chapter 8 liabilities and stockholders’ equity. learning objectives after studying this chapter,...
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Chapter 8Chapter 8
Liabilities and Stockholders’ Liabilities and Stockholders’ EquityEquity
Liabilities and Stockholders’ Liabilities and Stockholders’ EquityEquity
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Learning ObjectivesLearning ObjectivesAfter studying this chapter, you should be able to… Describe how businesses finance their operations. Describe and illustrate current liabilities, notes payable, taxes,
contingencies, and payroll. Describe and illustrate the financing of operations through issuance
of bonds. Describe and illustrate the financing of operations through issuance
of stock. Describe and illustrate the accounting for cash and stock dividends. Describe the effects of stock splits on the financial statements. Describe financial statement reporting of liabilities and stockholders’
equity. Analyze the impact of debt or equity financing on earnings per
share.
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Learning Objective 1Learning Objective 1
Describe how businesses finance their operations
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Financing Operations
• Businesses must finance operations through one of two ways:– Debt Financing – includes all liabilities owed by a
business– Equity Financing – investments from owners of
the business. Stock is issued to represent ownership interest in a corporation.
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Learning Objective 2Learning Objective 2
Describe and illustrate current liabilities, notes payable, taxes,
contingencies, and payroll
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Liabilities
• Debts owed to others• Current liabilities – due within a short time,
usually 1 year• Long-term liabilities – due beyond 1 year• Some liabilities are contingent on the outcome
of future events
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Notes Payable
• Longer and more formal than accounts payable• Usually bear interest• Issued to creditors when merchandise or other
assets are purchased
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Assume that a business issues a 90-day, 12% note for $1,000, dated August 1, 2008 to satisfy an open account payable
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Income Taxes
• Includes federal income taxes and possibly state and local income taxes
• Most corporations are required to pay federal income taxes in four installments throughout the year
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Taxable Income vs. Income Before Taxes
• Taxable Income – determined according to federal tax laws (IRS Code)
• Income Before Taxes – determined according to generally accepted accounting procedures (GAAP)
• Differences between the two may need to be allocated between various financial statement periods
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Accounting for Temporary Differences
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Contingent Liabilities
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Payroll
• The amount paid to employees for services they provide during a period– Salary – payment for managerial, administrative,
or similar services– Wages – payment for manual labor, both skilled
and unskilled
• Payroll and related taxes significantly impact the net income of most businesses
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Recording Payroll
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Payroll Taxes
Employer Taxes• FICA• Federal and State
Unemployment Taxes
Employee Taxes• FICA• Federal and State
Income Taxes
Payroll taxes become a liability when the related payroll Payroll taxes become a liability when the related payroll is paid to employees. The liability is relieved when the is paid to employees. The liability is relieved when the
taxes are paid to the appropriate agencies. taxes are paid to the appropriate agencies.
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Learning Objective 3Learning Objective 3
Describe and illustrate the financing of operations through issuance of
bonds
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Bonds
• A form of interest-bearing note • Bonds include interest that must be paid on a
regular basis• Bonds face value must be repaid at maturity.• Bond indenture – contract between the
company issuing the bonds and the bondholders
• A bond issue is normally divided into several individual bonds. The most common face value is $1,000 per bond.
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Calculating the Bond Issue Price
• Based on the price buyers are willing to pay Depends on three factors:– The face amount of the bonds due at the maturity
date.– The periodic interest to be paid on the bonds –
stated in the bond indenture. Is called the contract or coupon rate.
– The market (effective) rate of interest
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Recording Bond Issuance
Assume that a business issues $100,000 of 12%, 5-year bonds, with interest of $6,000 payable semiannually.
Coupon and effective interest rates will be the same.Coupon and effective interest rates will be the same.
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Additional Bond Entries
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Bonds Not Issued at Face Value
• Discount on Bonds Payable– Market rate of interest > contract rate– Buyers are not willing to pay face value for the
bonds
• Premium on Bonds Payable– Market rate of interest < contract rate– Buyers are willing to pay more than face value for
the bonds
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Learning Objective 4Learning Objective 4
Describe and illustrate the financing of operations through issuance of
stock
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Stock
• Major means of equity financing
• Shares– Authorized – total number
allowed to issue – Issued – shares issued to
shareholders– Outstanding – shares currently
in the hands of stockholders
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Shares of Stock
• Can be issued with or without a monetary amount:– Par: monetary value stated on stock certificate – No-par: some states might require a stated value
• Legal Capital– Minimum stockholder contribution required by
some states
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Stock Rights
• Right to vote in matters concerning the corporation
• Right to share in distributions of earnings• Right to share in assets on liquidation
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Common and Preferred Stock
• Each share has equal rights
• Each share has voting rights
• Has preference rights over common stock
• Dividend rights stated in monetary terms or % of par
CommonCommonStockStock
Preferred Preferred StockStock
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Issuance of Stock
• The price at which stock sells depends on a variety of factors:– The financial condition, earnings record, and
dividend record of the corporation.– Investor expectations of the corporation’s potential
earning power.– General business and economic conditions and
prospects.
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Stock Issuance
Assume that a corporation issues 2,000 shares of $1 par value common stock for $55 per share.
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Reacquired Stock
• Treasury Stock– Stock that a corporation has issued and then
reacquires– Balance at year-end is reported as a reduction of
stockholders’ equity
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Learning Objective 5Learning Objective 5
Describe and illustrate the accounting for cash and stock dividends
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Cash Dividends
• Cash distribution of earnings by a corporation to its shareholders
• Most common form of dividend• Usually three conditions:
– Sufficient retained earnings– Sufficient cash– Formal action by the board of directors
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Dividend Announcement Dates
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Cash Dividends
Assume a company declares the following cash dividend on December 1 for payment on January 2:
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Stock Dividends
• Distribution of stock to stockholders (usually common shares)
• No distribution of cash or other assets• Requirements:
– Sufficient retained earnings– Formal action by board of directors
• Amount transferred for small stock dividends (<25% of outstanding shares) is market value per share
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Learning Objective 6Learning Objective 6
Describe the effects of stock splits on the financial statements
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Stock Splits
• Reduces the par value per share• Increase the number of shares outstanding• Major objective is to reduce the stock’s market
price per share in order to attract more investors
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Stock Splits
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Learning Objective 7Learning Objective 7
Describe financial statement reporting of liabilities and stockholders’ equity
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Financial Reporting of Liabilities and Equity
• Liabilities– Current are due within 1 year– Long-term are due beyond 1 year
• Stockholders’ Equity– Part of the balance sheet– Details of the changes in stockholders’ equity are
disclosed in a separate statement
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Balance Sheet
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Statement of Stockholders’ Equity
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Learning Objective 8Learning Objective 8
Analyze the impact of debt or equity financing
on earnings per share
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Earnings Per Share
• Major profitability measure reported in the financial statements
• Followed closely by the financial press
Net Income – Preferred DividendsNet Income – Preferred DividendsNumber of Common SharesNumber of Common Shares
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Effect of Alternative Financing Plans
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End of Chapter 8End of Chapter 8