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What is the Nature of Equity?
1. Holder of equity interest in a business entity is an owner.
2. This represent, ownership, management, claim to share in profit or losses and residual claim to the assets of the business.
What are the characteristics of Equity?
- 1. Higher risk
- 2. No fixed return
- 3. Issuance creates dilution of power
- 4. No tax benefits for paying dividends
- 5. Report in stockholders equity section
What are the characteristics of Debt?
- 1. Lower risk than equity
- 2. Fixed Return
- 3. Issuance effects risk/credit rating
- 4. Interest payments are tax deductible
- 5. Report in Liabilities section
What are examples of Hybrid Debt or Equity instruments?
- 1. mandatorily redeemable preferred stock (Equity)
- 2. Cash settled stock appreciation right (debt)
- 3. Convertible Bond (Debt until converted)
How do Sole Proprietorships and Partnerships account for owners equity?
There is a single account for each owner called capital account.
How do Corporations account for Stockholders Equity?
By equity source:
- 1. Contributed Capital
- 2. Retained Earnings
What are the four types of Contributed Capital?
- 1. Preferred Stock Par Value
- 2. Common Stock (minimum legal capital)
- 3. Additional Paid in Capital
- 4. Other Contributed Capital/Adjustments
What are the preferences given to Preferred Stockholders?
- 1. Preferred dividend return
- 2. Preferred distribution in liquidation
- 3. Dividend preference is oftern cumulative
- 4. Generally do no participate in earnings beyond dividend preferences
What does Common Stock Represent?
True residual equity interest in the corporation.
- 1. Dividends after preferred are paid
- 2. Dividends only if Board approves
- 3. If liquidation occurs...common stock gets left over.
- 4. Right to vote for Board of Directors
What does the account "Additional Paid-in Capital represent?
- the amount of contributed capital paid by stockholders in excess of the legal minimum capital associated with either common or preferred stock.
- 1. Amount in excess of par value
- 2. Amoun in excess of stated value
- 3. Note: None in No-Par States
How do you account for stock issuance?
1. No income effect
2. Par or Stated-Value is reported in the common stock account...with any amount in addition being reported as Additional Paid-In Capital.
- Debit Cash
- Credit Common Stock
- Credit APIC
Why do Corporations repurchase stock?
- 1. To meet stock option obligations
- 2. To thwart takeover attempts
- 3. To drive up stock price
- 4. To dive up earnings per share
- 5. To obtain stock for other purposes, such as stock-for-stock acquitions
Repurchased stock may be cancelled or held in treasury.
How do you account for Treasury Stock?
- Debit Treasury Stock
- Credit Cash
Reissuance at a gain
- Debit Cash
- Credit Treasury Stock
- Credit APIC, TS Transactions
What is Retained Earnings?
1. Previously earned profits that have not ben distributed to stockholders
2. Distributions to shareholders of these retained profits are called dividends, if paid in cash or property, and reduce the retained earnings account.
What are cash dividends?
1. Can only be paid if Board approves
- 2. Critical dates
- Date of Declaration
- Date of Record
- Date of Payment
What is the measurement method of stock options?
1. Black Scholes-Merton Formula
What are stock option Accounting Entries?
- 1. Expense Entry
- 2. Expiration Entry
- 3. Exercise Entry