Lecture 11 Flashcards
Overview of Debt Vs Equity
Significant acquisitions of assets and payments for goods and services are financed from two sources: Debt (from creditors) and Equity (from owners)
Classified in the Stockholders’ Equity section of the B/S.
* Consists of both Retained Earnings and Contributed Capital
* Equity does not have to be repaid.
* Dividends are optional.
* Most stockholders have voting rights.
* Stockholders are permanent owners.
Debt
* Classified as a Liability on the Balance Sheet.
* Interest on debt is tax deductible.
* Interest must be paid.
* Bondholders have no say in
how the company is run.
* Bond investors are gone once they are paid.
Sample proxy card for shareholders allows for two things
Allows for votes on things like (1) electing members of the board, (2) other management AND shareholder proposals.
Common shares,preferred shares and retained earning
Common Shares
* Have voting rights and receive residual monies
* May have different classes with different voting rights
Preferred Shares
* Rights depend on share characteristics – usually no voting rights
* Usually pay a fixed % dividend
* Priority over common stockholders for receipt of dividends
Retained Earnings
* All net incomes earned since firm began less all dividends declared
* Not the same as or equal to cash
Authorized shares, iissued / outstanding shares
Shares are usually issued for cash
Example: Issuance of 100,000 common shares for $50 per share:
Shares issued for noncash consideration, recorded at the fair value of the consideration received
Example: Issuance of 1,000 common shares for a truck valued at $20,000:
- Authorized Shares – number of shares the company is allowed to sell
- Issued/Outstanding Shares – number of shares that have been sold
Cash (+A) 5,000,000
Common Shares (+SE) 5,000,000
Equipment (+A) 20,000
Common Shares (+SE)
20,000
Why would a company buy back its own shares?
and what are the steps
Smith Bank has a balance of $10,000,000 in its Common Shares account and 1,000,000 common shares outstanding on December 31, 2020.
Prepare the journal entries for the following repurchases:
For cash you do it this way
Why would a company buy back its own shares?
* To return cash to shareholders
* To invest in yourself when share price is low
* To reduce number of shares issued (which increases earnings per share and
return on common shareholders’ equity) * To have shares on hand for compensation * To prevent hostile takeovers
Steps:
* Debit Common Shares for the average “cost” per share ($ amount in
Common Shares account/# shares outstanding) of reacquired shares
* Credit Cash for amount paid
* If we paid less for the shares than average cost, credit Contributed Surplus (SE)
* If we paid more for the shares than average cost, debit Contributed Surplus (if any), debit any remaining difference to Retained Earnings
First
we can clacualte the avergae cost per share by the $ amount ehy bought the shares over total shares = 10$ per share. then you mulitply that by 25,000 to find that =250,000. and you credit stockholder equity becaue the company is removing the 250,000 and putting it towards them. and the differnec between the 250,000 and the price they paid is the gain or loss you ssociated with it contirubted surplus or contriubted deficit
So it woul
Cash (-a) 200,000
contirubed surplus (+se) 50,000
common shares (-se) 250,000
Cash divdiden thers the declarion date, record date and payment date
A cash dividend is a distribution from Retained Earnings that can be paid to preferred and common shareholders
* If dividends are paid to both the preferred and common shareholders, the preferred shareholders have to be paid first
Declariton date: the board of directors formally authorized the cash dividend and annoucned it toshareholders
Retained earning (-SE)
Dividends payable (+L)
Record date: Whoever owns the shares on that date will be entitled to errcieve the dividend payment
No entry
Paymet date: date when patment is amde to shareholders
Dividends payable (-L)
Cash (-a) xx
Stock dividend
how are they recorded
In December 1, 2020, Shinra Corporation declares a 10% stock dividend on their common shares, payable on December 15, 2020. On the declaration date, Shinra had a balance in Common Shares of $1,000,000 with 100,000 shares outstanding, and the market value of shares was $20.
Journal entry on the declaration date:
Journal entry on distribution date:
After distribution:
A stock dividend is a distribution of stock, rather than cash, to shareholders. This might happen because:
* Firms may not have the cash to pay cash dividends
* Firms may not want to set a precedent for cash dividends
* Firms may want share prices to be lower to attract more investors
recorded as % based on uber shares outstanding
recored at fair value
Stock dividends recorded as a % based on number of shares outstanding
* Stock dividends recorded at fair value (market price per share) because this is what the corporation would have paid if the shares had been issued for cash, rather than as a stock dividend
On December 1, 2020, Shinra Corporation declares a 10% stock dividend on their common shares, payable on December 15, 2020. On the declaration date, Shinra had a balance in Common Shares of $1,000,000 with 100,000 shares outstanding, and the market value of shares was $20.
Journal entry on the declaration date:
Retained Earnings (-SE)
Stock Dividends Distributable (+SE)
Journal entry on distribution date:
Stock Dividends Distributable (-SE) Common Shares (+SE)
After distribution:
# Shares Outstanding: 110,000
200,000 200,000
200,000 200,000
A stock split, Example company delacres 4 for 1 stock split
what doesnt it effect
of shjares owned by J.smith goes from 40,000 to 160,000
A stock split is when a company distributes shares to its shareholders in a set ratio based on their ownership
of outstnading stock goes from 400,000 to 1,600,000
MV of one share goes from 100 to 25
% ownership of J.smith
o journal entry is required for stock splits
* No effect on total share capital, retained earnings, or total shareholders’ equity
Stock Splits vs. Stock Dividends
From a shareholder’s perspectives, what is the difference between a 2:1 stock split and a 100% stock dividend?
No difference – In both cases, we double the number of shares outstanding and the market price of each share will likely fall by 50%
* Normally, if we increase the number of shares by more than 25%, then we treat the event as a stock split and make no journal entries
* If the increase in the number of shares is less than 25%, we would treat the event as a stock dividend and make the appropriate entries
What is earnign per share and what odes it indicate
Determine # of shares by looking at # of shares outstanding by # of months they were issued:
Jan 1 – April 30 9,000 shares outstanding
May 1 – December 31 15,000 shares outstanding
- Widely used ratio to evaluate changes in shareholder wealth
Earning per share = Net income - preferred dividends ) / weighted average # of common shares
Weighted Average = (9,000 x 4/12) + (15,000 x 8/12) = 13,000
ncreased EPS over prior years suggests that the company is improving
* EPS is not comparable across companies – doesn’t account for the price investors paid for the shares
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