ACCT 202B Chapter 18

debt and equity

A corporation raises money to fund its business operations by some mix of these. They are external funding

debt

notes, bonds, leases, and other liabilities

equity

ownership interests of shareholders

shareholders’ equity

a residual amount - what’s left over after liabilities have been subtracted from assets

shareholders’ equity equation

assets - liabilities = shareholders’ equity

net assets

assets - liabilities

paid-in capital and retained earnings

the two sources that ownership interests of shareholders primarily arise from

stockholders’ equity, shareowners’ equity, shareholders’ investment, stockholders’ investment, shareholders’ equity

alternate titles for shareholders’ equity

Pfizer

stockholders’ equity example

General Electric

shareowners’ equity example

Target

shareholders’ investment example

FedEx

stockholders’ investment example

Apple

shareholders’ equity example

paid-in capital

consists primarily of amounts invested by shareholders when they purchase shares of stock from the corporation or arise from the company buying back some of those shares or from share-based compensation activities

retained earnings

represents earned capital and is accumulated on behalf of shareholders and reported as a single amount

treasury stock

indicates that some of the shares previously sold were brought back by the corporation from shareholders

comprehensive income

represents the total nonowner changes in equity for a reporting period. Includes all changes in shareholders’ equity other than those from transactions with owners

other comprehensive income

some nonowner changes not included in traditional net income

accumulated other comprehensive income

the sum of all the OCI that has been reported in current and prior periods

Four gains and losses not included in income statements

net holding gains (losses) available-for-sale investments in debt securities

gains (losses) from and amendments to pensions and other postretirement benefit plans

deferred gains (losses) on derivatives

adjustments from foreign currency translation

Two attributes of OCI reported

components of comprehensive income created during the reporting period

the comprehensive income accumulated over the current and prior reporting periods

OCI reported

components of comprehensive income created during the reporting period

AOCI reported

the comprehensive income accumulated over the current and prior reporting periods

additional paid-in capital

companies keep track of individual additional paid-in capital accounts in company records but ordinarily report these amounts as this single subtotal

statement of shareholders’ equity

reports the transactions that cause changes in its shareholders’ equity account balances

three ways a company can be organized

sole proprietorship

partnership

corporation

limited liability

the single most important advantage of corporate organization. Owners are not personally liable for debts of a corporation. A corporation is a separate legal entity responsible for its own debts

limited liability - shareholdres’ liability

limited to the amounts they invest in the company when they purchase shares

ease of raising capital

Because corporations sell ownership interest in the form of shares of stock, ownership rights are easily transferred

Paperwork and documentation

Taxation

The two disadvantages of the corporate form of business

Paperwork and documentation

To protect the rights of those who buy a corporation’s stock or who loan money to a corporation, the company’s state of incorporation and the federal government impose extensive reporting requirements

Double taxation

Caused by corporations being separate legal and taxable entities

Taxation

Corporations pay income taxes on their earnings. If those earnings are distributed as cash dividends, shareholders pay personal income taxes on the previously taxed earnings

Corporations

those formed by private individuals for the purpose of generating profit

Public corporation

the stock of publicly held corporations is available for purchase by the general public

Private corporation

shares of privately held companies are owned by only a few individuals and are not available to the general public

Private to public

Frequently, companies begin as smaller, privately held corporations. Then as success broadens opportunities for expansion the corporation goes public

churches, hospitals, universities, and charities

corporations not organized for profit and do no sell stock

S corporation

have characteristics of both regular corporations and partnerships. Owners have limited liability protection of a corporation but avoid double taxation. limitation on number of owners

how do owners avoid double taxation?

income and expenses are passed through to the owners

limited liability company

owners are not liable for the debts of the business, except to the extent of their investment

how a limited liability company differs from a limited partnership

all members of a limited liability company can be involved with managing the business without losing liability protection

limited liability company vs S corporation

Avoids double taxation in the same way as S corporations but has no limitations on the number of owners

limited liability partnership

partners are liable for their own actions but not entirely liable for the actions of other partners

Model Business Corporation Act (MBCA)

serves as a guide to states in the development of their corporate statutes. Although state laws are not uniform, most states have adopted this as the basis for their state laws.

articles of incorporation

describe…

the nature of the firm’s business activities

the shares to be authorized and the par value (if any) of those shares

the composition of the initial board of directors

common shares

if a corporation has only one class of shares, this is how they’re labeled

ownership rights held by common shareholders are as follows

the right to vote on matters that come before the shareholders, including the election of corporate directors

the right to share in profits when dividends are declared

the right to share in the distribution of assets if the company is liquidated

preemptive right

a common shareholder’s right to maintain one’s percentage share of ownership when new shares are issued

If more than one class of shares is authorized by the articles of incorporation…

the specific rights of each must be stated

Terminology of different share types

Class A, class B, etc.

Preferred stock, class A, and class B common stock

Common and preferred

Preferred stock, common stock, and capital stock

Common and serial preferred

Airbnb

Class A, class B, etc. example

Alphabet

Preferred stock, class A, and class B common stock example

Costco

Common and preferred example

Zillow Group

Preferred stock, common stock, and capital stock example

Smucker’s

Common and serial preferred example

Preferred stock

Shares with certain preferences or features that distinguish them from common shares

Common rights of preferred shareholders include…

typically have a preference to a specified amount of dividends. If the board of directors declares dividends, preferred shareholders will receive the designated dividend before any dividends are paid to common shareholders

customarily have a preference as to the distribution of assets in the event the corporation is dissolved

right of conversion

allows preferred shareholders to exchange shares of preferred stock for common stock at a specified conversion ratio

redemption privilege

allows shares to be returned for a predetermined price

Cumulative (or noncumulative)

if the specified dividend is not paid for a given year, the dividends in arrears accumulate and must be made up in a later year before any dividends are paid on common shares

dividends in arrears

unpaid dividends

participating (or nonparticipating)

allows preferred shareholders to receive additional dividends beyond the stated amount

hybrid securities

preferred shares are a cross between equity and debt

hybrid securities - equity

preferred shareholders receive dividends each year the company pays dividends

hybrid securities - debt

the company is obligated to buy back the shares at a specified future date with cash (or other assets) at a fixed or determinable date in the future

mandatorily redeemable financial instrument

must be reported in the balance sheet as a liability, not as shareholders’ equity

Par value back then

originally indicated the real value of shares

Par value now

there is no relationship between the par value of a stock and its fair value

Shares with very low par values

used to dodge state laws restricting distributions based on par value

Par value and legal capital’s similarity to designations of common and preferred shares

have been eliminated entirely from the Model Business Corporation Act

journal entry to record issuance of shares for cash

debit cash

credit common stock

credit pain-in capital - excess of par

journal entry to record issuance of no-par shares

debit cash

credit common stock

situations where company might issue shares for noncash consideration

pay for promotional and legal services

payment for land or equipment

for some other noncash asset

noncash consideration treatment

still should be recorded at the grant-date fair value of the shares to be issued. consistent with the accounting requirement for employee share-based payment awards and with the general rule for accounting for noncash transactions

when a company sells more than one security for a single price

the cash received is typically the sum of the separate market values of the two securities. Each is then recorded at its market value.

when only one security’s value is known

the second security’s market value is inferred from the total selling price

what happens when company sells shares?

incurs legal, promotional, and accounting services necessary to effect the sale

effect of services incurred

reduces net proceeds from selling the shares and reduces amount credited to paid-in capital - excess of par account

when a company feels its stock’s market price is undervalued

may decrease the supply of stock in the marketplace

when a company tries to increase net assets by buying its shares at a low price and sell them back at a higher price…

purchase of shares is not viewed as an asset

how is a share buyback viewed?

as a way to distribute company profits without paying dividends

primary motivation for most stock repurchases?

offset the increase in shares that routinely are issued to employees under stock awards and stock option compensation programs

Tax Cuts and Jobs Act of 2017

ignited an unprecedented volume of share buybacks

Bank of America’s stock buyback program

designed to offset the effect of its stock option and stock plan purchases

a stock dividend

a proposed merger

as a defense against a hostile takeover

things that reacquired shares can be distributed in

a company’s choice for how to account for the buyback

the shares can be formally retired

the shares can be called treasury stock

accepting for share buybacks as treasury stock

viewed as a temporary reduction shareholders’ equity

cost of acquiring shares

“temporarily” debited to a negative shareholders’ equity account labeled treasury stock

issued, but not outstanding

shares as treasury stock designation

single transaction

what the purchase of treasury stock and its subsequent resale are considered

cost to repurchase < amount received from the initial sale

that remaining investment increases equity in the paid-in capital-share repurchase account

cost to repurchase > amount received from the initial sale + any paid-in capital created by previous repurchases

that additional amount paid decreases equity through a reduction of retained earnings

subsequent sale of shares after shares are retired

recorded exactly like any sale of shares

resale of treasury shares

viewed as the consummation of the single transaction that began when the treasury shares were repurchased