Chapter 11 Accounting

What's a key difference between stock dividends and stock splits?

A key difference between them is that a stock dividend causes a reduction in Retained Earnings, whereas a true "stock split" doesn't.

Why are Dividends reported on the statement of retained earnings?

Because Dividends are redistributions of a company's accumulated prior earnings.

a company primarily concerned about the impact of financing on income taxes may decide to rely on ________

Debt financing - because its interest payments are tax deductible

ON which dividend date is a liability created?

Declaration Date

When a stock dividend occurs, the company must do what to the balance sheet?

Decreased Retained Earnings (to show that a dividend was declared) Increase common stock (to show that additional shares were issued)

What are the common stock returns an investor can acquire?

Dividends and Increase in stock price.

Authorized shares makes up of

all the stocks

Stock splits are:

an increase in the total number of authorized shares by a specified ratio (such as 2 for 1). (if its a 2 for 1 ratio....each issued share is called in and two new shares are issued in its place)

Stock dividends

are distributed to a corporation's stockholders on a pro rata basis at no cost to the stockholder (pro rata basis means - that each stockholder receives additional shares equal to the percentage of shares held.)

Reissuance of treasury stock and stock issuances only affect the:

balance sheet.

par value -

insignificant value per share of capital stock. It has little meaning today.

Treasury stock =

issued shares that have been reacquired by the company. During the time that treasury stock is held by the corporation, the shares do not carry voting, dividend or other stockholder rights.

but receiving dividends is part of

operating

Issued shares =

shares of stock that have been distributed by the corporation. These shares will be forever owned by one stockholder or another, unless the company has repurchased them.

When a cash divided is declared

stockholder's equity is decreased.

A low P/E ratio means

that they don't expect strong performance.

How does the balance change in Retained Earnings?

the balance in this account increases when the company reports net income, and it decreases when the company reports a net loss (expenses greater than revenues) or declares cash or stock dividends to stockholders.

Date of payment =

the date on which the cash is disbursed to pay the dividend liability. It follows the date of record.

no par value stock =

similar to stock with par value, except it does not have a specified legal value per share.

When a corp sells its repurchased stock (Treasury stock)

Debit Cash (price you most recently sold for) Credit Treasury Stock (-xSE) (+se) (price you bought back for, not the price you just sold for) Credit Additional paid-in capital (+se)

Whats the journal entry like on the date of payment?

Debit Dividends payable (-L) (b/c you're satisfying the liability) Credit Cash (-A) (because you're paying out cash when you satisfy the liability

Cash flows from investing activities = the cash inflows and outflows related to the purchase and disposal of investments and long-lived assets. Typical cash flows from investing activities include:

Inflows = cash provided by (1) Sale or disposal of property, plant, and equipment, (2) sale or maturity of investments in securities. Outflows = cash used for (1) purchase of property, plant, and equipment, (2) Purchase of investments in securities.

What type of dividend is the only distribution that affects total stockholders' equity?

cash dividend because it is the only one that distributes the company's resources to stockholders.

When a corp repurchases shares of its stock:

debit cash Credit Treasury Stock (+xSE) (-SE)

Issued makes up

outstanding + Treasury stock

How are corporations created?

By submitting an application to a state government (not the federal government)

A cash outflow occurs on which dividend date?

Date of payment

Preferred stock issuance:

Debit Cash (-A) (# of shares * $ per share) Credit Preferred Stock (+SE) (# of shares * par value) Credit Additional paid-in capital preferred (+se) (Cash - preferred stock)

What are dividends in arrears?

Dividends in arrears occur when a company fails to turn a substantial enough profit to pay the dividends guaranteed to its preferred shareholders. For dividends to be paid to common shareholders, any dividends in arrears due to the owners of preference shares must be paid first.

What is the cost method?

Most companies record the purchase of treasury stock based on the cost of the shares when they are purchased by the company.

Authorized shares =

a corporation's max number of shares of stock that the corporation is allowed to issue.....this is indicated on the corporations charter.

Both stock dividends and stock splits increase the number of shares outstanding and decrease the per-share market price True or false

True

true or false: Both stock and cash dividends reduce retained earnings

true

Cash flows from financing activities = include exchanges of cash with stockholders and cash exchanges with lenders (for principal on loans).....cash inflows and outflows related to financing sources external to the company (owners and lenders) Common cash flows from financing activities include:

Inflows = cash provided by (1) Borrowing from lenders through formal debt contract.(2) issuing stock to owners Outflows = cash used for = (1) repaying principal to lenders (2) Repurchasing stock from owners. (3) Paying cash dividends to owners. -

Cash flows from operating activities = cash inflows and outflows related to components of net income....the cash inflows and outflows related directly to the revenues and expenses reported on the income statement.

Typical cash flows from operating activities include: Cash inflows = cash provided by (1) Collecting from customers, (2) receiving dividends (3) Receiving interest. Cash outflows = cash used for (1) Purchasing services (electricity, etc) and goods for resale (2) paying salaries and wages, (3) paying income taxes and (4) paying interest.

Why are stock options used for employee pay packages?

because it gives employees the option of acquiring the company's stock a lower predetermined price.

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

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

debt financing =

borrowing money from lenders.

How does a stock split work?

by revising the corporate charter to reduce the per-hare par value of all authorized shares, so that the total par value across all shares is unchanged.

what type of stock must a corporation have?

common stock

What are EPS and ROE useful for? (not P/E)

evaluating a company's return to stockholders.

paying cash dividends is part of

financing

Price/Earnings (P/E) Ratio

Helps you determine what a reasonable price would be for the company's stock. The most basic way to determine the value investors place on a company's common stock.

If the P/E is higher in the year than the average industry is willing to pay then it shows that

the investors appeared to anticipate the improved performance because they were willing to pay more than the industry average.

Whats one the main reason for issuing a stock dividend?

to reduce the market price per share of stock - which is good because it makes the stock more attractive to investors who acquire stock in round lots (multiples of 100 shares)

Initial public offering =

very first issuance of a company's stock to the public. (makes private companies public.

Will repurchase of company's stock increase the return on equity?

yes

4 common stock transactions are:

(1) Contributed Capital (represents paid-in capital) (2) Retained Earnings (represents earned capital) (3) Treasury stock (reports shares that were previously owned by stockholders but have been reacquired and now held by the corporation) (4) Accumulated other comprehensive income (Reports unrealized gains and losses, which are temporary changes in the value of certain assets and liabilities the company holds.)

What are the preferred stock offers dividend preferences?

(1) Current Dividend preference - requires that preferred dividends be paid before paying any dividends to holders of common stock. This is a feature of all preferred stock. After the current dividend preference has been met, and if not other preference exists, dividends may be paid to the common stock-holders. THIS IS THE FEATURE OF PREFERRED STOCK THAT GRANTS PRIORITY ON PREFERRED DIVIDENDS OVER COMMON DIVIDENDS. (2) Cumulative Dividend preference - the preferred stock feature that requires current dividends not paid in full to accumulate for every year in which they are not paid. These cumulative unpaid amounts (called DIVIDENDS IN ARREARS) must be paid before any common dividends can be paid. A cumulative dividend is a sum that publicly traded companies must remit to preferred shareholders without regard to the company's earnings or profitability. A cumulative dividend must be paid, whereas a regular dividend, also called a non-cumulative dividend, may be paid to or withheld from shareholders at the company's discretion. If a company cannot pay a cumulative dividend when it is due, it is still responsible for paying it in the future, possibly with interest, and it must fulfill this obligation before it can award dividends to common shareholders. This feature makes cumulative preferred shares more valuable than non-cumulative preferred shares or common shares. If the preferred stock is noncumulative, dividends can never be in arrears; any preferred dividends that are not declared are permanently lost. Because preferred stockholders are unwilling to accept this unfavorable feature, preferred stock is usually cumulative.

Date of Payment balance sheet effects:

(1) Decrease current assets (Cash), (2) Decrease current liabilities.(Dividends payable (-L))

Why may a company's board of directors declare a stock dividend?

A COMPANY'S BOARD OF DIRECTORS MAY DECLARE A STOCK DIVIDEND RATHER THAN A STOCK SPLIT TO SIGNAL TO FINANCIAL STATEMENT USERS THAT THE COMPANY EXPECTS SIGNIFICANT FUTURE EARNINGS.

Once the board of directors formally declares a dividend, what is created?

A liability

Why would a company do a stock split?

A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed.

Preferred Stock issuance balance sheet journal entry:

Debit cash (+A) (per share value * # of shares) Credit Preferred Stock (+SE) (shares * par value) Credit Additional Paid-in capital - preferred (+SE) (Preferred stock - cash)

a company concerned about being able to pay its existing liabilities may decide to rely on:

Equity financing, because it can't afford to take additional debt...equity financing doesn't have to be repaid.

Whats a limitation to Financial leverage?

Financial leverage isn't always the best strategy, because it can screw you if you have higher interest expense on debt financing than your income from operations.

What would happen if a company accumulated more net losses than net income over its life?

It would report a negative (debit) Balance in the Retained Earnings Account. This amount is (1) showin in parentheses in the stockholders' equity section of the balance sheet (2) Deducted when computing total stockholders' equity, and (3) Typically called ACCUMULATED DEFICIT rather than Retained Earnings.

Where are dividends in arrears reported?

disclosed in he notes to the financial statements because dividends are not an actual liability until the board of directors declares them.

equity financing =

issuing new stock to investors

What does a High P/E ratio mean?

means investors expect the company to improve in the future and increase its profits, so they have factored in the future earnings when determining the current stock price.

The P/E ratio measures:

measures how many times more than current year's earnings investors are willing to pay for a company's stock. It is calculated by dividing a company's EPS for the year into the stock price at the time its EPS is reported.

Does a corporation have a legal obligation to pay dividends?

no decision is made by the board of directors and made each time a dividend is to be paid.

Is a journal entry needed for a stock split?

no because the decrease in par value per share offsets the increase in number of shares, so the financial position of the company is not affected.

Do cash dividends paid to stockholders reduce net income?

no.

Do stock dividends change total stockholders' equity?

no. It only changes the balances of some accounts within stockholders' equity.

Are any journal entries made on the Record date?

no. The date of record is the date on which this list of current stockholders is finalized. The dividend payable only to those names listed on the record date.

Is cash affected when the company splits its stock?

no. The total resources of the company does not change. ITs just like taking a four-piece pizza and cutting each piece into two smaller pieces.

Are you wealthier when the company declares a stock dividend and gives you (And all other stockholders) more shares of stock?

no...because when a stock dividend is issued, the stock market reacts immediately with a proportional decline in the stock price.

When a company reissues shares of its treasury stock, does it report a gain or loss on sale?

nope. even if it issues the shares for more or less than they cost when the company reacquired them.

Treasury stock is a _________ account

permanent account that is reported as a contra equity, subtracted from total stockholder's equity. (xSE) this makes sense b/c treasury stock is stock that is not outstanding and therefore should be removed from total stockholders' equity.

Why is Earnings Per share ratio so popular?

so popular because current earnings can predict future dividends and stock prices. (If a company generates increased earnings in the current year, it will be able to pay higher dividends in future years) (AKA, EPS influences expectations about future dividends, which investors factor into the current stock price) Another reason why EPS is so popular is because it allows you to easily compare results over time. (By considering earnings on a per-share basis, we adjust for the effect of additional stock issued, resulting in a clearer picture of what increases mean for each investor.)

Income investments =

stocks that consistently pay dividends people who do this prefer to receive their return in the form of dividends. Rather than wait for growth in stock value.

What is Financial Leverage?

strategy that allows a company to increase its return on equity (ROE). Rather then rely on equity financing, a company heavily relies on debt financing. A company may be able to generate more profit from using these borrowed funds than it incurred for interest on that debt. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottom-line earnings per share.

Name the 4 reasons why a company would want to repurchase its stock

(1) Distribute excess cash to stockholders (2) Send a signal to investors that the company itself believes its own stock is worth acquiring. (3) obtain shares that can be reissued as payment for purchases of other companies (4) Obtain shares to reissue to employees as part of employee stock option plans.

What are the three ratios that evaluate how well a company appear to be using its capital to generate returns for the company and ultimately for its stockholders?

(1) Earnings Per Share (EPS) (2) Return on Equity (ROE) (3)Price/Earnings (P/E) Ratio

advantages of equity financing?

(1) Equity doesn't have to be repaid (2) Dividends are optional

name 3 key transactions involving common stock:

(1) Initial issuance of stock (2) repurchase of stock into treasury (3) Reissuance of treasury stock.

Advantages of debit financing?

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

What are the 3 differences between preferred stock and common stock?

(1) Preferred stock allows different voting rights. - (the flexibility allows a corporation to separate stock ownership from voting control) (2) Dividends on preferred stock, if any, may be paid at a fixed rate. - (for example "7%, $1 par value" preferred stock means that the dividend will equal 7 cents per share (0.07 = 7% X $1.00) (3) Preferred stock carries priority over common stock. - (if a corporation distributes assets to its owners through dividends or at liquidation) (must be paid to preferred stockholders before common stockholders.) (also if the corporation goes out of business, its assets will be sold and used to pay creditors and then preferred stockholders.)

What are two key financial requirements that the board of directors must consider when declaring a cash dividend? Need both available.

(1) Sufficient Retained Earnings - the corporation must have accumulated a sufficient amount of retained earnings to cover the amount of the dividend. ACCOUNTING RULES REQUIRE THAT COMPANIES DISCLOSE ANY RESTRICTION IN THEIR FINANCIAL STATEMENT NOTES. (2) Sufficient cash - the corporation must have sufficient cash to pay the dividend. The mere fact that Retained Earnigns has a large credit balance does not mean that the company has sufficient cash to pay a dividend. Remember retained earnings is not cash.

what are the 4 basic benefits of a common stock:

(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 their ownership percentages, existing stockholders may be given the first chance to buy new issued stock before it is offered to others

Stock dividend on common stock:

(nothing but SE accounts) Debit Retained Earnings (-SE) Credit Common Stock (+SE) (keep in mind these cancel each other out...so no decrease/increase in stockholders equity)

Cash dividends decrease total stockholders' equity and Retained earnings but not stock dividends - dont do anything to stockholders equity.

Although Stock dividends you need to decrease Retained Earnings (to show that a dividend was declared) and increase common stock (to show that additional shares were issued)

When treasury stock is purchased with cash, what is the impact on the balance sheet equation?

Assets decrease and stockholders' equity decreases. - b/c treasury stock is not outstanding and therefore should be removed from total stockholders equity.

Common stock transactions only affect the __________

Balance sheet Corporations do not report income arising from gains or losses on transactions involving their own stock.

Why does the declaration of a cash dividend reduce stockholder's equity?

Because Dividends Declared is closed into Retained Earnings at the end of each fiscal year.

What accounts do you debit and credit on the declaration date? (increase in its liabilities and a corresponding increase in the dividends declared account.)

Debit Dividends Declared (+D) (this would be a negative amount under SE) Credit Dividends payable (+L) (positive number)

On the Declaration Date of a cash dividend:

Debit Dividends Declared (+D, -SE) Credit Dividends payable (+L) (keep in mind no assets on this, and that dividends declared is +D but actually it reduces stockholders equity.

When the dividend is paid or disbursed: (Date of payment)

Debit Dividends Payable (-L) Credit Cash (-A)

When a corporation issues common shares:

Debit cash (# of shares * market price per share) Credit Common Stock (+se) (# of shares * par value) Credit Additional Paid-in capital (+se)

Return on Equity (ROE)

Like EPS, ROE reports a company's return to investors. However, rather than relate net income to the average number of shares outstanding, the return on equity ratio relates net income to the average dollars of stockholder investment and earnings reinvested in the company. It tells you the amount earned for each dollar invested by stockholders A higher ratio means stockholders are likely to enjoy greater returns.

Are dividends declared by a company reported on its income statement?

NO because they are not expenses.

Because dividends are not an actual liability until the board of directors declares them....Are dividends in arrears reported on the balance sheet?

No. Instead, they are disclosed in the notes to the financial statements.

Earnings per share ratio: (most popular)

Reports how much profit is earned for each share of common stock outstanding. calculated by dividing the "bottom line" net income by the average number of common shares outstanding. Most companies report EPS on the Income Statement immediately below Net Income or in the notes to the financial statements.

What does Retained Earnings Represent?

Retained Earnings represents the company's total earnings that have been retained in the business (rather than being distributed to stockholders).

What are the rights that stock provides to stockholders? (3)

Right to vote Right to receive dividends share in residual assets at liquidation.

Outstanding shares =

Shares that are currently held by stockholders (not the corporation itself)

if you expect your company will be financially successful in the near future, you won't care that a ______________ reduces Retained Earnings because future earnings will replenish that account to allow cash dividends to be declared.

Stock Dividend

If you're managing a company that you expect will struggle financially in the future, you'll prefer a_____________ because it doesn't reduce retained earnings, so it doesn't reduce your ability to declare cash dividends in the future.

Stock Split

Growth investments =

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. For example: dell.

How can a fixed dividend be attractive to certain investors?

Such as company founders or retirees, who seek stable income from their investments.

What is the Dividends Declared account?

Temporary account that summarizes dividends declared during the year and later is closed to Retained Earnings at year-end, causing a decrease in Retained Earnings.

If the application to create a corporation is approved, the state issues a charter called:

The Article of incorporation spells out info about the corp such as its name, address, nature of business and ownership structure.

When are P/E ratios most meaningful?

When comparing a company over time with itself or with competitors in the same industry.

What is a limitation of EPS?

While EPS is an effective and widely used measure for comparing a company with itself over time, it is not appropriate for comparing across companies.

Can ROE be appropriately compared across companies?

Yes, because ROE uses dollars contributed to and reinvested in the company.