Chapter 10: Stockholders' Equity Flashcards
Ownership of a corporation is divided into a large number of equal parts or ______.
shares
Most large businesses are organized as corporations because incorporation increases the companies ability to _____ _____ (or capital) by easing the transfer of ownership and limiting the liability of owners.
raise cash
the owners of a corporation who own its shares in varying numbers.
stockholders/shareholders
the owners’ claims against the assets of a corporation after all liabilities have been deducted
stockholders’ equity (or owners’ equity)
Stockholders’ Equity is comprised of what 3 things?
- Capital stock, split between (1) preferred and common stock and (2) the associated additional paid-in capital.
- Retained earnings or deficit
- Treasury stock
Corporations are authorized, or chartered, by _____ laws.
state (Laws vary from state to state)
What is the name of the charter that includes information about the company?
A corporate charter, also called the articles of incorporation
T or F: A company can be chartered in another state from where its headquarters are.
True
All states require persons who wish to form a corporation to apply to a _______ _____ _____ for the issuance of a charter.
prescribed state official
What are the 3 things the corporate charter includes?
- Name and purpose of corporation
- Names of the incorporators
- Authorized Shares
the maximum number of shares that may be issued in each class of stock.
authorized shares
the number of shares actually sold to stockholders/investors (either sold or distributed through stock dividends or stock splits)
issued shares
T or F: A corporation rarely issues all of its authorized shares.
True
The typical corporate charter contains provisions that describe how stock may be issued by the corporation. What are these three provisions?
- First, authorizes the corporation to issue stock in a limited number of classes.
- Second, it sets an upper limit on the number of shares the corporation may issue in each class
- Third, it sets a lower limit on the amount for which each share must be sold.
Shares of stock are sold, or issued, when a corporation is _______. _______ _______ may be issued later.
formed; additional shares
the number of issued shares actually in the hands of stockholders/investors
outstanding shares
How do you calculate the number of outstanding shares?
Outstanding Shares - Shares Reacquired by the Corporation
When firms reacquire their own stock, the reacquired shares (are/ are not) considered to be outstanding.
are not
Stocks are either categorized as ______ or _______. These have different financial benefits and provide different rights regarding the governance of the corporation.
common; preferred
What are the 4 primary rights for owners of common stock?
- To vote for members of the board of directors
- To share in the profits and dividends of the company
- To keep the same percentage of shares of ownership if new shares are issued (preemptive rights)
- To a residual claim in the assets of the company should it be liquidated.
Common stockholders are only paid after the _______ and ________ _______ are paid in full (residual claim). This also means that common stockholders get _________ that is left over after those people are paid in full.
creditors; preferred stockholders; everything
Common stockholders receive the bulk of the financial gain from a profitable company through _____ _____ _______ and __________.
stock price appreciation; dividends
the value of the stock increases above the price initially paid (of course, it is also possible that the stock’s value decreases if the company is unprofitable– this is a risk of owning stock).
stock price appreciation
amounts paid periodically by a corporation to its stockholders as a return of their invested capital
dividends
Dividends represent a distribution of ________ ________, not an _______.
retained earnings; expense
T or F: Many companies do not pay dividends to common stockholders.
If true, why?
True; if the company has growth opportunities, they may elect to keep (or retain) earnings to fund these investment options rather than pay dividends.
Dividend payments are usually in the form of ______, but ______ _____ and _____ can also be given as dividends.
cash; noncash assets; stock
a class of stock that generally does not give voting rights, but grants specific guarantees and dividend preferences.
preferred stock
Preferred stock is similar to _____, as it pays a regular dividend.
debt
The value of preferred stock, like the value of debt, is most closely tied to ______ ____ _____ and the company’s overall ____________.
interest rate levels; creditworthiness
The value of common stock is most closely tied to the ___________ of the company.
performance
T or F: preferred stock is a more risky investment than common stock.
false; it is less risky
Preferred stockholders receive ________ over common stockholders in the payment of dividends and the distribution of assets in the event of liquidation.
priority
Preferred shareholders are paid dividends (before/after) common shareholders, and their dividends can be ________ and ________.
before; cumulative; participating
T or F: Preferred stock can be converted to common stock if the preferred stockholder elects to do so and certain conditions are satisfied.
True
Claims of preferred shareholders are satisfied (before/after) common shareholders in the event a company _________ its assets.
before; liquidates
Preferred stock can be _________ at a particular call price.
redeemable
the amount to be paid to the preferred stockholders
call price
The corporate charter may authorize or even require the corporation to repurchase (or redeem) any preferred shares that are _____. In such cases, the charter usually fixes the ____ _____ and specifies a _____ on or after which the shares may or must be repurchased.
This is similar to the repaying of the principal on a loan at the maturity date—particularly when the charter requires redemption at a specific date.
sold; call price; date;
T or F: Preferred shareholders can vote at stockholders’ meetings.
False; cannot vote
Because of the relative advantages of different forms of stock, corporations are typically authorized by their charters to issue _____ classes of preferred stock and _______ classes of common stock, each with a different set of terms and provisions.
several; several
Cash or other assets (capital) contributed by stockholders is usually divided between two accounts, on the basis of the _____ ______ of the stock.
par value
an arbitrary amount assigned to a stock to establish a minimum monetary value upon issuance, but does not determine its market value.
par value
T or F: par value determines a stocks market value
False; it does NOT
When a stock sells ABOVE its par value, the excess amount is called:
additional paid-in capital
T or F: stock rarely sells for exactly its par value
True
What formula do you use to calculate the amount that is recorded in the account that describes the type of stock (ex: common or preferred stock)?
Par value x the number of shares sold
the portion of a corporation’s stockholders’ equity contributed by investors (owners) in exchange for shares of stock.
capital stock
The common stock and preferred stock accounts, along with their additional paid-in capital are listed in the _______ section of the stockholders’ equity section of the balance sheet and taken together are known as _____ _______.
first; capital stock
the amount of capital that, under law, cannot be returned to the corporation’s owners unless the corporation is liquidated.
stated (or legal) capital
stock without a par value
no-par stock
Even when state law permits the issuance of no-par stock, it frequently requires that no-par stock have a _____ (______) value, set by the corporation, in order to establish the corporation’s stated/legal capital.
stated (legal)
Stated value, like par value, is recorded separately in the ______ (or ______) _____ account, while any excess paid over its stated value is recorded in what account?
- Common (or Preferred) Stock
- Additional Paid-In Capital– Common (or Preferred) Stock
the right granted by a corporation to purchase a specified number of shares of its common stock at a stated price and within a state time period.
stock warrant
Corporations issue stock warrants in the following two situations:
- They may issue warrants along with bonds or preferred stock as an “equity kicker” to make the bonds or preferred stock more attractive. Such warrants often have a duration of 5 or more years.
- They may issue warrants to existing stockholders who have a legal right to purchase a specified share of a new stock issue, in order to maintain their relative level of ownership in the corporation. Such warrants usually have a duration of less than 6 months.
Corporations can distribute cash to stockholders in the following two ways:
- The corporation can repurchase the shares from owners. (treasury stock)
- The corporation can issue dividends.
Historically, ________ were the most common method of distributing cash. Over recent years, however, repurchasing shares has become a more frequent method of cash distribution because it has ______ _______ for stockholders relative to dividends.
dividends; tax advantages
Dividends have often been taxed at (higher/lower) rates than gains from selling stock, although that is not currently the case.
higher
Dividends do have the advantage of allowing stockholders to:
receive assets from the corporation without reducing their ownership share.
When a corporation buys its own previously issued stock, it is called:
treasury stock
What are 6 reasons companies may purchase treasury stock?
- Buy out ownership of one or more shareholders.
- Reduce size of company’s operations.
- Reduce outstanding shares, which increases earnings per share and market value per share.
- Acquire shares that can be given out to employees under stock bonus, stock option, or stock purchase plans.
- Satisfy the terms of a business combination which requires shares of stock as part of the merger or acquisition.
- Reduce vulnerability to a potentially hostile takeover.
Treasury stock may be purchased on the ______ _______, by a general offer to the stockholders (called a _____ ______), or by ______ _______ with a major stockholder.
open market; tender offer; direct negotiation
If the objective of acquiring treasury stock is to reduce the size of corporate operations, the treasury shares may be ______ after purchase.
retired
Repurchased stock can be held in the corporation’s treasury until circumstances favor its ______, or until it is needed to meet ________ of the corporation that must be satisfied with shares of its stock.
resale; obligations
Transactions in treasury stock, even very large ones, usually do not require __________ ________.
stockholder approval
The purchase of treasury stock is a ________ of a company’s ______ rather than the acquisition of an investment.
reduction; equity
Treasury Stock purchases (increase/decrease) Stockholders’ Equity.
decreases
The account Treasury Stock is (credited/debited) when the company buys back some of its own stock (reacquisition).
debited
Treasury Stock is a _______-_______ account.
contra-equity
Company dividends (are/are not) paid on treasury stock.
are not
If treasury stock is later sold at a price HIGHER than its cost, the excess beyond the cost is (debited/credited) to what account?
credited; Additional Paid-In Capital– Treasury Stock
If treasury stock is later sold at a price LOWER than its cost, a (credit/debit) is made first to (what account?), until that account is depleted, then the remaining amount is (credited/debited) to _______ ________-.
debit; Additional Paid-In Capital– Treasury Stock; debited; Retained Earnings
When companies permanently retire treasury stock, the Common Stock account is (credited/debited) for the _____ ______ of the stock, and the Additional Paid-In Capital account is (debited/credited) (reduced) for the excess of its purchase price over par value. You would then (credit/debit) cash however much those two added together are.
debited; par value; debited; credit
Dividends represent distributions of accumulated ____ ______.
net income
Dividends (increase/reduce) retained earnings.
reduce
The most common type of dividend is paid in cash, based on a declaration from the board of directors. The dividend declaration specifies what 4 things?
- Declaration Date
- Dollar Amount of the Dividend (usually stated as the number of dollars per share)
- Date of Record
- Payment Date
the date on which a corporation announces its intention to pay a dividend on common or preferred stock.
declaration date
the date on which a stockholder must own one or more shares in order to receive the dividend.
date of record
the date on which the dividend is actually paid out.
payment date
If a share of stock is sold between the date of record and the dividend payment date, the (new/former) owner of the share receives the dividend.
former
If a share of stock is sold between the declaration date and the date of record, the (new/former) owner receives the dividend.
new
The corporation’s record of dividends and retained earnings provides useful information to what two groups?
- Board of directors and managers (who must formulate a dividend policy)
- Stockholders/potential investors
When retained earnings has been reduced to _____, any additional dividends must come from ______ ______. Such dividends are called ________ dividends and must be charged first against additional paid-in capital, then the Common (or Preferred) Stock accounts.
zero; capital stock; liquidating
The presence of significant ________ will usually prevent, or at least require close monitoring of, liquidating dividends. Since these dividends are a return of _____-___ _____, they (are/are not) taxed as income to the recipients.
liabilities; paid-in-capital; are not
dividend that transfers additional shares of stock from the company to its stockholders.
stock dividend
Stock Dividends:
- For each share outstanding, a fixed number of new shares is issued.
- An amount of Retained Earnings is transferred to contributed capital accounts
This process is known as:
Capitalization of Retained Earnings
T or F: While a cash dividend reduces both total assets and total equity, a stock dividend alters neither total assets nor total equity.
true
The amount of retained earnings capitalized for each new share depends on the ______ of the stock dividend.
size
______ _______ _______ increase the number of outstanding shares by less than 25%; they are capitalized using the stock’s _______ value just before the dividend.
small stock dividends; market
_______ ______ ______ increase the number of outstanding shares by 25% or more; they are capitalized at _____.
large stock dividends; par
Although a stock dividend increases the _______ of shares held by each stockholder, it does not alter the _______ of shares held.
number; proportion
T or F: Neither stock dividends nor splits, enhance the total market value of a corporation’s outstanding common stock
true
A stock split (increases/decreases) the number of outstanding shares without changing the proportionate ownership of a corporation.
increases
A stock split (increases/decreases) the per-share par value (or stated value) without affecting Retained Earnings.
decreases
a stock issue that increases the number of outstanding shares without changing the balance of the equity accounts.
stock split
A stock split has the effect of distributing the _____ ______ over a larger number of shares.
par value
Stock splits are used to (increase/reduce) the price of the stock per share, often to enable (larger/smaller) investors to afford the stock.
For example, a two-for-one stock split would cut the ______ price of the stock in half.
reduce; smaller; market
T or F: No journal entry is required to record a stock split because no account balances change
True
For stock dividends, state the effect it has on the following things:
1. Number of shares outstanding
2. Par value per share
3. Total Contributed Capital
4. Retained Earnings
5. Total Stockholders’ Equity
- Increases
- No effect
- Increases
- Decreases
- No effect
For stock splits, state the effect it has on the following things:
1. Number of shares outstanding
2. Par value per share
3. Total Contributed Capital
4. Retained Earnings
5. Total Stockholders’ Equity
- Increases
- Decreases
- No effect
- No effect
- No effect
While dividends on common stock are set by the corporation’s _____ ____ _____, dividends on preferred stock are usually established as one of the ______ of the _____.
- board of directors
- terms; issue
Most preferred stock has a _____ dividend as a percentage of its ____ ______.
fixed; par value
(ex: an 8% preferred share with a $100 par value has an annual dividend of $8 ($100 par x 8%).
T or F: Preferred stock has no voting rights, but dividends must be paid on preferred stock prior to common stock.
True
Preferred Stock preferences include (2):
- Current dividend preference
- Cumulative dividend preference
T or F: Preferred stock ALWAYS has a current dividend preference.
True
a provision that requires that current dividends must be paid to preferred stockholders before any dividends are paid to common stockholders.
current dividend preference
T or F: the current dividend preference doesn’t guarantee payment of preferred dividends. In lean years, companies may not pay any dividends to either preferred or common shareholders.
true
If the total amount available for dividends is (more/less) than the preferred dividend, the total amount available is paid to ________ shareholders.
less; preferred
a provision that requires the eventual payment of all preferred dividends– both dividends in arrears and current dividends– before any dividends are paid to common stockholders.
cumulative dividend preference
cumulative preferred stock dividends remaining unpaid for one or more years.
dividend in arrears
the accumulated earnings (or losses) over the entire life of the corporation that has not been paid out in dividends.
retained earnings
A negative Retained Earnings is called a ______.
deficit
How do you calculate the ending balance of retained earnings?
(Beginning Retained Earnings + Net Income - Dividends) = Ending Retained Earnings
Stockholders want to understand these two things:
1. How the _______ of their shares of stock will change
2. How the company will distribute any _______ cash to stockholders.
- value
- excess
A primary driver of an increase in stock price is ________.
profitability
the return that the company earns (in other words, its net income).
profitability
The two most common ratios used to evaluate stockholder profitability are:
- Return on Common Equity
- Earnings Per Share (EPS)
ratio that shows the growth in equity from operating activities.
Return on Common Equity
ratio that measures the net income earned by each common share of stock.
Earnings Per Share (EPS)
How do you calculate Return on Common Equity?
(Net Income - Preferred Dividends) / Average Common Stockholders Equity
How do you calculate Common Stockholders Equity?
Stockholders Equity - Preferred Stock
How do you calculate Earnings Per Share (EPS)?
(Net Income - Preferred Dividends) / Average Common Shares Outstanding
T or F: No gains or losses are recognized for treasury stock transactions.
True
When a company retires its own common stock, the company must:
a.) record a gain or loss depending on the difference between original selling price and repurchase cost
b.) decrease the Common Stock account balances by the original issue price
c.) get the approval of the state to do so
d.) issue a different class of stock to the former stockholders
b.) decrease the Common Stock account balances by the original issue price
When a company declares a cash dividend, which of the following is true?
a.) Assets are decreased.
b.) Assets are increased.
c.) Stockholders’ equity is increased.
d.) Liabilities are increased.
d.) Liabilities are increased.
