CH 11 Summary

Book value per common share is equity applicable to common shares divided by the number of outstanding common shares. Book value per preferred share is equity applicable to preferred shares divided by the number of outstanding preferred shares.

Compute book value and explain its use in analysis.

Dividend yield is the ratio of a stock's annual cash dividends per share to its market value (price) per share. Dividend yield can be compared with the yield of other companies to determine whether the stock is expected to be an income or growth stock.

Compute dividend yield and explain its use in analysis.

A company with a simple capital structure computes basic EPS by dividing net income less any preferred dividends by the weighted-average number of outstanding common shares. A company with a complex capital structure must usually report both basic and diluted EPS.

Compute earnings per share and describe its use.

A common stock's price-earnings (PE) ratio is computed by dividing the stock's market value (price) per share by its EPS. A stock's PE is based on expectations that can prove to be better or worse than eventual performance.

Compute price-earnings ratio and describe its use in analysis.

Convertibility permits the holder to convert preferred to common. Callability permits the issuer to buy back preferred stock under specified conditions. Preferred stockholders usually hold the right to dividend distributions before common stockholders. When preferred stock is cumulative and in arrears, the amount in arrears must be distributed to preferred before any dividends are distributed to common.

Preferred stock has a priority (or senior status) relative to common stock in one or more areas, usually (1) dividends and (2) assets in case of liquidation. Preferred stock usually does not carry voting rights and can be convertible or callable.

Many companies face statutory and contractual restrictions on retained earnings. Corporations can voluntarily appropriate retained earnings to inform others about their disposition. Prior period adjustments are corrections of errors in prior financial statements.

Explain the items reported in retained earnings. Stockholders' equity is made up of (1) paid-in capital and (2) retained earnings. Paid-in capital consists of funds raised by stock issuances. Retained earnings consists of cumulative net income (losses) not distributed.

A corporation acts through its agents, who are its officers and managers. Corporations are regulated and subject to income taxes. Authorized stock is the stock that a corporation's charter authorizes it to sell. Issued stock is the portion of authorized shares sold. Par value stock is a value per share assigned by the charter. No-par value stock is stock not assigned a value per share by the charter. Stated value stock is no-par stock to which the directors assign a value per share.

Identify characteristics of corporations and their organization. Corporations are legal entities whose stockholders are not liable for its debts. Stock is easily transferred, and the life of a corporation does not end with the incapacity of a stockholder.

Explain characteristics of, and distribute dividends between, common and preferred stock. Preferred stock has a priority (or senior status) relative to common stock in one or more areas, usually (1) dividends and (2) assets in case of liquidation.

Par value stock is a value per share assigned by the charter. No-par value stock is stock not assigned a value per share by the charter. Stated value stock is no-par stock to which the directors assign a value per share.

Treasury stock is subtracted from equity in the balance sheet. If treasury stock is reissued, any proceeds in excess of cost are credited to Paid-In Capital, Treasury Stock. If the proceeds are less than cost, they are debited to Paid-In Capital, Treasury Stock to the extent a credit balance exists. Any remaining amount is debited to Retained Earnings. When stock is retired, all accounts related to the stock are removed.

Record purchases and sales of treasury stock and the retirement of stock. When a corporation purchases its own previously issued stock, it debits the cost of these shares to Treasury Stock.

If a stock has neither par nor stated value, the entire proceeds are credited to the stock account. Stockholders must contribute assets equal to minimum legal capital or be potentially liable for the deficiency.

Record the issuance of corporate stock. When stock is issued, its par or stated value is credited to the stock account and any excess is credited to a separate contributed capital account.

On the date of payment, cash is paid to stockholders and the current liability is removed. Neither a stock dividend nor a stock split alters the value of the company. However, the value of each share is less due to the distribution of additional shares. The distribution of additional shares is according to individual stockholders' ownership percentage. Small stock dividends (≤25%) are recorded by capitalizing retained earnings equal to the market value of distributed shares. Large stock dividends (>25%) are recorded by capitalizing retained earnings equal to the par or stated value of distributed shares. Stock splits do not necessitate journal entries but do necessitate changes in the description of stock.

Record transactions involving cash dividends, stock dividends, and stock splits. Cash dividends involve three events. On the date of declaration, the directors bind the company to pay the dividend. A dividend declaration reduces retained earnings and creates a current liability. On the date of record, recipients of the dividend are identified.