Equity Flashcards
What rights does each share of stock carry?
Each share of stock has certain rights and privileges, including the right to vote for directors, share in profits and losses, and share in corporate assets upon liquidation.
What is the preemptive right?
The preemptive right allows existing stockholders to maintain their ownership level by sharing proportionately in any new issues of stock in the same class.
What are the advantages of the share system?
The share system facilitates dividend payouts and stockholder meetings, and is governed by the Uniform Stock Transfer Act and the Uniform Commercial Code.
What does common stock represent?
Common stock represents the basic ownership interest in a corporation, bearing the ultimate risks of loss and receiving the benefits of success.
What is preferred stock?
Preferred stock represents special preference given in exchange for sacrificing some rights of common stock, often having preference to claims on earnings and liquidation.
What is stockholders’ equity?
Stockholders’ equity represents a claim against a portion of the total assets of the company, also known as owners’ equity, shareholders’ equity, or corporate capital.
How is stockholders’ equity calculated?
Stockholders’ equity is the difference between the assets and liabilities of a company, also referred to as the residual interest.
What is Legal Capital?
Legal Capital is the par value of the stock issued by the company.
What is contributed capital?
Contributed capital is how much the investors contributed to the company.
What are the two primary sources of equity?
The two primary sources of equity are contributed capital and earned capital.
What is the formula for stockholders’ equity?
Stockholders’ equity = Capital Stock + Additional Paid-In Capital + Retained Earnings - Treasury Stock (at cost).
What is earned capital?
Earned capital (Retained Earnings) is what the company earned and kept, consisting of cumulative earnings and losses.
What is capital stock?
Capital stock is part of contributed capital, including common and preferred stock issued by a company.
What is additional paid-in capital?
Additional Paid-In Capital is part of contributed capital that increases when stock is sold or issued above par.
What does retained earnings represent?
Retained earnings represent undistributed income that remains invested in the company.
What is treasury stock?
Treasury stock is when a company buys back its own stock, shown as a negative in accounting.
What is the nature of treasury stock in accounting?
Treasury stock is a contra-equity account with a normal debit balance.
How is treasury stock accounted for when reacquired?
When reacquiring stock, debit Treasury Stock for the cost of the acquisition and credit Cash.
What happens when treasury stock is sold for more than its cost?
When selling treasury stock for more than its cost, the excess is credited to Paid in Capital from Treasury Stock.
Can treasury stock transactions increase retained earnings?
Treasury stock transactions can decrease but not increase retained earnings.
What are the procedures for issuing stock?
- State must authorize stock. 2. Corporation offers shares for sale. 3. Corporation receives funds for stock and issues shares.
What are authorized shares?
Authorized shares are how many shares of stock a company could issue, if it chose to.
What are Issued Shares?
Issued Shares are the total number of shares a company has distributed. They cannot exceed the authorized number.
What are Outstanding Shares?
Outstanding Shares are the shares that are in the hands of stockholders. They are calculated as issued shares minus treasury shares.
What is Par Value?
Par Value is a number assigned to the stock that has no relationship to its fair value. It is usually low and helps companies avoid contingent liability associated with stock issued below par.
What is Additional Paid-In Capital?
Additional Paid-In Capital refers to capital in excess of par value. It is also called additional paid-in capital.
How is Common Stock valued when issued?
For example, if 10,000 shares of $2 par value common stock are issued for $10, the valuation would be:
- Common Stock: $20,000
- Additional Paid-In Capital: $80,000
What is No-Par Stock?
No-Par Stock has no par value, meaning there is no additional paid-in capital. All value is attributed to the stock itself.
What are the advantages of No-Par Stock?
No-Par Stock avoids contingent liability that could occur if a corporation issues par value stock at a discount and the questionable treatment of using par value as the basis for fair value.
What are the disadvantages of No-Par Stock?
Some states levy high taxes on no-par issues, and in some states, the total issue price for no-par stock may be considered legal capital, reducing flexibility in paying dividends.
How is No-Par Stock recorded?
No-Par Stock is issued for whatever price it will bring, without a premium or discount. It should be carried at issue price without any additional paid-in capital or discount reported.
What is No-Par Stock with Stated Value?
No-Par Stock with Stated Value acts like par value. Excess over stated value is recorded as Additional Paid-In Capital in Excess of Stated Value.
What are the requirements for No-Par Stock with Stated Value?
Some states require a stated value for no-par stock, and a company cannot issue below it. When shares are issued above stated value, the stated value is accounted for as common stock, and the excess is recorded as paid-in capital in excess of stated value.
What is lump-sum issuance or exchange?
When corporations issue two or more classes of securities for a single lump sum payment, often occurring during acquisitions.
What are the two methods for allocating proceeds in lump-sum issuance?
Proportional and Incremental methods.
Describe the Proportional Method.
The lump sum received is allocated proportionally to classes of securities based on fair market value.
Describe the Incremental Method.
Used when fair value cannot be determined for all classes. Fair value is used for known classes, and the remainder is allocated to unknown values.
What is the valuation issue in stock issued in noncash transactions?
Companies should record stock at either the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.
What should companies consider when exchanging unissued stock or treasury stock?
The cost of the shares should NOT be considered the decisive factor in establishing the fair value of the property or services.
How should companies adjust the ‘paid in capital in excess of par - common stock’ amount?
Adjust it to reflect the fair value of the transaction.
What is watered stock?
Watered stock is when a company intentionally overvalues the property or service received, creating inflated asset values.
What are secret reserves?
Secret reserves are when a company intentionally undervalues recorded assets, resulting from excessive depreciation or understatement of assets.
How should direct costs of issuing stock be reported?
Direct costs to sell stock are reported as a reduction of the proceeds received from the sale of stock.
What is treasury stock?
Treasury stock is repurchased stock that is not considered an asset and reduces stockholders’ equity.
What are some reasons a company would reacquire stock?
- To provide tax-efficient distributions to shareholders.
- To increase earnings per share and return on equity.
- To provide stock for employee compensation.
- To thwart takeover attempts.
- To create demand and stabilize stock price.
- To ‘go private’ by eliminating outside ownership.
What is the effect of stock buybacks on stock price?
Stock buybacks can stabilize or increase stock price.
What is the impact of buybacks on companies?
Buybacks can hurt companies in the long run, even if they think their shares are undervalued.
What is the effect of treasury stock transactions on retained earnings?
Treasury stock transactions may decrease retained earnings in certain circumstances.
What is the Treasury Stock account?
The Treasury Stock account is a Contra-Equity Account with a normal debit balance.
What are the two methods for acquiring treasury stock?
The two methods are the cost method and the par value method.
IFRS only allows the cost method.
How is treasury stock recorded using the cost method?
Debit the Treasury Stock account for the reacquisition cost; report this account as a deduction from total paid-in capital and retained earnings.
How is treasury stock recorded using the par value method?
Record all transactions in treasury shares at their par value and report treasury stock as a deduction from capital stock only.
What happens when selling treasury stock above cost?
When the selling price exceeds cost, credit the difference to Paid-in Capital from Treasury Stock.
Don’t credit a gain account because treasury stock isn’t an asset.
How should gains on sales of treasury stock be recorded?
Gains on sales of treasury stock using the cost method should be credited to Paid-in Capital from Treasury Stock.
A gain should not be recognized from stock transactions with a company’s own stockholders.
What is the treatment of treasury stock gains on the balance sheet?
List Paid-in Capital separately on the balance sheet.
Treasury stock ‘Gain’ cannot increase retained earnings.
What happens when selling treasury stock below cost?
Debit the excess of cost over selling price to Paid-In Capital from Treasury Stock.
If the credit balance in Paid-In Capital from Treasury Stock is eliminated, debit any additional costs to retained earnings.
Can treasury stock decrease retained earnings?
Yes, treasury stock can decrease retained earnings, but it cannot increase it.
What is the process for retiring treasury stock?
The board may approve the retirement of treasury shares, which cancels treasury stock and reduces the number of outstanding shares.
What happens to retired shares?
Retired shares become ‘authorized and unissued’ and reduce the total approved number of shares.
What are the key differences between preferred stock and common stock?
Preferred stock possesses certain preferences or features not found in common stock, such as preference as to dividends, preference to assets during liquidations, convertibility to common stock, callability, and lack of voting rights.
What is a redeemable preferred stock?
A type of preferred stock that is most like debt, with a mandatory redemption date and amount.
What is the preference for dividends in preferred stock?
Preference for dividends does not ensure payment; companies must pay dividends on preferred stock before common stock.
What is cumulative preferred stock?
Cumulative preferred stock requires the corporation to pay all accumulated dividends before paying dividends to common stockholders.
What are dividends in arrears on cumulative preferred stock?
Dividends in arrears on cumulative preferred stock are disclosed in the notes to financial statements.
What is participating preferred stock?
Participating preferred stock may provide holders with more than the stated amount, allowing them to receive their prescribed return and additional dividends if the company pays amounts in excess of the stated preferred stock rate.
What happens if a company fails to pay a dividend for participating preferred stock?
If a company fails to pay a dividend for participating preferred stock in any year, it does not have to pay that before paying common dividends.
What is Callable Preferred Stock?
Callable Preferred Stock permits the corporation to call or redeem outstanding shares at specified future dates and prices. Many preferred issues are callable, with the call price typically slightly above the issue price.
What is the purpose of Callable Preferred Stock?
It allows the corporation to use capital obtained by issuing stock while it’s needed, then give it back.
What is Redeemable Preferred Stock?
Redeemable Preferred Stock is more like debt than other kinds of stock. It can set a ceiling on share price unless convertible into common stock.
What are Class B Shares?
Class B Shares are a type of common stock that carry super voting powers and are used to protect owner interest. They are controversial and used by companies like Dow Jones & Co, Ford, NY Times, and Google.
Why do tightly held companies create new classes of stock?
To provide cash, increase liquidity, or put public value on a company without diluting owner voting control.
How is accounting for Preferred Stock similar to Common Stock?
Proceeds are allocated between par value and additional paid-in capital, with separate accounts maintained for different classes of shares.
What is Convertible Preferred Stock?
Convertible Preferred Stock is considered a part of stockholders’ equity, and the book value method is employed for its accounting.
What is the Book Value Method for Convertible Preferred Stock?
The method involves debiting Preferred Stock and related Paid-In Capital in Excess of Par - Preferred Stock account, and crediting Common Stock and Paid-In Capital in Excess of Par - Common Stock.
What happens when preferred stock is converted into common stock?
Any excess of the par value of the common shares issued over the carrying amount of the preferred being converted should be accounted for.
How is Preferred Stock classified in financial statements?
Preferred Stock is classified as stockholders’ equity and reported at par value as the first item in the section, with excess over par reported as additional paid-in capital.
What are dividends of preferred stock considered?
Dividends of preferred stock are a distribution of income, not an expense.
What must companies disclose regarding preferred stock?
Companies must disclose the pertinent rights of outstanding preferred stock.
What are dividend payouts?
Dividend payouts are important signals for the market, indicating a portion of a company’s profits.
A dividend check provides proof that at least some portion of a company’s profits is genuine.
Why are companies reluctant to reduce or eliminate dividends?
Companies are reluctant to reduce or eliminate their dividend as securities markets might view the change negatively.
What factors influence a company’s dividend policy?
The type of shareholder a company has (taxable or nontaxable, retail investor or institutional investor) plays a role in determining the company’s dividend policy.
Why are dividend amounts usually less than retained earnings?
Dividend amounts are usually less than retained earnings for several reasons, including maintaining agreements with creditors and meeting state incorporation requirements.
What is one reason companies retain earnings instead of paying dividends?
To finance growth or expansion, companies may retain assets that would otherwise be paid out as dividends, often referred to as ‘plowing profits back into business.’
What is the purpose of smoothing out dividend payments?
Smoothing out dividend payments allows companies to accumulate dividends in good years and use those earnings for dividends in bad years.
What must management consider before declaring a dividend?
Management must consider the availability of funds to pay the dividend and ensure that both the present and expected future financial position warrant it.
What does the SEC encourage companies to disclose?
The SEC encourages companies to disclose their dividend policies in their annual reports, especially if they do not pay dividends or expect to pay them in the foreseeable future.
What is a liquidating dividend?
A liquidating dividend is a dividend not based on retained earnings.
What are the types of dividends?
Cash Dividends, Property Dividends, Liquidating Dividends, Stock Dividends.
How do dividends affect stockholders’ equity?
All dividends, except stock dividends, reduce stockholders’ equity.
What is the process for declaring cash dividends?
The board votes by resolution to declare a dividend.
What are cash dividends based on?
Cash dividends are based on the number of dividends outstanding.
What is a declared cash dividend considered?
A declared cash dividend is a liability, typically a current liability.
How are cash dividends typically declared?
Cash dividends are typically declared as a certain percent of par, or an amount per share.
Do companies declare or pay cash dividends on treasury stock?
No, companies do not declare or pay cash dividends on treasury stock.
What is the goal of growth companies regarding cash dividends?
Growth companies pay little or no cash dividends to use funds to expand internally.
What is recorded on the date of declaration?
At declaration: Debit Retained Earnings (or Cash Dividend declared), Credit Dividends Payable.
What happens on the date of record?
At date of record - no entries. Need to know who owns the stock on this date.
What is recorded on the date of payment?
At date of payment: Debit Dividends Payable, Credit Cash.
Who has priority in dividend distributions?
Preferred shareholders have priority over common shareholders.
What are property dividends?
Dividends payable in assets of the corporation other than cash, such as merchandise, real estate, or investments.
What should a company do when distributing property dividends?
RESTATE AT FAIR VALUE the property and recognize any gain or loss.
How are equity investments recorded when paying a dividend?
At date of declaration:
Equity Investments (Adjust to fair value) $100,000
Unrealized Holding Gain or Loss - Income $100,000
Retained Earnings (Property Dividend declared) $500,000
Property Dividends Payable $500,000
At date of record:
Property Dividends Payable $500,000
At date of payment:
Equity Investments $500,000
What is a liquidating dividend?
A return to stockholders of a portion of their original investment, based on something other than retained earnings.
How do liquidating dividends affect paid-in capital?
Liquidating dividends reduce paid-in capital.
What does depletion represent in the context of stockholder’s investment?
Depletion represents a return of part of the stockholder’s investment.
