Accounting for Treasury Stock and Dividends

Chapter 14: Treasury Stock (T/S) Example - Cost Method

Case III: Resale of Treasury Stock

  • Transaction Overview: Rey resells 100 shares of Treasury Stock (T/S) at $42 per share.

    • Cash Proceeds Calculation:

    • Cash proceeds = 100 shares × $42/share = $4200.

    • Accounting Entries:

    • Cash account increases by $4200.

    • Paid-in Capital - Treasury Stock (PIC - T/S) account shows a cost from the previous transaction: 500.

    • Remaining balance to Retained Equity (RIE).

  • Balance Sheet Treatment:

    • Treasury Stock is a contra account to Stockholders' Equity (S/E).

    • Before transactions, Rey's Retained Earnings (R/E) was $925,000.

S/E Section of Balance Sheet Calculation

Amount

C/S

$1,250,000

PIC-C/S

$4,750,000

Total

$6,000,000

Less: T/S

(33,600)

Net S/E

$6,891,000

Chapter 14: Par Value Method

  • Acquisition Entry: When treasury stock is acquired (1000 shares at $48 per share for a stock option plan) it involves:

    • Remove the original sales price from the stock.

    • Notes:

    • T/S on balance sheet will be shown as contra to the par value method.

    • Entry includes:

      • T/S $5,000 (debit)

      • PIC-C/S $19,000

      • R/E $24,000

      • Cash outflow remains $48,000.

  • Case IV: Rey resells 100 shares of T/S at $45 per share.

    • Cash proceeds = 100 shares × $45/share = $4500.

    • Entries follow the same pattern as above.

Chapter 14: Dividends - Cash and Other Assets

Overview of Dividends

  • Definition: Dividends are returns of capital to shareholders; not an expense of the corporation.

    • Generally involve cash payments and become a liability only when declared.

  • Note: Treasury stock shares are excluded from dividend calculations.

  • Economic Role of Dividends: They signal the future prospects of a firm; some companies borrow to continue paying dividends.

Dividend Policies

  • Payout Ratio:

    • Formula: Payout Ratio = (Cash Dividends Paid) / (Net Income - P/S Dividends).

    • Considerations for firms like Amazon and Microsoft which may not pay dividends early on due to IRS constraints.

  • Investor Decisions: Investors may prefer to retain earnings for capital appreciation instead of dividends.

  • Rate of Return: If a firm’s rate of return is not competitive, dividends might not be paid.

Example Calculation:

  • If $1,000 is invested at 5% for 25 years:

    • Future Value = $10,000 given the formula:
      FV = 10000(1.05)^{25} = 10000 imes 3.38635 = 33,863.55

  • Comparing returns with investments in stocks like Microsoft during the 90s.

Chapter 15: Accounting for Cash Dividends

Important Dates for Dividend Accounting

  • Declaration Date: Establishes liability, recognized by:

    • Dr. R/E

    • Cr. Dividends Payable

  • Date of Record: No entry required; determines who receives dividends.

  • Payment Date:

    • Dr. Div. Payable

    • Cr. Cash

Cash Dividend Example

  • Company: Sizzle, Inc.

    • C/S: $5 par, 625,000 shares issued

    • PIC-C/S: $6,875,000

    • R/E: $1,240,000

    • T/S: (15,000 shares @$18)

    • Dividend Declared: 60¢ per share (12% on par).

Entry Example!

  • Date: 12/1/20B

    • Dr. R/E (Declaration)

    • Cr. Div Pay

  • No entry on 12/10/20B (Date of Record).

  • Payment on 12/20/20B

    • Dr. Div Pay

    • Cr. Cash

Chapter 14: Stock Dividends & Splits

Other Types of Dividends

  • Liquidating Dividend: Not based on R/E, treated as return of capital.

  • Stock Dividends: No cash flow. Classified as small or large based on percentage.

    • Small: <20-25% of existing shares, recorded at FMV at declaration.

    • Large: >20-25% of existing shares, recorded at par value.

  • Stock Splits: No entry recorded, creates memo in general journal.

Example Entries

  • Small Stock Dividend Declaration:

    • R/E

    • Stock Div Distributable (credit)

    • Payment when shares are issued.

Stock Splits

  • General Objective: Adjust stock price while maintaining shareholder equity.

    • Example: 2-for-1 split results in half the par value.

Chapter 15: Earnings per Share (EPS)

Basic EPS Calculation

  • Definition: EPS = (Net Income - P/S Dividends) / (Weighted Avg C/S Outstanding).

  • Fully Diluted EPS: Adjusts for convertible securities that can increase share count.

    • Examples include convertible bonds and stock options.

Example Problem

  • Hayride Company has:

    • 1,000,000 shares issued, Net Income of $850,000.

Weighted Average Calculation Steps

1) Total shares and dates to compute weights.
.
2) Compute weight with months outstanding for shares.
3) Sum the results for the weighted average number of shares.

Chapter 16: Investments in Securities of Other Firms

Objective of Investment

  • Firms invest in the securities of others for returns.

Investment Classification

  • Trading Securities: Recorded at fair value with unrealized gains/losses recognized in income.

  • Debt Securities Classifications:

    • Held to Maturity, available for sale, and trading based on management intent.

Example: Trading Securities

  • Casper Productions purchases 2% of Max, Inc.:

    • Purchase Entry: Cash = $360,000 + fees.

    • Dividend Received: Cash + Dividend Income.

    • Year-end Adjustment: Fair Value adjustment for unrealized holding gains or losses.

Conclusion

In summary, this detailed accounting guide presents the principles of Treasury Stock, Dividends, EPS, and Investments in other firms' securities. Understanding these topics is crucial for navigating financial statements in a business context while considering the implications of various transactions.