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FAIS 3 > Ch 15 > Flashcards

Ch 15 Flashcards

0
Q

3 special characteristics of corporate form that affect accounting

A

1 influence of state corporate law

2 use of capital stock or share system

3 development of variety of ownership interests

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1
Q

3 primary forms of business organization

A

1 proprietorship

2 partnership

3 corporation

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2
Q

Articles of incorporation

A

Anyone wishes to establish corporation sends articles of

Incorporation to state in which incorporation is desired

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3
Q

Corporate charter

A

Recognizes company as legal entity subject to state law

State issues corporate charter

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4
Q

How many state can a corporation incorporate in?

A

Only 1

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5
Q

It is the company’s advantage to incorporate in a state whose laws favor the…

Example?

A

Corporate form of business organization

Ex. Delaware has favorable tax and regulatory environment

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6
Q

How can a company restrict certain rights and privileges when it issues stock?

A

Through a special contract

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7
Q

In the absence of restrictive provisions, what 4 rights does each share of stock provide to share proportionately in?

A

1 profits and losses
2 management (right to vote for directors)
3 corporate assets upon liquidation
4 preemptive right

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8
Q

Preemptive right, define

What is it referred to as?

A

Share proportionately in any new issues of stock of same class

Referred to as stock right or warrant

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9
Q

What does the preemptive right protect?

A

Protects existing shareholder from involuntary dilution of

Ownership interest

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10
Q

Registrars and transfer agents

A

Specialize in providing services for recording and transferring
Stock

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11
Q

Common stock

A

Class of stock represents ownership interest

Residual corporate interest that bears ultimate risks of loss
And receives benefits of success

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12
Q

Who generally controls the management of the corporation?

A

Common stockholders

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13
Q

Preferred stock

A 
Special class of stock where certain common stock rights are
Sacrificed in return for other special rights and privileges
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14
Q

3 other names for owners equity?

A

1 stockholders’ equity
2 shareholders’ equity
3 corporate capital

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15
Q

What 3 categories normally appear as part of stockholders’ equity?

A

1 capital stock
2 additional paid in capital
3 retained earnings

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16
Q

What do capital stock and additional paid in capital constitute?

A

Contributed (paid-in) capital

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17
Q

Retained earnings

A

Earned capital of the company

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18
Q

Contributed (paid-in) capital

A

Total amount of capital stock

Amount provided by stockholders to corporation for use in
business

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19
Q

What 2 items does contributed capital include?

A

1 par value of all outstanding stock

2 premiums less discounts on issuance

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20
Q

Earned capital

A

Capital that develops from profitable operations

Consists of all undistributed income that remains invested in
The company

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21
Q

Residual interest

A

Owners’ or Stockholders’ interest in a company

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22
Q

What does stockholders’ (owners’) equity represent?

A

Cumulative net contributions by stockholders + retained earnings

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23
Q

3 steps companies follow when they issue stock?

A

1 state must authorize stock in certificate of incorporation or
Charter
2 corp. offers shares for sale, entering into contracts to sell stock
3 after receiving amounts for stock, corp issues shares

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24
Q

Par value of stock, relationship with fair value?

A

Par value of stock has no relationship to its fair value

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25
Q

What do low par values help companies avoid?

A

The contingent liability associated with stock sold below par

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26
Q

Accounting for par value of preferred stock and common stock

A

Company credits these accounts when it originally issues shares

No additional entries made unless issues additional shares or
Retires them

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27
Q

Paid in capital in excess of par account

A

Indicates any excess over par value paid in by stockholders

In return for shares issued to them

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28
Q

What claim does an individual stockholder have on excess paid in capital?

A 
Individual stockholder has no greater claim on excess paid in 
than all other holders of the same class of shares
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29
Q

No-par stock

A

Many states permit issuance of capital stock without par value

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30
Q

2 reasons of issuance of no par stock

A

1 avoids contingent liability if issued par value at discount

2 the questionable treatment of using par value for fair value
Never arises

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31
Q

2 Major disadvantages of no par stock?

A

1 Some states levy high taxes on these issues

2 Less flexibility for paying dividend, because no par stock may
Be considered legal capital

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32
Q

True no par stock should be carried in amounts at issue price without any…

A

Additional paid in capital or discount reported

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33
Q

Stated value of no par stock (required by some states)

A

Minimum value below which company can’t issue stock

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34
Q

Lump sum sales

A

How to allocate proceeds among several classes of securities

Sold at once

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35
Q

2 methods that companies can use in allocation of lump sum sales?

A

1 proportional method

2 incremental method

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36
Q

Proportional method 1) when does it occur? How is it allocated?

A 
1 if fair value or other sound basis for determining relative value
Is available for each class of security

2 company allocates lump sum received among securities on proportional basis

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37
Q

Incremental method 1) when does it occur? How is it allocated?

A

1 instances where company can’t determine fair value

2 company uses fair value of securities as basis for classes it
Knows and allocates remainder of lump sum where it doesn’t
Know FMV

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38
Q

Stock issued in noncash transactions

A

Issuance of shares for property or services

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39
Q

General rule for stock issued in noncash transactions

A

Companies should record stock issued for services or property
Other than cash at either FMV of stock issued or FMV of noncash
Consideration received

Whichever is more apparent

40
Q

If treasury shares are used to acquire property or services, the cost of the treasury shares should…

A

Not be considered the decisive factor in establishing FMV
of the property or services

FMV of treasury stock should be used to value property or
services

41
Q

Watered stock

A

Overvaluation of stockholders’ equity resulting from inflated
asset values

Results from Intentional overvaluation of property or services
received

42
Q

Secret reserves

A

Corporation undervalues the recorded assets

As result of issuance of stock for property or services

43
Q

5 common costs of issuing stock

A 
1 underwriting costs
2 accounting and legal fees
3 printing costs
4 taxes
5 reduction of amounts paid in
44
Q

What kind of costs are stock issuance costs?

A

Cost of financing

45
Q

5 reasons corporations repurchase shares

A

1 tax efficient distributions of excess cash to shareholders
2 increase EPS and return on equity
3 provide stock for employee stock compensation contracts
Or meet potential merger needs
4 thwart takeover attempts or reduce # of stockholders
5 stabilize the stock price

46
Q

Make a market in the stock

A

Stabilize the stock price

47
Q

Leverage buyout (LBO)

A

Company borrows money to finance stock repurchases

48
Q

Treasury stock

A

Reacquired shares that aren’t retired

49
Q

Is treasury stock an asset?

A

No, incorrect to imply that corp can own part of itself

50
Q

When a corporation buys back some of its own outstanding stock, it has not acquired an asset, it has…

A

Reduced net assets

51
Q

Treasury stock is essentially the same as…

A

Unissued capital stock

52
Q

2 accounting methods for handling treasury stock accounts

A

1 cost method

2 par (stated) value method

53
Q

Cost method

A

Results in debiting Treasury Stock account for reacquisition Cost

And in reporting this account as deduction from paid-in
Capital and retained earnings on balance sheet

54
Q

Par (stated) value method

A

Records all transactions in treasury shares at their par value

And reports the treasury stock as deduction from capital
Stock only

55
Q

Outstanding stock

A

Number of shares of issued stock that stockholders own

56
Q

Sale of treasury stock above cost

A

When selling price of shares of treasury stock exceeds its cost,
Company credits difference to Paid-in Capital from Treasury Stock

57
Q

When corporation sells treasury stock below its cost it…

A

Debits excess cost over selling price to Paid-in Capital from
Treasury Stock

58
Q

Retiring of treasury shares

A

Corp debits paid in capital accounts applicable to retired shares
Instead of cash (as with sale of treasury stock)

Approved by board of directors

59
Q

5 features most often associated with preferred stock issues?

A 
1 preference as to dividends
2 preference to assets in event of liquidation
3 convertible into common stock
4 callable at option of the corporation
5 non voting
60
Q

Companies usually issue preferred stock with a par value, expressing the dividend preference as…

A

A percentage of the par value

61
Q

Preferred stock: preference of dividends

A

Corporation must pay stated dividend rate or amount applicable
To preferred stock before paying any dividends on the common
Stock

62
Q

Cumulative preferred stock

A

Requires that if corp fails to pay dividend in any year, it must
Make it up in later year before paying any dividends to common
Stockholders

63
Q

Dividend in arrears

A

If directors fail to declare dividend at normal date for dividend
Action

Dividend is said to be passed, not disclosed in liabilities section
But in notes of financial statements

64
Q

Holders of Participating preferred stock

A

Share ratably with common stockholders in any profit distributions
Beyond the prescribed rate

65
Q

Convertible preferred stock

A

Allows stockholders , at their option, to exchange preferred shares
For common stock at predetermined ratio

66
Q

Callable preferred stock

A

Permits corporation at its option to call or redeem the outstanding
Preferred shares at specified future dates

And at stipulated prices

67
Q

Redeemable preferred stock

A

More like debt than equity instrument

Has mandatory redemption period or redemption feature that
Issuer cannot control

68
Q

5 reasons why few companies pay dividends in amounts equal to their legally available retained earnings

A

1 maintain agreements with bond covenants/specific creditors
2 meet state corp. requirements
3 retain assets to finance growth or expansion
4 smooth out dividend payments year to year
5 build up buffer against possible losses or errors in calculation

69
Q

State corporation requirements for dividends

A

Earnings equivalent to cost of treasury shares purchased be
Restricted against dividend declarations

Protects against loss for creditors

70
Q

Before declaring a dividend management must consider…

A

The availability of funds to pay the dividend

71
Q

4 forms of dividend distributions

A

1 cash dividends
2 property dividends
3 liquidating dividends
4 stock dividends

72
Q

Which dividends reduce total stock holders equity in the corporation?

A

All dividends except stock dividends reduce total stockholders
Equity in the corporation

73
Q

Liquidating dividend

A

Dividend not based on retained earnings

74
Q

Why is there time between the date of declaration and date of payment for cash dividends to stock holders?

A

Gives time for company to prepare current list of stockholders
that receive the dividends

75
Q

What is a declared dividend classified as?

A

Liability

76
Q

Does a company declare and pay dividends on treasury stock?

A

No

77
Q

Property dividends AKA dividends in kind

A

Dividends payable in assets of corp other than cash

78
Q

When declaring a property dividend the corporation should…

A

Restate at fair value the property it will distribute, recognizing
Any gain or loss as difference between property’s FMV and
Basis at date of declaration

79
Q

Any dividend not based on earnings reduces corporate…

A

Paid in capital to extent it is a liquidating dividend

80
Q

Stock dividend

A

Company distributes no assets

Issuance by corp of its own stock to shareholders on pro rata
Basis, without receiving any consideration

81
Q

When the stock dividend is less than 20-25% of common shares outstanding at time of dividend declaration, what is the company required to transfer?

A

Company required to transfer FMV of stock issued from retained
Earnings

82
Q

Small (ordinary) stock dividends

A

Stock dividends of less than 20-25%

83
Q

Stock dividend entries merely reflect a reclassification of…

A

Stockholders’ equity

84
Q

Many state do not permit the issuance of stock dividends for…

A

Treasury shares

85
Q

Stock split

A

Split in shares to achieve lower stock price

Ex. 2 for one split, splits par value in half on stockholders equity
And doubles the number of shares issued of common stock

86
Q

Stock split vs. stock dividend

A

Both increase number of shares outstanding

Stock splits decrease par value of share, stock dividends increase
Par value of outstanding shares

87
Q

Large stock dividend AKA Split up effected in form of dividend AKA stock split

A

Stock dividend of more than 20-25% of shares previously

Outstanding

88
Q

In a split up effected in the form of a dividend the company transfers from retained earnings to capital stock…

A

The par value of stock issued

89
Q

Restrictions of retained earnings, how are they disclosed?

A

Best disclosed by note

90
Q

Basic format for presentation of statement of stockholders equity, 4 things

A

1 balance at beginning of period
2 additions
3 deductions
4 balance at end of period

91
Q

What 3 ratios of stockholders’ equity do analysts use to evaluate company’s profitability and Longterm solvency?

A

1 return on common stock equity
2 payout ratio
3 book value per share

92
Q

Return on common stock equity AKA return on equity (ROE)

A

Measures profitability from shareholders viewpoint

Shows how many dollars of net income the company earned for
Each dollar invested by the owners

93
Q

Return on common stock equity equation

A

Return on common stock equity =
(Net income - preferred dividends)/(avg. common stockholders’ equ.)

Note: amount of common stock equity = total stockholders equity less par value of preferred stock

94
Q

Trading on the equity

A

Practice of using borrowed money or issuing preferred stock

In hopes of obtaining higher rate of return on money used

95
Q

Payout ratio equation

A

Payout ratio = cash dividends/net income

96
Q

Book value per share of stock

A

Amount each share would receive if company were liquidated

On basis of amounts reported on balance sheet

97
Q

Book value per share equation

A

Book value per share =

common stockholders’ equity)/(outstanding shares

FAIS 3 (17 decks)

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