Ch. 11 Financial

Dividends require information concerning three dates:

Declaration date: - Date on which the board of directors authorizes or declares the dividend and on this day the company has a legal obligation that it will pay the dividend. (with this liability, they are going to have to journalize it.) Record date: - Date on which registered shareholders are eligible for dividend. (So lets say you had the stock on the day of declaration, but you sold it before the record date, you will not receive the dividend. Payment date: - When the company issues the dividend checks to bondholders

Forming a corporation

Initial steps: - File application / paperwork with the Secretary of State. - If you do this appropriately and pay appropriate fees, the state will grant a corporate charter. (gives you the legal right to have a corporation) - Then the corporation will develop various by-laws. (helps govern the corporation, and how it will operate and choose positions, etc) - Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, & New Jersey have certain advantages). ○ If you incorporate in a state that doesn't mean you only operate in that state, you can operate/sell your products wherever you want. It's just simply a part of following the steps to actually create a corporation. - Share the corporate earnings through receipt of dividends. Corporations engaged in interstate commerce must obtain a license from each state in which they do business.

Example 1:17:10

Microsystems Inc. currently has 100,000 shares of common stock outstanding issued at $25 per share and no debt. It is considering two alternatives for raising an additional $5 million: Plan A involves issuing 200,000 shares of common stock at the current market price of $25 per share. Plan B involves issuing $5 million of 12% bonds at face value. Income before interest and taxes will be $1.5 million; income taxes are expected to be 30%. Plan A

Earnings Performance: Return on Common Stockholders Equity ratio

Net Income - Preferred Dividends / Average Common Stockholders Equity = Return on Common Stockholders Equity *Preferred Dividends = Amt given to the preferred stockholders *Avg. common stockholders equity with be beginning of years stockholders equity - end / 2 "Return on" is a good indicator of stockholders equity

Ex:

On February 1, 2014, Mead acquires 4,000 shares of "its stock" at $8 per share. Prepare the entry. - This would be treasury stock because its its own stock. - The treasury stock would increase by the amount of treasury stock we've acquired. - & since we paid $8 per share x 4,000 shares, we have 32,000 of treasury stock. - Were not going to be dealing with excess of par values or any of that when dealing with treasury stock. - Everything we record goes into the treasury stock and we record how much we had to pay - Credit cash 32,000 **If you see the word "outstanding" on the balance sheet: it includes issued stock that remains in the hands of outsiders, people who are outside of the corporation. **Treasury stock is on the inside of the company.

When issuing common stock, we want to satisfy certain objectives...

Primary objectives: 1) Identify the specific sources of paid-in capital. 2) Maintain the distinction between the paid-in capital and retained earnings. Other than consideration received, the issuance of common stock affects only paid-in capital accounts. - In other words, issuing stock is very much a contributed capital, it is not a retained earnings.

Why do corporations issue stock dividends?

Reasons why corporations issue stock dividends: 1.) Satisfy stockholders' dividend expectations without spending cash. 2.) Increase the marketability of the corporation's stock. 3.) Emphasize that a portion of stockholders' equity has been permanently reinvested in the business.

Retained Earnings Restrictions

Restrictions can result from: 1.) Legal restrictions. 2.) Contractual restrictions. 3.) Voluntary restrictions. (Company decides to restrict a portion of its retained earnings.) Restrictions = That part of the Retained Earnings is no longer available for paying dividends. - Disclosures for restrictions will typically be made in the foot notes

Ex: Cumulative Dividend

Scientific Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding. Each $100 share pays a $7 dividend (.07 x $100). The annual dividend is $35,000 (5,000 x $7 per share). If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends in the current year. Question broken down: - There are 5,000 shares of preferred stock - This preferred stock is 7%, $100 par (that means that the dividend on an annual basis = 7% of the par value. Or in this case the dividend should be $7 per share each year. - Also, this is cumulative preferred stock which means that if last years dividend wasn't paid, then it would have to be paid along with this years. - The annual dividend for the preferred stock (5,000 x 7 per share = $35,000) - If dividends are two years in arrears (means that they were not payed last year or the previous year, how much would preferred stockholders get before common stockholders could ever receive anything? Well this year preferred stockholders are entitled to see 2 years of dividends in arrears (Annual dividend x 2) plus the current year dividend. $70,000 + $35,000 = $105,000 - If any less than that was declared in the current year, preferred stockholders are going to get it all. - If more than 500,000 was declared as a dividend, preferred stockholders get the 1st 105, common stock holders will split the rest.

Ex on 43:08 Problem with important definitions: "issued" and "outstanding"

So, if this company had authorized 400,000 and had issued 100,000 shares, what happens when the company itself goes out and reacquires 4,000 of those shares? - We would update the balance sheet on the stockholders equity section to show that yes there are still 100,000 shares that have been issued but only 96,000 of them remain outstanding (b/c the company reacquired 4,000 of their own shares). Both the number of shares issued (100,000), outstanding (96,000), and the number of shares held as treasury (4,000) are disclosed.

Preferred stock example

Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Journalize the issuance of the preferred stock. - That means $10 of par value per share. - & they sell it to shareholders for $12 per share. - Debit Cash collected: 10,000 x $12 = 120,000 - Credit the Preferred Stock account for the par value: 10,000 x $10 = 100,000 - Credit "Paid-in Capital in Excess of Par Value —Preferred Stock" because you issued preferred stock for more than par. **Preferred stock like common stock may have a par value or no-par value.

Stock Issue considerations 31:43

The stockholder's equity section of a corporations balance sheet has 2 subsections: - Paid-in capital (the corporations contributed capital) and Retained Earnings. Paid in Capital includes: - Common stock, and Preferred stock. - And from these 2, we might even have something called Paid-in Capital in Excess of par. (All corporations have common stock, but only some have preferred stock as a second class of stock.) The other big section includes: the Retained Earnings account (by itself). - Retained Earnings = Net Income (earned capital) that a corporation retains for future use in the business. Formal definition for paid-in capital: - Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for shares of ownership.

Issuance of Stock

Then, the company wants to issued the shares. (So issuance of stock means selling the shares to the shareholder.) Corporation can issue common stock - directly to investors or - indirectly through an investment banking firm and they would sell it for us (for a fee). IF you're using an investment baking firm, you are most likely a public corporation not a private one. Top five exchanges by value of shares traded: 1.) New York Stock Exchange 2.) Nasdaq stock market 3.) London Stock Exchange 4.) Tokyo Stock Exchange 5.) Euronext

President & CEO

They have the overall responsibility of managing the businesses day to day operating activities. - What products should they be producing - What markets should they be selling in - What price should they be charging, ETC ** Of course you're going to be doing this with the help of a whole lot of people but its their job to really run the business.

Stock Dividends

This occurs when a company issues stock instead of cash and pays this out as a dividend. - Pro rata (proportional) distribution of the corporation's own stock. - Results in decrease in retained earnings and increase in paid-in capital. Ex: assume a co has 100 shares of stock, and you own 30 shares, you own 30% of the company. If the company issued a 10% stock dividend, that means they would be issuing 10 shares (100x.10 = 10 shares.) Coupled with the original shares, the co would now have 110 shares. - You used to own 30 of the 100. IF you get a proportionate share, you should get 30% of these 10 new shares. (33/110 instead of 30/100). This way you still own 30% of the company.

Authorized Stock

To create a corporation, we have to satisfy certain legal requirements. We must first create a corporate charter. - And that charter indicates the amount of stock that a corporation is authorized to sell. - The number of authorized shares is often reported in the stockholders' equity section. (on the balance sheet) - A key here to authorize shares is to know that a corporation cannot sell or issue stock unless it has first authorized that many shares.

What is Treasury Stock?

Treasury stock - corporation's own stock that it has reacquired from its shareholders, but not retired. (They're holding it in their "treasury", they might save it and use it for the future.) So, why does a corporation purchase its own stock? 1.) To reissue shares to officers and employees under bonus and stock compensation plans. 2.) Maybe the companies stock isn't trading very frequently, so buying their own stock increases the amount of trading of the company's stock. 3.) Might want to have a bunch of their own shares on hand because they might want to use it to buy or acquire another company (This would be called a stock for stock exchange.) 4.) To increase earnings per share. If fewer shares of stock are outstanding, then earnings / # of shares outstanding increases earnings per share. (A way to increase a company's earnings per share is simply to take some of the shares off the market place.) Another infrequent reason is to eliminate hostile shareholders trying to buy up your company's stock and take over ownership.

Balance Sheet Presentation - Classifications of paid in capital

Two classifications of paid-in capital: 1.) Capital stock (know whats in this) 2) Additional paid-in capital (where we put the excess of the amount contributed)

Preferred stock

Typically, preferred stockholders have a priority/higher positon when people are lining up for: 1.) dividends and 2.) assets in the event of liquidation (residual claims when the company liquidates) - In other words, when a company goes bankrupt, who does it pay first? Creditors, then preferred stockholders, then last common stockholders. *However, preferred stockholders hardly ever have voting rights. Each paid-in capital account title should identify the stock to which it relates: ○ If you issued perferred stock for more than par you woud use this account name: "Paid-in Capital in Excess of Par Value —Preferred Stock" ○ If you issued common stock for more than par you would use this account name: "Paid-in Capital in Excess of Par Value —Common Stock"

Stock Splits

Were gonna split stock into smaller pieces. - Reduces the market value of shares. - No entry recorded for a stock split. - Decrease par value or stated value and increase number of shares that we have. EX: 100 shares & 10 par If it was a 2:1 split, that means we would have 200 shares but it would be 5$ par for each share. - We still have $1,000 par value either way, so no journal entry necessary.

Debt Versus Equity Decision

When obtaining capital from outsiders, like creditors or shareholders, the company's management has to decide how they are going to acquire it either by: - Issuing debt (& that creates a liability such as a bond payable) or - Issue stock (& create more equity)

Paying a dividend is a financing outflow

(Review)

Effects of Stock Dividends

- Changes the composition of stockholders' equity. (Total equity doesn't change, were just changing it from one account to the other.) - Total stockholders' equity remains the same. - No effect on the par or stated value per share. - Increases the number of shares outstanding **Decreases retained earnings and increases the pay-in capital.

Treasurer

The one who has custody over the company's funds - Recall from previous chapters: Internal controls and how important it is to safeguard the company's assets - Well, a lot of that falls into the lap of the treasurer. - Also in charge of maintaining the company's cash position and make sure they're liquid enough to pay the bills as they come due.

Par and No-Par Value Stocks

- Capital stock (the stock that we issue in exchange for contributed capital) that has been assigned to par value is more well known - Years ago, some people issued stock to stockholders, and then insiders decided to strip out money from the company, leaving the shareholders with nothing. Then laws were passed that determined the legal capital per share that a company must retain in the business for the protection of corporate creditors. (Basically laws were passed that say no matter what, a compnay cannot strip out the par value out of the company.) The par value has to be retained in the company as legal capital or as stockholders equity no matter what. - Today, however, many states have gotten passed these rules and do not require a par value so we simply call those shares, "No-par value stock" which is fairly common today. - In many states they do not have a par value, but a stated value (stated value operates essentially the same as par value we just give it a slightly different name.)

Purchase of Treasury Stock

- Generally accounted for by the cost method. (We record things at cost, or their historical cost.) - Were going to credit cash for the amount we paid Debit "Treasury Stock" account for the price paid. (Keep in mind that the treasury account is not an asset, it shows on the SE portion of the balance sheet) - Treasury stock is a contra stockholders' equity account, not an asset. - Treasury Stock decreases by the same amount when the company later sells the shares.

Other forms of business organizations

- Limited partnerships ○ Allows some of the partners to have limited liability. ○ This is very handy if you want some of the advantages of partnerships and you want some of the advantages of limited partnership. - Limited liability partnerships (LLPs) - Limited liability companies (LLCs) - S Corporation ○ Specialized version of a corporation (but still is a corporation.) ○ Still offers limited liability to all the shareholders ○ But what it does have that makes it special is: No double taxation. (Only a single tax) ○ Not every corp. can be an S corporation to escape taxes, but only corporations with less than 100 shareholders.

Retained Earnings 1:05:15

- Retained earnings is net income that a company retains for use in the business. - Net income increases Retained Earnings and a net loss decreases Retained Earnings - Retained earnings is part of the stockholders' claims on the *total* assets of the corporation, not claims against a specific asset. - Retained earnings is an equity account, nto an asset. - R.E. normally has a credit balance, but could have a debit balance. A debit balance in Retained Earnings is identified as a deficit. (means net loss is bigger than net income)

Dividend Preferences that preferred bondholders have

- Right to receive dividends before common stockholders. - Per share dividend amount is stated as a percentage of the preferred stock's par value or as a specified amount. - Cumulative dividend: holders of preferred stock must be paid their annual dividend for the current year PLUS any dividends in arrears (dividends that had not been paid in previous years), before common stockholders receive dividends

Characteristics that distinguish corporations from proprietorships and partnerships.

- Separate Legal Existence ○ Corporation acts under its own name rather than in the name of its stockholders. - Limited Liability of Stockholders ○ Owners benefit from this. Shareholders are not responsible for the corporations debts. - Transferable Ownership Rights ○Shareholders may sell their stock to whoever they please. Shares can be bought or sold to anyone, given as gifts, inherited, etc. (& dont need permission.) - Ability to Acquire Capital ○ Corporation can obtain capital through the issuance of stock to shareholders. Easier to obtain money. - Continuous Life The life of a corporation continues as a going concern even if there is a withdrawal, or death of a stockholder, employee, etc. - Corporate Management ○ Separation of ownership and management prevents owners from having an active role in managing the company - Government Regulations Corporatons face a lot more government regulations and theres a lot more paper work that needs to be done and i.e more money needs to be put into it. - Additional Taxes ○ Corporations pay income taxes and in addition, stockholders pay taxes on cash dividends. (this is known as double taxation.)

Corporations can be classified two ways:

1.) Classified by Purpose: - Not for profit (Salvation Army, American Cancer Society, etc) - For profit (Facebook, IBM, etc) 2.) Classified by Ownership: - Publicly held ○People who own the company can be virtually anyone, (i,e. shareholders,) and the stock can be freely traded. Ownernship is offered to the public at large. - Privately held ○ Corporation still has stock, but it is not offered to the public at large. (One family or one group of investors). ○ AKA Closely held investors

Bond financing advantages

1.) If we issue bonds, then we have not diluted ownership of the company & stockholder control is not affected. - Bondholders do not have voting rights, so current owners (stockholders) retain full control of the company. 2.) Tax savings result. - Bond interest is deductible for tax purposes; dividends on stock are not. Tax deduction lowers taxable income and lowers taxes paid by the company. 3.) Return on common stockholder's equity may be higher - Although bond interest expense reduces net income, return on common stockholders equity often is higher under bond financing because of no additional shares of commons stock are issued. AKA bonds dont give ownership to them, so you're own equity can become higher if theres less people who have ownership of the company.

Stockholders Rights

1.) Vote in election of board of directors and on actions that require stockholder approval. 2.) Share the corporate earnings through receipt of dividends. 3.) The right to keep the same percentage of ownership when new shares are being issued by the company. (Called a Preemptive right) - EX: if you were a shareholder and owned 14% of a company & the company decided to issue new shares, this would give you the right to purchase 14% of the new shares. So you would have 14% of the original company, & you would have 14% of the new shares, so after this occurs you would still own 14% of the company. (You wouldn't have to, only if you wanted to.) 4.) Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. - Residual = kind of like whats left over. - Shareholders have the right to share in the assets of a company, if the company were to liquidate or close their doors and thar right is in proportion to their holdings. - So, a 14% shareholder has a right to 14% of the residual amount of assets. - If a company has a lot of assets but isn't profitable and goes out of business, first the company has to pay off all its liabilites to the lenders (or creditors), and THEN if anything is left over / if there is a residual, that would go up to the shareholders & it would go in proportion to their holdings. - So a 14% shareholder will receive 14% of the remaining residual.

Corporation Organization Chart

14:40 Starting @ the top: - Stockholders vote/choose the chairman and board of directors - Chairman & board of directors help establish broad policies for the organization - Then, the baord hires a President and Chief Executive officer to start implementing and working those policies (sometimes theses are 2 different individuals and sometimes these 2 positions are collapsed into 1.) - Then underneath all that, most corporations have General Counsel/Secretary (lawyers), along with various VP's in charge of different things. - Likewise, a corporation will have a treasurer and a controller (key positions along with the president and CEO)

Expanded stockholders equity on the balance sheet

1:08:57

Dividends

A distribution to stockholders on a pro rata (proportional to ownership) basis. - meaning if i own 1% of the company and theres a dividend, then i should get 1 % of it. Types of Dividends: 1. Cash dividends (most often) 2. Property dividends (company could have land that it gives to its shareholder) 3. Stock dividends (compnay issued more shares of stock to the stockholders) 4. Scrip (promissory note to pay something in the future.) Dividends are expressed: (1) as a percentage of the par or stated value, or (2) as a dollar amount per share. (most common)

Review question

ABC Corp. issues 1,000 shares of $10 par value common stock at $12 per share. When the transaction is recorded, credits are made to: - Credit Common stock by 10,000 - Credit Paid in capital in excess of par value by 2,000 ***keep in mind that were going to put the par value in the common stock account. And with 1,000 shares at $10 a piece that is going to = 10,000. The rest that were going to get in excess of par value ($12 per share) goes into the paid-in capital account.

Controller

AKA: Chief accounting officer - Maintaining or controlling the company's accounting records (the book keeping side of things.) - The financial reporting, the preparing of financial statements - Also plays an important roll in the internal controls along with the treasurer in certain aspects of maintaining strong internal controls for a business

Which are advantages to the corporation? Which are a disadvantages?

Advantages: -Separate Legal Existence - Limited Liability of Stockholders - Transferable Ownership Rights - Ability to Acquire Capital - Continuous Life Disadvantages: - Government Regulations - Additional Taxes Could be an advantage OR disadvantage: - Corporate Management The hired managers could be skilled professionals but at the same time, this makes it hard for the outside shareholders to know whats going on inside among the managers. And sometimes managers don't make the decisions that the shareholders want them to.

Journalizing issues of common stock

○ Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value common stock. Prepare Hydro-Slide's journal entry if (a) 1,000 share are issued for $1 per share. - Means that each share has $1 par value - In this case, stocks are issued for the same amount as the par value. (Stock cannot be issued less than par value can only be issued for the same amount or more). Cash 1,000 Common Stock (1,000 x $1) 1,000 ○ What if they had been issued for $5 per share? Cash 5,000 Common Stock (1,000 x $1) = 1,000 Paid-in capital in excess of parvalue 4,000 - Remember common stock account only shows the par value of the stock issued. - Then, to make sure debits = credits, credit the paid-in capital in excess of par value for the remaining $4,000. ○ What would happen if the company had a stated value instead of a par value? - We would essentially do the same thing except we would drop the word par and replace it with the word "stated".

Example: Defecit on the balance sheet

1:05:55

Corporation

An entity that is separate and distinct from its owners.

Cash Dividend

For a corporation to pay a cash dividend, it must have: 1.) Retained earnings - Payment of dividends comes from retained earnings and is legal in all states. (Paying dividends out of something other than R.E can be illegal) 2.) Must have an dequate amout of cash to pay the dividend to the shareholders 3.) The only way they're going to have a dividend payed is if it was declared by the Board of Directors.

Liquidation Preference

Preferred stockholders have preference on corporate assets if the corporation fails. - Preference may be: ○ for the par value of the shares or ○ for a specified liquidating value

Ex continued

Stockholders' equity section assuming Hydro-Slide, Inc. has retained earnings of $27,000. On the balance sheet, we would see that Stockholders equity section has 2 parts: 1) Paid in capital - Would show both the common stock for the par value and paid-in capital in excess of par. 2) Retained Earnings

Debt Versus Equity Decision stakes

This decision is a huge one in the business world because it can affect return on common stock holders equity, which can affect profitability, and leverage (debt to assets ratio) and more.

Where does treasury stock belong on the balance sheet? 37:25

Treasury stock does not belong in either the Paid-in Capital or the Retained Earnings portion of stockholders equity section. - It has its own area and notice it says "less" which means it is going to be subtracted from everything else in order to calculate ending stockholders equity.

Which of these statements about stock dividends is true? a.) Stock dividends reduce a company's cash balance. b.) A stock dividend decreases total stockholders' equity. c.) A stock dividend has no effect on total stockholders' equity. d.) A stock dividend ordinarily will increase total stockholders' equity.

c.) A stock dividend has no effect on total stockholders' equity.

Which of these statements is false? a. Ownership of common stock gives the owner a voting right b. The stockholders' equity section begins with paid-in capital. c. The authorization of capital stock does not result in a formal accounting entry. d. Legal capital is intended to protect stockholders.

d. Legal capital is intended to protect stockholders.