Ch. 11- Stockholders' Equity

Record the issuance of 100,000 shares of $.01 par value stock at the market price of $20 per share...

*Debit:* Cash for 2,000,000 (100,000 x $20) *Credit:* Common Stock for 1,000 (100,000 x $.01) Additional Paid-in capital for 1,999,000 ($2,000,000 - $1,000)

What is considered a "large" stock dividend? small?

+25% or -25% of the company's outstanding stock

Earnings Per Share (EPS)

- most famous of all ratios - reports how much profit is earned for each share of common stock outstanding formula: net income / # of common shares outstanding **any dividends on preferred stock are subtracted from net income - usually reported on the Income Statement immediately below Net Income or in the notes - allows for easy comparison of results over time because we adjust for the effect of additional stock issued by considering earnings on a per-share basis - higher ratio = greater profitability ***Because net income can be effected by things like cost of inventory, estimations of bad debt, and depreciation of long-lived tangible assets... EPS is NOT good at comparing across companies

4-Main Elements of Stockholders' Equity on the Balance Sheet:

1. Contributed Capital--reports the amount of capital the company received from investors' contributions, in exchange for the company's common stock and preferred stock. Contributed capital represents *paid-in capital* 2. Retained Earnings--reports the cumulative amount of net income earned by the company less the cumulative amount of dividends since the corp. was first organized. Retained earnings represents *earned capital* 3. Treasury Stock--reports shares that were previously issued to and owned by stockholders but have been reacquired and are now held by the corp. 4. Accumulated Other Comprehensive Income (loss)--reports unrealized gains and losses, which are temporary changes in the value of certain assets and liabilities the company holds. They relate to pensions, foreign currencies, and financial investments. (AOCI)

2-most common dividend preferences...

1. Current (a feature of all preferred stock to pay dividends, first, to preferred stockholders and THEN to common stockholders) 2. Cumulative

Advantages of Equity Financing:

1. Equity does not have to be repaid 2. Dividends are options.

Advantages of Debt Financing

1. Interest on debt is tax deductible 2. Debt does not change stockholder control

What benefits accompany common stock ownership?

1. Voting rights 2. Dividends 3. Residual Claim --if the company ceases operations, stockholders share in any assets remaining after creditors have been paid 4. Preemptive Rights--to retain ownership percentages, existing stockholders may be given the first chance to buy newly issued stock before it is offered to others

2-forms of Investor-Return on Common Stock

1. dividends 2. increases in stock price

When deciding whether to declare a cash dividend, a company's board of directors considers what?

1. possible tax law changes 2. sufficient retained earnings 3. sufficient cash

Why might a company repurchase stock?

1. send a signal to investors 2. obtain shares that can be reissued as payment for purchases of other companies 3. obtain shares to reissue to employees as a part of employee stock purchase plans 4. reduce the # of outstanding shares to increase price per-share measures of earnings and stock value

Why might a company exec. give stock dividends?

1. to lower the market price per share of stock--making it more affordable to small investors 2. to demonstrate commitment to stockholders while conserving cash during difficult times 3. to signal an expectation of significant future earnings

Select those statements below that are TRUE about cash dividends. (select all that apply) a. on the declaration date, liabilities are increased b. on the payment date, retained earnings are decreased c. on the date of record, retained earnings are decreased d. on the payment date, current assets are decreased

A & D

Statement of Stockholders' Equity

A more comprehensive version of the statement of retained earnings, which includes a column for each stockholders' equity account and shows the factors that increased and decreased these account balances during the period

Year-end

All temporary accounts, including Dividends, are closed into Retained Earnings at each accounting year-end Debit: retained earnings Credit: dividends **the closing entry has NO effect on total S.E.

A corp. may be restricted from paying a dividend if ____________________ (check all that apply.) a. the treasury stock balance is above mandated levels b. a creditor's loan agreement is violated c. the shares outstanding are greater than the # of shares issued d. the dividend is greater than the amount of retained earnings

B & D

Mega Corp. repurchased 1,000 shares of its $1 par value common stock for $8,000. The effect of this transaction on the accounting equation includes a(n) _________________. (check all that apply) a. decrease in liabilities b. decrease in S.E. c. increase in liabilities d. increase in assets e. increase in S.E. f. decrease in assets

B & F

Why might a lender impose dividend restrictions?

Because it doesn't want to lend money to a corp. and then have the corp. pay it out in dividends to stockholders

Sources of *financing* for corporations include _______________

Borrowing & issuing stock

Debt Financing

Borrowing money from lenders

How are corporations created?

By submitting an application to a state government (not federal). Laws vary by state, favoring Delaware as one of the largest states for incorporations. If the application is approved, the state issues a charter, also called "the articles of incorporation"

A stock dividend _____________ . (check all that apply) a. causes total S.E. to decrease b. increase a stockholders' % ownership in the corp. c. causes retained earnings to decrease d. distributes additional shares of stock to existing stockholders' on a pro rata basis

C & D

Refurbish, Inc. reissued 1,000 shares of its treasury stock for $10,000. Prior to reissuance, the Treasury Stock balance was $12,000, which included the $8,000 cost of the 1,000 shares reissued. As a result of this transaction... (check all that apply) a. net income on the income statement will be $2,000 higher b. stockholders' equity on the balance sheet will be $8,000 higher c. stockholders' equity on the balance sheet will be $10,000 higher d. treasury stock on the balance sheet will equal $4,000

C & D

Price/Earnings (P/E) ratio

Current Stock Price (per share) / Earnings per Share (annual) **how many times more than the current year's earnings, that investors are willing to pay for a company's common stock ** higher ratio means expected success in the future

Record Date

Cut-off date for determining the specific stockholders to be paid the cash dividend--no journal entry is recorded on this date

Stock Dividends

Distributed to a corp. stockholders' on a pro rata basis at no cost to the stockholder

What happens to "dividends" account at the year-end?

Dividends account is deducted from Retained Earnings when its closed at year-end... until then, the temporary account is accounted for as a decrease in S.E.

GAAP (does/does not) permit a corporation to report income or losses from investments in its own stock.... why?

Does NOT. Because transactions with the owners are not considered profit-making activities. Instead, this type of transaction affects only the balance sheet, just like other stock issuances.

Why is the corporate form so popular?

Ease of participation: - Shares of stock can be purchased in small amounts - Ownership interests are transferable (stock exchange) - Stockholders are not liable for the corporation's debts (unlike sole proprietorships and partnerships) A corporation is a separate legal entity that exists apart from its owners, meaning the corporation doesn't die just because its owners due (e.g. Thomas Edison founded General Electric)

Seasoned New Issues

If a company has issued stock previously, additional issuances of new stock by the company are referred to as seasoned new issues

Cumulative dividend preference

If all or a part of the current dividend is not paid in full, the cumulative unpaid amount, known as "dividends in arrears," must be paid before any future common dividends can be paid

Income Investment

Investors, such as retired people, who need a steady income, prefer to receive their return in the form of dividends.. thus, an investment which consistently pays dividends (e.g. Coca-Cola)

If you expect your company to be financially successful in the near future, what should you do?

Issue stock dividends to signal confidence

Treasury Stock

Issued shares that have been reacquired by the company *contra-equity* account When a company reissues shares previously reported as treasury stock, it does not report a gain or loss on sale, even if it issues the shares for more or less than they cost when the company reacquired them.

Cost method

Method used by most companies to record treasury stock using the cost incurred to acquire its shares Debit: Treasury stock for [amount of stock x price per share] Credit: Cash for [amount of stock x price per share]

Return on Equity (ROE)

Net Income - Preferred Dividends / Avg. Common S.E. **higher the ratio, the better

No voting rights vs. Super-voting rights

No voting rights are useful if you want to raise financing from a key stockholder who already owns a lot of common stock and you don't want that stockholder to take control... Super-voting rights are useful if you want to issue shares to the public but not give up voting control

A stock dividend affects what balances?

Only the balance within S.E.; it does NOT change a company's total S.E. or ownership %

What is the separate entity assumption and how does this affect stock exchanged between investors?

Owners' transactions are recorded only if they directly involve the corporation and, thus, stock exchanged amongst investors (not between the corp.) are not recorded by a journal entry

Par Value

Par value has little meaning today. It is an old concept from long ago, originally introduced to prevent stockholders from removing contributed capital of businesses that were about to go bankrupt... Stronger laws and regulations exist today to prevent this from happening, so par value no longer has this use. However, some states charge corporate fees based on total par value. Thus, par value is typically set at a token amount, such as $0.01 per share. [value per share of capital stock specified in the charter]

Accumulated Deficit

Rather than be called "Retained Earnings," the negative (debit) balance in the retained earnings account when a company accumulates more net losses than net income over its life

How are stock dividends accounted for?

Recorded by transferring an amount from retained earnings to contributed capital accounts... the value used to record a stock dividend varies depending on the size of the stock dividend, recorded at par value; thus, the decrease in retained earnings equals the increase in the Common Stock account. - large stock dividends are recorded at par value - small stock dividends are recorded at market value

Outstanding shares are issued __________

Shares - treasury shares

Issued Shares

Shares of stock that have been distributed by the company

Outstanding Shares

Shares that are currently held by stockholders (not the corp. itself) *not reported on the face of the balance sheet but instead has to be computed as the difference between issued shares and treasury stock*

No-par value stock

Similar to stock with par value, except it does not have a specified legal value per share... In any event, par value is a legal concept and is not related in any way to the market value of the company's stock.

If you're a company struggling financially in the future, will you prefer to issue a stock split or stock dividend?

Split... because it doesn't reduce retained earnings

Stock Options

Stock options give employees the option of acquiring the company's stock at a predetermined price, often equal to the then-current market price... if the employees work hard and meet the corporation's goals, the company's stock price will increase. If the price declines, employees haven't lost anything. Accounting rules require that, at the time the company grants stock options, an expense must be reported for the estimated cost associated with stock options, even if the option price equals the current stock price.

Growth investment

Stocks that pay little or no dividends because companies that reinvest the majority of their earnings tend to increase their future earnings, potential, along with their stock price (more risky) (e.g. Google)

Dividends

Temporary account, closed out at year-end & deducted from retained earnings *NOT* an expense account, rather, they are a *distribution of prior profits*

Common Stock

The basic voting stock issued by a corporation to stockholders.

Payment Date

The date on which cash is disbursed to pay the dividend liability owed to each stockholder Debit: dividends payable Credit: cash

Declaration Date

The date on which the board of directors officially approves a dividend, thereby creating a legal liability Debit: Dividends Credit: Dividends Payable

Initial Public Offering (IPO)

The very first issuance of a company's stock to the public--"going public"

How do we think about Retained Earnings in terms of equity?

Think of retained earnings as the amount of equity that the company itself has generated for stockholders (through profitable operations) but not yet distributed to them

Equity Financing

When a company needs a large amount of long-term financing and chooses to obtain it by issuing new stock to investors

When does the term dividend imply a *cash* dividend?

When it stands alone, no adjectives--"dividend"

Treasury stock represents ___________.

a contra-equity account & the amount paid for stock reacquired and currently held in treasury

If treasury stock were reissued at a price below its repurchase price, the difference between the repurchase price and the reissue price is recorded as ________________

a reduction in Additional Paid-in Capital Debit: Cash & Additional Paid-in Capital Credit: Treasury Stock

Stock Splits

an increase in the total # of authorized shares by a specified ratio (e.g. 2-for-1 ratio means every share of stock is called in and 2 new shares are issued in its place); does NOT affect retained earnings or cash, so the total resources of the company do not change **typically requires revising the corp. charter to reduce the per share par value of all authorized shares, so that the total par value remains unchanged ******no journal entry is needed

All transactions between a company and its stockholders affect ______________ accounts only.

balance sheet accounts only (they do not affect the company's income statement)

Most stock issuances are ________

cash transactions

What is EPS *not* good for assessing?

cross-company comparison

Preferred stock is usually _______________

cumulative

Dividends in Arrears

cumulative unpaid amounts that must be paid first, before any future common dividends can be paid **not reported on the balance sheet because it does not become a liability until declared

"pro rata"

each stockholder receives additional shares equal to the % of shares held

The issuance of preferred and common stock do what to "additional paid-in capital"?

increase

What happens to preferred dividends that are not declared?

permanently lost

Accounting rules require that companies disclose any ____________ in their financial statement notes

restrictions

The creation and oversight of all corporations are regulated by __________

state law

Preferred stock

stock that has specified rights over common stock... 1. preferred stock allows different voting rights--allows you to separate stock ownership from voting control 2. Dividends on preferred stock, if any, may be paid at a fixed rate--better suited for more stable investors (e.g. retirees) 3. Preferred stock carries priority over common stock--any dividend the company makes (either through dividends or liquidation) must be paid to preferred stockholders because they can be paid to common stockholders

Under IFRS, preferred stock is typically classified as ______________, what is the one exception?

stockholders' equity--however, if the issuing company is contractually obligated to pay dividends or redeem the stock at a future date, then preferred stock is classified as a liability

Restrictions on Retained Earnings can severely limit _______

the ability to pay dividends

Authorized Shares

the maximum # of shares of capital stock of a cop. that can be issued, as specified in the charter

A corporation's charter indicates what?

the maximum # of shares of stock that the corp. is allowed to issue