Accounting Ch.11

What is the role of stock in financing a corporation?

Stock allows corporations to raise large amounts of money by enabling investors to easily participate in ownership.

What are the benefits of corporate ownership?

Limited legal liability, ability to raise capital, transferable ownership interests, and separate legal entity status.

How does a corporation's separate legal entity status benefit it?

It can own assets, incur liabilities, sue or be sued, and enter contracts independently of its owners.

What is required to create a corporation?

An application must be submitted to a state government, and if approved, a charter is issued.

What is common stock?

The basic voting stock issued by a corporation, giving stockholders voting rights, dividends, and residual claims.

What are voting rights in common stock?

For each share owned, stockholders get a set number of votes on major issues.

What are dividends in the context of common stock?

Stockholders receive a share of the corporation's profits distributed as dividends.

What is a residual claim for common stockholders?

Stockholders share in any assets remaining after creditors have been paid if the company ceases operations.

What are preemptive rights in common stock?

Existing stockholders may have the first chance to buy newly issued stock to retain their ownership percentages.

What is the difference between equity and debt financing?

Equity financing involves issuing new stock, while debt financing involves borrowing money from lenders.

What is reported in the stockholders' equity section of the balance sheet?

Contributed capital, retained earnings, treasury stock, and accumulated other comprehensive income.

What does contributed capital represent?

The amount of capital that stockholders have contributed to the corporation.

What are retained earnings?

The cumulative amount of net income earned by the company less cumulative dividends since its inception.

What is treasury stock?

Shares that were previously issued but have been reacquired by the corporation.

What is the purpose of stock authorization?

To define the specific rights and characteristics of stock before it can be issued.

What is par value in stock?

An insignificant value per share specified in the corporate charter, originally to prevent capital removal.

What is no-par value stock?

Capital stock that has no par value specified in the corporate charter.

What is an initial public offering (IPO)?

The very first issuance of a company's stock to the public.

What happens to stock after the initial issuance?

Investors can exchange shares for cash without affecting the corporation's financial statements.

What are stock options?

Options that give employees the right to acquire the company's stock at a predetermined price.

Why might a corporation repurchase its stock?

To signal confidence, obtain shares for acquisitions or employee plans, and reduce outstanding shares.

How are repurchased shares recorded?

As treasury stock using the cost incurred to acquire the shares.

What is the significance of outstanding shares?

Shares currently held by stockholders, excluding treasury stock.

What are authorized shares?

The maximum number of shares that a corporation is allowed to issue as specified in its charter.

What are issued shares?

Shares of stock that have been distributed by the corporation.

What is the impact of stock transactions on financial statements?

Transactions between a company and its stockholders affect only the balance sheet, not the income statement.

What is accumulated other comprehensive income (AOCI)?

It accumulates other income-related items not yet included in net income, representing potential future gains and losses.

What is the purpose of reducing the number of outstanding shares?

To increase per-share measures of earnings and stock value.

What method do companies use to record repurchased shares held as treasury stock?

The cost method.

Is treasury stock considered an asset?

No, treasury stock is not an asset; it is a contra-equity account.

What happens when a company reissues treasury stock?

It does not report a gain or loss from the reissuance.

What is the effect on Additional Paid-In Capital (APIC) when treasury stock is reissued below its repurchase price?

The difference is recorded as a reduction in APIC.

What are the two key financial requirements for declaring a cash dividend?

Sufficient retained earnings and sufficient cash.

What is the declaration date in relation to cash dividends?

The date the board of directors approves a dividend, creating a legal liability.

What is the record date for dividends?

The date on which the corporation prepares the list of current stockholders.

What occurs on the payment date for cash dividends?

The cash dividend is paid to the stockholders of record.

What happens to the Dividends account at year-end?

It is closed into Retained Earnings.

What is a stock dividend?

A dividend that distributes additional shares of a corporation's own stock to shareholders at no cost.

How are large stock dividends (more than 25%) recorded?

At par value.

How are small stock dividends (less than 25%) recorded?

At market value.

What is the purpose of issuing stock dividends?

To lower the market price per share and conserve cash.

What is a stock split?

An increase in the total number of authorized shares by a specified ratio, without affecting retained earnings.

Does a stock split affect a company's total resources?

No, cash is not affected by a stock split.

What is preferred stock?

Stock that has specified rights over common stock, including priority in dividends.

How do dividends on preferred stock typically differ from common stock?

Dividends on preferred stock may be paid at a fixed rate.

What voting rights do preferred stockholders typically have?

Preferred stock may allow different voting rights compared to common stock.

What is the relationship between preferred stock and common stock in terms of priority?

Preferred stock has priority over common stock.

What is the effect of declaring a cash dividend on retained earnings?

The Dividends account is subtracted from Retained Earnings.

What is the journal entry for declaring a cash dividend of $280 million?

Debit Dividends $280 million, Credit Dividends Payable $280 million.

What is the journal entry for paying a cash dividend?

Debit Dividends Payable $280 million, Credit Cash $280 million.

What is the impact of a stock dividend on total stockholders' equity?

It does not change total stockholders' equity.

What is the purpose of a stock split in terms of share price?

To make shares more affordable to investors.

What is the accounting treatment for a stock split?

There is no journal entry required for a stock split.

What happens to the par value of shares during a stock split?

The per-share par value is reduced, but the total par value remains unchanged.

What must be paid to preferred stockholders before common stockholders?

Dividends declared by the corporation.

In the event of a corporation going out of business, who gets paid first?

Creditors and then preferred stockholders; common stockholders are paid last.

How does issuing preferred stock affect a company's financials?

It increases the company's cash and stockholders' equity.

What is the accounting entry when a company issues preferred stock?

Debit Cash, Credit Preferred Stock, and Credit Additional Paid-In Capital (APIC).

What does preferred stock redemption refer to?

The reacquisition of previously issued preferred stock, formally retiring it.

What is the accounting entry for redeeming preferred stock?

Debit Preferred Stock and APIC, Credit Cash.

What is the current dividend preference in preferred stock?

It grants priority on preferred dividends over common dividends.

What happens to dividends if preferred stock is designated as cumulative?

Unpaid dividends accumulate and must be paid before common dividends.

What are dividends in arrears?

Dividends on cumulative preferred stock that have not been declared in prior years.

What is the definition of Retained Earnings?

Total earnings retained in the business rather than distributed to stockholders.

What increases Retained Earnings?

Net income reported by the company.

What is an Accumulated Deficit?

A negative balance in Retained Earnings due to more net losses than net income.

What does the statement of stockholders' equity show?

Causes of changes in all stockholders' equity accounts.

How is Earnings per Share (EPS) calculated?

EPS = (Net Income - Preferred Dividends) ÷ Average Number of Common Shares Outstanding.

What does a higher EPS indicate?

Greater profitability.

What is the Return on Equity (ROE) Ratio?

ROE = (Net Income - Preferred Dividends) ÷ Average Common Stockholders' Equity.

What does a higher ROE suggest?

Stockholders are likely to enjoy greater returns.

What does the Price/Earnings (P/E) Ratio measure?

How many times more than the current year's earnings investors are willing to pay for a company's common stock.

What is the accounting treatment for large stock dividends?

Recorded at the stock's par value.

What defines a large stock dividend?

When the issue is more than 25% of the outstanding shares.

How are small stock dividends accounted for?

At the market value of the company's stock.

What must be recorded as Additional Paid-In Capital during small stock dividends?

The excess of market value over par value.

What happens to dividends if preferred stock is non-cumulative?

Any dividends not declared in previous years are lost permanently.

What is the impact of financial leverage on ROE?

It can increase ROE if profits from borrowed funds exceed interest expenses.

What does a higher P/E ratio indicate?

Investors anticipate an improvement in the company's future results.

What is the effect of declaring cash or stock dividends on Retained Earnings?

It decreases the Retained Earnings account.

What is the formula for calculating the cash needed for preferred stock redemption?

Cash = Number of shares redeemed × Price per share.

What is the significance of the par value in stock dividends?

It is used to record large stock dividends.

What is the treatment of dividends in arrears on the balance sheet?

They are disclosed in the notes to the financial statements, not reported as liabilities.