acct ch 9 & 10

dividends ____________ retained earnings

reduce

how are assets distributed to stockholders?

repurchasing their shares paying dividends

premium

when bonds selling price is above face value

discount

when bonds selling price is below face value

interest net of income taxes

(1 - Tax Rate) x Interest

Installment bonds differ form typical bonds in what way?

A portion of each installment bond payment pays down the principal balance

If a company purchases treasury stock for $6,000 and then reissues it for $5,000, the difference of $1,000 is:

decrease in stockholders equity

When bonds are issued at a premium, the interest expense for the period is the amount of interest payment for the period

minus the premium amortization for the period

both common and preferred stock are recorded at:

par value

Bonds are priced at the present value of the

periodic interest payments and the principal

When bonds are issued at a discount, the interest expense for the period is the amount of interest payment for the period

plus the discount amortization for the period

is face value or market value placed on balance sheet

premium and discount accounts are netted with bonds payable on the balance sheet, so on the date of issue the book value of the bonds payable is equal to the market value

The bond issue price is determined by calculating the:

present value of the stream of interest payments and the present value of the maturity amount

what happens when stated interest rate is lower than market value interest rate?

the lack of demand for such bonds will bid the market price below face value (discount)

with a fixed rate who bears the risk of changing rates?

the lender

When a company declares a 3-for-1 stock split, the number of outstanding shares:

tripples

when are bonds a good investment?

when stated interest rate is higher than market value

difference between straight-line and effective interest rate method

with the effective interest rate method the interest expense changes every period, but the effective interest rate on the bond book value is constant. The straight-line method, on the other hand, has a constant interest expense each period, but the effective interest rate on the bond book value changes every period.

yield for premium

yield < stated rate

yield for discount

yield > stated rate

how is interest allocated for classic installment debt?

Installment debt payments are the same each period, but the portion that is considered interest changes because the outstanding principal balance is changing.

When bonds are issued by a company, the accounting entry typically shows an

increase in liabilities and an increase in stockholders' equity

3 cash flows the issuing corporation must account for

inssuance interest repayment

interest payments with effective interest rate method

interest payments are calculated with face value and the stated rate of interest. These payments are the same each period. Interest expense, under the effective rate method, is calculated by using the Carrying Value (Face Value − Discount Balance or Face Value + Premium Balance) and the yield, or market rate, of interest.

bond buyer

lender

what happens if a lease under a year is signed?

no assets or liabilities are recognized on the balance sheet at the time the lease is signed (i.e., no journal entry is made when the lease is signed) record rent expense as you make the lease payments

what effect to stock dividends and stock splits have on SE?

none

the income statement is _______________ by treasury stock transactions because the income statement _____________________

not affected is reserved for transactions with non owners

how are bonds priced?

at present value of future cash flows (interest payments and repayment of principle)

the difference between capital and operating leases:

capital leases require a liability to be recorded, operating leases do not

bond book value

carrying value

what type of stockholders receive the bulk of the gain from profitable companies?

common stockholders

what does it mean when retained earnings is restricted

communicates to stockholders that this portion of retained earnings is not eligible for dividend payout

why would a company grant stock options?

compete for top-talent employees aligns incentives of employees with owners

What best describes the discount on bonds payable account?

contra-liability

what two things are stockholders primarily interested in?

creation of value distribution of value

Any amount of cash received over the face value is ______________ to a premium.

credited

Preferred stock is tied to the companies ____________ while common stock is tied to the companies _____________

creditworthiness performance

An important indicator of the purchasing power of money is

CPI

why would companies issue stock warrants?

"equity kicker" to existing owners

what type of accounts are premium/ discount on bonds payable accounts?

"valuation" accounts because they affect the value at which the liability is shown on the balance sheet

long term creditors focus on ratios that incorporate

Long-term debt interest expense/payments

what is a stock split?

Market value goes down so that more people can have stock. In a 2:1 split, if you had 1share of stock you now have 2

Is the total amount of interest expense over the life of the bond higher when we use straight-line amortization or the effective interest rate method?

Neither—the total amount of interest expense is identical under both methods. What changes is the interest expense allocated to each period

Is it always better to have lower debt to equity, debt to total assets, and long-term debt to equity ratios?

No. Debt provides opportunities for leverage. Think about it in this way—if you're guaranteed a return greater than your interest payments, it would not make sense to avoid borrowing. Of course, the reality is that while no returns are guaranteed, interest payments are unavoidable.

When a company purchases treasury stock:

The cost of the treasury stock reduces stockholders' equity

Why is the effective interest rate method GAAP?

The effective interest rate method does a better job of expense recognition by more accurately allocating, or matching, the time value of money to the proper period. Under the effective interest rate method, the interest expense is equal to market rate of interest (or yield) at issue on the bond book value. This makes sense because market forces will ensure that the creditor receives the market rate of return on the investment.

face value (par value)

The payment to the bondholder at the maturity of the bond

Which ratios focus on a companies ability to make interest payment?

Times interest earned ratios (often called coverage ratios because they provide information on the company's ability to meet or cover its interest payments)

What is the effect of a stock dividend on stockholders' equity?

Total stockholders' equity stays the same.

The result of using the effective interest method of amortization of the discount on bonds is that:

a constant interest rate is charged against the debt carrying value

the cost of stock repurchases is recorded as

a debit to treasury stock (reduction in stockholders equity)

The issue price of long-term debt is typically quoted as __________

a percentage of face value

The premium on bonds payable account is shown on the balance sheet as

an addition to a long-term liability

what happens if a lease greater than a year is signed?

an asset and liability are recognized at the time the lease is signed asset is debited to recognize the benefits that the leased asset will provide in the future and a liability is credited to recognize the obligation to make future lease payments

why is borrowing through the use of bonds attractive to businesses?

because the relative cost of issuing debt (interest payments) is often lower than the loss of issuing equity (giving up ownership shares)

Debt securities are issued in exchange for _____________

borrowed cash

bond seller

borrower

advantages for common stockholders

call provisions voting rights

Any amount of cash received under the face value is _______________ to a discount.

debited

which ratios. contain all debt and are better for companies that use short term debt?

debt to equity ratio and debt to total asset ratio

which ratio looks at the mix of debt to equity financing?

long-term debt to equity ratio

When a company retires its own common stock, the company must:

decrease the Common Stock account balances by the original issue price.

advantages for preferred stockholders

dividen preferences conversion privleges liquidation preferences

which amount is recognized as bonds payable/ repaid at maturity

face value

underwriters

generate a profit either by offering a price that is slightly less than the expected market price (thereby producing a profit on resale) or by charging the borrower a fee

Classic installment debt payments

home mortgages, or car payments

why is inflation an advantage of financing with debt?

in periods of inflation, debt permits the borrower to repay the lender in dollars that have declined in purchasing power

negative aspect to financing with debt

inflexibility of payment If a payment is not made as scheduled, the borrower can be forced into bankruptcy. This attribute of debt makes it a more risky source of capital than equity

interest for premium

interest expense < interest paid

interest for discount

interest expense > interest paid

why would you finance with debt rather than stock?

interest expense on debt is deductible for tax purposes financing with bonds is the interest net of income taxes

why is interest expense different between the two periods

interest expense using the straight-line method is the same each period. In contrast, the interest expense using the effective interest method results in a different amount each period. This is because the interest expense is based on a constant rate

With regard to preferred stock,

its stockholders may have the right to participate, along with common stockholders, if an extra dividend is declared.

advantages of leasing over buying

less cash needed protection and flexibility lower cost financing with tax advantages

When a company declares a cash dividend, which of the following is true?

liabilities are increased

reasons a company might repurchase its own stock

prevent unwanted takeover increase earnings per share needs stock for employee bonus

If a company finds that it cannot make its payments on debt, it may be forced into __________ or bankruptcy.

restructuring the debt

components of stockholders equity

retained earnings net income loss on_______

Which of the ratio measures the growth in equity from operating activities?

return on common equity

Accounting for leased assets reflects the underlying concept of whether or not a company has obtained the

risks and benefits of ownership

Many companies structure a lease to avoid

showing a lease on the balance sheet

interest amortization methods

straight line method effective interest rate method (GAAP)

3 advantages of financing with debt

tax deductible leverage inflation

with a variable rate who bears the risk of changing rates?

the borrower

what should be considered when a company decides to declare a cash dividend on common stock?

the cash available and retained earnings balance

what happens when stated interest rate is higher than market value interest rate?

the demand for such bonds will bid the price up above face value (premium)

Which of the following is true of the balance sheet presentation of a bond issued at a discount?

the discount is subtracted from bonds payable

yield

the market rate of interest demanded by creditors; yield may differ from stated rate because the underwriter disagrees with the borrower as to the correct yield or because of changes in the economy or creditworthiness of the borrower between the setting of the stated rate and the date of issue.

As a result of a stock split,

the par value of the stock is changed in the reverse proportion as the stock split.

Which of the following is true of the balance sheet presentation of a bond issued at a premium?

the premium is added to bonds payable

market rate

the rate that borrowers are willing to pay and lenders are willing to accept for a particular bond and its risk level

leverage

the use of borrowed capital to produce more income than needed to pay the interest on a debt (another benefit of financing with bonds rather than stock)

why do corporations sell stock

to raise capital