAAP and is not fraud. ( True or False)

True

Purchasing treasury stock can defend against a hostile takeover? ( True or False)

True

Purchasing treasury stock can increase the price of a firm's stock. ( True or False)

True

The direct and indirect method of cash flow statement preparation will yield the same result. (True or False)

True

An aggressive accounting practice could include not adjusting the value of inventory due to a reduce in its market value. ( True or False) ( Why?)

True- reducing the value of inventory would lead to the reduction of an asset account.

Both Common Stock and Preferred Stock are Equity ( T/F)

True- rights of stockholders can be different

If a stock has no par value, the cash and common stock accounts are used to journal the sale of stock. ( True or False)

True-n since no par value; additional paid in value account is not utilized when journalizing the issue of stock.

hostile takeover

a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger

A high P/E suggest :

a stock is possibly overvalued. stock price is high relative to earnings.

A low P/E could suggest :

a stock is possibly undervalued. stock price is low relative to earnings.

Weighted-average common stock is calculated by:

adjusting the stock based upon the number of days that the new stock was outstanding during the year

retained earnings

amount of money that the firm has retained since the establishment of the firm.

Cash flow statement provides :

an alternative view of the firm's performance that is generated by operating activities

Big Bath Accounting is :

an earnings management technique. Often results in a big loss ( all at once) in one year in order to drive increased profit or eliminate loss in future years. ( Big Loss - One time- Small or Zero Profit in Future )

What type of account is treasury stock ?

contra equity ( asset)

Declaration Date of Dividend

date that the board of directors declare that a cash dividend will be paid

persistent earnings

earnings that are expected to recur over time. Also known as sustainable earnings or permanent earnings.

Why can purchasing treasury stock increase a firm's stock price ?

firm purchasing their own stock reduces the quantity of available shares in the market. Based on less availability of shares the stock price could increase even though the firm's value did not change.

Operating activities include

major day to day activities

Earnings Per Share (EPS) measures:

net income earned on each share of common stock

What type of earnings are most useful for predictions of future company performance ?

persistent earnings

accrural accounting

practice of recording revenue and expenses when they are incurred, regardless of when cash is exchanged.

What activity is recorded in the statement of stockholders equity?

records the changes in the balance of the stockholders equity over a period of time

How can purchasing treasury stock defend against a hostile takeover?

reduces available shares- acquisition of the firm would occur due to purchase of a majority of the firm's stock. Therefore given them major voting power.

transitory earnings

result from transactions or events that are not likely to occur again in the foreseeable future or that are likely to have a different impact on earnings in the future

redeemable preferred stock

stock that permits a corporation to buy back the preferred stock at some future date

Earnings ( accounting ) Quality refers to :

the ability of net income to help predict future performance of the company

ROE measures:

the ability of the company's management to generate earnings from the resources that owners provide. ( earnings driven by equity)

stock split

the division of a single share of stock into more than one share

Price/Earnings (P/E) Ratio is a comparison of :

the market price of each share of common stock to the earnings per share. (Indicates how the stock is trading relative to current earnings )

common stock

the most basic form of stock ownership, including voting rights on major issues and receiving dividends

issued stock

the number of shares sold to investors; includes treasury shares

earnings management

the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income ( in order to manage or manipulate earnings results )

authorized stock

the total number of shares available to sell, stated in the company's articles of incorporation ( includes issued shares and unissued shares)