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ACG 2021 Financial Accounting

ACG 2021 Financial Accounting. Stockholders’ Equity. Characteristics of a Corporation. Separate legal entity Exists separately from owners Can enter in contracts, sue or be sued Continuous life Change of ownership does not end Corporate life Ownership can be transferred Limited liability

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ACG 2021 Financial Accounting

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  1. ACG 2021Financial Accounting Stockholders’ Equity

  2. Characteristics of a Corporation • Separate legal entity • Exists separately from owners • Can enter in contracts, sue or be sued • Continuous life • Change of ownership does not end Corporate life • Ownership can be transferred • Limited liability • Only Corporate debts • No personal obligation for corporate liabilities

  3. Characteristics of a Corporation • Separation of ownership and management • Stockholders own the corporation • Elect Board of Directors • Sets Policies and appoints officers • Elect Chairperson (CEO) • Elect President (COO) • In charge of day-to-day operations • Corporate taxation • Franchise Tax (some states) • Corporate Taxes on Income • Double Taxation • Corporation is Taxed on Earnings • Individuals are taxed on dividends from earnings • Government regulation • Disclosure of Information for Stakeholders (Investors, Creditors, Taxing Authorities, etc.) to make informed decisions • Accounting

  4. Advantages of a Corporation • Can raise more capital than a proprietorship or partnership can • Continuous life • Ease of transferring ownership • Limited liability of stockholders

  5. Disadvantages of a Corporation 1. Separation of ownership 2. Corporate taxation 3. Government regulation

  6. Authority Structure of a Corporation

  7. Vote Dividends Liquidation Preemption Stockholders’ Rights

  8. Stockholders Rights • Unless Withheld by Agreement • Voting • One Vote for each share owned • Dividends • Right to Receive proportionate share • Liquidation • Right to Receive proportionate share of Net Assets • Preemption • Right to Maintain one’s proportionate ownership • Usually withheld from stockholders

  9. ACG 2021Financial Accounting Stockholder’s Equity Section of the Balance Sheet

  10. Stockholders’ Equity Two main components: • Paid-in capital (contributed capital) • Amount contributed by stockholders • Stock (At Par) • Additional Paid in Capital • Retained earnings • Equity Earned but not paid in Dividends

  11. The par value of a stock was the share price upon initial offering; the issuing company promised not to issue further shares below par value, so investors could be confident that no one else was receiving a more favorable issue price. This was far more important in unregulated equity markets than in the regulated markets that exist today. Quoted from Wikipedia at http://en.wikipedia.org/wiki/Par_value Most common stocks issued today do not have par values; those that do (usually only in jurisdictions where par values are required by law) have extremely low par values, for example a penny par value on a stock issue at USD$25/share. What is Par Value

  12. Capital Stock • Authorized shares • Total # of Shares available for sale • Outstanding shares • Total # of Shares actually sold • Represents 100% ownership • Often Less than shares authorized

  13. Types of Capital Stock • Common Stock • Residual Equity Holder • Paid Dividends after Preferred Stockholders • After Creditors & Preferred Stockholders are satisfied, Common stockholder receives liquidation • Dividends are not subject to Limit • Voting Rights (controls the corporation)

  14. Types of Capital Stock • Preferred Stock • Rights and Privileges • Current Dividend Preference • May be in Arrears • Though in Arrears is not a liability • Dividends are still discretionary

  15. Case Dividend Declared Non-Cumulative Pfd Common A 1000 1000 0 B 7000 6000 1000 C 13000 6000 7000 D 19000 6000 13000 Cumulative Pfd Common Arrears A 1000 1000 0 17000 B 7000 7000 0 11000 C 13000 13000 0 5000 D 19000 18000 1000 Dividend Example Assumptions: Preferred Stock is 6%, $100 par value, two years in arrears, 1000 Shares outstanding; common stock is $10 par, 1000 shares outstanding

  16. ACG 2021Financial Accounting Accounting for Issuance of Common Stock and Re-purchase of Treasury Stock

  17. Common Stock at Par Suppose IHOP’s common stock has a par value of $10 per share. The company issues 6,200 shares of common stock at par. What is the entry? Jan 8 Cash (6,200 x $10) 62,000 Common Stock 62,000 To record issuance of stock

  18. Common Stock above Par Suppose IHOP’s common stock has a par value of $0.01 per share. The company issues 6,200 shares of common stock for $10 per share. What is the entry? Jul 23 Cash (6,200 x $10) 62,000 Common Stock 62 Paid-in Capital in Excess of Par 61,938 To record issuance of stock

  19. Balance SheetCommon Stock Above Par Stockholders’ Equity Common Stock, $.01 par; 40,000 shares authorized, 6,200 shares issued $ 62 Paid-in capital n excess of par 61,938 Total paid-in capital $ 62,000 Retained earnings 194,000 Total stockholders’ equity $256,000

  20. Common Stock at Par Suppose IHOP’s common stock is no par value stock. The company issues 6,200 shares of common stock for $20 per share. What is the entry? Jul 23 Cash (6,200 x $20) 124,000 Common Stock 124,000 To record issuance of stock

  21. Preferred Stock • Accounting for preferred stock follows the pattern illustrated for common stock.

  22. Treasury Stock Transactions • Shares that a company has issued and later reacquired. • Shares needed for Employee Stock Plan Distribution • Increase net assets • Buy Low, Sell High • Avoidance of a takeover • Contra Stockholder Equity

  23. Stockholder’s Equity at December 31, 2005 (if no treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Total equity $263,490 IHOP Corp. Before Purchaseof Treasury Stock

  24. IHOP Corp. Purchaseof Treasury Stock During 2005, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock. Nov 1 Treasury Stock 5,170 Cash 5,170 Purchased treasury stock

  25. Stockholder’s Equity at December 31, 2005 (with treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Less: Treasury stock (288 shares at cost) (5,170) Total equity $258,320 IHOP Corp. After Purchaseof Treasury Stock

  26. Sale of Treasury Stock Assume that on July 22, 2006, the shares of treasury stock are sold for $5,300. Jul 22 Cash 5,300 Treasury Stock 5,170 Paid-in Capital from Treasury Stock Transactions 130 Sold treasury stock (Loss would require debit of retained earnings)

  27. Stockholder’s Equity at December 31, 2006 Common Stock $ 203 Paid-in capital in excess of par 69,785 Retained earnings 193,632 Total equity $263,620 Equity before purchase of treasury stocks 263,490 Increase in stockholders’ equity $ 130 IHOP Corp. After Sale of Treasury Stock

  28. Retirement of Stock • Decreases the outstanding stock of the corporation • Retired shares cannot be reissued • There is no gain or loss on retirement

  29. Equity Transactions on the Cash Flow Statement During 2003, IHOP issued stock, repurchased stock, but paid no dividends. Cash flows from financing activities: Proceeds from issuance of common stock $172,000 Purchase of treasury stock (5,170,000) Net cash used by financing activities $(4,998,000)

  30. ACG 2021Financial Accounting Retained Earnings and Dividends

  31. Retained Earnings • Is Not Cash • Is Not a Reserve held for Dividends • Is the account used to Record • Cash Dividends • Stock Dividends • Is Profits Reinvested into Corporation • Credit Balance = Earnings > Losses + Dividends • Debit Balance (Deficit) = Earnings < Losses + Dividends

  32. Dividends and Splits • Dividend- corporation’s return to its stockholders of some of the benefits of earnings • Cash or Stock • Stock split - increase in the number of authorized, issued, and outstanding shares

  33. Dividend Dates • Declaration date • BOD announces dividend • Date of record • Stockholders who own stock by this date will receive dividend • Payment date • When dividend is paid

  34. Preferred Stock Dividends The preferred stock of Pinecraft is cumulative. Suppose the company passed the 20x6 preferred dividend of $150,000. In 20x7, the company declares a $500,000 dividend. Retained Earnings 500,000 Dividends Payable-Preferred 300,000* Dividends Payable-Common 200,000 Declared a cash dividend *$150,000 x 2 years

  35. Stock Dividend IHOP declared a 10% stock dividend in 2006. Assume IHOP had 20,000,000 shares of common stock outstanding. The stock is trading for $15 per share. How would this stock dividend be recorded?

  36. Stock Dividend Retained Earnings (20,000,000 X 10% X $15) 30,000 Common Stock (20,000,000 X 10% X $0.01)20 Paid-in Capital in Excess of Par Common 29,980 Distributed a 10% stock dividend

  37. Stock Splits • Corporations like stock prices within a specific trading range • Higher prices might discourage small investors • The more widely held a stock (small and large investors) the less volatile the market pricing may be • Thus, stock splits are used to reduce the market price by • Increasing the number of authorized, issued, and outstanding shares of stock • Proportionate reduction in stock’s par value • Decreasing market price

  38. Stock Split Example

  39. ACG 2021Financial Accounting Stock Valuations

  40. Stock Values • Market value • Market Price • Redemption value • Set price for Preferred stock • Not Equity but a liability • Liquidation value • Amount paid to Preferred stockholders in case the company liquidates • Book value • Amount of Stockholders Equity per outstanding share

  41. Book Value Per Share • Preferred stock = (Redemption value + Dividendsin arrears) ÷ Number of shares of preferred outstanding • Common stock = (Total stockholders’ equity –Preferred equity) ÷ Number of shares of common stock outstanding

  42. Stockholders’ Equity Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share $ 40,000 Additional paid-in capital in excess of par – preferred 4,000 Common stock, $10 par, 20,000 shares authorized, 5,500 shares issued 55,000 Additional paid-in capital in excess of par – common 72,000 Retained earnings 85,000 Treasury stock – common, 500 shares at cost ( 15,000) Total stockholders’ equity $241,000 Book Value

  43. Book Value Common Stock Suppose that four years’ (including the current year) cumulative preferred dividends are in arrears and that preferred stock has a redemption value of $130 per share.

  44. Book Value – Preferred Stock Preferred equity: Redemption value (400 shares × 130) $ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600 Preferred equity $ 61,600 61,600 / 400 = $154.00

  45. Book Value Common Stock Preferred equity: Redemption value (400 shares × 130) $ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600 Preferred equity $ 61,600 Common equity: Total stockholders’ equity $241,000 Less preferred equity – 61,600 Common equity $179,400 Book value per share: $179,400 ÷ 5,000 shares* $ 35.88 *5,500 shares issued minus 500 treasury shares

  46. ACG 2021Financial Accounting Ratios: Return on Assets and Return on Equity

  47. Ratio Definitions • Return on Assets • Measure of a company’s ability to generate profits from the use of its assets • (Net income + Interest expense) ÷ Average total assets • Return on Equity • Measure of income earned from common stockholders’ investment in the company • (Net income – Preferred dividends) ÷ Average common stockholders’ equity

  48. End of Chapter 9

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