Liabilities and Stockholders' Equity

Chapter 8: Liabilities and Stockholders' Equity

• Business Financing:

  • Debt Financing:
  • Involves all liabilities owed by a business.
  • Examples include Notes Payable and Bonds Payable.
  • Equity Financing:
  • Investments from owners.
  • Issuance of stock represents ownership interest.

• Debt Financing (Liabilities):

  • Introduces the concept of debts owed to others.
  • Types of Liabilities:
  • Current Liabilities: Due within a year.
  • Long-term Liabilities: Due after a year.
  • Contingent Liabilities: Dependent on future events.

• Current Liabilities:

  • Defined by the ability to repay from existing current assets or other current liabilities within one year.
  • Examples: Notes Payable, Accounts Payable, Taxes Payable, Unearned Revenues, Payroll Liabilities.

• Accounts Payable and Accruals:

  • Comprises purchases on account, such as merchandise and supplies.
  • Accounts Payable: Obligations recorded as part of adjustments during the accounting period.

• Notes Payable:

  • Formal debt instruments used instead of accounts payable.
  • Typically short-term; involves interest payments.
  • Classifications: Current (due within a year) or Long-term.

• Component of Payroll Accounting:

  • Payroll: Amounts paid for employees' services.
  • Salary vs. Wages:
  • Salary: For managerial roles.
  • Wages: For manual labor.
  • Two types of liabilities: Employee deductions and employer payroll-related taxes.

• Payroll Taxes:

  • Become liabilities when payroll is processed.
  • Categories:
  • Employer Taxes: FICA, Federal and State Unemployment Taxes.
  • Employee Taxes: FICA, Federal and State Income Taxes.

• Recording Payroll Example:

  • McDermott Co. had a gross payroll of $13,800 with specific FICA and withholding amounts.

• Contingent Liabilities:

  • Potential liabilities from past transactions.
  • Classified based on the likelihood of occurrence (Probable, Reasonably Possible, Remote) and ability to measure liability (Estimable, Not Estimable).

• Decision Tree for Accounting Contingent Liabilities:

  • Probable & Estimable: Record expense and liability.
  • Reasonably Possible & Not Estimable: Disclose liability.
  • Remote: No action required.

• Bonds:

  • Form of interest-bearing liability. Include face value due at maturity.
  • Example: Issuing $100,000 6% bonds, with semiannual payments.

• Interest on Bonds:

  • Interest calculations based on face value and stated interest rate.
  • Example of semi-annual payments calculated correctly.

• Bond Pricing:

  • Determined by market demand considering the bond's face amount, periodic interest, and the market rate.
  • Discount on Bonds Payable: Market rate > stated rate leads to lower selling price.
  • Premium on Bonds Payable: Market rate < stated rate leads to higher selling price.

• Components of Stockholders’ Equity - Equity Financing:

  • Capital Stock: Common & Preferred.
  • Treasury Stock: Repurchased stock.
  • Retained Earnings: Profits retained in the business after dividends.

• Stock Types and Rights:

  • Common vs. Preferred: Common shareholders receive voting rights, while preferred shareholders have preference on dividends.
  • Authorized, Issued, and Outstanding shares classifications are critical.

• Issuance of Stock:

  • Influenced by the company's financial condition and market conditions.
  • Example of Caldwell Company issuing stock at a premium.

• Dividends:

  • Decrease retained earnings. Types include cash and stock dividends.
  • Cash dividends require sufficient retained earnings and board approval.

• Cash Dividend Process:

  • Steps include Declaration, Record, and Payment dates, with an example from Hiber Corporation.

• Stock Dividends:

  • Distribution of additional shares without cash exchange; affects retained earnings.
  • Small dividends calculated at market value, large dividends at par value.

• Stock Split:

  • Reduces the par value of stock, increases share count; no cash involved. Designed to attract more investors.

• Statement of Stockholders' Equity Example:

  • Illustrates how dividends, stock issuances, and retained earnings are reported over time.

• Debt Ratio:

  • Indicator of solvency and financial condition; calculated as Total Liabilities / Total Assets.

• Earnings Per Share (EPS):

  • Major profitability measure, calculated as (Net Income - Preferred Dividends) / Number of Common Shares.