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Theory of Financial Accounting II > Chapter 15: Stockholders' Equity > Flashcards

Chapter 15: Stockholders' Equity Flashcards

1
Q

Incremental Method

for valuing stock issued with other securities

A

When fair value for all securities cannot be determined

uses whichever fair value is known as value for that part and then the remainder for the other

If no values are known the securities may require expert appraisal

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2
Q

Stockholders’ equity disclosures

A

Rights and privileges of securities outstanding

  • dividend and liquidation preferences
  • participation rights, unusual voting rights
  • call prices and dates
  • conversion or exercise prices and pertinent dates
  • sinking fund requirements
  • significant contract terms

Note to disclose restrictions on retained earnings

(some may go directly in the equity section, not the notes)

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3
Q

Statement of Stockholders’ Equity

A

Often in columnar format with columns or all SE accounts

Rows:

  • beginning balance
  • addition and deduction transactions (listed out)
  • balance at end of period

Requirement to show changes in each SE account, can be done in multiple ways

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4
Q

Redeemable Preferred Stock

A

has mandatory redemption period

very like a debt

must now be classified as a liability and measured as such

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5
Q

Equity Ratios

A

Evaluate profitability and long-term solvency

  • Return on common stockholders’ equity (ROE)
  • Payout Ratio
  • Book value per share
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6
Q

Return on Common Stockholder’s Equity

A

ROE
measures company profitability: dollars of net income for each dollar of investment

comparative between companies also helpful

= (net income - preferred dividends) / average common stockholders’ equity

Average common stockholders’ equity = total SE less PAR VALUE of preferred stock

expressed as a percentage

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7
Q

Trading on Equity

A

Using borrowed money or issuing preferred stocks in the hope of obtaining a higher rate of return on the money used

ROE > ROA (return on total assets)

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8
Q

Recording stock issued in non-cash transactions

A

Companies should record stock issued for services or property other than cash at either the fair value of the stock issued or the fair value of the non-cash consideration received - whichever is more clearly determinable

Avoid using book, par, or stated values to value

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9
Q

Recording preferred stock: cumulative vs non-cumulative

A

When a dividend is declared

Non-cumulative: preferred stockholders receive their dividend (% of par) and remaining is distributed to common stockholders

Cumulative: preferred stockholders receive their dividends PLUS any dividends on past non-dividend years, only then is remaining dividend distributed to common stockholders

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10
Q

Watered stock

A

Stock held at too high value due to overvaluation of property/ services received in exchange

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11
Q

Par/stated value method for recording purchase of treasury stock

A

Debit treasury stock at par value (may be debit common stock?)

shown on balance sheet as reduction to capital stock only

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12
Q

Cost method for recording purchase of treasury stock

A

More popular than the par/stated value method

Debit Treasury stock (at acquisition cost)
Credit Cash

Shown on balance sheet as a reduction to stockholder’s equity

No consideration for the original price on the sale of stock

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13
Q

Reporting Treasury stock on the balance sheet

A

Stockholders’ Equity section of the balance sheet

Paid in Capital

Common Stock

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14
Q

Reporting Treasury stock on the balance sheet

A

Stockholders’ Equity section of the balance sheet

Paid in Capital
       Treasury Stock 
        Common Stock
        PIC
          Total Paid In Capital
Retained Earnings
     Total Paid in capital and retained earnings
Less cost of treasury stock
      Total stockholders' equity

Disclose number of shares

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15
Q

Secret Reserves

A

When a corporation undervalues its recorded assets

  • excessive depreciation / amortization
  • undervaluing exchanges
  • misstating expenses vs capital expenditures

Understatement of an asset/ overstatement of liabilities

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16
Q

Convertible preferred stock

A

Allows stockholder to exchange preferred shares for common at a predetermined ratio

Book value method employed, no gain or loss recognized

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17
Q

Recording costs of issuing stock

A

Record as a reduction to amount paid in
ONLY direct costs
- underwriting, accounting/legal fees, printing, taxes

issue costs - cost of financing

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18
Q

Reporting preferred stock disclosures

A

Must disclose pertinent rights of any preferred stock outstanding

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19
Q

Recording stock issued for a receivable

A

Receivable recorded as contra-equity account

(risk of collection is high)

generally just don’t record equity until cash is received

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20
Q

Reasons companies buy back shares

A
  • tax efficient distributions to stockholders (lower capital gain tax on sale of stock)
  • increase EPS / return on equity
  • increase ratios without changing performance
  • to provide stock for employees compensation or merger needs
  • to thwart takeover attempts / reduce number of stockholders
  • to make a market for the stock (creates demand)
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21
Q

Leveraged buyout

A

(LBO)

company borrows money to finance stock repurchases

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22
Q

Treasury stock

A

Corporation’s own stock, reacquired after having been issued and fully paid

NOT AN ASSET + ownership does not give any rights to company to act as own shareholder

purchase recorded at cost (cost method - normally) or par (par method - occasionally)

in most states is a restriction on retained earnings

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23
Q

Considerations on declaring a dividend

A
  • agreements with creditors and state requirements of restricted retained earnings
  • need to hold earning to finance growth
  • liquidity / flexibility of assets
  • buffer for potential future issues
  • availability of funds for dividends or liabilities
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24
Q

Characteristics of the corporate form

A
  • influence state corporate law
  • use of capital stock or share system
  • development of a variety of ownership interests
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25
Q

Steps to issuing stock

A

1) state authorizes stock (certificate of incorporation/ charter)
2) corporation offers shares for sale & enters into contract to sell
3) in receipt for cash shares are issues (this is when journal entry occurs)

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26
Q

Recording sale of treasury stock

A

Use inventory costing methods for repurchase price

Debit cash
Credit treasury stock at repurchase cost

if sell ABOVE repurchase price:
Credit PIC - Treasury stock

If sell below repurchase price:
Debit PIC - Treasury stock if it is available
if not Debit retained earnings

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27
Q

Business incorporation acts

A

vary by state - account follows provisions of laws

Definition of terms may vary between states

28
Q

Gains

A

Gains on sales only occurs when selling assets, additional money from stock is “additional paid in capital”

29
Q

Retiring treasury stock

A

Board of directors decision

  • treasury stock cancelled
  • issued shares decrease

Retired = authorized and unissued

Debit paid in capital (common stock, preferred stock, APIC)
Credit Treasury stock

30
Q

Dividend policy disclosures

A

Encouraged by SEC to include in annual report

31
Q

Recording cash dividends

A

on date of declaration:
Debit Retained Earnings
Credit Dividends payable
(may potentially use “cash dividends declared” account that is closed to RE at year end

Date of record: no entry

Date of payment:
Debit Dividends Payable
Credit cash

32
Q

Recording preferred stock dividends

non-participating vs participating

A

After preferred dividend is assigned

non-participating: all remaining dividend distributed among common stock

Participating- may be specified in the contract. otherwise:

  • common stock receives like percentage of par value outstanding
  • remainder of dividend is divided by TOTAL par value to find rate of participation
  • multiple by part to determine amount of participation between common and preferred
33
Q

Payout Ratio

A

Ratio of cash dividends to net income - if preferred stock exists do not include

= cash dividends on common stock / net income available to common stockholders

DO NOT subtract non-controlling interest

34
Q

Book value per share

A

The amount each share would receive if the company were liquidated, based on the balance sheet

= common stockholders’ equity / outstanding common shares

35
Q

Recording property dividends

A

1) record gain (credit) or loss (debit) as necessary
2) record dividend declared
Debit Retained Earnings or Property Dividends Declared
Credit Property Dividends Payable
3) at date of distribution:
debit property dividends payable
credit property account

36
Q

Recording liquidating dividends

A

Date of declaration:
Debit Retained earnings
Debit PIC-Common stock
Credit dividends payable

Date of payment:
Debit Dividends Payable
Credit Cash

37
Q

Recording Ordinary stock dividend

A

(ordinary dividend = less than 20-25%)
MUST BE PROPORTIONATE

Date of declaration:
Transfer retained earnings to paid in capital:
Debit Retained Earnings (fair value)
Credit common stock dividend distributable (par value)
Credit PIC - common stock

Distribution
Debit common stock distributable
Credit common stock

38
Q

Large stock dividend

A

Should really be called stock split up

Stock dividend of more than 20-25% (SEC says 25%) number of shares previously outstanding

more resembles stock split than dividend and reduces unit market price

still require transfer par value of stock issued from retained earnings

split up effected in the form of a dividend

39
Q

Recording a stock dividend

A

No assets paid out or liability incurred

40
Q

Shareholder Rights

A

In the absence of restrictive provisions

  • to share proportionately in profits and losses
  • to share proportionately in management (by voting for directors
  • to share proportionately in corporate assets upon liquidation
  • to share proportionately in any new issue of stock of the same class (called the preemptive right, prevents dilution of ownership)
41
Q

Registrar or transfer agent

A

provide services to corporations to record and transfer stock (maintaining required records)

42
Q

Components of stockholders equity

A 
contributed capital/ paid in capital:
- capital stock 
- additional paid in capital 
Earned capital
- retained earnings
Other
- accumulated other comprehensive income
43
Q

Book value per share with preferred stock

A

Any dividends in arrears
current year requirements
+ participating
potential dividends for preferred stock must be removed from the stockholders’ equity before dividing by common shares outstanding

44
Q

Accumulated other comprehensive income

A

Not retained earnings or contributed capital

ex: unrealized gains and losses on AFS debt/ investments/ derivative transactions

45
Q

Preferred stock features

A

Depend on the contract,

  • preference as to dividend (amount expressed as % of par value, or if no par value expressed as $/share)
  • preference as to assets in event of liquidation
  • convertible into common stock
  • callable at the option of the corporation
  • non-voting
46
Q

Stock dividends

A

The issuance by a corporation of its own stock to its stockholders on a pro rata basis

essentially reclassifies retained earnings to contributed capital

stockholders maintain proportionate interest - book value per share is lower

47
Q

Cumulative preferred stock

A

Accumulated dividends in arrears (must make up missed years of preferred stock before paying common stock)

no liability is recorded until the dividend is declared - cumulative status just disclosed in financial statements

most preferred stock is cumulative

48
Q

Participating preferred stock

A

receives preferred dividends AND dividends at the same rate as common stockholders if excess over preferred

rare

49
Q

Stockholders’ equity

A

Residual interest

= net assets (aka assets - liabilities)

a claim against a portion of total assets, not specific assets

amount depends on profitability

50
Q

Recording a stock split

A

no accounting entry- just a memorandum note on the changed par value/ changed quantity

51
Q

Callable preferred stock

A

company may call (redeem) all standing shares

call/ redemption price pre-set generally above issue price (which sets a ceiling on share price

when redeemed must pay dividends in arrears

52
Q

Stock split

A

Reduces market price of stock - same total values - multiplied shares

Shareholders retain % ownership

now more shares for sale at a lower price

Reverse stock splits also happen (unsplitting)

53
Q

Recording stock sold below par value

A

Rarely occurs

Discount on par value recorded as a DEBIT to additional paid-in capital (Equity account, credit NB)

may be able to call on purchaser/ holder to pay difference to avoid loss on liquidation

54
Q

Recording issuance of par value stock

A

Debit Cash
Credit preferred stock/ common stock at par
Credit PIC - preferred stock/ common stock

55
Q

No Par Stock

A
  • illegal in some states
  • may be considered legal capital - reduces flexibility of paying dividends
  • may have higher taxes
  • some states may require to have a stated value (minimum price of stock)
56
Q

Recording issuance of no par stock

A

NO PIC

Debit Cash
Credit Common Stock

if has stated value may use APIC account for amount over stated value

57
Q

Recording lump sum sales of stock with other securities

A

proportional method or incremental method

58
Q

Proportional method for valuing stock issued with other securities

A

used if there is a sound basis for determining relative value

value allocated based on % of total fair value

59
Q

Types of dividends

A
  • Cash dividends
  • property dividends (in kind0
  • liquidating dividends

expect for stock dividends all dividends reduce total stockholders’ equity

60
Q

Property dividends

A

dividends in kind: most often securities or stock in other companies (investments) (sometimes merchandise, real estate)

Date of declaration
- restate at fair value the property to be distributed (recognize gain or loss)

61
Q

Cash dividend process

A

1) Date of declaration (dividend = current liability)
2) date of record - all stockholders on current list will receive a dividend
3) date of payment

generally a significant lag between one and three

may be an amount per share or a percent of par

no dividends on treasury stock

62
Q

Other considerations for computing book value per share

A
  • # of authorized and UN issued shares
  • treasury shares on hand
  • commitments of issuance of unissued / treasury shares
  • rights and privileges of stock authorized
  • if liquidating value of preferred stock is greater than carrying value of amount use liquidating amount in book value computation
63
Q

Liquidating dividend

A

Dividend not based on retained earnings (base on paid in capital, REDUCES paid-in-capital)

a return of the stockholders’ investment

may take place over an extended period as company disposes of assets

DISCLOSE

64
Q

Small (ordinary) stock dividend

A

Stock dividend less than 20-25% of common shares outstanding at time of declaration

company required to transfer the fair value of the stock issued from retained earnings

65
Q

Treasury shares and stock dividends

A

May be state requirements

66
Q

Balance sheet stockholders’ equity

A

Capital stock
List types of stock, par value/no par, any preferred dividends, shares outstanding, issued, and authorized
total capital stock
PIC
List types
Total paid in capital (stock + PIC)
Retained earnings
Total paid in capital and retained earnings
Less Treasury stock
+ accumulated comprehensive other loss/ income

Total stockholder’s equity

Theory of Financial Accounting II (8 decks)

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