FAR CPA Lessons 143-151 Flashcards
What are the two major types of owner’s Equity?
- Earned
2. Contributed
Explain Earned Capital
There is no one measurement basis for earned capital (retained earnings) because all of the measurement bases that are reflected in net income are also reflected in retained earnings.
Explain Contributed Capital
The primary measurement basis for contributed capital is the historical value of direct investments made in the firm by investors, in return for shares of capital stock.
What are the rights of common shareholders?
- The right to participate in major operating and financing decisions through the exercise of voting rights - including voting for the board of directors, the external auditors, and other major issues.
- Preferred shareholders receive their dividend allocation prior to any allocation to the common shareholders - dividends are not mandatory
- The preemptive rights of common shareholders allow current shareholders to maintain their existing percentage of the firm in the event of a new stock issuance by the firm. (Not always present)
- In liquidation credits are satisfied first, then preferred shareholders then common shareholders
What are the rights of preferred shareholders?
- Typically they do not have voting rights
- Receive dividends first before common shareholders
- withcumulativepreferred stock and participating preferred stock, can enhance this dividend preference for preferred shareholders
- In liquidation credits are paid first then preferred shareholders
Define retained earnings
the running total of all other comprehensive income items through the balance sheet date.
Define treasury stock
the cost or par value of the common stock of a firm purchased by that firm, depending on the method used by the firm.
Sole proprietorship
the ownership of the business enterprise consists of a single individual or party.
Partnership
the ownership of the business enterprise consists of two or more participants.
Corporation
- ## Stock my be held by a small number of investors or a large number if traded on the exchange
Advantages of a Corporation
- Shareholders have limited liability, the corporation if a separate legal entity - creditors cannot seek relief from owners
- If public it is easier to raise money for a corporation than other type of entity because anyone can purchase shares of a public corporation
- The actions of one shareholder (unless that shareholder is an officer of the corporation) do not bind the corporation or other shareholders
Disadvantages of a Corporation
- Double taxation of corporate profits. A corporation must pay income taxes and file an annual tax return. Dividends to shareholders are taxed on their personal returns.
- Corporations are subject to a great deal more regulation, including SEC reporting requirements for publicly held corporations.
Corporation
- Stock my be held by a small number of investors or a large number if traded on the exchange
Define Limited liability companies
allow all owners to be involved in the management of the business with each being liable only to the extent of their investment. Double taxation is avoided.
Define Limited liability partnerships
less generous with respect to the limited liability feature.
Define Par Value
the minimum legal issue price for capital stock in most states and appears on the stock certificate.
What protection does legal capital provide?
- Dividends may not be paid from legal capital.
- In many states, firms may not pay dividends to common stock in an amount that would cause total assets to be less than total liabilities plus the liquidation preference of preferred stock.
- If there were no such protection, management could liquidate the corporation by paying back the shareholders their investment, leaving the creditors with assets that might not be worth their book value.
Explain preemptive right
The preemptive rights of common shareholders allow current shareholders to maintain their existing percentage of the firm in the event of a new stock issuance by the firm. Without the preemptive right, management could issue shares in an effort to reduce the percentage ownership (and influence) of a shareholder who disagrees with the current management over major issues affecting the direction of the firm.
If a firm issues 100k shares of common stock and I already own 2% i am giving the right to purchase 2% of the new stocks first
Explain dividends in arrears
If preferred stock is cumulative and dividends for a year are not paid, then the dividends are said to be in arrears.
issued shares =
issued shares = # Outstanding shares + # Treasury Shares
What are issues shares, outstanding shares & Treasury Shares?
Issued - The number of shares ever issued by the firm but not retired
Outstanding - The number of shares currently held by stockholders
Treasury - he number of shares purchased by the issuing firm and not yet reissue
Required disclosures for equity/stocks
- Rights and preferences of each class of stock including - liquidation preferences and voting rights
- Number of shares authorized, issued, and outstanding for each class of stock
- Par value for each class of stock
- Treasury shares
- Restrictions regarding dividends and dividends in arrears
- Call and conversion information
Required disclosures for owners equity
- Rights and preferences of each class of stock including - liquidation preferences and voting rights
- Number of shares authorized, issued, and outstanding for each class of stock
- Par value for each class of stock
- Treasury shares
- Restrictions regarding dividends and dividends in arrears
- Call and conversion information
IFRS - main categories for owners equity
- issued share capital
- retained earnings
- other equity including reserves
IFRS calls common stock
ordinary shares
IFRS calls preferred stock
preferences shares
IFRS calls Paid-in capital in excess of par
Share premium
JE for cash transactions stock issuance
Credit the stock account for the par or stated value of the stock sold.
The remainder is recorded to a contributed capital account
JE for stocks issued as true no-par stock
Credit the entire amount to the common stock account
JE to record the stock sold on a subscription
Debit cash & stock subscription receivable for the total of the remaining payments and credit common stock subscribed and contributed capital in excess of par.
Common stock amount = par X # of shares subscribed
Cont Cap amount = (Contract price - par) X # of shares subscribed
If a stock subscription defaults on payments what are the potential options of the previous payments?
Depending on the contract terms
- Return all payments to subscriber.
- Issue shares in proportion to payments made
- The subscriber receives no refund or shares.
What type of account is stock subscription receivable?
Contra Equity Account
What is a basket sale?
A basket sale occurs when two or more securities are bundled together and sold in a single transaction.
What is the proportional method for allocating the amount recorded in a basket sale?
When both securities have established market values, the allocation will be based on their respective fair values.
What is the incremental method for allocating the amount recorded in a basket sale?
When only one security has an established fair value, that security is assigned proceeds equal to the known fair value. Any incremental proceeds are allocated to the remaining security sold.
What account are stock issuance costs recorded to?
Contributed capital in excess of par accounts
Initial Journal Entry for Common stock sold on a subscription basis
DR: Cash (amount received)
DR: Subscriptions receivable (balance due)
CR: Common stock subscribed (par)
CR: Additional paid-in capital (plug)
Where is excess money recorded when an entity calls their stock?
Debit difference is recorded in retained earnings
Credit difference is recorded in a contributed capital account
*No gains or losses are recorded because the transactions are between the firm and its owners
Where is excess money recorded when preferred stocks are converted into common stock?
Retained Earnings is debited
When can redeemable preferred stock be redeemed?
- Redeem the stock at a specified future date at a specified price
- At the option of a shareholder
What does manditorily redeemable mean?
If the obligation to redeem is dependent on a future uncertain event, the instrument is considered to be mandatorily redeemable when that event occurs, or when the event becomes certain to occur.
Mandatorily redeemable financial instruments (such as redeemable preferred stock) are classified as:
Debt rather than owners’ equity - unless the redemption is required to occur only if the issuing firm goes out of business.
At what point are cumulative preferred dividends considered a liability?
cumulative preferred dividends are not considered liabilities until declared by the board of directors.
What are the two methods to record treasury stock?
Cost Method
Par Value Method
Explain Cost Method for recording treasury stock
Records the treasury stock account at the cost of shares reacquired;
Explain Par Value method for recording treasury stock
Records the treasury stock account at the par value of shares reacquired.
Under the Cost Method for Treasury Stock (TS) When is there a:
Increase in Contributed Capital from TS?
Decrease in Contributed Capital from TS?
Increase: Reissue at a price exceeding cost
Decrease: Reissue at a price less than cost
Under the Par Value Method for Treasury Stock (TS) When is there a:
Increase in Contributed Capital from TS?
Decrease in Contributed Capital from TS?
Increase: Purchase at a price less than original issue price
Decrease: Purchase at price exceeding original issue price
How is it treated when a firm purchases their treasury stock and retires it rather than reissues it?
Retired shares are placed back into the authorized but unissued category
What is the declarative date for stock dividends?
The date the board of directors formally declares the dividend.
- At this date, the firm recognizes a liability and a reduction in retained earnings. The firm’s net assets are reduced.
What is the date of record for stock dividends?
simply a cut-off date - The shareholders of record on this date will be the recipients of the dividend payments
What is the payment date for stock dividends?
The date the dividends are actually distributed to the shareholders. Firms typically pay dividends quarterly.
What is the journal entry to declare dividends?
Debit Retained Earnings
Credit Dividends Payable
Define Scrip Dividend
A scrip dividend is first distributed in note payable (scrip) form because the firm does not have the cash at the date of declaration to pay the dividend but wants to assure the shareholders that the dividend is forthcoming.
Journal Entry for Liquidating Dividends
Treated as a return of capital rather an return on capital
Debit Retained Earnings
Debit contributed capital
Credit dividends payable
Explain Stock Dividends
A stock dividend is a distribution by a firm of its stock to its shareholders in proportion to their existing holdings. No liability is recorded. Each investor simply holds more shares, but each share is worth proportionately less than before the dividend. Each investor maintains the previous ownership percentage.
What is the purpose of stock dividends?
Stock dividends are distributed to reduce the market price of the firm’s stock (often because the stock price has become too high for potential investors) and also to reduce demand by shareholders for cash dividends.
What is the difference between small & large stock dividends?
Small - % of dividend is les than 20-25%
Large - % of dividend is greater than 20-25%
Accounting for small stock dividends?
Capitalize at market price
Debit - retained earnings
Credit - Common stock & contributed capital in excess of par
Accounting for large stock dividends
Capitalize at par value
Debit - retained earnings
Credit - Common stock
Why do firms issue stock splits?
to reduce the market price and make the shares available to a larger number of shareholders.
Accounting for stock splits
There are no accounting entries because there are no changes to any account balances within owner’s equity
100% stock dividend vs a 2-for-1 stock slip
Effect on total Owner’s Equity
100% stock dividend - None
2-for-1 stock slip - None
100% stock dividend vs a 2-for-1 stock slip
Effect on retained earnings
100% stock dividend - Decrease
2-for-1 stock slip - None
100% stock dividend vs a 2-for-1 stock slip
Effect on par value
100% stock dividend - None
2-for-1 stock slip - Cut in Half
100% stock dividend vs a 2-for-1 stock slip
Effect on shares outstanding
100% stock dividend - Double
2-for-1 stock slip - Double
100% stock dividend vs a 2-for-1 stock slip
Effect on contributed capital
100% stock dividend - Increase
2-for-1 stock slip - None
100% stock dividend vs a 2-for-1 stock slip
Effect on common stock account
100% stock dividend - Increase
2-for-1 stock slip - None
Explain noncumulative preferred stock
If the preferred stock is noncumulative and any part of the current-year dividends are not paid, then they are never paid.
Order to allocated dividends
- Preferred - Any dividends in arrears
- Preferred - Current-period dividend
- Common - Matching amount - preferred % X total par of common outstanding
- Preferred - Additional %
- Common - Remainder
Define Stock Rights
Gives the holder the option to purchase a certain number of shares of the issuing firm at a specified price during a specified time period.
Entries for rights to existing shareholders for stock rights at issuance of rights
No Journal Entry made - no resources have been transferred
Entries for rights to existing shareholders for stock rights at exercise of rights
The usual entry to record the issuance of stock is made. The issue price is the exercise price as specified in the stock warrant, not the market price on the date of exercise - excess goes to excess capital
Entries for rights to existing shareholders for stock rights if rights lapse
No entry is made if the shareholder does not exercise the rights
Entries for rights to outside parties for services for stock rights at issuance of rights
Record an expense and owners’ equity account equal to the difference between the market price and exercise price, times the number of shares under option
Entries for rights to outside parties for services for stock rights at exercise of rights
Record the stock issuance at the exercise price and remove the owners equity account credited at issuance of the rights - excess goes to excess capital
Define States Restrict Retained Earnings
States may restrict retained earnings in the amount of the cost of treasury stock held by the firm. This is a protection for the creditors. It forces the firm to maintain its legal capital.
Define Bondholders Restrict Retained Earnings
Bondholders may restrict retained earnings through the debt agreement or bond covenant. This is also a protection for the creditors but this time is protection for a specific group of creditors—the bondholders themselves who want the firm to conserve cash so that their claims can be met.
What needs to be disclosed for retained earnings?
Both Restrictions & appropriations
What are appropriated retained earnings?
This amount of retained earnings has been declared off-limits for dividends so that funds may be conserved for a specific purpose or objective.
Book Value per Share Ratio
Common stockholders’ equity per share of outstanding common stock, at the end of the period.
Common Stockholders Equity/Ending Common Shares of Common Stock Outstanding
What makes up Common Stockholder’s Equity
Total OE - Liquidation Preference of Preferred Stock - Preferred Stock Dividends in Arrears
The purchase of treasury stock at any price has what effect on total owners’ equity & retained earnings?
Decreases total owners’ equity
Increases Retained earnings
What is Quasi-Reorganization?
An alternative to bankruptcy in some cases, quasi-reorganization allows a firm a fresh start and new, more conservative asset values.
Requirements for a Quasi-Reorganization
- Approval—Shareholder and creditor approval.
- Balance becomes zero—The retained earnings balance must be zero immediately after the quasi-reorganization.
- No negative balance after—No contributed capital account can have a negative balance after the quasi-reorganization.
- Assets down to market—Assets must be written down to market value (asset write-ups are possible but would be rare).
- Dated years after—Retained earnings must be dated for a period of 3 to 10 years after the quasi-reorganization to indicate that the balance reflects income earned after the quasi-reorganization.
Accounting steps for Quasi-Reorganization
- Write assets down to market value, further reducing retained earnings (increasing the deficit).
- Reduce contributed capital to absorb the retained earnings deficit.
- Change value/number of shares—If needed, change par value or the number of shares of common stock to absorb the remaining deficit.
Accounting for Property Dividends
- Any unrealized holding gain or loss is recognized. (Difference in Market value and book value)
- Record the dividend outflow
