ACC 356 Exam 2 Study Guide

What is stockholder’s equity?

difference between the assets of a company and its liabilities

Stockholders equity contains

CS, PS, APIC, retained earnings, treasury stock, accumulated OCI

What are some advantages of the corporate form of a business?

Limited liability & ease of capital accumulation

What are some disadvantages of the corporate form of a business?

double taxation, hard to form, heavily regulated, separation from management

Contributed (paid-in) capital

total amount paid in on capital stock—the amount provided by stockholders to the corporation for use in the business. includes items such as the par value of all outstanding stock and additional paid-in capital.

Earned capital

develops from profitable operations. It consists of all undistributed income that remains invested in the company.

Common stock characteristics: voting

right to vote in election of board of directors at annual meeting on action requiring stockholder approval

Common stock characteristics: residual claim

Owners are paid with assets that remain after all other claims (liabilities) have been paid

Common stock characteristics: preemptive right

Right to acquire a proportionate share of new issues of common stock. Without this right, existing stockholders might find their ownership interest reduced, or diluted, by the issuance of additional stock without their knowledge and at prices unfavorable to them.

Common stock characteristics: term

perpetual; no maturity or redemption date

Common stock characteristics: dividends

right to receive dividends when approved by BOD; dividends vary and aren’t guaranteed

What is the difference between par value and no-par value common stock?

Par value stock has a fixed nominal value, no-par does not

What are lump-sum sales of securities?

issuance of more than one type of security at the same time for a single, combined price

What is the proportional method of allocating the issuance price of a lump sale of securities? When is it used?

used when the fair value of each class of security is known. allocates the lump sum received based on the relative market value of each security

What is the incremental method of allocating the issuance price of a lump sale of securities? When is it used?

When the fair market value of one or more classes of securities involved in a lump-sum sale is unknown

Preferred stock characteristics: dividends

receive dividends before common stockholders.may not be paid each year, but always before common

Preferred stock characteristics: nonvoting

no voting rights

Preferred stock characteristics: liquidation

have a claim on the comp’s assets after creditors are paid and before common claims are paid

Preferred stock characteristics: term

perpetual/ redeemable by the owner bc of some specific event. Sometimes preferred stock is mandatorily redeemable and is reported as a liability

What is treasury stock?

shares that a company has repurchased from the open market, reducing the total number of outstanding shares available to investors

What are some reasons companies might choose to repurchase their own stock?

Reduce cost of capital, increase EPS, confidence, offset dilution, tax efficiency

What issue arises when treasury stock is resold below/above its original purchase price?

Both increase total assets and stockholders equity

What does it mean to retire treasury stock?

Cancel treasury stock & reduction in the number of shares of issued stock

What are dividends?

payments made by a company to its shareholders, representing a portion of the company’s profits

Are dividends an expense to the company?

No, they are a distribution of a company's profits to shareholders

What type of accounting happens on the date of declaration?

the declared cash dividend becomes a liability, so a journal entry is made. Because payment is generally required very soon, it is usually a current liability.

What type of accounting happens on the date of record?

determines the current stockholders. Stockholders on the date of record receive the dividend. No journal entry is required on the date of record

What type of accounting happens on the date of payment?

date dividend checks are mailed or deposited electronically to stockholders. A journal entry is made to record the payment of cash and reduction of the liability

What are cash dividends?

Board of directors vote on the declaration of cash dividends. A declared cash dividend is a liability. Companies do not declare or pay cash dividends on treasury stock

What are property dividends?

Dividends payable in assets other than cash. Restate at fair value the property it will distribute, recognizing any gain or loss.

What are liquidating dividends?

Any dividend not based on earnings reduces corporate paid-in capital. The portion of these dividends in excess of accumulated income represents a return of part of the stockholder’s investment

What are stock dividends?

Issuance by a company of its own stock to stockholders on a pro rata basis, without receiving any consideration. Used when management wishes to “capitalize” part of earnings. If stock dividend is less than 20 to 25 percent of the common shares outstanding, company transfers fair market value from retained earnings (small stock dividend)

What are stock splits?

reduce the market value of shares. No entry. Decrease par value & increase # of shares.

What is a small stock dividend?

Less than 20 to 25 percent of the number of shares previously outstanding.

What is a large stock dividend?

More than 20 to 25 percent of the number of shares previously outstanding

What are dilutive securities?

Convertible debt are bonds (or notes) that have the added feature of being able to convert into common stock during a specified period.

Define dilutive securities: convertible bonds

added feature of being able to convert into common stock during some specified period (generally five years)

Define dilutive securities: convertible preferred stock

includes an option for the holder to convert preferred shares into a fixed number of common shares

Define dilutive securities: stock options

give key employees the option to purchase common stock at a given price over an extended period of time.

Define dilutive securities: restricted stock

the company transfers stock (or units) to employees subject to an agreement that the stock cannot be sold, transferred, or pledged until vesting occurs

Define dilutive securities: stock warrants

gives investors the option to purchase a company’s stock at a specific price over a specific period

What is the difference between convertible debt and debt issued with stock warrants?

Convertible debt is a liability, debt issued with stock warrants is equity

What are detachable warrants?

Warrants may be sold separately from the bonds

What are nondetachable warrants?

Warrants can only be sold with the bonds

What are the accounting consequences of detachable warrants?

Proceeds get allocated

What are the accounting consequences of nondetachable warrants?

No proceeds allocation

Why might companies include stock-based compensation as part of their compensation package?

1. Base compensation on performance. 2. Motivate employees. 3. Help retain executives and recruit new talent. 4. Maximize employee’s after-tax benefit. 5. Use performance criteria over which employee has control.

What is a vesting period?

time an employee must work for a company before gaining full ownership of employer-provided benefits, such as retirement contributions or stock options

What are stock options?

gives key employees option to purchase common stock at a given price over extended period of time

What are restricted stock plans?

the company transfers stock (or units) to employees subject to an agreement that the stock cannot be sold, transferred, or pledged until vesting occurs.

From the employee’s perspective, which form of stock-based compensation is more generous between stock options and stock based compensation?

Stock options

What is basic earnings per share?

income earned by each share of common stock

What is the basic earnings per share formula?

Net income – preferred dividends / weighted avg # of shares outstanding

What are weighted average shares outstanding?

weighing the shares by the fraction of the period they are outstanding finds the equivalent number of whole shares outstanding for the year.

How do stock dividends and stock splits affect weighted average shares outstanding?

must treat as if they happened at the beginning of the period

What is the difference between basic earnings per share and diluted earnings per share?

Basic EPS fails to recognize the potential impact of a corporation’s dilutive securities.

Which financial statement are these financial ratios usually reported on?

Income statement and balance sheet

When is a company required to disclose EPS/DEPS?

when it has issued common stock that trades in a public market, or when it has made a filing or will fill with a regulatory agency in preparation for the sale of common stock in a public market.

What are stock appreciation rights?

the company gives an executive the right to receive compensation equal to the share appreciation, which is the excess of the market price of the stock at the date of exercise over a pre-established price

Why do companies use stock appreciation rights?

To lessen tax or interest cost

What is the difference between debt and equity investments?

Debt: commercial paper, money market funds, CD’s, treasury bills, asset backed securities, commercial/municipal bond investments. Equity: common & preferred stock

Held-to-maturity valuation

amortized cost using effective interest method

Held-to-maturity unrealized holding gains/losses

not recognized

Held-to-maturity other income effects

interest when earned;gains and losses from sale

Available-for-sale valuation

fair value

Available-for-sale unrealized holding gains/losses

recognized as OCI and as separate component of SE

Available-for-sale other income effects

interest when earned; gains and losses from sale

Trading securities valuation

fair value

Trading securities unrealized holding gains/losses

recognized in net income

Trading securities other income effects

interest when earned; gains and losses from sale

What are unrealized holding gains and losses?

Potential profit/losses from investments that have not been sold

Why are gains/losses considered unrealized?

they have not been realized into actual cash

How would we define held-to-maturity debt securities?

Only debt securities, bc equity securities have no maturity date. A positive intent to hold these securities to maturity. 2. The ability to hold these securities to maturity.

How are HTM securities valued on the balance sheet?

Investment assets recorded at amortized cost

How does this affect unrealized holding gains/losses?

Because HTM securities are carried at amortized cost, unrealized holding gains and losses are not recognized—not in net income, not in OCI

How would we define trading securities?

Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences

How are trading debt securities valued on the balance sheet?

Current assets, fair value

How do trading debt securities being valued at fair value affect unrealized holding gains/losses?

always affect net income and therefore retained earnings.

How would we define available for sale debt securities?

Debt securities not classified as held-to-maturity or trading securities.

How are AFS securities valued on the balance sheet?

OCI, fair value

How do AFS securities being valued at fair value affect unrealized holding gains/losses?

Do not affect current period profit, but go into OCI (equity)

What level of influence is assumed at less than 20% equity ownership?

Little to no influence

How is the “less than 20% ownership of equity investments” investment valued on the balance sheet?

Fair value method

How do less than 20% ownership of equity investments affect unrealized holding gains/losses?

Go to net income

What level of influence is assumed between 20% and 50% equity ownership?

significant

How is the 20% to 50% equity investment valued on the balance sheet?

equity

How does 20% to 50% equity ownership affect unrealized holding gains/losses?

Not recognized

What other income effects do we account for with this level of investment?

Proportionate share of investees net income

What level of influence is assumed at greater than 50% equity ownership?

control

How is the greater than 50% equity investment valued on the balance sheet?

consolidation

How do greater than 50% equity investments affect unrealized holding gains/losses?

Not recognized

What other income effects do we account for with this level of investment?

n/a

What is a credit impairment?

deterioration in the credit quality of a financial asset

How is a change in creditworthiness for HTM securities handled?

current expected credit loss (CECL) model to measure impairment

Held-to-maturity impairment je

DR BDE, CR allowance for doubtful accounts for the amount of impairment

Held-to-maturity impairment je (probable that a company will be unable to collect all amounts due under the terms of the transaction)

permanent write-off. DR Allowance for Doubtful Accounts, CR Accounts Receivable

How is a change in creditworthiness for AFS securities handled?

collection of the cash flows OR sale of the securities.

Why do we need “special” accounting for changes in the creditworthiness of trading securities?

No need for special treatment. They are marked at fair value and recognized as net income

What is an accounting change?

modification in an organization’s accounting policies, estimates, or reporting methods

What is the difference between a change in accounting principle and a change in accounting estimate?

Accounting principle: A change from one generally accepted accounting principle to another one. Accounting estimate: change that occurs as the result of new information or additional experience