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FA > Topic 12: Equity > Flashcards

Topic 12: Equity Flashcards

1
Q

3 Ways of financing the corporation

A

① Borrow (Notes, Bonds, Leases)
② Issue Equity (Contributed capital)
③ Retaining funds (Retained Earnings)

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2
Q

2 risks for bonds financing

A

① Inflation effect: The value of the resulting interest and principal payments to the investor is much less when inflation is high.

②Bond default risk: Bond ratings issued by credit rating agencies sould express the investment qualitoes of many publicly traded bonds.

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3
Q

What are credit rating?

A

Credit ratings are opinions about credit risk and about the ability and willingmess of an issuer, such as corporation or state or city government, to meet its financial obligations in full and on time.

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4
Q

Characteristics:

A
  • Forward looking
  • Do not indicate investment merit
  • Are not absolute measures of default probability
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5
Q

Fundamental characteristic of the credit rating’s scale

A
  • Ordinality: implies that all rating along the scale are comparable
  • Consistency: same scale used for all class of issuers, industries, instruments and regions.
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6
Q

Components of Stockholders’ Equity

A

• Paid in Capital: amounts received from stockholders

  • Externally generated
  • Resulting from transactions with outsiders

• Retained earnings: earned by profitable operations:

  • internally generated
  • Results from internal corporate decisions to retain net income for use in the company
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7
Q

Paid-in Capital, classes of stock?

A

① Common
② Preferred

  • Par value
  • No Par value
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8
Q

Characteristics of Common Stock

A

§ Basic rights (unless withheld):

o Vote: voting on corporate malers
o Dividends: receive a proportionate
part of dividend declared
o Liquidation: receive a proportionate part of assets remaining, after debt and preferred stock
o Preemption: mantain their proportionate ownership in the corporation (issue of new shares)
§ Class A (right to vote) and Class B
(non-voting)

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9
Q

Characteristics of Preferred Stock

A

§ Advantages over common stock
o Receive dividends before common
o Fixed dividend amount
o Upon liquidation, receive assets before common but subordinate to debt

§ Rights to vote generally withheld
§ Class A and Class B

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10
Q

Characteristics of Par value Stock and No-value

A

Par value:Arbitrary amount assigned to a share of stock

No-par value: No arbitrary amount assigned

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11
Q

Issuance of Common Stock

Smart Touch’s common stock carried a par value of $1 per share

② Issue At a Premium (Above par)
On January 2, issued additional 1,000,000 of shares at issue price of $20:

A

o Premium: Amount received above par ($20 - $1 = $19)
o The premium is not a gain/profit!
o Creates a new equity account: Paid-in capital in excess of par

Journal entry:

CASH 20M
Common Stock 1M
Paid-in capital in excess of par 19M

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12
Q

Issuance of Common Stock

Smart Touch’s common stock were NO-PAR value
③ No-par stock
On January 1, 2013 issued 1,000,000 of shares for $1
On January 2, issued addi6onal 1,000,000 of shares for $20

A

o Full amount received is credited to Common stock
o No need for Paid-in capital in excess of par account

Journal entry:
JAN1
CASH 1M
Common Stock 1M

JAN2
CASH 20M
Common Stock 20M

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13
Q

④ A corporation may issue stock for assets other than cash

Stock in exchange for assets On January 2, Smart Touch (instead of cash) received a building worth $ 20,000,000 in exchange for the 1,000,000 shares of its $ 1 par common stock

A

o Asset received recorded at the current market value
o The asset (Building) is debited instead of cash

Journal entry:

Building 20M
Common Stock 1M
Paid-in capital in excess of par 19M

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14
Q

What are the 2 main segments of stockholder’s equity?

A

Paid-in Capital

Retained Earnings

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15
Q

Which is more permanent, paid-in capital or retained earnings?

A

Paid-in capital is more permanent because corporations can use retained earnings for dividends, which decreases the size of the company’s equity

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16
Q

How are paid-in capital and retained earnings ?

  • similar?
  • different?
A

Both represents stockholders’s equity of the corporation

Paid-in capital and retained earnings come from different sources:

  • Paid-in capital comes from the stockholders
  • Retained earnings comes from profitable operations
17
Q

What are the main categories of paid-in capital?

A
  • Preferred stock

- Common stock

18
Q

What is treasury stock?

A

Created when a company buys back shares of its own common stock.

  • Contra equity Account (debit balance)
  • Recorded at cost paid to reacquire the shares
  • Decreases company’s stock (outstanding shares)

=>cannot receive cash dividends!

19
Q

Methods for treasury stock

A

① Buy in the open market: Maximum flexibility
② Buy back a fixed number of shares ar a fixed price: Tender offer to repurchase a specific number of shares with a fixed price (with premium)
③ Dutch Auction Tender offer with a range of acceptable prices
④ Repurchase by direct regotiation with a major stockholder

20
Q

2.a Sale of treasury stock
At cost

On April 1, Smart Touch resells 100 of the treasury shares for $ 5 each (cost $ 5)

A

o Sold at the same price paid to reacquire
o No difference between cost and sale price to journalize.

Journal entry:

CASH 500
Treasury Stock 500

21
Q

2.a Sale of treasury stock
Above cost

On April 2, Smart Touch resolds 200 of the treasury shares for $ 5 each (cost $ 5)

A

o Sold for more than cost
o Difference credited to a new stockholders’ equity account: Paid-in capital from treasury stock transactions

Journal entry:

CASH (200*0.06) 1’200
Paid-in cap. from treasury stock transaction 200
Treasury Stock 1’000

22
Q

2.a Sale of treasury stock
Below cost

On April 3, Smart Touch resolds 200 treasury shares for $ 4.3 each (cost $ 5)

A

o Sold for less than cost
o Difference:
-debited to Paid-in Capital from treasury stock transactions, if available
- otherwise, debit Retained earnings for the remaining amount

Journal entry:

CASH (200*4.3) 860
Paid-in cap. from treasury stock transaction 140
Treasury Stock (CQ-) 1’000

23
Q

2.a Sale of treasury stock
Below cost
On April 4, Smart Touch resold additional 200 treasury shares for $ 4.50 each
-Difference = ($ 5 - $ 4.50)* 200 shares = $100
-April 2: Paid-in Capital from treasury stock transactions: $200
- April 3: Paid-in Capital from treasury stock transactions ($140)
= Available Paid-in Capital from treasury stock transactions = $60

A

The remainder ($ 100 - $ 60 = $ 40) in loss is debited to Retained earnings.

Journal entry:

CASH (200*4.5) 900
Paid-in cap. from treasury stock transaction 60
Retained Earnings 40
Treasury Stock (CQ-) 1’000

24
Q

What are the effect of the repurchase of previously issued stock and the resale of treasury stock on Total Assets?

A

-Effects of Purchase:
Decrease total assets by full amount of payment

-Effects of Sale:
Increase total assets by full amount of cash receipt

25
Q

What are the effect of the repurchase of previously issued stock and the resale of treasury stock on Total stockholders’ equity?

A

-Effects of Purchase:
Decrease total stockholders’ equity by full amount of payment=> INCREASE EPS

-Effects of Sale:
Increase total stockholders’ equity by full amount of cash receipt

26
Q

Types of dividends

A

Cash dividends

Stock dividends

Property dividends

27
Q

When dividend becomes a liability?

A

After the board of directoirs declares the dividend

28
Q

When does a company declare a cash dividend?

A
  • The company must have enough Retained Earnings to declare the dividend
  • The company must have enough cash to pay the dividend
29
Q

Steps for distributing the dividends

A

① Declaration date: the board of directoir declares the dividend. At that point, the dividend becomes a liability.
② Date of record: the stockholder that owns the stock on the date of record will receive the dividend.
③ Payment date: Payment of divident occurs

30
Q

Effects of stock dividends distribution

A
  • Total number of shares issued and outstanding increases
  • Ownership percentages remains the same

NO effect on total stockholders’ equity
NO effect on assets or liabilities

31
Q

Why do companies issue Stock dividends ?

A
  • Conserve Cash
  • Reduce market price per share=> less expensive, more attractive investment
  • Reward investors=> shareholders receive something of value
32
Q

Steps to declare a stock divid

A

same three date as cash dividend.

!!!declaration date does not create a liability!!!

33
Q

When record stock dividend?

A

only when > 20-25% of issued and outstanding shares par or stated value of shares to be distributed.

34
Q

Effects of stock split

A
  • No effects on account balances and total stockholders’ equity
  • Reduce the market value of shares
  • Leave unchanged the market capitalization
  • Does not dilute the ownership interest of existing shareholders
35
Q

Describe different values of shares?

A

Market Value:
• Price at which a person can buy or sell a share
• Most important to shareholders
• Affected by company performance and general economic conditions

Liquidation Value:
• Amount guaranteed to preferred stockholders if company liquidates

Book value per share:
• Amount of equity per each share of stock
• If the company has both preferred and common stock outstanding.

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