Chapter 10

Advantages and Disadvantages of a corporation

Advantages -Limited personal liability -Limited liability guarantees that stockholders in a corporation can lose no more than the amount they invested in - Ability to raise capital and transfer ownership - An investor can sell his or her ownership interest (shares of stock) at any time and without affecting the structure of the corporation or its operations Disadvantages - Additional Taxes - More Paperwork

Accounting Equation

An equation showing the relationship among assets, liabilities, and owner's equity

Stockholder Rights

1. right to vote 2. right to receive dividends 3. right to share in the distribution of assets

Retained Earnings Over a Four-Year Period

Let's look at an example. Illustration 10-13 shows how net income and dividends impact the balance in retained earnings over a four year period.

Comparison of Financing Alternatives

Preferred stock actually has a mixture of attributes somewhere between common stock (equity) and bonds (liabilities). This illustration provides a comparison of common stock, preferred stock, and bonds along several dimensions. Note that preferred stock falls in the middle between common stock and bonds for each of these factors.

Treasury stock

The number of issued shares repurchased by the company.

Purchase of Treasury Stock

The debit to Treasury Stock reduces stockholders' equity. Treasury Stock is a contra equity account.

Features of Preferred Stock

convertible redeemable cumulative

Stockholders' Equity Section

displays the stockholders' equity section of the balance sheet for Canadian Falcon following the issuance of both common and preferred stock. The balance of retained earnings is discussed later in this chapter.

Cash Dividends

• Distributions by a corporation to its stockholders • A change in a quarterly or annual cash dividend paid by a company can provide useful information about future prospects • Not all companies pay dividends; for example, growth companies prefer to reinvest earnings rather than distribute them

Stock Dividends

•: additional shares of a company's own stock given to stockholders as dividends

Earned Capital

retained earnings

Convertible

shares can be exchanged for common stock

redeemable preferred stock

shares can be returned to the corporation at a fixed price

Outstanding Stock

number of issued shares held by investors. Only these shares receive dividends.

Issued stock

number of shares that have been sold to investors. A company usually does not issue all its authorized stock. - Outstanding Stock - Treasury Stock

Earnings per Share

•Measures net income earned per share of common stock

Small Stock Dividends

•Recorded at market value, not par value. •Does not change total assets, total liabilities, or total stockholders' equity. •Decreases one equity account, Retained Earnings, increases two other equity accounts, Common Stock and Additional Paid-in Capital.

Par Value

•Legal capital per share of stock that's assigned when the corporation is first established •Par value has no relationship to the market value of the common stock E.g Facebook's common stock has traded above $100 per share since 2015, but it has a par value of $0.000006 per share. - Some laws permit corporations to issue no-par stock. No-par value stock is common stock that has not been assigned a par value e.g Nike or Procter & Gamble

Corporation

A business owned by stockholders who share in its profits but are not personally responsible for its debts

•Large stock dividends

Records a decrease in retained earnings and an increase in common stock; recorded at par value

Return on Equity

Return on Equity = Net Income / Average Stockholder's Equity •Measures the ability of company management to generate earnings from the resources that owners provide

Cumulative

shares receive priority for future dividends if dividends are not paid in a given year

Invested Capital

the amount of money paid into a company by its owners

authorized stock

the total number of shares available to sell, stated in the company's articles of incorporation - Issued - Unissued

Allocate Dividends Between Preferred and Common Stock: NONCOMULATIVE

there are no dividends in arrears to consider. The dividend of $10,000 in 2021 will be split, with $2,400 paid first to preferred stockholders for the current year and then the remaining $7,600 paid to common stockholders.

Stages of Equity Financing

•Corporations first raise money from founders of the business, friends, and family •To grow, companies seek investments from: qAngel investors - Wealthy investors, like those featured on the television show Shark Tank qVenture capital firms - Provide additional funding and business expertise qInitial public offering (IPO) - The first time a corporation issues stock to the general public

Dividend Dates

•Declaration date: date on which board of directors declares the cash dividend to be paid •Record date: specific date on which the company will determine who will receive the dividend (registered owners of stock) •Payment date: date of the actual cash distribution

Price-Earnings Ratio (PE ratio)

•Indicates how the stock is trading relative to current earnings

Dividend Yield

•Measures how much a company pays out in dividends relative to its share price

To boost earnings per share

Earnings per share is calculated as earnings divided by the number of shares outstanding. Stock purchases reduce the number of shares outstanding, thereby increasing earnings per share. However, with less cash in the company, it's more difficult for companies to maintain the same level of earnings following a share purchase

Recording Cash Dividends

The Dividends account is a temporary stockholders' equity account that is closed into Retained Earnings at the end of each period. Dividends are legally payable, once declared by the board of directors, so Dividends Payable is credited. Dividends Payable is classified as a current liability in the balance sheet because once they are declared, the company is legally obligated to pay them in the near future.

Statement of Stockholders' Equity

The statement of stockholders' equity reports how each equity account changed during the year. Helps you understand the Total Stockholders' Equity

Statement of Stockholders' Equity Section

The stockholders' equity section of the balance sheet, like the one we just examined for Nvidia, shows the balance in each equity account at a point in time. In contrast, the statement of stockholders' equity summarizes the changes in the balance in each stockholders' equity account over time. - The statement of stockholders' equity shows the change in each equity account balance over time.

Allocate Dividends Between Preferred and Common Stock: COMULATIVE

For this type of preferred stock, if dividends are not declared in a given year, they accumulate until the company does declare dividends. Common stockholders are not entitled to dividends in any year until stockholders of cumulative preferred stock are attributed all dividends to which they are entitled.

Treasury Stock

- Company's own issued stock that it has purchased - A corporation's own stock that it has reacquired - Over two-thirds of all publicly traded companies report treasury stock in their balance sheets

Retained Earnings

- Earnings retained in the corporation and not paid out as dividends - Equals all net income less all dividends, since the company began operations - Has a normal credit balance - Retained Earnings = All net income since the company began − All dividends since the company began

Stockholders' Equity Section for balance sheet

- Preferred stock, $0.001 par value, no shares issued - Common stock, $0.001 par value, 868 shares issued - Additional paid-in capital - Total paid-in capital - Retained earnings - Less: Treasury stock, 283 shares - Accumulated other comprehensive loss - Total stockholders' equity - The stockholders' equity section of the balance sheet presents the balance of each equity account at a point in time.

Treasury Stock: Companies buy back their own stock for various reasons:

- To boost underpriced stock - To distribute surplus cash without paying dividends - To boost earnings per share - To satisfy employee stock ownership plans

Stock Split

- a large stock dividend that includes a reduction in the par or stated value per share - Reduces par value per share and increases shares outstanding - no need to record transaction

Public or Private Corporation

Frequently, companies begin as smaller, privately held corporations. Then, as success broadens opportunities for expansion, the corporation goes public.

Preferred stock

1.Preferred stockholders usually have first rights to a specified amount of dividends (a stated dollar amount per share or a percentage of par value per share). If the board of directors declares dividends, preferred shareholders will receive the designated dividend before common shareholders receive any. 2.Preferred stockholders receive preference over common stockholders in the distribution of assets in the event the corporation is dissolved. - No voting rights

To satisfy employee stock ownership plans

Another motivation for stock purchases is to acquire shares used in employee stock award and stock option compensation programs. Microsoft, for example, reported that its board of directors had approved a program to purchase shares of its common stock to offset the increase in shares from stock option and stock purchase plans.

Accounting for preferred Stock

Assume that Canadian Falcon issues 1,000 shares of $30 par value preferred stock for $40 per share. We record the transaction as follows

Authorized, Issued, Outstanding, and Treasury Stock

Authorized has 2 things: Issued Stock - Outstanding Stock - Treasury Stock Unissued Stock

Accounting For Common Stock (no Par)

Cash Common Stock Simple Equation: Shares x $ per share

Accounting for common stock (par value)

Cash: shares x $ per share Common Stock shares x par value Additional Paid in Capital difference

Earned Capital

This component of equity represents the net assets of the company that have been earned for the stockholders rather than invested by the stockholders.

Effects of a stock Split and stock dividend

This illustration summarizes the effects of a stock split and a stock dividend.

To boost underpriced stock

When company management feels the market price of its stock is too low, it may attempt to support the price by decreasing the supply of stock in the marketplace. An announcement by Johnson & Johnson that it planned to buy up to $5 billion of its outstanding shares triggered a public buying spree that pushed the stock price up by more than 3%.

Reissuance of Treasury Stock (above cost)

When we resell the treasury shares at $35, we must reduce the Treasury Stock account at the same $30 per share. We record the $500 difference (= 100 shares × $5 per share) as a credit to Additional Paid-in Capital.

To distribute surplus cash without paying dividends

While dividends usually are a good thing, investors do pay personal income tax on them. Another way for a firm to distribute surplus cash to shareholders without giving them taxable dividend income is to use the excess cash to purchase its own stock. Under a stock purchase, only shareholders selling back their stock to the company at a profit incur taxable income.

Organization Chart

a diagram that shows the structure of an organization, classifications of work and jobs, and the relationships among those classifications

Contributed (invested) Capital

Common Stock Preferred Stock Additional Paid in Capital

Types of Common Stock

authorized - Shares available to sell (= Issued + Unissued) issued - Shares actually sold (= Outstanding + Treasury) outstanding - Shares issued and held by investors treasury - Shares issued and repurchased by the company