Chapter 11 FinAcct

treasury stock

a corporation's own stock that has been issued but was subsequently reacquired by and is still being held by the corporation

dividends in arrears

dividends on cumulative preferred stock that have not been declared in prior years

how is treasury stock reported on the balance sheet? How is the "gain or loss" on reissued treasury stock reported on the financial statements?

the treasury stock is not an asset, it is a permanent account and ir reported as a contra-equity account. it is subtracted from total stockholders' equity. this reporting practice makes sense because treasury stock is not outstanding and therefore should be removed from total stockholders equity.

what are the two financial requirements to support the declaration of a cash dividend? what are the effects of a cash dividend on assets and stockholders' equity?

the two financial requirements to support declaring cash dividends are: 1. to have sufficient retained earnings, because not enough retained earnings can limit the ability to pay dividends 2. sufficient cash

outstanding shares

total number of shares of stock that are owned by stockholders on any particular date

issued shares

total number of shares of stock that have been sold; equals shares outstanding plus treasury shares held

reissunace below repurchase price

(recorded at reduction) dr Cash (+A) dr Additional paid-in capital (-SE) cr treasury stock (-xSE, +SE)

stockholders are also called..

shareholders

lesson 4 describe the characteristics of preferred stock and analyze transactions affecting preferred stock

-preferred stock provides investors certain advantages including current dividend preferences and a preference on asset distributions in the event the corporation is liquidated -if preferred stock carries cumulative dividend rights, any part of a current dividend that is not paid (called dividends in arrears) must be paid in full before any additional dividends can be paid

how do stock repurchases affect the EPS and ROE ratios?

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dr dividends declared

dr Dividends declared(+D, -SE) cr dividends payable (+L(

what are the differences between common stock and preferred stock?

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advantages of equity financing

1. equity does not have to be repaid 2. dividends are optional

common stock

the basic voting stock issued by a corporation

lesson 1 explain the role of stock in financing a corporation

the law recognizes corporations as separate legal entities. owners invest in a corporation and receive capital stock that can be bought from and sold to other investors. stock provides a number of rights, including the rights to vote, to receive dividends, and share in residual assets at liquidation

what is treasury stock? why do corporations acquire treasury stock?

treasury stock is the repurchase of stock. they may want to repurchase because 1. they want to 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

reissuance of treasury stock

when a company reissues shares of its treasury stock, it does not report a gain or loss on sale, even if it issues the shares for more or less than the cost at reacquisition GAAP does not permit a corporation to report income or losses from investments in its own stock because transactions w/ the owners are not considered profit-making activities

what are the relative advantages of equity versus debt financing?

*equity does not have to be repaid, and dividends are optional, a company would likely choose equity financing if they were concerned about being able to pay its existing liabilities and it can't afford to take on more debt *debt -the interest on debt is tax deductible whereas dividends on stock are not tax deductible, and debt does not change stockholder control, issuing stock gives new stockholder the right to vote and share in earnings. A company would choose debt financing if it was concerned about the impact of financing on income taxes and chose debt financing because the interest payments are tax deductible

lesson 3 - explain and analyze cash dividends, stock dividends, and stock split transactions

- cash dividends reduce stockholders' equity (retained earnings) and create a liability (dividends payable) when they are declared by the board of directors (on the date of declaration). the liability is reduced when the dividends are paid (on the date of payment) -stock dividends are pro rata distributions of a company's stock to existing owners. the transaction typically is accounted for by transferring an amount of retained earnings into contributed capital accounts -a stock split also involves the distribution of additional shares to owners but no additional amount is transferred into the contributed capital accounts. instead, the per-share par value of stock is reduced

just prior to filing for bankruptcy protection in 2009, GM asked its bondholders to exchange their investment in GMs bonds for GM stock. The bondholders rejected this proposal. Why might GM have proposed this exchange? Why might the bondholders have rejected it?

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what are the two basic sources of stockholders' equity? explain each

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what are the usual characteristics of preferred stock?

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what is one interpretation of a high P/E ratio?

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you work for a public company that has relied heavily on debt financing in the past and is now considering a preferred stock issuance to reduce its debt-to-asset ratio. d-t-a is one of the key ratios in your company's loan covenants. should the preferred stock have a fixed annual dividend rate, or a dividend that is determined yearly? in what way might this decision be affected by IFRS?

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identify the primary advantages of the corporate form of business

1. a corporation is considered a separate legal entity 2. a corporation does not die 3. liability is limited 4. it can raise large amounts of money easily (stock) -stock allows shareholders to participate in corp. by: -shares of stock can be purchased in small amounts -ownership interests are transferable -stockholders are not liable for corporations debts

identify and explain the three important dates with respect to dividends

1. declaration date - increase current liabilities, decrease retained earnings 2. date of record - no effect 3. date of payment - decrease current assets, decrease current liabilities

par value

1. for shares of stock, this is a legal amount per share established by the board of directors; it establishes the minimum amount a stockholder must contribute and has no relationship to the market price of the stock

advantages of debt financing

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

what are the primary reasons for issuing a stock dividend?

1. issuing a stock dividend is that it reduces the market price per share of stock -when a stock dividend occurs, the company must decrease retained earnings (to show that a dividend was declared) and increase common stock (to show that additional shares were issued)

frequent mistake

DO NOT record a liability for dividends in arrears at the end of each year. they are recorded as a liability ONLY when dividends are declared on the cumulative preferred stock

repurchase of stock

a company may want to repurchase b/c: 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

lesson 2 explain and analyze common stock transactions

a number of key transactions involve common stock 1. initial issuance of stock 2. repurchase of stock into treasury 3. reissuance of treasury stock each is illustrated in the chapter, note that these transactions have only balance sheet effects; corporations do not report income arising from gains or losses on transactions involving their own stock

explain each of the following terms a) authorized common stock b) issued common stock c) outstanding common stock

a)authorized common stock is the maximum number of capital stock a company is allowed to issue b)issued common stock is the stock that has been issued and owned by a stockholder, unless the company has repurchased them c) outstanding stock are shares that are actually owned by stockholders. outstanding shares is not reported on the balance sheet

stock split

an increase in the total number of authorized shares by a specified ratio; does not decrease retained earnings in a stock split, the total number of authorized shares is increased by a specified amount, 2:1. in this instance, each issued share is called in and two new shares are issued in its place. cash is not affected when the company splits stock, so the total resources of the company do not change. a stock split involves revising corporate charter to REDUCE the per-share par value of all authorized shares, so that the total par value across all shares is unchanged, and doubles the number of shares outstanding.

what is the distinction between par value and no-par value capital stock?

before stock is issued, its specific rights and characteristics must be authorized and defined in corporate charter. the par value is a characteristic that was used to prevent stockholders from removing contributed capital of businesses that were about to go bankrupt. This is outdated because of legislative improvements so no-par value stock is issued, which is similar to par value but does not have a specified legal value per share. *These par value concepts are not related to bonds par value.

your company has been very profitable and expects continued financial success. its stock price has reached a point where the company needs to make it more affordable. would you recommend a stock dividend or a stock split? why?

both stock dividends and stock splits increase the number of shares outstanding and decrease per-share market price. a key difference is that a stock dividend causes a REDUCTION in retained earnings whereas a "true" stock split does not reduce retained earnings. Since the company is not struggling financially, they should not choose a stock split. The company should choose a stock dividend to reduce retained earnings and reduce the stock price. (it also signals to financial statement users that the company expects significant future earnings)

additional paid in capital is also called..

capital in excess of par

no par value stock

capital stock that has no specified par value

what is the difference between cumulative and noncumulative preferred stock?

cumulative dividend preference states that 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. 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

price/earnings ratio

current stock price (per share) / earnings per share (annual)

stock dividend

declared by the board of directors to distribute to existing stockholders additional shares of corporation's own stock dividends are distributions of a company's accumulated prior earnings, and are reported on the statement of retained earnings. when declared, they will increase current liabilities and decrease retained earnings. on the date of payment they decrease current assets and decrease current liabilities

reissuance journal entry

dr Cash (+A) ( # of shares x $ per share) cr Treasury stock (-xSE, +SE) cr Additional paid-in capital (+SE) (# of shares x [ stock price - treasury price])

stock issuance journal entry:

dr cash (+A) cr common shares (+SE) (# of shares sold x par value per share) cr additional paid-in capital

stock dividend journal entry

dr retained earnings (-SE) cr common stock (+SE)

repurchase journal entry

dr treasury stock (+xSE, -SE) cr Cash (-A) *companies record the purchase of treasury stock based on cost of shares when purchased (# of shares x $ per share)

helpful reminder

large stock dividends are recorded at par value; small stock dividends are recorded at the stock market price, with the excess of market over par accounted for as additional paid-in capital

authorized shares

maximum number of shares of a corporation's capital stock that can be issued

earnings per share

net income / ave. number of common shares outstanding

return on equity

net income / average SE

cumulative dividend preference

preferred stock feature that requires specified current dividends not paid in full to accumulate for every year in which they are not paid. these cumulative preferred dividends must be paid before any common dividends can be paid

what is a stock dividend? how does a stock dividend differ from a cash dividend?

stock dividends are distributed to a corporation's stockholders on a pro rata basis ( each stockholder receives add'l shares equal to the percentage of shares held) at no cost to the stockholder. a stock dividends by itself provides no economic value, all stockholders receive a pro rata distribution of shares, which means that each stockholder owns exactly the same proportion of the company after a stock dividend as before (like having 10 dimes instead of $1) but one of the main reasons for issuing a stock dividend is that it reduces the market price per share of stock. a cash dividend reduces stockholders' equity because dividends declared is closed into retained earnings at the end of each fiscal year. The payment of cash dividend reduces cash (by the same amount) and the BOD must consider : 1. sufficient retained earnings, because the restrictions on retained earnings can limit the ability to pay dividends, accounting rules require that companies disclose any restrictions in their financial statement notes 2. sufficient cash to pay the dividends

preferred stock

stock that has specified rights over common stock preferred stock is a special form of stock by: 1. preferred stock allows different voting rights, this allows a corp. to separate stock ownership from voting control. 2. dividends on preferred stock, if any, may be paid at a fixed rate 3. preferred stock carries priority over common stock, preferred stockholders have a higher priority than common stockholders if a corp distributes assets to its owners through dividends or at liquidation

payment date

the date on which a cash dividend is paid to the stockholders of record

declaration date

the date on which the board of directors officially approves a dividend

date of payment journal entry

the date on which the cash is disbursed to pay the dividend liability dr dividends payable (-L) cr cash (-A)

record date

the date on which the corporation prepares the list of current stockholders as shown on its records. dividends are paid only to the stockholders who own stock on that date

why is the EPS number so popular? what are its limitations?

the earnings per share ratio is calculated by dividing net income by the average number of shares of common stock outstanding during the year. this ratio makes it easy to compare a company's earnings over time - but it does not allow reliable comparisons across companies because it does not adjust for likely differences in the number of shares that each company has outstanding

analyze the earnings per share, return on equity, and price/earnings ratios

the earnings per share ratio is calculated by dividing net income by the average number of shares of common stock outstanding during the year. this ratio makes it easy to compare a cmpany's earnings over time but it does not allow reliable comparisons across companies because it does not adjust for likely differences in the number of shares that each company has outstanding -the return on equity ratio relates earnings to each dollar contributes to and retained by the company. because it is calculated using dollar amounts contributed to and retained by a company, it allows comparisons to be made across companies. -the price/earnings ratio relates the company's current stock price to its most recent annual earnings per share, indicating the value investors place on the company's stock

current dividend preference

the feature of preferred stock that grants priority to preferred dividends over common dividends