Chapter 11 Stockholders' Equity
Price earnings ratio
To determine the value investors place on a company's common stock. Measures how many time more than current years earnings investors are willing to pay for s company's stock.
Capital account
To record capital contributions and accumulate periodic income or loss
Ima Rich purchased 100 shares of Stockits, Inc.'s $1 par value common stock for $5 per share. Which statements are true regarding the effect of this transaction on Stockits' financial statements?
Stockholders' equity on the balance sheet increases the financing activities section of the statement of cash flows increases.
Preferred stock allows different voting rights. Dividends may be paid at a fixed rate. Carries priority over common stock.
How does preferred stock differ from common stock?
Earnings per share
How much profit is earned for each share of common stock outstanding
Dividends can never be in arrears
If preferred stock is noncumulative,
No Dividends Payable
Stockit Inc has 1000 shares of 5%, $100 par value, cumulative preferred stock outstanding. In its first two years of business, Stockit did not declare a dividend. Stockits balance sheets at the end of its first two years of business should include:
Current dividend preference
Shares x par value x dividend preferred dividends must be paid before any dividends are paid to common stockholders
Dividends in arrears
Sharesxparvaluexdividendx2years
- Borrowing - Issuing stock
Sources of financing for corporations include:
Income investment
Stocks that consistently pay dividends
Growth investments
Stocks that pay little or no dividends
Contributed capital
The amount of capital the company received from investors contributions in exchange for the company's common stock and preference stock
Charter
The articles of incorporation that spells out information about the corporation such as its name adress nature of business and ownership Structure.
Transferring an amount from retained earnings to common stock
Stock dividends are recorded by
Common stock
The basic voting stock issued by a corporation to stockholders
Declaration Date
The board of directors officially approves a dividend
Retained earnings
The company's total earnings that have been retained in the business. The amount of equity that the company itself has generated for stockholders but not distributed to them.
Retained earnings
The cumulative amount of net income earned by the company less the cumulative amount of dividends since the corporation was first organized. Also represents earned capital
Dividends in arrears
The cumulative unpaid amount that must be paid before any future common dividends can be paid.
Declaration date
The date on which the board of directors officially approves a dividend.dividends are not an expense
Record date
The date on which the corporation prepares the list of current stockholders shown on its records. Dividends can be paid only to the stockholders who own stock on that date.
Additional paid in capital
The decrease in retained earnings is greater than the increase in common stock so the excess market value over par value is
Initial public offering
The first issuance of a company's stock to the public.
- Debit to Dividends - Credit to Dividends Payable
The journal entry to record the declaration of a dividend includes:
Authorized shares
The maximum number of shares of capital stock of a corporation that can be issued as specified in the charter.
Sold
The number of shares issued represents the number of shares ____
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 unpaid amounts also known as dividends in arrears must be paid before any common dividends can be paid.
Stock splits
The total number of authorized shares is increased by a specific amount . Revising the corporate charter to reduce the per share par value of all authorized shares.
Current and cumulative
The two most common dividend preferences are
Transferring an amount from retained earnings to contributed capital amounts.
Stock dividends are recorded by
Date of Record
Stock records are finalized to determine which stockholders are to receive payment
Preferred stock
Stock that has specified rights over common stock
Cumulative preferred stock is entitled to receive current dividends plus "dividends in ____________" before any future common dividends can be paid.
arrears
Preferred stock carries priority over common stock _________.
both for dividends and at liquidation.
stock dividend
distrubites additional shares of stock to existing stockholders on a pro rata basis at no cost to the stockholders
payment date
dividends payable is decreased
Which of the following line item amounts are under the retained earnings column of a statement of stockholders' equity?
dividends: common; dividends: preferred; net income
A corporation ___________ have a legal obligation to pay dividends
does not
comparing EPS across companies is not advised because..
the number of shares outstanding may vary accounting methods used may vary
The amount stockholders have invested in exchange for stock
Contributed Capital of 1,000,000 represents:
Partnership
Formed by two or more people reaching a mutual agreement about the terms of the relationship
Declaration date, date of record, date of payment, year end
Four important dates for a cash dividend
Stock options
Give employees the option of acquiring the company's stock at a predetermined price often equal to the then current market price
Outstanding shares
Shares that are currently held by stockholders
Daffy Duct, Inc. issued 10,000 shares of $1 per value common stock at $10 per share. The journal entry to record this transaction includes a ______________.
$90,00 debit to cash, $100,000 credit to cash, $10,000 credit to common stock
Retained Earnings
- are decreased by dividends - all of the companys earnings kept rather than distributed to stockholders - sometimes called earned capital - increased by net income
Justin's Thyme, Inc.has the following December 31,2012, equity balances: Common Stock, $20,000; Additional Paid-in Capital, $30,000; and Retained Earnings, $50,0000. If JT repurchases $10,000 of the stock as Treasury stock, the total Stockholders' Equity balance would equal..
90,000
Payment date
A cash outflow occurs on which dividend date?
Retained Earnings
A companys past profits that are kept instead of being paid to stockholders are:
Sufficient cash
A corporation must have this to pay the dividend. If a company has retained earnings it doesn't mean they have this as well.
Payment date
A dividend that distributes additional shares of a corporations own stock
Investors expect the company to improve in the future and increase its profits.
A high PE ratio means
Par value
A large stock dividend is recorded at
They don't expect strong future performance
A low PE performance means
Limited
A major advantage of the corporate form of ownership is ____ legal liability
Limited Legal Liability
A major advantage of the corporate form of ownership is:
Market value
A small stock dividend is recorded at
Seasonal new issues
Additional issues of new stock by the company if the company had issued stock previously
Year end date
All temporary accounts including dividends are closed into retained earnings.
Stock split
An increase in the total number of authorized shares by a specified ratio. Does not affect retained earnings
Par value
An insignificant value per share of capital stock specified in the charter. First introduced to prevent stockholders from removing contributed capital of businesses that were about to go bankrupt.
Owners
Another term for stockholders is:
100,000
AnuU Inc sold 100,000 shares of the 1,000,000 shares it is allowed to sell. AnuU repurchased 10,000 of these shares. The number of shares issued equals ____ shares
Companies disclose any restrictions in their financial statement notes
Because restrictions on retained earnings can limit the ability to pay dividends accounting rules require that...
Debt financing
Borrowing money from lenders.
No par value stocks
Capital stock that has no par value specified in the corporate charter. It does not have a specified legal value per share. Is a legal concept and is not related to the market value of the company's stock.
Statement of stockholders equity
Contains a column for each stockholders equity account and shows factors that increased and decreased the account balances during the period.
Price earnings ratio
Current stock price/ earnings per share
50,000 increase to total SE 50,000 increase to total assets
Daffy Duct Inc issued 10,000 shares of $1 par value common stock at $5 per share. The effect of this transaction on the accounting equation includes a:
- 10,000 Credit to Common Stock - 90,000 Credit to Additional Paid in Capital - 100,000 Debit to Cash
Daffy Duct, Inc issued 10,000 shares of $1 par value common stock at $10 per share. The journal entry to record this transaction includes a:
Equity Financing
Dew Drop Inn has a current ratio of 0.9 to 1.0 and $4 of debt for every $1 of equity. If Dew Drop Inn needs additional financing, it would best improve its financial situation with:
Debit
Dilution Solutions repurchased 1000 shares of its $1 par value common stock for $5000. The journal entry to record this transaction includes a _____ to Treasury Stock
Retained Earnings
Dividends is closed into _____ at the end of the fiscal year
Payment Date
Dividends payable is decreased
When Diva, Inc. declared a $10,000 cash dividend, it recorded a debit to _______________ and a credit to Dividends ______________.
Dividends; Payable
Future stock prices
EPS is a good predictor of:
2 for 1
Each issued share is called in and two new shares are issued in its place
Net Income
Earnings per share (EPS) equals _____ divided by the average shares of common stock outstanding
Primary advantages of a partnership
Ease of information. Complete control by the partners. Lack of income taxes
- Have preference as to dividends - Have preference over common stockholders
Investors who acquire preferred stock:
Treasury stock
Issued shares that have been reacquired by the company
Equity financing
Issuing new stock to investors Does not have to be repaid but interest must be paid on debt when a company needs a large amount of long-term financing
45,000
Lox Stock and Bagel Inc issued 50,000 shares of the 100,000 authorized. It has since repurchased 5000 of its shares. The number of shares outstanding equals ______ shares
Return on equity
Net income- preferred dividends/ average common stockholders equity
Earnings per share
Net income- preferred dividends/ average number of common shares outstanding
These statements are true about cash dividends
On the payment date, current assets are decreased on the declaration date, liabilities are increased.
Declaration date
On which date is a liability credited?
Drawing account
Record the owners withdrawals of cash or other assets from the business
Return on equity
Reports a company's return to common stockholders
Treasury stock
Reports shares that were previously issued to and owned by stockholders but have been reacquired and at now held by the corporation.
Accumulated other comprehensive income
Reports unrealized gains and losses that are temporary changes in the value of certain assets and liabilities that the company holds.
Dividends is closed into ________________ _____________________ at the end of the fiscal year.
Retained Earnings
Kept; Balance sheet and statement of retained earnings
Retained Earnings of 100,000 represent a corporation's cumulative earnings _____ and is shown on the ______
Profits Retained Net Income Kept
Retained Earnings represents cumulative ____ by the business
Issued shares
Shares of stock that have been distributed by the corporation
Repurchase of stock
To send a signal to investors that the company itself believes its own stock is worth securing. To obtain shares that can be reissued as payment for purchases of other companies, to obtain shares to reissue to employees as part of employee stock purchase plans. And reduce the number of outstanding share to increase per share measures of earnings and stock value.
Dividends on common stock
Total dividends declared-total dividends on preferred stock
Stockholders Equity section of the Balance Sheet
Treasury Stock is reported in the
What are the benefits of common stock?
Voting Rights, the right to receive dividends if they're declared, a preemptive right to buy newly issued stock before it is offered to others, a residual claim on assets after creditors and preferred stockholders have been satisfied.
A capital account and drawing account
What are the two owners equity accounts needed
Dividends can be paid if sufficient retained earnings and sufficient cash are available.
What are two fundamental requirements for the payment of a dividend?
Stock issuance
When a corporation distributes its shares to existing or new stockholders in exchange for cash
Sufficient retained earnings and sufficient cash
When deciding whether to declare a cash dividend. A company's board of directors considers possible tax law changes and
To lower the market price per share of stock. To demonstrate commitment to stockholders while conserving cash. To signal an expectation of significant future earnings.
Why would a company issue a stock dividend?
The declaration of a dividend results in:
a decrease in retained earnings after temporary accounts are closed; an increase in liabilities; an increase in dividends
stock splits and stock dividends
cause total stockholders' equity to remain the same
stock split
causes the par value per share to change
stockholders equity statement
changes in retained earnings and paid-in capital
Ownership structure can vary from one company to another, but the most basic form of corporations offer :
common stock
most basic form of corporation
common stock
The owners of a(n) _____________ are not personally responsible for the debts of the business
corporation
the journal entry to record reissuing treasury stock at a price below the cost of the treasury stock
debit Additional Paid-In Capital debit Cash credit Treasury Stock
entry to record the issuance 100 shares 3% $100 par value preferred stock price of $105
debit cash $10,500 credit Preferred Stock $10,000 credit additional paid-in capital preferred $500
the journal entry to record the payment of a previously declared dividend
debit to dividends payable credit to cash
Dividends payable is recorded as a credit on the
declaration date
effect of repurchasing stock using the cost method
decrease stockholders equity decrease assets increase Treasury Stock
Retained Earnings are _____________.
decreased by dividends, all of the company's earnings kept rather than distributed to stockholders; sometimes called earned capital; increased by net income
the risk from financial leverage
decreases when a company issues new shares of stock increases when the cost of borrowing is greater than the return
retained earnings
earned capital
A corporation is a separate legal entity that can:
enter into contracts sue or be sued own assets
Advantages of equity financing over debt financing includes:
equity financing does not require repayment, dividends are optional
An increase in EPS is an indicator of ________.
higher profitability
Issuing 1000 shares of 5%, $100 par value, cumulative preferred stock for $110 in cash per share affects the accounting equation by
increase total assets increase total stockholders equity increasing additional paid-in capital
advantages of debt financing over equity financing include:
interest payments are deductible; stockholders' control will not be diluted
Retained Earnings of $100,000 represent a corporation's cumulative earnings_____________ and is shown on the ____________.
kept; balance sheet and statement of retained earnings
Dividends Payable is a(n) _________________ account with a normal balance and is initially recorded on the _______________ date.
liability, credit, declaration
a major advantage of the corporate form of ownership is _______________ legal liability.
limited
Dividends on preferred stock:
may be paid at a fixed rate are paid before dividends on common stock are more attractive than common stock dividends to investors who want a stable income.
corporation that has a loan covenant
may be required to repay the loan immediately if it violates the covenant must disclose the covenant in the notes to the financial statements
EPS
net income / average shares of common stock outstanding
Earning per share (EPS)
net income / average shares of common stock outstanding stock price / P/E ratio
owners of a corporation
not personally responsible for the debts of a business
The number of shares outstanding
number of shares issued - number of shares in treasury
another term for stockholders is_____________.
owners
advantages of a corporation
ownership interest are easily transferable it can raise large amounts of money by issuing stock
contributed capital
paid-in capital
cumulative stock
preferred stock that receives its current dividend and dividends in arrears
Investors earn a return on stock investments by:
receiving dividends; selling stock for more than its cost
Treasury Stock
reduces total stockholders' equity is shares of stock no longer outstanding is a contra-equity account the amount paid for stock reacquired and currently held in treasury
ROE
reports net income relative to average common stockholders equity in dollars
Stock dividends
require a journal entry
A company's past profit that are kept instead of being paid to stockholders are
retained earnings
Corporations can raise large amounts of money because
shares of stock can be purchased in small amounts, so even small investors can participate.
the number of shares issued represents the number of shares ______________.
sold
Diva Inc. declared and paid $10,000 of dividends in 2015. Dividends of $10,000 may be found on the ____________.
statement of retained earnings
What is needed to calculate the P/E ratio
stock price; Earnings Per Share
contributed captial of $1M is found in the _________________section of the _____________.
stockholders' equity; balance sheet
date of record
stocks are finalized to determine which stockholders are to receive payments
Contributed capital of $1M represents:
the amount stockholders have invested in exchange for stock
declaration date
the board of directors officially approve a dividend
The effect of transactions on financial statements when 100 shares for par value of $1 for $5 per share
the financing activities section of the statement of cash flows increases stockholders' equity on the balance sheet increases.
refurbish, inc. reissued 1,000 shares of its treasury stock for 10,000. Prior to the resistance, 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
treasury stock on the balance sheet will equal 4,000 stockholders equity on the balance sheet will be 10,000 higher
stock option
typically given to employees as part of their compensation that gives them the opportunity to buy the companys stock at a predetermined price recorded as an expense at the time it was granted
laws governing corporations
vary from state to state
no-par value stock
when a corporation charter does not specify legal value per share
when should a corporation record a liability for dividends on its cumulative preferred stock
when the dividends have been declared
