Chapter 11

READILY MARKETABLE

An investment is readily marketable when it can be sold easily whenever the need for cash arises.

CATEGORIES OF SECURITIES

1. Trading securities are bought and held primarily for sale in the near term to generate income on short-term price differences. 2. Available-for-sale securities are held with the intent of selling them sometime in the future. 3. Held-to-maturity securities are debt securities that the investor has the intent and ability to hold to maturity.

valuation guidelines for 3 types of securities. (These guidelines apply to all debt securities and to those stock investments in which the holdings are less than 20%)

1. Trading- at fair value with changes reported in net income 2. available for sale- at fair value with changes reported in the stockholders' equity section 3. held to maturity (debt only)- at amortized cost

Each share of common stock gives the shareholder the following ownership rights:

1. Vote in board of directors and on actions that require stockholder approval. 2. Share in corporate earnings through receipt of dividends. 3. preemptive right: Maintain the same % of ownership when new shares of stock are issued. 4. residual claim: Share in assets upon liquidation.

declaration date

1. board of directors authorizes/ announces cash dividend 2. entry is required to recognize decrease in Retained Earnings and increase in liability Dividends Payable

Additional taxes

1. corporations, as seperate legal entities, must pay state and federal income taxes. 2. Stockholders must pay taxes on dividends. Thus, it is argued that corporations are subject to double taxation: once at the individual level, and once at the corporate level

primary objectives in accounting for the issuance of common stock:

1. identify the specific sources of paid in capital 2. maintain the distinction between paid in capital and retained earnings

stock split

1. issuance of additional shares to stockholders according to their percentage ownership. 2. the number of shares is increased in the same proportion so that par/ stated value per share is decreased. 3. has no effect on total paid-in capital, retained earnings, and total stockholders' equity. 4. not necessary to formally journalize a stock split.

Entry on balance sheet to record authorized stock

Company Balance Sheet (partial) date Stockholders' equity ->Paid in capital -->Common stock, x par value xxx shares authorized

disadvantages of a corporation vs. proprietorship/ partnerships

Corporation management-separation of ownership and management Government regulations Additional taxes

Payment of the dividend: ______ current assets ______ current liabilities ______ stockholders' equity REDUCES/ INCREASES/ DOES NOT CHANGE

Payment of the dividend: REDUCES both current assets and current liabilities but has no effect on stockholders' equity.

T/F The authorization of stock requires a formal accounting entry

The authorization of common stock does not result in a formal accounting entry because the event has no immediate effect on either corporate assets or stockholders' equity.

declared dividends

The board of directors has full authority to determine the amount of income to be distributed in the form of dividends and the amount to be retained in the business.

Three dates are important in connection with dividends: Which dates require accounting entries?

The declaration date. The record date. The payment date Accounting entries are required on the declaration date and the payment date.

dividend

a distribution by a corporation to its stockholders on a pro rata basis. Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend.

Paid-in capital

amount paid in to the corporation by stockholders in exchange for shares of ownership.

Available-for-Sale Securities

Held with the intent of selling them sometime in the future. If intent to sell securities w/i next year/ operating cycle, classified as current assets in the balance sheet. Otherwise, classified as long-term assets in the investments section Report at fair value.

trading securities

Held with the intention of selling them in a short period of time (< 3months). Adjust trading securities to fair value at the end of each period (mark-to-market accounting). Report changes from cost as part of net income. The changes are reported as unrealized gains or losses because the securities have not been sold. The unrealized gain or loss is the difference between the total cost of trading securities and their total fair value. Classify trading securities as a current asset.

When a corporation decides to issue stock it must answer the following questions:

How many shares should be authorized for sale? How should the stock be issued? What value should be assigned to the stock?

Other Revenue and Gains/ Other Expenses and Losses

Interest Revenue Loss on Sale of Investments Dividend Revenue Unrealized Loss—Income Gain on Sale of Investments Unrealized Gain—Income

Two common bases for classification of corporations are

by purpose. by ownership.

Par value stock

capital stock that has been assigned a value per share in the corporate charter. The par value may be any amount selected by the corporation. Par value is usually quite low

no- par value stock

capital stock that has not been assigned a value per share in the corporate charter. In many states the board of directors is permitted to assign a stated value to the no-par shares, which then becomes the legal capital per share.

payout ratio

cash dividends declared on common stock/ net incom

how do you record the journal entry when the issuance of common stock for cash is recorded, and the par value of the shares is NOT the same as the cash price?

cash is debited, the par value is credited to common stock, and the portion of the proceeds that is above or below par value is recorded in a separate paid-in-capital account (Paid-in Capital in Excess of Par Value- common stock).

Dividends can take four forms:

cash, property, script (promissory note to pay cash), or stock.

the directors of Media General declare a 50 cent per share cash dividend on 100,000 shares of $10 par value common stock. The entry to record the declaration is:

debit Cash Dividends $50,000 (100,000 × 50 cents) credit Dividends Payable $50,000 (100,000 × 50 cents)

Journal entry on payment date

debit Dividends Payable credit Cash

If Mead, Inc. has 100,000 shares of $5 par value common stock outstanding (all issued at par value) and it decides to acquire 4,000 shares of its stock at $8 per share, the entry is:

debit treasury stock 32000 (8 * 4000) credit cash 32000 (To record purchase of 4,000 shares of treasury stock at $8 per share)

Net losses

decrease (are debited to) retained earnings. do not decrease (are not debited to) paid-in capital accounts.

Payment date

dividend checks are mailed to the stockholders and the payment of the dividend is recorded

Preferred stockholders have a priority in relation to:

dividends assets in the event of liquidation

Retained Earnings

earned capital held for future use in the business

Corporation

entity created by law that is separate and distinct from its owners.

The record date

marks the time when ownership of the outstanding shares is determined for dividend purposes. The purpose is to identify the entities that will receive the dividend, not to determine the dividend liability.

interpertation: payout ratio

measures percentage of earnings distributed as cash dividends to common stockholders

interpretation: return on stockholders' equity

measures profitability from the common stockholders' view point. shows how many dollars of net income were earned for each dollar invested by common stockholders.

Short-Term Investments, aka marketable securities

securities held by a company that are (1) readily marketable and (2) intended to be converted into cash within the next year or operating cycle, whichever is longer. Investments that do not meet both criteria are classified as long-term investments. Trading securities are always classified as short-term. Available-for-sale securities can be either short-term or long-term.

For stock dividend vs. stock split Total paid-in capital Total retained earnings Total par value (common stock) Par value per share

stock dividend Total paid-in capital: increase Total retained earnings: decrease Total par value (common stock): increase Par value per share: no change stock split Total paid-in capital: no change Total retained earnings: no change Total par value (common stock): no change Par value per share: decrease

GOVERNMENT REGULATIONS

1. State dictates requirements for issuing stock, distributions of earnings to stockholders, and effects of retiring stock. 2. Federal securities laws govern sale of capital stock to general public; disclosure of financial affairs to SEC (quarterly/ annual reports); and reporting requirements of securities markets.

small stock dividend vs. large stock dividend

A small stock dividend (less than 20%-25% of the corporation's issued stock) is recorded at the fair market value per share. A large stock dividend (greater than 20%-25% of the corporation's issued stock) is recorded at par or stated value per share.

The acquisition of treasury stock ____________ stockholders' equity. (REDUCES/ INCREASES/ DOES NOT CHANGE)

REDUCES (contra stockholders equity account)

T/F Retained earnings is earned capital held for future use in the business.

T

T/F The issuance of common stock affects only paid-in capital accounts.

T

Authorized stock

The amount of stock a corporation is authorized to sell is indicated in the corporate charter. If all authorized stock is sold, a corporation must obtain consent of the state to amend its charter before issuing additional shares.

stock dividends

pro rata distribution of the company's own stock to stockholders. results in an increase in paid-in capital and a decrease in retained earnings does not decrease total stockholders' equity or total assets

The accounting for investments in common stock depends on:

the extent of the investor's influence over the operating and financial affairs of the issuing corporation <20% = insignificant = cost method b/t 20% & 50% = significant = equity method >50% = controlling = consolidated financial statements

corporation management

Stockholders manage corporation indirectly through board of directors, which they elect.

Short-term paper

(1) certificates of deposits (CDs) issued by banks, (2) money market certificates issued by banks and savings and loan associations, (3) Treasury bills issued by the U.S. government, (4) commercial paper issued by corporations with good credit ratings. meets this criterion because a company can readily sell it to other investors.

return on stockholders' equity

(net income - preferred stock dividends)/ average common stockholders' equity

Bonds have three primary advantages relative to common stock in Debt Versus Equity Decision

1. Stockholders control is not affected. Bondholders do not have voting rights, so current stockholders retain full control of the company. 2. Tax advantages. Bond interest is deductible for tax purposes; dividends on stock are not. 3. Return on common stockholders' equity may be higher. Although bond interest expense reduces net income, return on common stockholders' equity often is higher under bond financing because no additional shares of common stock are issued.

Why might a company acquire treasury stock?

1. To reissue to employees under stock compensation plans. 2. To increase trading of the company's stock in the securities market. (Signal that management believes the stock is underpriced to enhance the market value) 3. To use in acquisition of other companies. 4. To reduce shares outstanding, increasing earnings per share.

Corporations issue stock dividends for the following reasons:

1. To satisfy stockholders' without spending cash. 2. To increase the marketability of its stock by increasing the number of shares outstanding and thus decreasing the market price per share 3. To emphasize that a portion of stockholders' equity has been permanently reinvested in the business and is, therefore, unavailable for cash dividends.

T/ F The amount of stock that a corporation is authorized to sell is established through various organized U.S. securities exchanges.

F. The amount of stock that a corporation is authorized to sell is indicated in the corporate charter.

DEFICIT

A debit balance in retained earnings. It is reported as a deduction in the stockholders' equity section.

HOLDINGS OF LESS THAN 20%: Recording Acquisition of Stock

At acquisition, stock investments are recorded at cost. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any. Under the cost method, companies record the investment at cost and recognize revenue only when cash dividends are received. debit Stock Investments ($ per share * number of shares) credit cash

Within paid-in capital, two classifications are recognized:

Capital stock. Additional paid-in capital.

HOLDINGS OF LESS THAN 20%: Recording Dividends

During the time the company holds the stock, it makes entries for any cash dividends received. debit cash ($ per share dividend * number of shares) credit Dividend Revenue report Dividend Revenue under "Other revenues and gains" in the income statement.

T/F No-par stock is capital stock that has a market value of zero.

F. No-par stock is capital stock that has not been assigned a value in the corporate charter.

T/F Par value stock has been assigned a value per share that is equal to its market value.

F. Par value stock has been assigned a value per share in the corporate charter.

stated value

In many states, the board of directors is allowed to assign a stated value to the no- par shares. The stated value of no-par stock may be changed at any time by action of the directors. Stated value, like par value, does not indicate or correspond to the market value of the stock.

BALANCE SHEET PRESENTATION

In the balance sheet presentation, companies must classify investments as either short-term or long-term.

For a corporation to pay a cash dividend, it must have the following:

Retained earnings Adequate cash Declared dividends

characteristics that distinguish a corporation from proprietorships and partnerships:

Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management Government regulations Additional taxes

advantages of a corporation vs. proprietorship and partnership

Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management-professional managers

forming a corporation

States grant corporate charters. Although a corporation may have operating divisions in a number of states, it will be incorporated in only one state.

stock dividend effects

Stock dividends change the composition of stockholders' equity some retained earnings are transferred to paid-in capital. However, total stockholders' equity and the par/ stated value per share remain the same. Outstanding shares: increases Total paid-in capital: increases Retained earnings: decreases Total stockholders' equity: stays the same

Debt has one major disadvantage relative to common stock.

Under debt agreements, the company locks in fixed payments that must be made in good times and bad. Interest must be paid on a periodic basis, and the principal of the bonds must be paid at maturity. With common stock financing, the company can decide to pay low, or no dividends if earnings are low.

journal entry for purchase of treasury stock

Under the cost method, Treasury Stock is debited for the price paid for the shares. The same amount is credited to Treasury Stock when the shares are disposed of.

HOLDINGS OF LESS THAN 20%: Recording Sale of Stock

When a company sells a stock investment, it recognizes the difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the stock as a gain or a loss. debit Cash (debit : Loss on Sale of Stock Investments) credit: Stock Investments (credit: gain on Sale of Stock Investments) report the loss account under "Other expenses and losses" in the income statement and shows a gain on sale under "Other revenues and gains."

net loss

When expenses exceed revenues. In contrast to net income, a net loss decreases retained earnings. In closing entries, a company debits a net loss to the Retained Earnings account. It does not debit net losses to paid-in capital accounts. To do so would destroy the distinction between paid-in and earned capital. If cumulative losses and dividends exceed cumulative income over a company's life, a debit balance in Retained Earnings results.

Treasury stock

a corporation's own stock that has been issued, fully paid for, reacquired by the corporation and held in its treasury for future use.

The stockholders' equity section of a corporation's balance sheet includes:

paid-in (contributed) capital and retained earnings (earned capital).

Retained earnings

payment of dividends from retained earnings in legal in all states, while in many states, payment of dividends from legal capital is prohibited.

dividends in arrears.

preferred dividends not declared in a given period when preferred stock is cumulative. They are not a liability because no obligation exists until the board of directors declares a dividend, but they should be disclosed in the notes to the financial statements.

cumulative preferred stock

preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders receive dividends.

balance sheet, stockholders equity headings

stockholders equity ->paid in capital -->capital stock, x% preferred stock, x par-value, x shares authorized, x shares issued, x shares outstanding -->common stock, x par-value, x shares authorized, x shares issued, x shares outstanding -->additional paid-in captial --->in excess of par value preferred stock --->in excess of par value common stock --->from treasury stock ---->total additional paid in capital ---->total paid in capital ->retained earnings ->total paid in capital and retained earnings ->less: treasury stock-common (x shares at cost) Total stockholders equity

What is the new par value per share if Medland Corporation splits its 50,000 shares of common stock on a 2-for-1 basis?

that one share of $10 par value stock is exchanged for two shares of $5 par value stock.

investment portfolio

the group of securities when a company holds stock (and/or debt) of several different corporation., Stock investments are investments in the capital stock of corporations.

equity method

the investor records its share of the net income of the investee in the year when it is earned. Under the equity method, the company: 1. initially records the investment in common stock at cost. 2. After that, it adjusts the investment account annually to show the investor's equity in the investee. 3. Each year, the investor does the following. (1) It increases (debits) the investment account and increases (credits) revenue for its share of the investee's net income. 2Conversely, the investor increases (debits) a loss account and decreases (credits) the investment account for its share of the investee's net loss. (2) The investor also decreases (credits) the investment account for the amount of dividends received. The investment account is reduced for dividends received because payment of a dividend decreases the net assets of the investee.

ISSUING PAR VALUE COMMON STOCK FOR CASH AT PAR VALUE

the par value of the shares is credited to Common Stock and debited to Cash.