Accounting & Financial Reporting

Accounting & Financial Reporting
BUSG 503 Michael Dimond

Financial Statements for Sysco (SYY)

Financial Statements How much profit did the company make?
How much did they invest in assets? Was the purchase of equipment an expense? How are the assets allocated? How did they finance their assets? How did cash change during the period? How did owners’ wealth (equity) change during the period? What return did the owners get on their investment?

Initial questions about the balance sheet
Some companies carry high levels of cash. Why is that? Is there a cost to holding too much cash? Is it costly to carry too little cash? The relative proportion of short-term and long-term assets is largely dictated by companies’ business models. Why is this the case? Why is the composition of assets on balance sheets for companies in the same industry similar? By what degree can a company’s asset composition safely deviate from industry norms? What are the trade-offs in financing a company by owner versus non-owner financing? If non-owner financing is less costly, why don’t we see companies financed entirely with borrowed money? How do shareholders influence the strategic direction of a company? How can long-term creditors influence strategic direction? Most assets and liabilities are reported on the balance sheet at their acquisition price, called historical cost. Would reporting assets and liabilities at fair market values be more informative? What problems might fair-value reporting cause?

Initial questions about the income statement
Assume a company sells a product to a customer who will pay in 30 days. Should the seller recognize the sale when it is made or when cash is collected? When a company purchases a long-term asset such as a building, its cost is reported on the balance sheet as an asset. Should a company, instead, record the cost of that building as an expense when it is acquired? If not, how should a company report the cost of that asset over the course of its useful life? Manufacturers and merchandisers report the cost of a product as an expense when the product sale is recorded. How might we measure the costs of a product that is sold by a merchandiser? By a manufacturer? If an asset, such as a building, increases in value, that increase in value is not reported as income until the building is sold, if ever. What concerns arise if we record increases in asset values as part of income, when measurement of that increase is based on appraised values? Employees commonly earn wages that are yet to be paid at the end of a particular period. Should their wages be recognized as an expense in the period that the work is performed, or when the wages are paid? Companies are not allowed to report profit on transactions relating to their own stock. That is, they don’t report income when stock is sold, nor do they report an expense when dividends are paid to shareholders. Why is this the case?

Initial questions about the statement of cash flows
What is the usefulness of the statement of cash flows? Do the balance sheet and income statement provide sufficient cash flow information? What types of information are disclosed in the statement of cash flows and why are they important? What kinds of activities are reported in each of the operating, investing and financing sections of the statement of cash flows? How is this information useful? Is it important for a company to report net cash inflows (positive amounts) relating to operating activities over the longer term? What are the implications if operating cash flows are negative for an extended period of time? Why is it important to know the composition of a company’s investment activities? What kind of information might we look for? Are positive investing cash flows favorable? Is it important to know the sources of a company’s financing activities? What questions might that information help us answer? How might the composition of operating, investing and financing cash flows change over a company’s life cycle? Is the bottom line increase in cash flow the key number? Why or why not?

Stockholders’ Equity Stockholders: Stockholders’ equity:
Owners of a corporation Have a residual interest in assets after liabilities are satisfied Stockholders’ equity: Two major components Contributed capital Retained earnings

Effect of Stockholders’ Equity Items on the Statement of Cash Flows

Stockholders’ Equity Contributed Capital: Retained earnings:
Amount a corporation receives from the sale of stock (common or preferred) to the stockholders Additional Paid-In Capital : amount received at issuance that exceeds the par value of the stock Retained earnings: Amount of net income, over the life of the company not paid out as dividends An important link between the income statement and the balance sheet

Retained Earnings Connects the Income Statement and the Balance Sheet

Stock versus Debt Financing: Pros & Cons

Components of the Stockholders’ Equity Section of the Balance Sheet
Number of Shares Par Value Additional Paid-In Capital Retained Earnings

Contributed Capital Common stock Preferred stock Carries voting rights
The common stockholders elect the corporation’s officers Establish its bylaws and governing rules Three basic types: Par value No-par value Stated value Preferred stock Flexible and tailored to a company’s needs Preference in dividends

Basics of Capital Stock
Total amount of stock that a corporation’s charter authorizes it to sell Corporations must disclose information related to their stock, such as par value and number of shares authorized and issued. The corporate charter determines the number of shares of stock the corporation is authorized to sell. We can also find the number of shares actually issued by the company. In our example, the company had issued a total of 92,556,295 shares by the end of Notice that this common stock has a par value of $0.01. Low par values are normal in business. Let’s look at the meaning of par value. Total amount of stock that has been issued or sold to stockholders

Number of Shares Authorized shares: the maximum number of shares a corporation may issue as indicated in the corporate charter Issued shares: the number of shares sold or distributed to stockholders Outstanding shares: the number of shares issued less the number of shares held as treasury stock

Issuance of Stock Issued for cash or for noncash assets
When issued for cash: Par value reported in the stock account Amount in excess of par is reported in the Paid-In Capital account When exchanged for noncash items: Recorded at the fair market value of the stock or the assets received, whichever is most readily determined

Recording Stock Issued for Cash
Assume that on July 1, a firm issued 1,000 shares of $10 par common stock for $15 per share

Recording Stock for Noncash Consideration
Assume that on July 1, a firm issued 500 shares of $10 par preferred stock to acquire a building. The stock is not widely traded, and the current market value of the stock is not evident. The building has recently been appraised by an independent firm as having a market value of $12,000

Issuing Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Paid-In Capital in Excess of Par Value, Common Stock. When par value stock is sold for cash, the Common Stock account is credited for the par value of the stock sold. Remember that par value and market value are not related. The difference between the par value of the stock and the market value of the stock is credited to Paid-In Capital in Excess of Par. If you added together the amount of par value in the Common Stock account and the amount in the Paid-In Capital in Excess of Par, Common Stock, you would have the market value of the sale of the stock.

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Part I Let’s record the entry for Matrix Incorporated for the issue of 100,000 shares of $2 par value stock for $25 in cash. Part II Matrix would debit Cash for the market value of the stock sold: 100,000 shares times $25 per share. Matrix would credit Common Stock for the par value of the share sold: 100,000 shares times $2 per share. And, they would credit Paid-In Capital in Excess of Par Value, Common Stock, for the excess of market over par: 100,000 shares times $23 dollars per share. 11-20

This is the way Matrix would report the common stock on its balance sheet. The $200,000 is the par value of the stock sold and the $2,300,000 is the excess over par value Matrix received for the stock. These two amounts added together total $2,500,000, the amount of cash received for the sale of the stock. 11-21

Issuing Stock for Noncash Assets
Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Record: The asset received at its market value. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Paid-In Capital in Excess of Par, Common Stock. A similar situation occurs when par value stock is exchanged for noncash assets. The Common Stock account is credited for the par value of the stock sold. The difference between the par value of the stock and the market value of the assets received is credited to Contributed Capital in Excess of Par. If you added together the amount of par value in the Common Stock account and the amount in the Paid-In Capital in Excess of Par, Common Stock, you would have the market value of the assets received. 11-22

Issuing Stock for Noncash Assets
Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Part I Let’s record the entry for Matrix Incorporated for the issue of 100,000 shares of $2 par value stock for land valued at $2,500,000. Part II Matrix would debit Land for its market value. Matrix would credit Common Stock for the par value of the share sold: 100,000 shares times $2 a share. And, they would credit Paid-In Capital in Excess of Par Value, Common Stock, for the excess of land’s market value in excess of the par value. 11-23

Cash Dividends Declared only if a company has sufficient cash available and adequate retained earnings Not an expense on the income statement Date of declaration: cash dividends are declared Payment date: cash dividends are paid Date of record: dividend is paid to the stockholders who own the stock as of this date

Entries for Cash Dividends
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Dividends Dana Incorporated declared a $1 per share dividend on January 19 on its 10,000 common shares outstanding. The entry on January 19 includes a debit to Retained Earnings and a credit to Common Dividend Payable of $10,000. Date of Declaration Record liability for dividend. 11-25

On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. No entry required on February 19. On February 19, the record date, we need to know who owns the stock, but an accounting entry is not needed. Date of Record No entry required. 11-26

On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. On March 19, the payment date, Dana Incorporated would debit Common Dividend Payable and credit Cash for the $10,000 dividend. Date of Payment Record payment of cash to stockholders. 11-27

Dividend Payout Ratio =
The annual dividend amount divided by the annual net income Annual Dividend Annual Net Income Dividend Payout Ratio =

Stock Dividends Why a stock dividend?
The issuance of additional shares of stock to existing stockholders Firms use stock dividends for several reasons Do not require the use of cash Reduce the market price of the stock The lower price may make the stock more attractive Do not represent taxable income to recipients Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well.

Stock Dividends Small Stock Dividend
Distribution is £ 25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. A stock dividend can be classified as small or large. A small stock dividend is a distribution of stock that is less than or equal to 25% of the outstanding shares. A large stock dividend is a distribution of stock that is greater than 25% of the outstanding shares. Let’s look at the entries to record a small and large stock dividend. 11-30

Recording a Small Stock Dividend
Assume that Shah Company’s Stockholders’ Equity category of the balance sheet appears as follows as of January 1, 2014:

Recording a Small Stock Dividend (continued)
Assume that on January 2, 2014, Shah declares a 10% stock dividend to common stockholders to be distributed on April 1, Small stock dividends (usually those of 20% to 25%) normally are recorded at the market value of the stock as of the date of declaration. Assume that Shah’s common stock is selling at $40 per share on that date

Stockholders’ Equity Section

Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend. Here is the equity section for Quest Incorporated prior to a small stock dividend. 11-34

On December 31, 2011, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, Let’s make the December 31 entry. Quest declares a 2% stock dividend. The stock was selling for $10 a share. On the declaration date, Quest would debit Retained Earnings for the number of shares declared times the market value of the stock. In this example, that amount is $20,000. The account Common Stock Dividend Distributable is credited for the par value of the shares declared. In this example, that amount is $2,000. The excess is credited to Paid-In Capital in Excess of Par Value. In this example, that amount is $18,000. 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 11-35

Before the stock dividend. After the stock dividend.
Comparing Quest’s equity section before and after the stock dividend shows that the Common Stock Dividend Distributable account is reported with the common stock and the Paid-In Capital in Excess of Par Value is reported as additional paid-in capital. Retained Earnings also decreased based on the previous entry. 11-36

Recording the Declaration of a Large Stock Dividend
Assume that instead of a 10% dividend, on January 2, 2014, Shah declares a 100% stock dividend to be distributed on April 1, The stock dividend results in 5,000 additional shares being issued and certainly meets the definition of a large stock dividend

Recording the Declaration of a Large Stock Dividend (continued)
The effect when the stock is actually distributed is as follows: The Stockholders’ Equity category of Shah’s balance sheet as of April 1 after the stock dividend is as follows:

Recording a Large Stock Dividend
Router, Inc. shows the following stockholders’ equity section just prior to issuing a large stock dividend. Here is the equity section for Router, Incorporated prior to a large stock dividend. 11-39

Recording a Large Stock Dividend
On December 31, 2011, Router declared a 40% stock dividend, when the stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share. Router declares a 40% stock dividend. On the declaration date, Router would debit Retained Earnings for the number of shares declared times the par value of the stock. In this example, that amount is $20,000. The account Common Stock Dividend Distributable is credited for the par value of the shares declared. In this example, that amount is $20,000. 50,000 × 40% = 20,000 shares × $1 par value = $20,000 11-40

Stock Splits A distribution of additional shares of stock to stockholders according to their percent ownership. $10 par value Old Shares Common Stock 100 shares A stock split is the distribution of additional shares of stock to stockholders according to their ownership percentage. When a stock split occurs, the corporation calls in the outstanding shares and issues new shares of stock. In the process of a stock split, the par value of the stock changes. Let’s look at an example. New Shares $5 par value Common Stock 200 shares 11-41

Stock Splits After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this . No accounting entry is made. After the split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required, and that Retained Earnings is not reduced. In many respects a 100% stock dividend and a two-for-one stock split result in similar impacts in the stock market. The stock split usually requires more administrative tasks to call in and reissue stock certificates. However, sometimes corporations do not reissue certificates in a stock split, saving some of the administrative costs. 11-42

Usually has a stated dividend rate Normally has no voting rights
Preferred Stock A separate class of stock, typically having priority over common shares in . . . Dividend distributions Distribution of assets in case of liquidation Usually has a stated dividend rate Normally has no voting rights Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation. Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. It normally does not have voting rights. 11-43

Preferred Stock Flexible and tailored to a company’s needs
Dividends must be distributed to preferred stockholders before common stockholders Right to the company’s assets before the common stockholders during liquidation The dividend rate may be stated in two ways: Percentage of the stock’s par value Per-share amount LO 2

Preferred Stock Additional Terms and Features
Convertible: allows preferred stock to be exchanged for common stock Redeemable: allows stockholders to sell stock back to the company Callable: allows the firm to eliminate a class of stock by paying the stockholders a specified amount

Preferred Stock Additional Terms and Features
Cumulative: the right to dividends in arrears before the current-year dividend is distributed Participating: allows preferred stockholders to share on a percentage basis in the distribution of an abnormally large dividend

Cumulative or Noncumulative Dividend
Vs. Noncumulative Cumulative Dividends in arrears must be paid before dividends may be paid on common stock. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative preferred stockholders have the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders. When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears and must be disclosed in the financial statements. Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods. Let’s look at an example. Most preferred stock is cumulative. 11-47

Computing Dividend Payments for Noncumulative Preferred Stock
Assume that on December 31, 2014, Stricker Company has outstanding 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock. Stricker was unable to declare a dividend in 2012 or 2013 but wants to declare a $70,000 dividend for 2014

Computing Dividend Payments for Cumulative Preferred Stock
If the terms of the stock agreement indicate that the preferred stock is cumulative, the preferred stockholders have a right to dividends in arrears before the current year’s dividend is distributed

Example: Consider the following stockholders’ equity section of the balance sheet This company has both common stock and preferred stock. The directors did not declare a dividend in In 2012, the directors declare and pay cash dividends of $42,000. Let’s see how this dividend is distributed if the preferred stock is cumulative and if it is noncumulative. The board of directors did not declare or pay dividends in In 2012, the board of directors declare and pay cash dividends of $42,000. 11-50

If the preferred stock is noncumulative, these stockholders have no rights to the missed dividends of the year However, they get first distribution of the dividends declared in The dividend for the preferred stock in 2011 is calculated as follows: $100 par value times nine percent times 1,000 shares. Since $42,000 in dividends were declared, preferred would first get their $9,000, and the remaining $33,000 would be divided evenly among the common stockholders. If the preferred stock is cumulative, these stockholders have rights to the missed dividends of 2011 in addition to the dividend in The preferred stockholders first get a distribution of $9,000 for the missed dividends of Then they get another $9,000 for the dividend in Since $42,000 in dividends were declared, preferred would first get their $18,000 and the remaining $24,000 would be divided evenly among the common stockholders. An additional preference for preferred stock is participation in dividends if they are declared above certain limits. This participation feature does not apply until common stockholders receive dividends equal to the preferred stock’s dividend percent. This is not a common preference seen in practice. 11-51

Treasury Stock Represents the corporation’s own stock, previously issued to shareholders, repurchased from stockholders and not retired, but held for various purposes Repurchase is recorded as a debit to Treasury Stock, a contra-equity account For an amount to be treated as treasury stock: It must be the corporation’s own stock It must have been issued to the stockholders at some point It must have been repurchased from the stockholders It must not be retired, but must be held for some purpose

Recording the Purchase of Treasury Stock
Assume that the Stockholders’ Equity section of Rezin Company’s balance sheet on December 31, 2014, appears as follows:

Recording the Purchase of Treasury Stock (continued)
Assume that on February 1, 2015, Rezin buys 100 of its shares as treasury stock at $25 per share.

Purchasing Treasury Stock
On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. Let’s change our focus to treasury stock. When a corporation repurchases shares of its own stock, it is called treasury stock. Corporations acquire shares of their own stock for several reasons. These reasons include to use the shares to acquire another corporation, to purchase shares to avoid a hostile takeover of the company, to reissue them to employees as compensation, and to maintain a strong market for their stock or to show management confidence in the current price. Let’s see how this would be recorded: On May 8, Whitt Incorporated purchased 2,000 of its own shares in the market for $8,000. The entry on May 8 includes a debit to Treasury Stock and a credit to Cash for $8,00, which is the amount of the purchase. The treasury stock would be reported on the balance sheet in the equity section as a reduction from total equity. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. 11-55

Selling Treasury Stock at Cost
On June 30, Whitt sold 100 shares of its treasury stock for $4 per share. On June 30, Whitt sold 100 shares of the treasury stock for $4 per share. This entry would include a debit to Cash and a credit to Treasury Stock for $400. This was a nice clean entry because we sold the treasury stock for its original cost of $4 per share. Let’s see what happens when the selling price of the treasury stock is different than the cost. $8,000 ÷ 2,000 shares = $4 cost per treasury share 11-56

Selling Treasury Stock Above Cost
On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share. On July 19, Whitt sold 500 shares of the treasury stock for $8 per share. Remember that the original cost of the treasury stock was $4 per share. This entry would include a debit to Cash for $4,000. The credit Treasury Stock is for $2,000. This is the original cost of $4 per share times the 500 shares sold. The difference between the selling price and the cost of the treasury stock is credited to Paid In Capital, Treasury Stock. In this example, that amount is $2,000. Now, let’s see what happens if we sell treasury stock for less than its original cost. 11-57

Selling Treasury Stock Below Cost
On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. On August 27, Whitt sold 400 shares of the treasury stock for $1.50 per share. Remember that the original cost of the treasury stock was $4 per share. This entry would include a debit to Cash for $600. The credit to Treasury Stock is for $1,600. This is the original cost of $4 per share times the 400 shares sold. The difference between the selling price and the cost of the treasury stock is debited to Paid-In Capital, Treasury Stock. In this example, that amount is $1,000. 11-58

Statement of Retained Earnings
Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. The statement of retained earnings is a summary of the activity that occurred in retained earnings during the period. It begins with the balance at the beginning of the period. If a company has net income, it is added to the beginning retained earnings balance. If a company has a net loss, then that would be subtracted. Any dividends declared are subtracted to arrive at the ending retained earnings balance. 11-59

Restricted Retained Earnings
Legal Contractual Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Retained earnings can have legal or contractual restrictions. In most states, the corporate charters will not allow companies to purchase treasury stock in excess of the balance in retained earnings. Some loan agreements place restrictions on how much dividends can be based on the balance in retained earnings. Restrictions on retained earnings are generally disclosed in the notes to the financial statements. 11-60

Appropriated Retained Earnings
A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities. Directors can voluntarily limit the use of retained earnings. This is called an appropriation. When there is an appropriation of retained earnings, it is separately reported in the financial statements and disclosed to inform users of special activities that require funds. 11-61

Prior Period Adjustments
Correction of material errors in past years’ financial statements. If an amount is incorrectly expensed, add amount to retained earnings. Prior period adjustments are corrections of errors that occurred in prior periods’ financial statements. Prior period adjustments are reported net of tax effects on the statement of retained earnings. 11-62

Statement of Stockholders’ Equity
Explains the reasons for the difference between the beginning and ending balances for all accounts in the Stockholders’ Equity category of the balance sheet LO 8

Statement of Stockholders’ Equity
Many companies issue a statement of stockholders’ equity rather than a simple statement of retained earnings. The statement of stockholders’ equity is more inclusive and discloses changes in all equity accounts, not just retained earnings. This is a more inclusive statement than the statement of retained earnings. 11-64

Earnings per Share Earnings per share is one of the most widely cited items of accounting information. Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding Earnings per share is one of the most widely used ratios. It is calculated as net income minus preferred dividends divided by weighted-average common shares outstanding. 11-65

Price-Earnings Price- earnings ratio = Market value per share
This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities. Price- earnings ratio = Market value per share Earnings per share If earnings go up, will the market price of my stock follow? The price-earnings ratio reveals information about the stock market’s expectation for a company’s future growth in earnings, dividends, and opportunities. It is calculated as market value per share divided by earnings per share. 11-66

Annual cash dividends per share
Dividend Yield Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. Dividend yield = Annual cash dividends per share Market value per share The dividend yield ratio provides the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. It is calculated as the annual cash dividend per share divided by the market value per share. 11-67

Book Value per Share—Common
Records amount of stockholders’ equity applicable to common shares on a per share basis. Book value per common share = Stockholders’ equity applicable to common shares Number of common shares outstanding The book value per common share ratio records the amount of stockholders’ equity applicable to common shares on a per share basis. It is calculated as stockholders’ equity applicable to common shares divided by the number of common shares outstanding. 11-68

Book Value per Share—Preferred
Records amount of stockholders’ equity applicable to preferred shares on a per share basis. Book value per preferred share = Stockholders’ equity applicable to preferred shares Number of preferred shares outstanding The book value per preferred share ratio records the amount of stockholders’ equity applicable to preferred shares on a per share basis. It is calculated as stockholders’ equity applicable to preferred shares divided by the number of preferred shares outstanding. 11-69

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