9-1 PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. F13 9 Financing Activities Financial Accounting Ingram and Albright 6 th edition Information for Decisions

9-2ObjectivesObjectives Once you have completed this chapter, you should be able to—

9-3 1.Identify information that companies report about obligations to lenders and explain the transactions affecting long-term debt. ObjectivesObjectives 2.Describe appropriate accounting procedures for contingencies and commitments, including capital leases. 3.Identify information reported in the stockholders’ equity section of a corporate balance sheet and distinguish contributed capital from retained earnings.

9-4 4.Explain transactions affecting stockholders’ equity and describe how these transactions are reported in a company’s financial statements. ObjectivesObjectives 5.Distinguish between preferred stock and common stock, and discuss why corporations may issue more than one type of stock.

9-5 Liabilities refer to an organization’s obligations to deliver payments, goods, or services in the future. Types of Obligations

9-6 Types of Obligations (1)A present responsibility exists to transfer resources to another entity at some future time. (2)The organization cannot chose to avoid the transfer. (3)The event creating the responsibility has already occurred. Three attributes define a liability for an organization:

9-7 Liabilities of Favorite Cookie Company include obligations to: lenders (Notes Payable and Interest Payable) suppliers (Accounts Payable) employees (Wages Payable) customers (Unearned Revenue) Types of Obligations

9-8 Exhibit 1 Balance Sheet Presentation of Liabilities for Favorite Cookie Co. December Current Liabilities: Accounts payable$ 16,260$ 9,610 Wages payable3,590 Unearned revenue2,7704,250 Interest payable Notes payable, current 6,000 5,000 Total current liabilities$ 29,430$19,510 Notes payable, long-term 80,200 73,200 Total liabilities$109,630$92,710

9-91 ObjectiveObjective Identify information that companies report about obligations to lenders and explain the transactions affecting long-term debt.

9-10 Debt Obligations A firm’s short-term and long-term borrowings are obligations to creditors.

9-11 Debt Obligations As you can see in the next two slides, Favorite Cookie Company, debt is separated into short-term debt (current liabilities) and long-term debt.

9-12 December 31, December 31, Liabilities: Current liabilities: Accounts payable$ 16,260$ 9,610 Wages payable3, Unearned revenue2,7704,250 Interest payable Notes payable, current 6,000 5,000 Total current liabilities29,43019,510 Notes payable, long-term 80,200 73,200 Total liabilities$109,630$92,710 Exhibit 1 Balance Sheet Presentation of Liabilities for Favorite Cookie Co.

9-13 Liabilities: Current liabilities: Accounts payable$ 16,260$ 9,610 Wages payable3, Unearned revenue2,7704,250 Interest payable Notes payable, current 6,000 5,000 Total current liabilities29,43019,510 Notes payable, long-term 80,200 73,200 Total liabilities$109,630$92,710 Exhibit 1 Balance Sheet Presentation of Liabilities for Favorite Cookie Co. December 31, December 31,

9-14 Long-term debt includes notes and bonds payable. Debt Obligations Notes and bonds payable are contracts between borrowers and creditors.

9-15 Company debts secured by company assets are referred to as secured debts. Major companies often issue debentures, or unsecured debts. Debt Obligations

9-16 These commonly are issued by governments. Bond issues that require a portion of the bonds to be repaid each year are called serial bonds. Debt Obligations

9-17 Callable bonds are bonds that a company can reacquire after the bonds have been outstanding for a specific period. Debt Obligations

9-18 Callable bonds are bonds that a company can reacquire after the bonds have been outstanding for a specific period. Debt Obligations A company might issue 30-year bonds that are callable after five years at 102% of maturity value.

9-19 Debt Transactions Favorite Cookie Company issued $20,000 of five-year bonds on January 1, The bonds pay 8% annually ($1,600) at the end of each year. maturity value or face value Stated rate of interest

9-20 Debt Transactions If Favorite Cookie Company’s bonds are sold to provide the investor with a 9% return, then this actual rate of return is known as the effective rate of interest. How is the issue price of Favorite’s 8% bonds determined if the effective rate of interest is 9%?

9-21 Exhibit 3 Example of the Relationship of Bond Cash Flows to Present Value

9-22 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 $20,000 x.08 Maturity value of bond

9-23 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 x periods, 9%

9-24 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 x $20,000 Maturity value of bond

9-25 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 x $20,000 x periods, 9%

9-26 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 x $20,000 x PV of bonds =$6,223 + $12,999 PV of bonds =$19,222

9-27 Exhibit Exhibit 4 Bond Amortization Table Total 8,777777

9-28 Debt Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Cash19,222 Bonds Payable19,222 Favorite Cookie Company would record the bond sale on January 1, 2008.

9-29 Debt Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Interest Expense–1,730 Bonds Payable130 Cash–1,600 At the end of 2008, Favorite Cookie Company would record the interest paid and the interest expense.

9-30 Debt Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Bonds Payable–20,000 Cash–20,000 When the bond matures on December 31, 2012, the liability is removed when the maturity value of the bond is paid.

9-31 Financial Reporting of Debt Balance Sheet Liabilities: Long-term debt$19,352 Income Statement Nonoperating expenses: Interest expense1,730 Statement of Cash Flows Cash flow from operating activities: Interest paid(1,600) Cash flow from financing activities: Long-term debt issued19,222 Dec. 31, 2008

9-32 Balance Sheet Liabilities: Long-term debt$19,494 Income Statement Nonoperating expenses: Interest expense1,742 Statement of Cash Flows Cash flow from operating activities: Interest paid(1,600) Financial Reporting of Debt Dec. 31, 2009

9-33 Balance Sheet Liabilities: Long-term debt$19,648 Income Statement Nonoperating expenses: Interest expense1,754 Statement of Cash Flows Cash flow from operating activities: Interest paid(1,600) Financial Reporting of Debt Dec. 31, 2010

9-34 Balance Sheet Liabilities: Long-term debt$19,816 Income Statement Nonoperating expenses: Interest expense1,768 Statement of Cash Flows Cash flow from operating activities: Interest paid(1,600) Financial Reporting of Debt Dec. 31, 2011

9-35 Balance Sheet Liabilities: Long-term debt---- Income Statement Nonoperating expenses: Interest expense$ 1,783 Statement of Cash Flows Cash flow from operating activities: Interest paid(1,600) Cash flow from financing activities: Debt repaid(20,000) Financial Reporting of Debt Dec. 31, 2012

9-36 Debt Transactions When the effective rate of interest on debt is less than the stated rate, the debt is said to be issued at a premium. The borrower receives more for the bonds when they are sold than the maturity value of the bonds.

9-37 Debt Transactions When the effective rate of interest on debt is more than the stated rate, the debt is said to be issued at a discount. The borrower receives less for the bonds when they are sold than the maturity value of the bonds.

9-38 Exercise 9-6 Click the button to skip this exercise. If you experience trouble making the button work, type 42 and press “Enter.” Watercrest Company sold 20-year bonds having a face value of $400,000 at a price of $360,728. The bonds pay annual interest at 7% and were priced to yield an effective rate of 8%. (a) Using the format presented in the chapter, record the issuance of the bonds. Press “Enter” or left click the mouse for solution.

9-39 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings (a)Cash360,728 Bonds Payable360,728 Exercise 9-6 (b) Record the first payment of interest. Press “Enter” or left click the mouse for solution.

9-40 Exercise 9-6 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings (b)Interest Expense–28,858 Bonds Payable858 Cash28,000 (c) Record the repayment of principal at maturity. Assume that the last payment of interest has already been made and recorded. Press “Enter” or left click the mouse for solution.

9-41 Exercise 9-6 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings (c)Bonds Payable–400,000 Cash–400,000

Determine appropriate accounting procedures for contingencies and commitments, including capital leases. ObjectiveObjective

9-43ContingenciesContingencies A contingency is an existing condition that may result in an economic effect if a future event occurs.

9-44ContingenciesContingencies If a contingency probably will result in a loss, and the amount of the loss can be reasonably estimated, it should be included as a liability on a company’s balance sheet.

9-45CommitmentsCommitments A commitment is a promise to engage in some future activity that will have an economic effect. Commitments usually involve agreements to purchase or sell something in the future.

9-46 Operating leases are expensed in the period in which the leased assets are used. CommitmentsCommitments Capital leases are recorded as liabilities, and the related leased resources are recorded as assets.

9-47 Favorite Cookie Company signs a lease on January 1, 2008 to acquire computer equipment. The lease is for three years, the assumed life of the equipment. The company agrees to pay $10,000 a year, including 8% interest. Capital Leases

9-48 Using a table: PVA =A x IF (Table 4) PVA=$10,000 x $25,771= $10,000 x Using Excel: Enter: =PV(0.08,3,-10000) Capital Leases

9-49 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Leased Assets25,771 Capital Lease Obligation25,771 On January 1, 2008, Favorite Cookie Company records the present value of lease payments. Capital Leases

9-50 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Capital Lease Obligation–7,938 Interest Expense–2,062 Cash–10,000 On December 31, 2008, Favorite Cookie Company records the $10,000 payment, which includes interest expense. Capital Leases $25,771 x.08

Identify information reported in the stockholders’ equity section of a corporate balance sheet and distinguish contributed capital from retained earnings. ObjectiveObjective

9-52 Stockholders’ equity: Common stock, $1 par value, 50,000 shares authorized, 20,000 and 10,000 issued$ 20,000 $ 10,000 Paid-in capital in excess of par190,000 90,000 Retained earnings130,417 42,990 Treasury stock, 1,000 shares at cost (12,000) 0 Total stockholders’ equity$328,417 $142,990 Exhibit 8 Stockholders’ Equity for Favorite Cookie Company December 31,

9-53 Stockholders’ Equity Contributed capital is the direct investment made by stockholders in a corporation.

9-54 Stockholders’ Equity Retained earnings is the accumulation of profits reinvested in a corporation. Treasury stock is stock repurchased by a company from its stockholders.

9-55 Contributed Capital Corporations primarily issue shares of stock in exchange for cash. Common stock or capital stock represents the ownership rights of investors in a corporation.

9-56 Contributed Capital A charter is the legal right granted by a state that permits a corporation to exist. The par value of stock is the value assigned to each share by a corporation in its corporate charter.

9-57 Contributed Capital Paid-in capital in excess of par value is the amount in excess of the stock’s par value received by a corporation from the sale of its stock.

9-58 Contributed Capital Issued shares are shares that have been sold by a corporation to investors. Outstanding shares are shares currently held by investors.

9-59 Retained Earnings Year Net Income Dividends Increase in Retained Earnings Balance of Retained Earnings 2006 $ $ 52,990 $10,000 $42,990 42, ,427 20,000 87, ,417 Favorite Cookie Company

9-60 Exercise 9-13 Click the button to skip this exercise. If you experience trouble making the button work, type 66 and press “Enter.” The charter of Pelenova, Inc. states that it may issue up to one million shares of common stock. Over the life of the company 255,000 shares have been sold to investors. Total profits over the life of the company have been $876,000, and exactly one-half of that amount has been paid out in dividends. As of today’s balance sheet date, the company holds 13,000 shares that have been bought back from shareholders. What is the number of authorized shares? Press “Enter” or left click the mouse for solution.

9-61 Exercise 9-13 Since the authorized shares is the number permitted by the company’s charter, the answer is one million shares. ContinuedContinued

9-62 Exercise 9-13 The charter of Pelenova, Inc. states that it may issue up to one million shares of common stock. Over the life of the company 255,000 shares have been sold to investors. Total profits over the life of the company have been $876,000, and exactly one-half of that amount has been paid out in dividends. As of today’s balance sheet date, the company holds 13,000 shares that have been bought back from shareholders. What is the number of issued shares? Press “Enter” or left click the mouse for solution.

9-63 Exercise 9-13 Issued shares is the number that have been sold to investors. For Pelenova, Inc., the number of issued shares is 255,000. ContinuedContinued

9-64 Exercise 9-13 The charter of Pelenova, Inc. states that it may issue up to one million shares of common stock. Over the life of the company 255,000 shares have been sold to investors. Total profits over the life of the company have been $876,000, and exactly one-half of that amount has been paid out in dividends. As of today’s balance sheet date, the company holds 13,000 shares that have been bought back from shareholders. What is the number of outstanding shares? Press “Enter” or left click the mouse for solution.

9-65 Exercise 9-13 Pelenova, Inc. has 242,000 shares outstanding. These shares are the ones currently held by stockholders (255,000 – 13,000).

Explain transactions affecting stockholders’ equity and describe how these transactions are reported in a company’s financial statements. ObjectiveObjective

9-67 Exhibit 10 Examples of Transactions That Affect Common Stockholders’ Equity *An increase in treasury stock decreases stockholders’ equity.

9-68 Equity Transactions Dec. 31, 2008 –107, ,427

9-69 Equity Transactions Dec. 31, 2008 Transfers net income earned during 2008 to Retained Earnings –107, ,427

9-70 Equity Transactions Dec. 31, 2008 Deducts the amount of dividends paid during 2008 from Retained Earnings –107, ,427

9-71 Equity Transactions Dec. 31, 2008 Records the purchase of treasury stock –107, ,427

9-72 Equity Transactions Dec. 31, 2008 Records the amount received from the sale of common stock. –107, ,427

9-73 Equity Transactions A company cannot earn profit from equity transactions. When treasury stock is sold at a price higher than its cost, a profit is not recorded. The incremental amount is added to paid-in capital.

9-74 Cash Dividends Three dates are important for dividend transactions: 1)The date of declaration is the date on which a corporation’s board of directors announces that dividends will be paid. 2)The date of record is the date used to determine who will receive the dividend. 3)The date of payment is the date on which the dividends are mailed to those receiving dividends.

9-75 Issuing New Stock The right to maintain the same percentage of ownership when new shares are issued is the stockholder’s preemptive right.

9-76 Issuing New Stock When a new stock issue is prepared, stock rights are issued to existing owners. These rights authorize the recipient to purchase new shares.

9-77 Stock Dividends Stock dividends are shares of stock distributed by the company to the stockholders without any charge. Assume Druid Company distributed a 5% stock dividend on June 1, If you owned 1,000 shares before the stock dividend, on June 1, 2007 you would receive 50 additional shares (1,000 shares x 5%).

9-78 Stock Dividends An important point about stock dividends is that the firm’s total stockholders’ equity does not change when a stock dividend is declared or issued.

9-79 Stock Split When a corporation issues a stock split, it issues a multiple of the number of shares of stock outstanding before the split.

9-80 Exercise 9-17 Click the button to skip this exercise. If you experience trouble making the button work, type 89 and press “Enter.” Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (a) What was Fast Start’s total contributed capital at year end? Press “Enter” or left click the mouse for solution. $8,900,000 ($700,000 common stock plus $8,200,000 paid-in capital in excess of par value) ContinuedContinued

9-81 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (b) How many shares of common stock were outstanding at year end? Press “Enter” or left click the mouse for solution. 1,340,000 shares (1,400,000 issued less 60,000 treasury shares) ContinuedContinued

9-82 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (c) What dollar amount of treasury stock did Fast Start hold at year end? Press “Enter” or left click the mouse for solution. $480,000 ContinuedContinued

9-83 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (d) What dollar amount of treasury stock did Fast Start repurchase during the year? How much common stock did the company issue? Press “Enter” or left click the mouse for solution. Stock repurchased = $220,000; stock issued = 100,000 shares ($50,000 ÷ $0.50) ContinuedContinued

9-84 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (e) What was the amount of dividends paid during the year? Press “Enter” or left click the mouse for solution. $335,000 ContinuedContinued

9-85 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (f) How much cash flow came from financing activities associated with shareholders’ equity during the current year, excluding the effect of net income? Press “Enter” or left click the mouse for solution. ContinuedContinued

9-86 Exercise 9-17 Cash flow: Paid for dividends$(335,000) Purchase of stock(220,000) Sale of stock 800,000 Net cash flow$245,000 ContinuedContinued (f)

9-87 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (f) What was the source of that cash flow? Press “Enter” or left click the mouse for solution. The sale of stock, $800,000 ContinuedContinued

9-88 Exercise 9-17 Refer to page 347 of your textbook for the selected portion of the company’s recent financial statements. Use this data to answer questions involving Fast Start Corporation, a manufacturer of automobile ignitions. (g) How much net income came from financing activities associated with stockholders’ equity during the current year? Press “Enter” or left click the mouse for solution. $0; financing activities do not create net income

Distinguish between preferred stock and common stock, and discuss why corporations may issue more than one type of stock. ObjectiveObjective

9-90 Preferred Stock Preferred stock is stock with a higher claim on dividends and assets than common stock.

9-91 Preferred Stock Preferred stock is stock with a higher claim on dividends and assets than common stock. Cash dividends must be paid to preferred stockholders before they can be paid to common stockholders.

9-92 Preferred stockholders normally do not have voting rights in a corporation. Preferred Stock

9-93 Preferred stockholders normally do not have voting rights in a corporation. Preferred Stock Preferred stock often is issued at par value or has no par value. In some cases a liquidation value is reported for preferred stock.

9-94 Some companies issue redeemable preferred stock. This is stock the issuing company plans to repurchase at a particular time in the future. Preferred Stock

9-95 Some companies issue redeemable preferred stock. This is stock the issuing company plans to repurchase at a particular time in the future. Redeemable preferred stock is not included as part of stockholders’ equity. It is reported as a separate item between liabilities and stockholders’ equity. Preferred Stock

9-96 Preferred stock that can be converted into shares of common stock is referred to as convertible preferred stock. Preferred Stock

9-97 T HE E ND C HAPTER 9

9-98