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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 13 1.

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1 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 13 1

2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Account for stock dividends Account for stock splits Account for treasury stock Report restrictions on retained earnings Complete a corporate income statement including earnings per share

3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for stock dividends 3 1 1

4 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Cash dividends Actual money goes out to share holders. This is real money. Shareholders can spend it. Stock dividends This is not money. No money is sent to anybody. The company sends additional shares of stock to every owner, proportional to their shares held. Every owner maintains the exact same percentage ownership in the company. Question: Which does not involve the cash account?

5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A distribution of a corporation’s own stock Affects only stockholders’ equity accounts No effect on total stockholders’ equity No effect on assets or liabilities Stockholders receive proportionate shares Example–10% stock dividend; every stockholder receives 10% more shares If you own 100 shares, you get 10 more If I own 10 shares, I get 1 more Total number of shares issued and outstanding increases Ownership percentages remain the same 5

6 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Conserve cash Continue dividends without using cash Reduce market price per share 6 Share supply increases; market price decreases Less expensive; more attractive investment Reward investors Shareholders receive something of perceived value If I just got more shares, and everyone else got more shares too, are any of us really better off?

7 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The point of this transaction is to put the retained earnings more visibly “in the hands” of the investor. A small stock dividend shouldn’t materially affect the stock price, so we do the transaction at market price. 1)Take the market value of the new shares out of retained earnings {Debit Retained earnings} 2)Put that amount into Common stock account subject to that accounts par value limits {Credit Capital stock} {Or, Credit: Stock dividend to be distributed} 3) Put the residual in the Additional paid In capital account {Credit: Additional paid in capital}

8 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Same three dates for a stock dividend Declaration date; record date; distribution date We are preparing one single summary transaction Pull full market value from retained earnings Put it in the common stock account, subject to par Demo: Issue a 5% stock dividend on common stock There are 2,000,000 shares of $1 par stock outstanding The stock is trading at $50 (market value) What did we just do to the usefulness of the balance sheet? 8

9 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. These are greater than 25%, large enough to affect stock price. So, there is no pretending that they won’t. Since we aren’t pretending to support market price, we just take the par value out of retained earnings and reposition that as common stock This keeps the stock price affordable to smaller investors and placates investor return desires. 9

10 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Large Distribution is greater than 20% to 25% of issued shares Debit Retained earnings for par or stated value of shares Credit Common stock for par or stated value of shares Rare Journal entry demo: 50% stock dividend 2,100,000 shares outstanding $1 par value These are quite rare, normally a company will either do a small stock dividend, or a stock split. 10

11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Equity after 5% Common Stock Dividend Equity after 50% Common Stock Dividend 11

12 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compare and contrast the accounting for cash dividends and stock dividends. 1.In the space provided, insert either “Cash dividends,” “Stock dividends,” or “Both cash dividends and stock dividends” to complete each of the following statements: a. ________________decrease Retained earnings. b. ________________ has(have) no effect on a liability. 12 Both cash dividends and stock dividends Stock dividends

13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. (Continued) c. ________________ increase Paid-in capital by the same amount that they decrease Retained earnings. d. ________________ decrease both total assets and total stockholders’ equity, resulting in a decrease in the size of the company. 13 Stock dividends Cash dividends

14 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Yummy, Inc., had 310,000 shares of $1 par common stock issued and outstanding as of December 1, The company is authorized to issue 1,400,000 common shares. On December 15, 2012, Yummy declared and distributed a 5% stock dividend when the market value for Yummy’s common stock was $3. Requirements: 1. Journalize the stock dividend. 2. How many shares of common stock are outstanding after the dividend? 14

15 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1.Journalize the stock dividend. 2. How many shares of common stock are outstanding after the dividend? 15 Journal Entry DATE ACCOUNTS DEBITCREDIT Dec 15 Retained earnings46,500 Common stock15,500 Paid in capital in excess of par-common31, , ,500 = 325,500

16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for stock splits

17 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 big slices at $4 each? 4 little slices at $2 each?

18 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. $100 stocks seem too expensive $50 stocks must be doing well $0.50 stocks must be underperforming companies Stock splits can be performed to put the per share price wherever you want it.

19 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Why is there price movement around stock splits? Small investors view the stock as more affordable. Sustainable stock price increase indicator. To the extent that people agree that the price will move, this belief alone may cause the move – especially if it is helped along a little…... 2-for-1.com GE, MSFT, HOG, AAPL, HD

20 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A stock split: Cuts par value per share Increases the number of shares of stock issued and outstanding Leaves all account balances and total stockholders’ equity unchanged Balances in the accounts are unchanged Record in a memorandum entry–a journal entry without debits and credits 20

21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Old Balance Sheet item: Common Stock, $1 par value, 3,150,000 Shares issued and outstanding $3,150,000 NEW Balance Sheet item: Common Stock, 50¢ par value, 6,300,000 shares issued and outstanding……………...$3,150,000

22 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Assume a company had 10,000 shares outstanding trading at $100 per share. How would different splits effect the number of shares outstanding and the stock price? Normal stock split: 2 for 1 Reverse stock split: 1 for 2

23 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Before split 23 After split

24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Stock dividends and stock splits have similarities and differences 24 Event Common stock Paid-in capital in excess of par Retained earnings Total stockholders ’ equity Cash dividend No effect Decrease Stock dividend Increase DecreaseNo effect Stock splitNo effect

25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Decorator Plus Imports recently reported the following stockholders’ equity (adapted except par value per share): Suppose Decorator Plus split its common stock 2 for 1 in order to decrease the market price per share of its stock. The company’s stock was trading at $20 per share immediately before the split. 25

26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1. Prepare the stockholders’ equity section of Decorator Plus Imports’ balance sheet after the stock split. 26 Paid-in capital: Common stock, $0.50 par, 960,000,000 shares authorized, 228,000,000 shares issued$ 114,000,000 Paid-in capital in excess of par140,000,000 Total paid-in capital$ 254,000,000 Retained earnings650,000,000 Total stockholders’ equity$ 904,000,000

27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. Were the account balances changed or unchanged after the stock split? 27 Paid-in capital: Common stock, $0.50 par, 960,000,000 shares authorized, 228,000,000 shares issued$ 114,000,000 Paid-in capital in excess of par140,000,000 Total paid-in capital$ 254,000,000 Retained earnings650,000,000 Total stockholders’ equity$ 904,000,000 Unchanged

28 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for treasury stock

29 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Shares that a company has issued and later reacquired Held as a contra equity account at repurchase cost No entry made to original capital stock account Reasons corporations purchase their own stock: Buy low and sell high to increase wealth To boost the company’s stock price To avoid a takeover by an outside party To make stock available for employee rewards An alternate way to give cash to shareholders 29

30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The maximum number of shares of capital stock that may be sold to the public. Authorized Shares Authorized Shares

31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Authorized Shares Authorized Shares

32 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Unissued Shares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been repurchased by the corporation. Issued Shares Issued Shares Outstanding shares are issued shares that are currently owned by stockholders. Authorized Shares Authorized Shares Where Treasury Stock Comes From NO voting rights! No dividends!

33 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Unissued Shares Outstanding Shares Issued Shares Issued Shares Outstanding shares are issued shares that are currently owned by stockholders. Authorized Shares Authorized Shares Where Treasury Stock Comes From When treasury stock is re-issued it becomes regular stock again!

34 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. It’s a good value! Stimulate Demand for stock Employee Rewards Increase Earnings per share

35 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Contra equity account Debit balance Recorded at cost (not par) Reported beneath Retained earnings on the balance sheet Reduction to total stockholders’ equity Decreases outstanding shares Not eligible for dividends Not eligible to vote 35 Issued stock – Treasury stock = Outstanding stock

36 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Purchase of treasury stock Company debits Treasury stock and credits Cash Sale of treasury stock at cost Next: Treasury stock earnings bypass the income statement! 36

37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sell 200 shares of that $5 cost $6 each Difference is credited to Paid-in capital from treasury stock transactions Sell 200 shares of that $5 treasury $4.30 Difference is debited to Paid-in Capital from treasury stock transactions, if available Debit Retained earnings if that account is empty 37

38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sell 200 shares of that $5 Treasury $4.50 per share. Paid-in capital from treasury stock transactions is insufficient to cover shortfall Debit Retained earnings for the difference 38

39 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Reported beneath Retained earnings as a reduction 39

40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Discount Center Furniture, Inc., completed the following treasury stock transactions: a.Purchased 1,400 shares of the company’s $1 par common stock as treasury stock, paying cash of $5 per share. b.Sold 400 shares of the treasury stock for cash of $8 per share. Requirements 1.Journalize these transactions. Explanations are not required. 2.Show how Discount Center will report treasury stock on its December 31, 2012 balance sheet after completing the two transactions. In reporting the treasury stock, report only on the Treasury stock account. 40

41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1.Journalize these transactions. Explanations are not required. 41 Journal Entry DATEACCOUNTSDEBITCREDIT a.Treasury stock7,000 Common stock7,000 Journal Entry DATEACCOUNTSDEBITCREDIT b.Cash3,200 Treasury stock2,000 Paid-in capital from treasury stock transaction 1,200

42 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. Show how Discount Center will report treasury stock on its December 31, 2012 balance sheet after completing the two transactions. In reporting the treasury stock, report only on the Treasury stock account. 42 Stockholders’ equity Treasury stock 1,000 shares at cost5,000

43 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Report restrictions on retained earnings

44 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Restrictions Requirement by lenders to maintain a minimum level of equity by limiting: Cash dividend payments Treasury stock purchases Reported in the notes to the financial statements Appropriations Restrictions on retained earnings recorded by formal journal entries Board of directors may designate purpose of appropriation Segregate in a separate account A portion of retained earnings for a specific use 44

45 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The heading Paid-in capital does not appear All additional paid-in capital accounts are combined 45

46 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Complete a corporate income statement including earnings per share

47 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Information about net income can be divided into two major categories Income from continuing operations. 1. The results of discontinued operations 2. The impact of extraordinary items. 3. The effects of changes in accounting principles. Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income.

48 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. More complex with unique items Public corporations must publish financial statements Sections Continuing Operations Special Items Earnings Per Share Details important to investors 48

49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Continuing Operations Why use this number? This should be the basis of forecasting future year earnings If you are buying into a company now, this is the basis you care about, not those other non-repeating items. 49 Should continue from period to period Useful for making projections about future earnings

50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Reported after income from continuing operations Reported net of any tax effects Two distinctly different gains and losses: Discontinued operations Extraordinary items Note: Plant asset gains/losses are part of continuing operations 50

51 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Segment of a business that has been sold Each segment is an identifiable division of company Reported separately because the segment will not be around in the future Operating profits/loss Gain/loss on sale of the segment 51

52 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Material in amount. Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future. Reported net of related taxes. NOT: lawsuits, strikes, recurring acts of nature, plant asset gains/losses Material in amount. Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future. Reported net of related taxes. NOT: lawsuits, strikes, recurring acts of nature, plant asset gains/losses

53 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Both unusual and infrequent Not expected to recur in the foreseeable future Examples: Losses from natural disasters Foreign government takeover (expropriation) Reported net of income tax effect Items not qualifying as extraordinary Gains and losses on the sale of plant assets Losses due to lawsuits Losses due to employee labor strikes Natural disasters that occur frequently in the area 53

54 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. During 2011, an earthquake caused $75,000 damage to Apex’s factory. The company reported income before extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2011 income statement? During 2011, an earthquake caused $75,000 damage to Apex’s factory. The company reported income before extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2011 income statement?

55 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Income Statement Presentation:

56 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures amount of net income for each share of common stock outstanding Separate EPS figure for different purposes Income from continuing operations Forward projection: if you are going to buy it Net income Historical perspective: if you already own it 56

57 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Calculation Preferred dividends also affect EPS 57

58 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Preferred dividends must be subtracted from income to compute EPS Preferred dividends are paid first Common will get what is left * Assume the annual preferred dividend would be $10,000 (10,000 shares X $1.00 dividend per share) 58

59 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Altar, Corp., earned net income of $118,000 for Altar’s books include the following figures: Preferred stock, 3%, $50 par, 1,000 shares issued and outstanding $ 50,000 Common stock, $2 par, 53,000 issued ,000 Paid-in capital in excess of par—common ,000 Treasury stock, common, 1,200 at cost ,000 1.Compute Altar’s EPS for the year. $(118,000 – 15,000)/51,800 = $2.25* ( ) rounded 59

60 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Growth rate Companies aim to increase earnings per share to demonstrate increasing wealth building power Earnings relative to stock price Comparing the stock price per share to the earnings per share provides a measure of value of the stock The Price to Earnings ratio compares stock price to earnings per share A measure of how much it costs to buy $1.00 in a company’s earnings. A high p/e ratio indicates an expensive stock A low p/e ratio indicates a value stock 60

61 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. P/E ratio = Price per share ÷ Earnings per share Using the P/E ratio: Find a company you like based on: Earnings – strong income statement Balance sheet – strong financial standing Cash flows – learn next week Situation analysis THEN, evaluate whether or not it is worth the purchase price by using the p/e ratio 61

62 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Reports how retained earnings changed over the accounting period Corporate dividends appear where drawings would appear in proprietorships or partnerships 62

63 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 63 Income Statement Statement of retained earnings

64 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Corrections for errors of an earlier period Due to the closing of accounts, the error is held in Retained earnings Correction called prior-period adjustment Correcting entry includes: Debit or credit to Retained earnings for error amount Debit or credit to asset or liability account that was misstated Reported on statement of retained earnings 64

65 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Change in total stockholders’ equity from all sources other than from its owners Net income plus or minus: Unrealized gains/losses on certain investments Foreign currency translation adjustments* Gains (losses) from post-retirement benefit plans* Deferred gains (losses) from derivatives* 65 *The calculation of these items will be explained in future accounting courses.

66 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Stock dividends are either small (less than 20%– 25%) or large (greater than 20%–25%). Small stock dividends are valued at the stock’s fair market value. Large stock dividends are valued at par. Stock dividends have no effect on total stockholders’ equity, but do increase paid-in capital and decrease Retained earnings. Stock splits reduce par value and market value per share. Stock splits increase the number of issued and outstanding shares. Stock splits have no effect on any general ledger accounts. 66

67 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Treasury stock occurs when a company repurchases previously issued shares. Treasury stock is a contra equity account; therefore, increases in Treasury stock decrease total stockholders’ equity. Treasury stock purchases are recorded at cost, not par. All gains/losses on treasury stock sales are reported in the stockholders’ equity accounts. Restrictions on retained earnings most often arise from loan restrictions. These restrictions usually require companies to maintain minimum levels of retained earnings, thereby restricting amounts available for cash dividends and treasury stock purchases. Restrictions must be disclosed in the footnotes to the financial statements. 67

68 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The corporate income statement extends its coverage to include items that aren’t continuing. Extraordinary items—those infrequent and unusual—are reported separately, net of their tax effect on the income statement. Earnings per outstanding common share are reported for each major income statement item. The statement of retained earnings may include prior-period adjustments for corrective items. Comprehensive income includes the four items identified that aren’t normally reported on the income statement. 68

69 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 69

70 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. 70


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