Liabilities and Stockholders Equity

Chapter 8

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.

Liabilities

Debts owed to othersCurrent liabilities – due within a short time,

usually 1 yearLong-term liabilities – due beyond 1 year

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 unskilledPayroll and related taxes significantly impact

the net income of most businesses

Payroll Taxes

Payroll taxes become a liability when the related payroll is paid to employees. The liability is

relieved when the taxes are paid to the appropriate agencies.

Employer Taxes

• FICA• Federal and

State Unemployment Taxes

Employee Taxes

• FICA• Federal and

State Income Taxes

Bonds

A form of interest-bearing note. Bonds include interest (paid annually, semi-annually,

or quarterly), and the 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.

Quoted as % of face amount.

Calculating the Bond Issue Price

Based on the price buyers are willing to pay. Depends on three factors:1. The face amount of the bonds due at the maturity

date.2. The periodic interest to be paid on the bonds – stated

in the bond indenture. Is called the contract or coupon rate.

3. The market (effective) rate of interest.

Note that if the effective rate of interest is the same as the coupon rate, bonds will sell at the face amount.

Bonds Issued at Face Value

Assume that, on January 1 2008, a business issues $1,000,000 of 10%, 5-year bonds, with interest payable semiannually.

What are the accounting entries required during the life of the bond?

Coupon and effective interest rates will be the same.

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.

Stock

Major means of equity financing. Money obtained is called Paid-in-Capital or Contributed

Capital Shares

• Authorized – total number allowed to issue. • Issued – shares issued to shareholders.• After issue, a corporation may buy back some of its

shares (Treasury Stock)• Outstanding – shares currently in the hands of

stockholders.

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 – Par value times issued stock

• Dividends cannot be paid if the event reduces S/E below the legal capital

Common Stock Rights

1. Right to vote in matters concerning the corporation.

2. Right to share in distributions of earnings.

3. Right to share in assets on liquidation.4. Pre-emptive right

Common and Preferred Stock

If only one class of stock, it is called common stock – each share has equal rights.

Corporations can offer one or more classes of stock with various preference rights

Most prevalent is one that is preferred as to dividends - called Preferred Stock.

Preferred dividend rights are usually stated in monetary terms or a percentage of par.

Demonstration Problem – Distributing Dividends

Belson Corporation has declared an annual dividend of $40,000 for the year. The outstanding stock was composed of 25,000 shares of 6% preferred stock, $20 par, and 40,000 shares of common stock, $1 par. Calculate the dividends to be paid to the preferred and common shareholders.

Stock Issuance

Assume that a corporation issues 50,000 shares of $1 par value common stock for $10 per share and 1,000 shares of $100 par value preferred stock at par.

Prepare the accounting entries associated with this issuance.

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.

Cash Dividends

Cash distribution of earnings by a corporation to its shareholders.

Most common form of dividends.Usually three conditions:

• Sufficient retained earnings• Sufficient cash• Formal action by the board of directors

Dividend Announcement Dates

Demonstration Problem – Cash Dividends

On January 15, the board of directors of Barns Incorporated declared a $0.25-per-share dividend on its common stock to shareholders of record on January 31, payable on February 15. Barns has 25,000 shares of stock authorized, 10,000 shares issued and 8,000 outstanding. Determine the following dates along with the accounting entries for each (if any).

Date of declaration Date of record Date of payment

Stock Dividends

Distribution of additional stock to stockholders (usually common shares).

No distribution of cash or other assets. In proportion to the number of shares held (pro-rata

distribution) Issuing stock dividends has no impact on total

assets, liabilities and S/E. However, it does change the composition of S/E by

transferring a portion of Retained Earnings to Paid-in-Capital at the market price of the stock.

Demonstration Problem – Stock Dividends

On January 15, Maple Corporation declares a 10% stock dividend on its $1 par common stock. On that date, Maple has 10,000 common shares outstanding and the market price of the shares is $50.

What are the accounting entries required for this issuance?

Stock Splits

Increase the number of shares outstanding. Major objective is to reduce the stock’s market

price per share in order to attract more investors. A “2 for 1” split doubles the number of shares

outstanding and drops the price in half. A stock split reduce the par value per share. The

balances in the accounts are not affected by a stock split.