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Treasury Stock

  • Definition: Treasury stock refers to shares that were previously issued and outstanding but have been repurchased by the company itself.

    • These shares are taken back to the issue level, meaning they are no longer in the hands of shareholders but are held by the company.

  • Purpose of Repurchasing Shares:

    • Support market price of shares.

      • Reducing the number of shares outstanding increases the value of remaining shares, especially affecting dividend distributions and voting power.

    • Example: If dividends are spread over 800 shares instead of 1000, each share becomes more valuable.

Key Components of Treasury Stock Transactions

  • Cost Method: The approach used to track treasury stock transactions. It involves recording the repurchase cost and revenue from resale based on the acquisition cost.

    • Example: On May 27, Hydro Clothing Inc. reacquired 60,000 shares at $8 each, totaling $480,000.

      • **Journal Entry: **

        • Debit: Treasury Stock $480,000

        • Credit: Cash $480,000

  • Subsequent Sale of Shares:

    • On August 3, Hydro Clothing sold 42,000 shares at $12 per share, totaling $504,000.

      • Journal Entry:

        • Debit: Cash $504,000

        • Credit: Treasury Stock $336,000 (42,000 shares × $8/share)

        • Note: The difference of $168,000 from the sale goes to the paid-in capital account, not through the income statement, to avoid appearing unethical.

          • Account title: Paid in Capital from Sale of Treasury Stock.

    • On November 14, the remaining shares (18,000) were sold at $6 each, totaling $108,000.

      • Journal Entry:

        • Debit: Cash $108,000

        • Credit: Treasury Stock $144,000 (18,000 shares × $8/share)

        • Loss of $36,000 since shares sold below cost.

        • Debit: Paid in Capital from Sale of Treasury Stock account to cover $36,000 loss.

Reporting Stockholders' Equity

  • Different reporting methods depending on what provides better decision-making insight:

    • Increased transparency for shareholders and decision-makers where necessary.

    • Simpler reporting when detailed disclosures do not impact decisions significantly.

  • Balance Sheet Face Disclosure:

    • Disclosure right on the balance sheet regarding treasury stock. Example: Detail the number of shares and their par value.

  • Retained Earnings:

    • Reflects the cumulative net income/loss and dividends paid.

      • Schedule might be provided illustrating changes in the retained earnings account, often required in comprehensive problems in accounting courses.

Prior Period Adjustments and Retained Earnings

  • Explanation of prior period adjustments when an error is found after closing accounts.

    • Must adjust retained earnings account, ensuring the current beginning balance reconciles with previous years.

  • Types of Restrictions on Retained Earnings:

    • Legal Restrictions: Obligatory retained earnings maintained for creditor protection.

    • Contractual Restrictions: Loan covenants requiring a certain retained earnings level.

    • Discretionary Restrictions: Board's intention to restrict dividends for future investments.

      • Example from a non-profit scenario.

Importance of Disclosures

  • Disclosures inform equity stakeholders regarding retained earnings and potential dividend payment intentions.

    • One line note can change perceptions of financial situations significantly.

Earnings per Share (EPS)

  • Definition: A profitability metric used by investors and creditors.

    • Formula: EPS=NetIncome−PreferredDividendsAverageCommonSharesOutstandingEPS = \frac{Net Income - Preferred Dividends}{Average Common Shares Outstanding}

    • Significance: Lower shares outstanding (due to treasury stock) can make each remaining share more valuable, improving EPS.

    • Example: McDonald's EPS might reflect an increasing trend over the years.

Statement of Cash Flows

  • Definition: Financial statement detailing cash inflow and outflow within a period, categorized into three sections:

    • Operating Activities: Cash flows from earning activities. Positive cash flow indicates good performance in generating revenue.

    • Investing Activities: Disbursements for purchasing long-term assets. Negative cash flow might indicate investment in the future growth.

    • Financing Activities: Cash used for debt repayment, dividends, or raising funds. Context varies based on whether cash is positive or negative.

  • Importance of analyzing cash flow context, to ensure financial stability and avoid misleading interpretations of a company's financial health.

Vocabulary in Cash Flow Statements

  • Cash inflows often referred to as “provided by” or “issued.”

  • Cash outflows referred to as “used by” or “purchased.”

  • Keywords Definition: Keywords such as "sale" and "purchase" provide insight into whether cash has been provided or used.

Summary and Key Takeaways from Class

  • Importance of cash flow statement order: Operating activities, then investing, then financing activities.

  • Knowledge of restrictions placed on retained earnings and necessary disclosures are critical for accurate financial reporting.

  • EPS as a reliable profitability measure often assessed by investors, with significant attention given to company performance and expectations.

Class Discussion Points

  • Reviewed cash flow statement for McDonald's, showcasing the significance of each section in analyzing the company's financial position and operational efficiency.