Chapter 11
Wok N Roll, Inc. began on January 1 by issuing 100,000 shares of $1 par value common stock and 1,000 shares of $100 par value, 5%, cumulative preferred stock. No dividends were declared for 2 years. In the 3rd year, Wok N Roll declared and paid a $0.50 dividend to its common stockholders. Assuming all shares originally issued are outstanding, the total dividend declared and paid in the 3rd year equals ______.
$65,000. Reason: Cumulative preferred stock receives 1,000 shares x $100 par x 5% x 3 years and common stock receives 100,000 shares x $0.50.
ROE (Return on Equity) formula and what it tells you
(NI - preferred dividends) / AVERAGE common SE ; amount of income earned per each dollar of common SE ; a higher ratio means stockholders are likely to enjoy greater returns
Why do companies issue stock dividends?
1) Lower the market price per share of stock 2) Demonstrate commitment to stockholders while conserving cash in difficult times 3) Signal an expectation of significant future earnings
Reasons for repurchasing of stock
1) Send a signal to investors that the company itself believes its own stock is worth acquiring 2) Obtain shares that can be reissued as payments for purchase of other companies 3) Obtain shares to reissue to employees as part of employee stock purchase plans 4) Reduce the number of outstanding shares to increase per-share measures of earning and stock value such as for NASDAQ or NYSE
A stock dividend has the following 3 characteristics:
1) has no effect on total stockholders' equity 2) reduces retained earnings 3) increases Common Stock
Advantages of Equity Financing
1. Equity does not have to be repaid 2. Dividends are optional
Advantages of debt financing
1. Interest on debt is tax deductible 2. Debt does not change stockholder control
How does preferred stock differ from common stock?
1. Preferred stock allows different voting rights 2. Dividends on preferred stock, if any, may be paid at a fixed rate 3. Preferred stock carries priority over common stock
Benefits of owning common stock
1. voting rights 2. dividends 3. residual claim 4. preemptive rights
On January 1, Year 1, Garden State issued 10,000 shares of $10 par, 7% cumulative preferred stock for $19 per share. What is the dividend amount?
10,000 x $10 par x 7% = 7,000
Company had 100,000 shares outstanding and declared a 10% stock dividend. How many shares are now outstanding?
110,000
Incentive Corporation has $47,000 in the company's bank account. At year-end, the accounts reflected a profit of $300. What is the maximum amount of cash dividends the company can declare and distribute?
300
Treasury stock
A corporation's own stock that has been reacquired by the corporation and is being held for future use. Do not carry voting, cash dividend, or other stockholder rights.
Accumulated Other Comprehensive Income
An entry in the stockholders' equity section of the balance sheet that reports the cumulative amounts of other comprehensive income. Other comprehensive income measures the amounts of all gains and losses in a period that bypass the income statement but affect stockholders' equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.
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.
EPS is a good or bad metric to compare different companies and why?
Bad because different companies have different accounting standards and number of shares outstanding
What is a small stock dividend?
Below 25% of the company's outstanding stock ; recorded at market value
What are the four main components of Stockholders' Equity?
Contributed capital, retained earnings, treasury stock, accumulated other comprehensive income (loss)
What is the difference between Current Dividend Preference and Cumulative Dividend Preference?
Current preference: grants priority on preferred dividends over common dividends. All preferred stock has current preference. Cumulative 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 cumulative unpaid amounts (called dividends in arrears) must be paid before any common dividends can be paid.
X-Co issued 1,000 shares of its 5%, $100 par value, cumulative preferred stock for $100 cash per share. The journal entry to record this event includes a ______
Debit Cash 100,000 Credit Preferred Stock 100,000
Company repurchased its stock for $25 per share. It then reissues 5,000 share of this treasury stock for $23. What is the journal entry?
Debit Cash 115,000 Debit Additional-Paid-In-Capital 10,000 Credit Treasury Stock 125,000
Company repurchased its stock for $25 per share. It then reissues 5,000 share of this treasury stock for $28. What is the journal entry?
Debit Cash 140,000 , Credit Treasury Stock 125,000 , Credit Additional-Paid-In-Capital 15,000
On January 1, Year 1, Garden State issued 10,000 shares of $10 par, 7% cumulative preferred stock for $19 per share. What is the journal entry?
Debit Cash 190,000 , Credit Preferred Stock 100,000 , Credit Additional Paid-In-Capital 90,000 NOTE: the 7% cumulative is only for dividends, not for the issuance of stock
Company issues 100,000 shares of its $0.01 par value stock at the market price of $20. What is the journal entry?
Debit Cash 2,000,000 , Credit Common Stock 1,000 , Credit Additional-Paid-In-Capital 1,999,000
Company issues 10,000 shares of stock and the market price is $30. The corporate charter doesn't specify a par value. What is the journal entry?
Debit Cash 300,000 Credit Common Stock 300,000 ; when there is no par value, everything is common stock
Company issues 500,000 shares of its $1 par value preferred stock for $800,000. What is the journal entry?
Debit Cash 800,000 , Credit Preferred Stock 500,000 , Credit Additional-Paid-In-Capital-Preferred 300,000
Company declares $10,000 in dividends will be paid. What is the journal entry?
Debit Dividends 10,000 , Credit Dividends Payable 10,000
Company pays $10,000 in dividends that were previously declared. What is the journal entry?
Debit Dividends Payable 10,000 Credit Cash 10,000
Company redeems 120,000 shares of its $1 par value preferred stock for $6 million. What is the journal entry?
Debit Preferred Stock 120,000 , Debit Additional-Paid-In-Capital-Preferred 5,880,000 , Credit Cash 6 million
At year-end, dividends of $10K need to be closed into retained earnings. What is the journal entry?
Debit Retained Earnings 10,000 Credit Dividends 10,000
At the beginning of the year, Jennings Corp. has 1,000,000 shares of $1 par value common stock authorized, 200,000 shares issued, and 150,000 shares outstanding. On March 31, Jennings' Board of Directors declared a 10% stock dividend at a time when its stock carried a market value of $30 per share. Prepare the journal entry required to record the March 31 stock dividend.
Debit Retained Earnings 450,000 , Credit Common Stock 15,000 , Credit Additional Paid-In-Capital 435,000 Explanation: This is a stock dividend so Retained Earnings will be reduced and no cash will be distributed. Since this is a small dividend, it's based on the market price (150,000 x $30 x .10 = 450,000). Common stock is based on the par value (150,000 x $1 x .10 = $15,000). Additional Paid-In-Capital is the difference.
Company had 50,000 shares outstanding with a market value of $31 and a $1 par value. The company announced a 100% stock dividend. What is the journal entry?
Debit Retained Earnings 50,000 Credit Common Stock 50,000 Explanation: Large stock dividends are calculated based on the par value. There is no Additional-Paid-In-Capital for large stock dividends.
Firm repurchased 50,000 shares of its stock for $25 per share and held these stock in treasury. What is the journal entry?
Debit Treasury Stock 1,250,000 , Credit Cash 1,250,000
Dividends are an expense as they reduce stockholder equity and they are a ______ account. True or false?
Dividends are not an expense. They reduce SE because they distribute prior profits. ; debit
Dividends in Arrears
Dividends on cumulative preferred stock that have not been declared in prior years.
Dividends payable is credited when there are dividends in arrears. True or false?
False. Dividends payable is only credited when dividends are declared
Stock splits increase common stock. True or false?
False. Only stock dividends increase common stock.
ROE (Return on Equity) is a good or bad metric to compare different companies?
Good
What is a large stock dividend?
More than 25% of the company's outstanding stock ; recorded at par value ; there is no additional paid-in-capital for large stock dividends
EPS (earnings per share) formula and what it tells you
NI - preferred stock dividends / Average number of shares outstanding (BE sure to calculate the average!) ; amount of net income generated per share of common stock, a higher ratio means more profitability
Examples of Accumulated Other Comprehensive Income
National Beverage's contracts to stabilize the cost of its aluminum cans, pensions, foreign currencies and financial investments
Company authorizes 1 million shares of $1 par, common stock. What is the journal entry?
No journal entry since the company didn't issue shares. It just authorized them.
Stock dividend affects which one or more of the following? Number of shares outstanding, par value/share, retained earnings, Stockholder Equity
Number of shares outstanding: Increases Par Value/share: No effect Retained Earnings: Reduces Stockholder Equity: No effect
Stock split affects which one or more of the following? Number of shares outstanding, par value/share, retained earnings, Stockholder Equity
Number of shares outstanding: Increases Par Value/share: Total par value will remain the same but par value per share will be cut in half Retained Earnings: No effect Stockholder Equity: No effect
Cash dividend affects which one or more of the following? Number of shares outstanding, par value/share, retained earnings, Stockholder Equity
Number of shares outstanding: No effect Par Value/share: No effect Retained Earnings: Reduces Stockholder Equity: Reduces
What are the benefits of the corporate form of business?
Shares of stock can be purchased in small amounts, ownership interests are transferable, stockholders are not responsible for the corporation's debts
Outstanding Shares
Shares that are currently held by stockholders (not the corporation itself). These are the shares eligible for dividends Issued Shares - Treasury Shares
Company's common share stock is priced at $0.01 and then the company issues a 2 to 1 stock split. What is the journal entry?
Stock splits don't need a journal entry since the SE/company's resources are the same
What are the 2 key financial requirements a company must meet before declaring dividends?
Sufficient retained earnings, sufficient cash
All transactions between a company and its stockholders affect only ___
The balance sheet accounts, not the income statement
A corporation is legally obligated to distribute dividends once they are declared. True or false?
True
Treasury stock reduces SE. True or false?
True
What does Retained Earnings reflect?
amount of equity that the company itself has generated for stockholders (through profitable operations) but not yet distributed to them
Treasury Stock is what type of account?
contra equity account so it's a debit account
What are the three Dividend Dates?
date of declaration, date of record, date of payment
A cash dividend differs from a 2-for-1 stock split in that a cash dividend does two things:
decreases Retained Earnings , decreases current assets
Stock dividends and how they work
distribution from earnings paid in additional shares of stock. Each stockholder receives additional shares pro rata ; each stockholder receives additional shares equal to the percentage of shares held. Ex: a stockholder who owns 10% of the company's shares would receive 10% of any additional shares as a stock dividend
A corporation's board of directors could prefer a stock split to a stock dividend because a stock split ______.
does not reduce retained earnings, so it does not reduce the ability to declare a cash dividend in the future
Authorized, issued, outstanding and treasury stock graphic
https://imgur.com/cTAS843
Residual claim
if the company ceases operations, stockholders share in any assets remaining after creditors have been paid
Earnings per share (EPS) appears on the ______.
income statement
A stock dividend differs from a cash dividend in that a stock dividend ______.
increases the number of shares outstanding
Dividends in arrears are reported in the _________
notes to the financial statements ; they are not reported on the balance sheet as a liability because they have not been declared yet
P/E Ratio formula and what it tells you
price per share/earnings per share ; how many times more than the current year's earnings investors are willing to pay for a company's common stock, a higher number means investors anticipate an improvement in the company's future results
Preemptive rights are
the right for existing shareholders the first chance to buy newly issued stock before it is offered to others
