ACCT101: CH 11 Vocabulary
stock split
A reduction in the par or stated value of a common stock and the issuance of a proportionate number of additional shares. A major objective of a stock split is to reduce the market price per share of the stock. This attracts more investors and broadens the types and numbers of stockholders. A stock split does not require a journal entry.
Issuing Stock
A separate account is used for recording the amount of each class of stock issued to investors in a corporation. Stock is often issued by a corporation at a price other than its par. The price at which stock is sold depends on a variety of factors, such as the following: The financial condition, earnings record, and dividend record of the corporation. Investor expectations of the corporation's potential earning power. General business and economic conditions and expectations. In order to distribute dividends, financial statements, and other reports, a corporation must keep track of its stockholders. Large public corporations normally use a financial institution, such as a bank, for this purpose. In such cases, the financial institution is referred to as a transfer agent or registrar.
retained earnings statement
A summary of the changes in the retained earnings in a corporation for a specific period of time, such as a month or a year.
Statement of Stockholders' Equity
A summary of the changes in the stockholders' equity in a corporation that have occurred during a specific period of time. A statement of stockholders' equity is normally prepared in a columnar format. Each column is a major stockholders' equity classification. Changes in each classification are then described in the left-hand column.
in arrears
Cumulative preferred stock dividends that have not been paid in prior years are said to be in arrears. Any preferred dividends in arrears must be paid before any common stock dividends are paid. In addition, any dividends in arrears are normally disclosed in notes to the financial statements.
Financial Analysis and Interpretation: Earnings per Share
Net income is often used by investors and creditors in evaluating a company's profitability. However, net income by itself is difficult to use in comparing companies of different sizes. Also, trends in net income may be difficult to evaluate if there have been significant changes in a company's stockholders' equity. Thus, the profitability of companies is often expressed as earnings per share.
CONT. Example of Stock Dividend To illustrate, assume that the stockholders' equity accounts of Hendrix Corporation as of December 15 are as follows:
On December 15, Hendrix Corporation declares a stock dividend of 5% or 100,000 shares (2,000,000 shares × 5%) to be issued on January 10 to stockholders of record on December 31. The market price of the stock on December 15 (the date of declaration) is $31 per share. The entry to record the stock dividend is as follows: After the preceding entry is recorded, Stock Dividends will have a debit balance of $3,100,000. Like cash dividends, the stock dividends account is closed to Retained Earnings at the end of the accounting period. This closing entry debits Retained Earnings and credits Stock Dividends.
CONT. Example of Date of... To illustrate, assume that on October 1, Hiber Corporation declares the following cash dividends with a date of record of November 10 and a date of payment of December 2:
On October 1, the declaration date, Hiber Corporation records the following entry:
SH Equity reduced by TS
See the SE section of the balance sheet on page 457. Format of 1st example preferred by professor.
stock
Shares of ownership of a corporation.
cash dividend
A cash distribution of earnings by a corporation to its shareholders. Three conditions for a cash dividend are as follows: Sufficient retained earnings Sufficient cash Formal action by the board of directors There must be a sufficient (large enough) balance in Retained Earnings to declare a cash dividend. That is, the balance of Retained Earnings must be large enough so that the dividend does not create a debit balance in the retained earnings account. However, a large Retained Earnings balance does not mean that there is cash available to pay dividends. This is because the balances of Cash and Retained Earnings are often unrelated. Even if there are sufficient retained earnings and cash, a corporation's board of directors is not required to pay dividends. Nevertheless, many corporations pay quarterly cash dividends to make their stock more attractive to investors. Special or extra dividends may also be paid when a corporation experiences higher than normal profits.
*stock dividend
A distribution of shares of stock to its stockholders. Stock dividends are normally declared only on common stock and issued to common stockholders. A stock dividend affects only stockholders' equity. Specifically, the amount of the stock dividend is transferred from Retained Earnings to Paid-In Capital. The amount transferred is normally the fair value (market price) of the shares issued in the stock dividend.
par value
A dollar amount assigned to each share of stock.
restrictions (also: appropriations)
Amounts of retained earnings that have been limited for use as dividends. Restrictions of retained earnings are classified as: Legal. State laws may require a restriction of retained earnings. Example: States may restrict retained earnings by the amount of treasury stock purchased. In this way, legal capital cannot be used for dividends. Contractual. A corporation may enter into contracts that require restrictions of retained earnings. Example: A bank loan may restrict retained earnings so that money for repaying the loan cannot be used for dividends. Discretionary. A corporation's board of directors may restrict retained earnings voluntarily. Example: The board may restrict retained earnings and, thus, limit dividend distributions so that more money is available for expanding the business. Restrictions of retained earnings must be disclosed in the financial statements. Such disclosures are usually included in the notes to the financial statements.
Reporting Retained Earnings
Changes in retained earnings may be reported using one of the following: Separate retained earnings statement Combined income and retained earnings statement Statement of stockholders' equity Changes in retained earnings may be reported in a separate retained earnings statement. When a separate retained earnings statement is prepared, the beginning balance of retained earnings is reported. The net income is then added (or net loss is subtracted) and any dividends are subtracted to arrive at the ending retained earnings for the period. Changes in retained earnings may also be reported in combination with the income statement. This format emphasizes net income as the connecting link between the income statement and ending retained earnings. Because this format is not often used, we do not illustrate it. Changes in retained earnings may also be reported in a statement of stockholders' equity.
Three dates included in a dividend announcement are as follows:
Date of declaration Date of record Date of payment
Example of EPS To illustrate, the following data (in thousands) were taken from recent financial statements of Google:
Google had no preferred stock outstanding; thus, no preferred dividends were subtracted in computing earnings per share. As illustrated, Google's earnings per share increased from $30.17 in Year 1 to $32.81 in Year 2. An increase in earnings per share is generally considered a favorable trend.
No Par Stock
In most states, no-par preferred and common stock may be issued. When no-par stock is issued, Cash is debited and Common Stock is credited for the proceeds. As no-par stock is issued over time, this entry is the same even if the issuing price varies.
Stockholders' Equity on the Balance Sheet
Method 1. Each class of stock is reported, followed by its related paid-in capital accounts. Retained earnings is then reported followed by a deduction for treasury stock. Method 2. The stock accounts are reported, followed by the paid-in capital reported as a single item, Additional paid-in capital. Retained earnings is then reported followed by a deduction for treasury stock. Significant changes in stockholders' equity during a period may also be presented in a statement of stockholders' equity or in the notes to the financial statements. The statement of stockholders' equity is illustrated later in this section. Relevant rights and privileges of the various classes of stock outstanding should also be reported.Footnote Examples include dividend and liquidation preferences, conversion rights, and redemption rights. Such information may be disclosed on the face of the balance sheet or in the notes to the financial statements.
Earnings per common share (EPS)
Net income per share of common stock outstanding during a period. (Net Income - Preferred Dividends) / Avg. Number of Common Shares Outstanding If a company has preferred stock outstanding, any preferred dividends are subtracted from net income. This is because the numerator represents only those earnings available to the common shareholders.
date of declaration
The date of declaration is the date the board of directors formally authorizes the payment of the dividend. On this date, the corporation incurs the liability to pay the amount of the dividend.
Accounting for Dividends
When a board of directors declares a cash dividend, it authorizes the distribution of cash to stockholders. When a board of directors declares a stock dividend, it authorizes the distribution of its stock. In both cases, declaring a dividend reduces the retained earnings of the corporation.
Premium on Stock
When stock is issued at a premium, Cash is debited for the amount received. Common Stock or Preferred Stock is credited for the par amount. The excess of the amount paid over par is part of the paid-in capital. An account entitled Paid-In Capital in Excess of Par is credited for this amount.
corporations
either publicly held/traded or privately held... • If you can buy/sell stock in a company, it is public. • A family business that is incorporated is privately held sin e you cannot buy stock without their consent. Advantage... • limited liability aka if someone sues the business they can only go after the corporate assets and not each stockholders personal assets Disadvantage... • "double taxation of dividends" • Dividends are paid out of net income which has already been taxed at the corporate level. Dividends are then considered to be income to the stockholder and are taxed again at the personal level. When a business decides to incorporate, they apply for a corporate charter in whatever state they choose and request shares of common stock to be authorized by the state for subsequent issuance.
Main Sources of Stockholders' Equity (2)
paid-in capital (also: contributed capital) main source of paid-in capital is from issuing stock retained earnings
Example of Preferred Stock The dividend rights of preferred stock are stated either as dollars per share or as a percent of par. For example, a $50 par value preferred stock with a $4 per share dividend may be described as either:
preferred $4 stock, $50 par or preferred 8%, $50 par
stock dividend
sometimes a company does not want to pay a dividend since it needs the money for future expansion...In order to attract investors, they may instead pay a stock dividend. They are not paying out cash but instead issuing more shares of stock. Stock dividend x (record at the stock's market value) ... CS distributable x (record at par value) - this is an equity account ... APIC x (the difference between market value and par value per share)
cash dividends (3 dates)
1.Date of declaration - when a company announces a dividend, this creats a liability; Dividend $1000 Dividend payable 1000 (current liability) 2. Date of record - there is no JE for this date. This means that in order to receive this dividend you must have owned the stock by this date. If you buy the stock after this date, then you buy the stock ex-dividend. 3. Date of payment - when the company actually pays the dividend Div. Payable 1000 Cash 1000
preferred stock
A class of stock with preferential rights over common stock.
More info on Dates (3)
At the end of the accounting period, the balance in Cash Dividends will be transferred to Retained Earnings as part of the closing process. This closing entry debits Retained Earnings and credits Cash Dividends for the balance of the cash dividends account. If the cash dividends have not been paid by the end of the period, Cash Dividends Payable will be reported on the balance sheet as a current liability.
Earnings per share can be used to compare two companies with different net incomes. For example, the following data (in millions) were taken from a recent year's financial statements for Goldman Sachs Group, Inc., and Wells Fargo & Company:
Based on earnings per share, Goldman Sachs is more profitable than Wells Fargo.
Example of Stock Split To illustrate, assume that Rojek Corporation has 10,000 shares of $100 par common stock outstanding with a current market price of $150 per share. The board of directors declares the following stock split: Each common shareholder will receive 5 shares for each share held. This is called a 5-for-l stock split. As a result, 50,000 shares (10,000 shares × 5) will be outstanding. The par of each share of common stock will be reduced to $20 ($100÷5). The par value of the common stock outstanding is $1,000,000 both before and after the stock split as shown in Exhibit 9 and computed as follows:
Because there are more shares outstanding after the stock split, the market price of the stock should decrease. For example, in the preceding example, there would be 5 times as many shares outstanding after the split. Thus, the market price of the stock would be expected to fall from $150 to about $30 ($150 ÷ 5).
Example of When the company issues the stock dividend shares...
CS distributable 50,000 ... CS 50,000 Stock dividend account gets closed out to Retained Earnings at the end of the period, just like cash dividends. Notice that there was no change in the values of assets, liabilities or equity. The effect this has on the balance sheet is to shift the value of the dividend out of retained earnings into the contributed capital section of the balance sheet. (the amounts go into the CS and APIC accounts). If the market price goes up in value in the future, then the shareholders will have more shares and will enjoy the increased value of their investment.
Example of Stock Dividend For example, a company has (before stock) dividend, 1,000,000 shares authorized, 500,000 issued and 400,000 outstanding (they must have bought 100,000 shares of treasury stock). They issue a 5% stock dividend. This means they issued 5% of the outstanding shares or 25,000 shares as a stock dividend (500,000 x .05). If the par value per share is $2.00 and the market price per share is $30.00, then the JE is;
Stock dividend 750,000 (25,000 x 30.00) ... CS distributable 50,000 (25,000 x 2.00) ... APIC 700,000 (25,000 x 28.00) The amount in APIC is simply the difference between the market value and the par value times the number of shares issued.
treasury stock
Stock that a corporation has once issued and then reacquires. A corporation may reacquire (purchase) its own stock for a variety of reasons, including the following: To provide shares for resale to employees To reissue as bonuses to employees, or To support the market price of the stock The cost method is normally used for recording the purchase and resale of treasury stock. Using the cost method, Treasury Stock is debited for the cost (purchase price) of the stock. When the stock is resold, Treasury Stock is credited for its cost. Any difference between the cost and the selling price is debited or credited to Paid-In Capital from Sale of Treasury Stock.
cumulative preferred stock
Stock that has a right to receive regular dividends that were not declared (paid) in prior years. Noncumulative preferred stock does not have this right.
Example of Classes of Stock To illustrate, assume that a corporation has issued the following preferred and common stock: 1000 shares of cumulative $4 stock, $50 par 4000 shares of common stock, $15 par
The corporation was organized on January 1, 2014, and paid no dividends in 2014 and 2015. In 2016, the corporation paid $22,000 in dividends, of which $12,000 was paid to preferred stockholders and $10,000 was paid to common stockholders, computed as follows: As a result, preferred stockholders received $12.00 per share ($12,000 ÷ 1,000 shares) in dividends, while common stockholders received $2.50 per share ($10,000 ÷ 4,000 shares). In addition to dividend preference, preferred stock may be given preferences to assets if the corporation goes out of business and is liquidated. However, claims of creditors must be satisfied first. Preferred stockholders are next in line to receive any remaining assets, followed by the common stockholders.
date of payment
The date of payment is the date the corporation will pay the dividend to the stockholders who owned the stock on the date of record. During the period of time between the record date and the payment date, the stock price is quoted as selling ex-dividends. This means that since the date of record has passed, any new investors will not receive the dividend.
date of record
The date of record is the date the corporation uses to determine which stockholders will receive the dividend. During the period of time between the date of declaration and the date of record, the stock price is quoted as selling with-dividends. This means that any investors purchasing the stock before the date of record will receive the dividend.
premium price that is more than its par
The excess of the issue price of a stock over its par value or the excess of the issue price of bonds over their face amount. For example, if common stock with a par of $50 is sold for $60 per share, the stock has sold at a premium of $10.
Forming a Corporation
The first step in forming a corporation is to file an application of incorporation with the state. State incorporation laws differ, and corporations often organize in those states with the more favorable laws. For this reason, more than half of the largest companies are incorporated in Delaware. After the application of incorporation has been approved, the state grants a charter or articles of incorporation. The articles of incorporation formally create the corporation. The corporate management and board of directors then prepare a set of bylaws, which are the rules and procedures for conducting the corporation's affairs. Costs may be incurred in organizing a corporation. These costs include legal fees, taxes, state incorporation fees, license fees, and promotional costs. Such costs are debited to an expense account entitled Organizational Expenses.
discount price that is less than its par
The interest deducted from the maturity value of a note or the excess of the face amount of bonds over their issue price. For example, if common stock with a par of $50 is sold for $45 per share, the stock has sold at a discount of $5. Many states do not permit stock to be sold at a discount. In other states, stock may be sold at a discount in only unusual cases. Because stock is rarely sold at a discount, it is not illustrated.
Appropriated Retained Earnings
This means that the company is restricting some of RE so that it will be used for a specific purpose, such as expansion and cannot be used to pay a dividend to the shareholders. Any RE that is appropriated(restricted) should be disclosed in the footnotes.
Characteristics of Stock
The number of shares of stock that a corporation is authorized to issue is stated in its charter. The term issued refers to the shares issued to the stockholders. A corporation may reacquire some of the stock that it has issued. The stock remaining in the hands of stockholders is then called outstanding stock. Upon request, corporations may issue stock certificates to stockholders to document their ownership. Printed on a stock certificate is the name of the company, the name of the stockholder, and the number of shares owned. The stock certificate may also indicate a dollar amount assigned to each share of stock, called par value. Stock may be issued without par, in which case it is called no-par stock. In some states, the board of directors of a corporation is required to assign a stated value to no-par stock. Corporations have limited liability, and thus, creditors have no claim against stockholders' personal assets. To protect creditors, however, some states require corporations to maintain a minimum amount of paid-in capital. This minimum amount, called legal capital, usually includes the par or stated value of the shares issued. The major rights that accompany ownership of a share of stock are as follows: • The right to vote in matters concerning the corporation. • The right to share in distributions of earnings. • The right to share in assets upon liquidation. • These stock rights normally vary with the class of stock.
stockholders
The owners of a corporation. (also: shareholders) The stockholders of a corporation have limited liability. This means that creditors usually may not go beyond the assets of the corporation to satisfy their claims. Thus, the financial loss that a stockholder may suffer is limited to the amount invested. The stockholders control a corporation by electing a board of directors. This board meets periodically to establish corporate policies. It also selects the chief executive officer (CEO) and other major officers to manage the corporation's day-to-day affairs. Exhibit 1 shows the organizational structure of a corporation. Note: Corporations have a separate legal existence, transferable units of ownership, and limited stockholder liability.
A sale of treasury stock may result in a decrease in paid-in capital. To the extent that Paid-In Capital from Sale of Treasury Stock has a credit balance, it is debited for any such decrease. Any remaining decrease is then debited to the retained earnings account. To illustrate, assume that on October 4, the corporation sells the remaining 400 shares of treasury stock for $40 per share. The entry to record the sale is as follows:
The preceding October 4 entry decreases paid-in capital by $2,000. Because Paid-In Capital from Sale of Treasury Stock has a credit balance of $9,000, the entire $2,000 was debited to Paid-In Capital from Sale of Treasury Stock. No dividends (cash or stock) are paid on the shares of treasury stock. To do so would result in the corporation earning dividend revenue from itself.
outstanding stock
The stock in the hands of stockholders.
common stock
The stock outstanding when a corporation has issued only one class of stock.
Classes of Stock
The two primary classes of paid-in capital are common stock and preferred stock. preferred stockholders have first rights (preference) to any dividends, and thus, they have a greater chance of receiving dividends than common stockholders. However, since dividends are normally based on earnings, a corporation cannot guarantee dividends even to preferred stockholders. The payment of dividends is authorized by the corporation's board of directors. When authorized, the directors are said to have declared a dividend.
treasury stock (TS)
There are times when a company will decide it is a good idea to buy back common stock that they previously issued. They are buying it back on the stock market from their own shareholders. This will reduce the number of shares outstanding nut NOT the number of shares issued. This is how you can have a different number of shares issued from those outstanding. If a company thinks the market price of their stock is too low, they might buy back shares to try to increase the market price per share. They might also do this to defend the company from another company's hostile takeover attempt. Or, they may want additional shares available to have for an employee stock option plan. These are the most common reasons a company buys back its own stock.
Dividend Yield Ratio
This is useful to investors who value dividends. Usually older, more conservative investors invest in stocks that pay dividends. Not all companies pay dividends. Some stocks are attractive because of the increase to their market value. Other companies that aren't growing a fast, will attract investors by paying a dividend since their stock may not appreciate in value as much as a "growth" stock.
Costs Incurred Organizing a Corp.
To illustrate, a corporation's organizing costs of $8,500 on January 5 are recorded as follows:
issuing stock shares
When a business decides to incorporate, they apply for a corporate charter in whatever state they choose and request shares of common stock to be authorized by the state for subsequent issuance. A company does not have to issue all stock shares authorized. For example, if a company has 1,000,000 shares authorized, they may issue 400,000 shares in exchange for cash. When a company issues/sells stock to the shareholders (this is how they raise money to expand the business) those shares are both issued and outstanding. Some states require that the company establish a par value for each share of stock. This par value is supposed to be for the protection of creditors of the company. The company's "Legal Capital" is not to be used for the purpose of paying stockholders dividends, but in the event of liquidation, can be used to help repay creditors.
legal capital
[(Par value per share) x (# of common shares issued)] This amount gets recorded in the Common Stock(CS) equity account. Most of the time, par value is set very low so that the market price per share is higher than the par value. When the market price is higher, we are selling the stock at a premium.
stock splits
a company will split its stock so that it appears more affordable to investors...They hope this will increase demand for their stock. It has no effect on the values on the balance sheet and there is no JE when a company's stock splits.
corporation
a legal entity, distinct and separate from the individuals who create and operate it As a legal entity, a corporation may acquire, own, and dispose of property in its own name. It may also incur liabilities and enter into contracts. Most importantly, it can sell shares of ownership, called stock. This characteristic gives corporations the ability to raise large amounts of capital.
preferred stock (PS)
is another way in which a company can raise capital...The advantage to the company with preferred stock is that preferred stockholders do not have voting rights as do the common stockholders. PS will receive dividends before CS does and if the company liquidates, then PS will recover their investment before CS. PS also has a par value but it usually a higher value than the CS. The journal entries for issuing preferred stock are the same as CS. PS can have features such as cumulative, participating. and convertible. • Convertible means that the PS holder can convert those shares into CS shares whenever they want. • Participating means that the PS holder will receive an additional dividend to the promised dividend if there is extra money available. The cumulative feature will be tested. This means that if the company did not pay a dividend this year the company will keep track of what should have been paid to the PS and will pay it in the future when there is money available to pay as a dividend. These dividends that were not paid are called, "in arrears". Common stock is NEVER cumulative.
