9-1 Financing Activities Electronic Presentation by Douglas Cloud Pepperdine University Chapter F9

9-2 1.Identify information that companies report about obligations to lenders and explain the transactions affecting long-term debt. 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. ObjectivesObjectives Once you have completed this chapter, you should be able to: ContinuedContinued

9-3 4.Explain transactions affecting stockholders’ equity and describe how these transactions are reported in a company’s financial statements. 5.Distinguish between preferred stock and common stock, and discuss why corporations may issue more than one type of stock. ObjectivesObjectives

9-4 Liabilities are an organization’s obligations to deliver payments, goods, or services in the future. Notes Payable Accounts Payable Interest Payable Wages Payable Unearned Revenue

9-5 Three attributes define a liability for an organization.

9-6 (1)A present responsibility exists to transfer resources to another entity at some future time. Attributes of a Liability

9-7 (1)A present responsibility exists to transfer resources to another entity at some future time. (2)The organization cannot choose to avoid the transfer. Attributes of a Liability

9-8 (1)A present responsibility exists to transfer resources to another entity at some future time. (2)The organization cannot choose to avoid the transfer. (3)The event creating the responsibility has already occurred. Attributes of a Liability

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, Mom’s Cookie Company, debt is separated into current- and long-term amounts.

9-12 Debt Obligations 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 Current debt for Mom’s Cookie Company

9-13 Debt Obligations 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 Long-Term Debt for Mom’s Cookie Company

9-14 Long-term debt includes notes and bonds payable. Debt Obligations

9-15 Notes and bonds payable are contracts between borrowers and creditors. Debt Obligations

9-16 Company debts secured by specific company assets are referred to as secured debts. Major companies often issue debentures, or unsecured debts. Debt Obligations

9-17 Most corporate bonds are repaid at the end of a fixed period. What about bonds that require a portion of the bond to be repaid each year? Those are commonly issued by governments and are referred to as serial bonds. Debt Obligations

9-18 Callable bonds require holders of this type of debt to resell the bonds to the issuing company if the issuer chooses to repurchase the bonds. Debt Obligations Yes, these bonds not only include specific dates for repurchasing, but specific prices that the issuer must pay to reacquire them. Don’t these bonds have to be outstanding for a specified period before they can be repurchased?

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

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

9-21 Debt Transactions PV of bonds =PV of annuity + PV of single amount PV of bonds = $1,600 x $20,000 x $20,000 x.08 5 periods, 9% Face value of bond 5 periods, 9%

9-22 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 (rounded) PV of bonds =$19,222

9-23 Exhibit 3 Example of the Relationship of Bond Cash Flows to Present Value

9-24 Debt Transactions To determine transactions recorded for the bonds, we need to develop an amortization table for Mom’s Cookie Company.

9-25 Exhibit 4 Bond Amortization Table Mom’s Cookie Company

9-26 Debt Transactions ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Cash19,222 Bonds Payable19,222 Mom’s Cookie Company would record the bond sale on January 1, 2005.

9-27 Exhibit 4 Bond Amortization Table Mom’s Cookie Company

9-28 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 2005, Mom’s Cookie Company would record the amount paid and the interest expense.

9-29 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, 2009, the liability is removed when the face value of the bond is paid.

9-30 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, 2005

9-31 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, 2006

9-32 After recording the fifth interest payment and related interest expense, Mom’s Cookie Company records paying the creditors the maturity value of the bonds: Financial Reporting of Debt Dec. 31, 2009

9-33 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

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

9-35ContingenciesContingencies A contingency is an existing condition that may result in an economic effect if a future event occurs.

9-36ContingenciesContingencies If a contingency probably will result in a loss, and the amount of the loss can be reasonable estimated, it should be included as a liability on a company’s balance sheet.

9-37CommitmentsCommitments A commitment is a promise to engage in some future activity that will have an economic effect.

9-38 Operating leases are expensed in the period in which the leased assets are used. CommitmentsCommitments

9-39 Capital leases are recorded as liabilities, and the related leased resources are recorded as assets. Capital Leases

9-40 Mom’s Cookie Company signs a lease on January 1, 2005 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

9-41 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

9-42 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Leased Assets25,771 Capital Lease Obligation25,771 Mom’s Cookie Company records the present value of lease payments. Capital Leases

9-43 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 Mom’s 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

9-45 December 31, 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 Mom’s Cookie Company

9-46 Stockholders’ Equity Contributed Capital is the direct investment made by stockholders in a corporation. Treasury stock is stock repurchased by a company from its stockholders. Retained earnings is the accumulation of profits reinvested in a corporation.

9-47 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.

9-48 Contributed Capital A charter is the legal right granted by a state that permits a corporation to exist.

9-49 Contributed Capital What is meant by par value? The par value of stock is the value assigned to each share by a corporation in its corporate charter.

9-50 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. Issued shares are shares that have been sold by a corporation to investors. Outstanding shares are shares currently held by investors.

9-51 Retained Earnings Year Net Income Dividends Increase in Retained Earnings Balance of Retained Earnings 2004 $ $ 52,990 $10,000 $42,990 42, ,427 20,000 87, ,417 Mom’s Cookie Company for 2005 and 2006.

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

9-53 Exhibit 10 Examples of Transactions That Affect Common Stockholders’ EquityContinuedContinued *An increase in treasury stock decreases stockholders’ equity.

9-54 Transfers net income earned during 2005 to Retained Earnings. Exhibit 10 Examples of Transactions That Affect Common Stockholders’ Equity Deducts the amount of dividends paid during 2005 from Retained Earnings.

9-55 Exhibit 10 Examples of Transactions That Affect Common Stockholders’ Equity Records the purchase of treasury stock. Records the amount received from the sale of common stock.

9-56 Equity Transactions A company cannot earn profit from equity transactions.

9-57 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.

9-58 Issuing New Stock The right to maintain the same percentage of ownership when new shares are issued is the stockholder’s preemptive right.

9-59 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.

9-60 Stock Dividends So, we had 1,000 shares before the stock dividend. Now we have 1,050. Stock dividends are shares of stock distributed by the company to the stockholders without any charge. Druid Company distributed a 5% stock dividend.

9-61 Stock Dividends An important point about issuing stock dividends is that the firm’s total stockholders’ equity does not change.

9-62 Stock Split When a corporation issues a stock split, it issues a multiple of the number of shares of stock outstanding before the split.

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

9-64 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.

9-65 Preferred Stock Preferred stockholders normally do not have voting rights in a corporation.

9-66 Preferred Stock 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 that can be converted into shares of common stock are referred to as convertible preferred stock.

9-67 T HE E ND C HAPTER F9

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