10-1 ©2006 Prentice Hall, Inc.. 10-2 ©2006 Prentice Hall, Inc. REPORTING & UNDERSTANDING...
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Transcript of 10-1 ©2006 Prentice Hall, Inc.. 10-2 ©2006 Prentice Hall, Inc. REPORTING & UNDERSTANDING...
10-1
©2006 Prentice Hall, Inc.
10-2©2006 Prentice Hall, Inc.
REPORTING & REPORTING & UNDERSTANDING UNDERSTANDING
SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY (1 (1 of 2)of 2)
Learning objectivesContributed capitalCash dividendsTreasury stockStock dividends and stock splits
10-3©2006 Prentice Hall, Inc.
REPORTING & REPORTING & UNDERSTANDING UNDERSTANDING
SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY (2 (2 of 2)of 2)
Retained earningsFinancial statement analysisBusiness risk, control, and
ethics
10-4©2006 Prentice Hall, Inc.
Learning ObjectivesLearning Objectives(1 of 3)(1 of 3)
Explain how a company finances its business with equity
Account for the payment of cash dividends and calculate the allocation of dividends between common and preferred shareholders
10-5©2006 Prentice Hall, Inc.
Learning ObjectivesLearning Objectives(2 of 3)(2 of 3)
Define treasury stock, explain why a company would purchase treasury stock, and account for its purchase
Explain stock dividends and stock splits
Define retained earnings and account for its increases and decreases
10-6©2006 Prentice Hall, Inc.
Learning ObjectivesLearning Objectives(3 of 3)(3 of 3)
Compute return on equity and earnings per share, and explain what these ratios mean
Recognize the business risks associated with equity and the related controls
10-7©2006 Prentice Hall, Inc.
Contributed CapitalContributed Capital
Three general forms of businessSole proprietorshipsPartnershipsCorporations
Stock—authorized, issued, & outstanding
Common stockPreferred stock
10-8©2006 Prentice Hall, Inc.
Stock—Authorized Issued and Outstanding (1 of 2)
Authorized sharesMaximum # of shares of stock a
corp is authorized to offer to the publicSpecified in the corporate charter
Issues sharesShares of stock that have been
offered and sold to shareholders
10-9©2006 Prentice Hall, Inc.
Stock—Authorized Issued and Outstanding (2 of 2)
Outstanding sharesIssued shares of stock owned by
shareholders rather than the corpTreasury stock
Stock that a corp buys back from shareholders
Outstanding shares = shares issued less treasury stock
10-10
©2006 Prentice Hall, Inc.
Common Stock(1 of 3)
Owners’ rightsVote for board of directorsShare in pro rata portion of corp profits
Dividends Share in assets in bankruptcy after
creditors and preferred shareholdersRight to acquire more shares when
corp issues new shares Pre-emptive right
10-11
©2006 Prentice Hall, Inc.
Common Stock(2 of 3)
Par valueArbitrary amount, usually small,
and has no real meaning in today’s business environment
Not required by most statesExcess of stock issue proceeds
above par value increases Additional Paid-in Capital account
10-12
©2006 Prentice Hall, Inc.
Common Stock(3 of 3)
Caffinators Coffee issued 500 shares of $1 par value stock for $8 per share
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
10-13
©2006 Prentice Hall, Inc.
Preferred Stock
Owners receive dividends before common shareholders
Priority claim on assets over common shareholders in bankruptcy
Usually do not have voting rights
10-14
©2006 Prentice Hall, Inc.
Cash DividendsCash Dividends
Distributions of earnings to ownersBoard of directors decide amount
and dates of dividend distributionsImportant dividend-related datesDistribution of dividends between c
ommon and preferred shareholdersDividend payment example
10-15
©2006 Prentice Hall, Inc.
Important Dividend-related Dates(1 of 2)
Declaration dateDate Board of directors decides it
will pay a dividendLegal obligation to pay dividends
is created, giving rise to Dividends Payable and increases Dividends (contra-equity)
10-16
©2006 Prentice Hall, Inc.
Important Dividend-related Dates(2 of 2)
Date of recordAll shareholders on date of record
entitled to receive dividendsPurchaser of stock after this date will not
receive the dividend declared
Payment dateDate dividend actually paid, Decreases cash and Dividends Payable
10-17
©2006 Prentice Hall, Inc.
Distribution of Dividends Between Common &
Preferred Shareholders
Cumulative preferred stockShareholders must receive any past,
unpaid dividends (dividends in arrears) before a company can pay current dividends to common shareholders
Noncumulative preferred stockPast, unpaid dividends do not
accumulate to preferred shareholders
10-18
©2006 Prentice Hall, Inc.
Dividend Payment Example(1 of 6)
Caffinators Coffee (CC) has the following stock outstanding on 1/1/2008100 shares of 8% 100 par, cumulative
preferred stock20,000 shares of $1/share common
stockCC has not paid a dividend since 2005
10-19
©2006 Prentice Hall, Inc.
Dividend Payment Example(2 of 6)
On 10/31/08 CC declared $5,000 annual dividends to be paid 11/15/08 to shareholders of record on 10/15/08
Annual dividend for preferred shareholders100 shares x 8% x $100 = $800
Total dividends payable to preferred shareholders3 years (2006-2008) x $800 = $2,400
10-20
©2006 Prentice Hall, Inc.
Dividend Payment Example(3 of 6)
Dividends payable to common shareholders$5,000 - $2,400 = $2,600Dividend per share
$2,600/20,000 shares = $0.13/share
10-21
©2006 Prentice Hall, Inc.
Dividend Payment Example(4 of 6)
Record the dividend declaration
Date Transaction Debit Credit
10/31/08
Assets = Liab. + Cont. Cap. + R/E
10-22
©2006 Prentice Hall, Inc.
Dividend Payment Example(5 of 6)
Record the dividend payment
Date Transaction Debit Credit
11/15/08
Assets = Liab. + Cont. Cap. + R/E
10-23
©2006 Prentice Hall, Inc.
Dividend Payment Example(6 of 6)
Assume the pref stock is noncumulative?
Date Transaction Debit Credit
10/31/08
11/15/08
Assets = Liab. + Cont. Cap. + R/E
10-24
©2006 Prentice Hall, Inc.
Treasury StockTreasury Stock
Stock a company purchases on the open market
Why firms buy their own stockAccounting for treasury stock pur
chaseSelling treasury stockReporting treasury stock
10-25
©2006 Prentice Hall, Inc.
Why Firms Buy Their Own Stock(1 of 3)
Have stock to distribute to employees for compensation plans
Use excess cash to increase shareholder wealthTo return cash to the shareholders if
they choose to sell shares to the firmMore flexible for firm and shareholders
than paying cash dividends
10-26
©2006 Prentice Hall, Inc.
Why Firms Buy Their Own Stock(2 of 3)
Reduce equityTreasury stock is contra-equity account
Increase the company’s earnings per share (EPS)EPS = Net income / # shares outstanding
How does buyback affect interest income?How does buyback affect # of shares?
10-27
©2006 Prentice Hall, Inc.
Why Firms Buy Their Own Stock(3 of 3)
To reduce the cash needed to pay future dividendsHow does this work?
To reduce chances of a hostile takeoverWhat makes a company an attractive
target for a hostile takeover?Stock repurchase program disclosed in
notes to financial statements
10-28
©2006 Prentice Hall, Inc.
Accounting for Treasury Stock Purchase (1 of 2)
Treasury stock accounted for at costSeparate treasury stock accounts
for common and preferred stockNo gain or loss reported on
purchase or sale of treasury stockIf a firm sells its treasury stock for
more than the purchase price, in which account would it go? Why?
10-29
©2006 Prentice Hall, Inc.
Accounting for Treasury Stock Purchase (2 of 2)
CC repurchased 50 shares for $15/share It believed its stock was undervalued
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
10-30
©2006 Prentice Hall, Inc.
Selling Treasury Stock(1 of 3)
Treasury stock account reduced by the cost of the shares soldHow do you reduce a contra-equity
account?Sales price > acquisition cost
Excess increases Paid-in-capital-TSSales price < acquisition cost
Decrease Paid-in-capital account
10-31
©2006 Prentice Hall, Inc.
Selling Treasury Stock(2 of 3)
CC sold the 25 shares of its treasury stock for $18/share
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
10-32
©2006 Prentice Hall, Inc.
Selling Treasury Stock(3 of 3)
CC sold the other 25 shares of its treasury stock for $12/share
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
10-33
©2006 Prentice Hall, Inc.
Reporting Treasury Stock
Treasury stock, a contra-equity account, is reported as a reduction to stockholders equity
Why aren’t gains and losses reported on the income statement?
10-34
©2006 Prentice Hall, Inc.
Stock Dividends and Stock Dividends and Stock SplitsStock Splits
(1 of 4)(1 of 4)
Stock dividendsDistribution of stock instead of cash
to shareholdersCapitalizing earningsLike using retained earnings to issue
new sharesReduce Retained EarningsIncrease Common StockIncrease Additional Paid in Capital
10-35
©2006 Prentice Hall, Inc.
Stock Dividends and Stock Dividends and Stock SplitsStock Splits
(2 of 4)(2 of 4)
CC declares 10% stock dividend on its 500 shares, $1 par, mkt value $14/sh
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
10-36
©2006 Prentice Hall, Inc.
Stock Dividends and Stock Dividends and Stock SplitsStock Splits
(3 of 4)(3 of 4)
Stock splitSplit original shares into two or more
sharesWhy would a firm split its stock?
No accounts are affected by stock splitPar value decreases so total par value is the
same ([par value per share] x [# of shares])Total shares outstanding increases
10-37
©2006 Prentice Hall, Inc.
Stock Dividends and Stock Dividends and Stock SplitsStock Splits
(4 of 4)(4 of 4)
CC did a 5 for 1 stock split on its 500 shares of $1 par stockHow many shares will be outstanding
after the stock split?What will the new par value be?If market value before the split was
$10/share, what should be the market value/share after the split? Is this usually the case?
10-38
©2006 Prentice Hall, Inc.
Retained EarningsRetained Earnings
What is the affect of the following on retained earnings?Net incomeNet lossDividends
Statement of retained earningsShows activity in retained earnings
for the period
10-39
©2006 Prentice Hall, Inc.
Financial Statement Financial Statement AnalysisAnalysis
(1 of 3)(1 of 3)
Return on equity (ROE)Measures return to common shareholders
Net income – preferred dividends _ Average common shareholders’ equity
Why are preferred dividends subtracted from net income?
How does ROA compare to ROE?Numerator? Denominator?
10-40
©2006 Prentice Hall, Inc.
Financial Statement Financial Statement AnalysisAnalysis
(2 of 3)(2 of 3)
Earnings per share (EPS)Measures return to common
shareholders
Net income – preferred dividends _ Weighted avg # shares outstanding
Basic earnings per share Assumes no securities that could be
converted into common stock are converted
10-41
©2006 Prentice Hall, Inc.
Financial Statement Financial Statement AnalysisAnalysis
(3 of 3)(3 of 3)
Earnings per share (continued)Diluted earnings per share
Assumes all securities that could be converted into common stock are converted
Which EPS will be greater, basic or diluted EPS?
Why is a comparison of EPS between firms not meaningful?
10-42
©2006 Prentice Hall, Inc.
Business Risk Control and Business Risk Control and EthicsEthics
(1 of 2)(1 of 2)
Risks faced by ownersStock may decrease in value or
become worthlessHow can investors reduce the risk of
stock ownership?Why do some companies choose to
be publicly traded?
10-43
©2006 Prentice Hall, Inc.
Business Risk Control and Business Risk Control and EthicsEthics
(2 of 2)(2 of 2)
Why have many publicly traded companies decided to go private after 2002?
How can a stockholder earn a return on their investment if the company does not pay dividends?
Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s
Kenneth W. Monfort College of [email protected] 10-
44©2006 Prentice Hall, Inc.