1. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Liabilities and Stockholders’ Equity CHAPTER 8

2. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Describe how businesses finance their operations Describe and illustrate current liabilities, notes payable, taxes, contingencies, and payroll Describe and illustrate the financing of operations through issuance of bonds Describe and illustrate the financing of operations through issuance of stock Describe and illustrate the accounting for cash and stock dividends (continued…)

3. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Describe the effects of stock splits on the financial statements Describe financial statement reporting of liabilities and stockholders’ equity Analyze the impact of debt or equity financing on earnings per share Financial Analysis: Describe and illustrate the use of the ratio of liabilities to total assets and the price- earnings ratio in assessing a company’s financial condition and prospects for future performance

4. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe how businesses finance their operations LEARNING OBJECTIVE 1

5. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Financing Operations Businesses must finance operations through one of the two ways: ________ Financing – includes all liabilities owed by a business ________ Financing – includes investments from owners of the business Proprietorship or partnership: obtains equity financing from ____________________ Corporation: obtains equity financing by ____________________

6. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe and illustrate current liabilities, notes payable, taxes, contingencies, and payroll LEARNING OBJECTIVE 2

7. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Liabilities Debts owed to others _______ liabilities – due within a short time, usually 1 year _______ liabilities – due beyond 1 year _______ liability – in some cases a company incurs a liability if certain events occur in the future

8. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Notes Payable Notes payable are often issued to: Satisfy an account payable Purchase merchandise or other assets ______: Issuer of the note ______: party receiving the note

9. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Notes Payable Assume that a business issues a 90-day, 6% note for $1,000, dated August 1 to satisfy an account payable

10. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Notes Payable Assume that a business issues a 90-day, 6% note for $1,000, dated August 1 to satisfy an account payable

11. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Income Taxes Includes federal income taxes and possibly state and local income taxes Most corporations are required to pay ______ _____ taxes in four installments throughout the year Taxable income of a corporation is determined according to the __________ Income before taxes reported on the income statement is usually different from ______ income

12. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Income Taxes Assume that a corporation, with a calendar-year accounting period, estimates its income tax expense for the year as $84,000 The effect on the accounts and the financial statements of the first of the four estimated tax payments of $21,000 (1/4 of $84,000) is as follows:

13. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Taxable Income vs. Income Before Taxes Taxable Income – determined according to __________________ (IRS Code) Income Before Taxes – determined according to __________________ Differences between the two may need to be allocated between various financial statement periods

14. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accounting for Temporary Differences

15. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contingent Liabilities Accounting Treatment of Contingent Liabilities

16. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Payroll Amount paid to employees for services they provide during a period ______ – payment for managerial, administrative, or similar services ______ – payment for manual labor, both skilled and unskilled Payroll and related taxes significantly impact the net income of most businesses

17. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Recording Payroll Assume that McDermott Co. had a gross payroll of $13,800 for the week ending April 11. Assume that the FICA tax was 7.5% of the gross payroll and that federal and state withholding were $1,655 and $280, respectively

18. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Payroll Taxes ___________ become a liability when the related payroll is paid to employees The liability is relieved when the taxes are paid to the appropriate agencies Employer Taxes ________ Employee Taxes ________

19. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Recording Payroll Taxes The effect on the accounts and financial statements of McDermott Co. of recording the payroll tax liabilities for the week follows:

20. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe and illustrate the financing of operations through issuance of bonds LEARNING OBJECTIVE 3

21. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Bonds A form of interest-bearing note Bonds include ______ that must be paid on a regular basis Bonds’ _______ must be repaid at maturity ____________: Contract between the company issuing the bonds and the bondholders A bond issue is normally divided into several individual bonds The most common face value is _____ per bond

22. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Calculating the Bond Issue Price The price that buyers are willing to pay for the bonds depends on three factors: ___________ of the bonds due at the maturity date ___________ to be paid on the bonds – stated in the bond indenture This is called the ________ or ________ rate _____/_____ rate of interest

23. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Recording Bond Issuance Assume that a business issues $100,000 of 6%, 5-year bonds, with interest of $3,000 payable semiannually. The market rate of interest at the time the bonds are issued is 6% Issuance of bonds payable at face amount on January 1.

24. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Recording Bond Issuance Assume that a business issues $100,000 of 6%, 5-year bonds, with interest of $3,000 payable semiannually. The market rate of interest at the time the bonds are issued is 6%

25. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Recording Bond Issuance Assume that a business issues $100,000 of 6%, 5-year bonds, with interest of $3,000 payable semiannually. The market rate of interest at the time the bonds are issued is 6%

26. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Bonds Not Issued at Face Value Market Rate = _______ Rate Selling Price = _______________ Discount on Bonds Payable Market rate of interest __ contract rate Buyers are only willing to pay ____ than the face value for the bonds Premium on Bonds Payable Market rate of interest __ contract rate Buyers are willing to pay ____ than the face value for the bonds

27. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe and illustrate the financing of operations through issuance of stock LEARNING OBJECTIVE 4

28. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Stock _______ – total number allowed to issue _______ – shares issued to shareholders _______ – shares currently in the hands of stockholders

29. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Shares of Stock Can be issued with or without assigning a monetary amount: _____: monetary value stated on stock certificate _____: some states might require a stated value Legal Capital Minimum stockholder contribution required by some states

30. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Stock Rights Right to _____ in matters concerning the corporation Right to share in distributions of ______ Right to share in assets on ______

31. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Common Stock Common Stock Preferred Stock Preferred Stock Common and Preferred Stock Each share has ________ rights Has preference rights over __________ ______ rights stated in monetary terms or as % of par

32. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Issuance of Stock The price at which stock sells depends on a variety of factors: The financial condition, earnings record, and dividend record of the corporation Investor expectations of the corporation’s potential earning power General business and economic conditions and prospects

33. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Issuance of Stock Assume that a corporation issues 2,000 shares of $1 par value common stock for $55 per share

34. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Reacquired Stock ____________ Stock that a corporation has issued and then reacquired Balance at year-end is reported as a _______ of stockholders’ equity A corporation may reacquire (purchase) its own stock for a variety of reasons To provide shares for ______ to employees To reissue as bonuses to ______ To support the __________ of the stock

35. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe and illustrate the accounting for cash and stock dividends LEARNING OBJECTIVE 5

36. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Dividends _____ dividend: When a board of directors authorize the distribution of cash to stockholders _____ dividend: When a board of directors authorize the distribution of its stock to the stockholders

37. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Dividends Cash distribution of earnings by a corporation to its ___________ Most common form of dividend Usually three conditions: ______________ Formal action by the ___________

38. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Dates in Dividend Announcement _________ _________ _________ ____ _________ _________ _______ _________ _________ _________

39. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Dividends Assume a company declares the following cash dividend on December 1 for payment on February 2:

40. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Stock Dividends Distribution of stock to __________ No distribution of cash or other assets Requirements: _________________ Formal action by ___________ Amount transferred for small stock dividends (<25% of outstanding shares) is _________ per share

41. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Stock Dividends To illustrate, assume a stockholder owns 1,000 of a corporation’s 10,000 shares outstanding. If the corporation declares a 6% stock dividend, the stockholder’s proportionate interest will not change, as shown below:

42. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe the effects of stock splits on the financial statements LEARNING OBJECTIVE 6

43. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. _____ Process by which a corporation reduces the par or stated value of its common stock and issues a proportionate number of additional shares Major objective is to _____ the stock’s market price per share in order to attract more investors

44. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Stock Splits

45. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Describe financial statement reporting of liabilities and stockholders’ equity LEARNING OBJECTIVE 7

46. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Reporting Liabilities and Stockholders’ Equity Liabilities _______ liabilities are due within 1 year _______ liabilities are due beyond 1 year Stockholders’ Equity Part of the balance sheet Details of the changes in stockholders’ equity are disclosed in a separate statement

47. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Balance Sheet

48. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Statement of Stockholders’ Equity

49. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Analyze the impact of debt or equity financing on earnings per share LEARNING OBJECTIVE 8

50. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Earnings Per Share Measures the income earned by each share of _________ Major profitability measure reported in the financial statements _________ – _____________ _______________________ Earning per Share =

51. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Alternative Financing Plans Plan 1:100% financing from issuing common stock, $10 par value Plan 2:50% financing from issuing 4% preferred stock, $50 par value 50% financing from issuing common stock, $10 par value Plan 3:50% financing from issuing 6% bonds 25% financing from issuing 4% preferred stock, $50 par value 25% financing from issuing common stock, $10 par value

52. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Financial Analysis: Describe and illustrate the use of the ratio of liabilities to total assets and the price-earnings ratio in assessing a company’s financial condition and prospects for future performance LEARNING OBJECTIVE 9

53. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Liabilities to Total Assets Useful in assessing a company’s financial condition and risk Indicates the percent of a company’s total _____ that are financed with _____ A high ratio indicates the company is financing its operations with a high percent of debt. Also, a high ratio indicates that the company may not be able to easily borrow additional funds ___________ = Ratio of Liabilities to Total Assets

54. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Liabilities to Total Assets The following data (in millions) were taken from two of Lowe’s recent financial statements Year 1 ($______ ÷ $______) Year 2 ($______ ÷ $______) Ratio of Liabilities to Total Assets _______

55. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. ____________ = Ratio of Liabilities to Stockholders’ Equity ________________ Ratio of Liabilities to Stockholders’ Equity

56. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Liabilities to Stockholders’ Equity The following data (in millions) were taken from two of Lowe’s recent financial statements Year 1 ($_____ ÷ $______) Year 2 ($_____ ÷ $______) Ratio of Liabilities to Stockholders’ Equity ______

57. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Price-Earnings Ratio Indicates the market’s assessment of the future earnings potential of a company _____________________________ = Price-Earnings Ratio _____________________________

58. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Price-Earnings Ratio The higher a company’s price-earnings ratio, the more favorable the market’s assessment of the future earnings potential and growth of the company Year 2Year 1 $1.43 $38.44 $1.42 $26.35 Market Price per Share of Common Stock Earnings per Share of Common Stock Year 1 ($_____ ÷ $_____) Year 2 ($_____ ÷ $_____) Price-Earnings Ratio ______

59. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. End of Chapter 8