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McGraw-Hill/Irwin
13-1
© The McGraw-Hill Companies, Inc., 2005
Accounting for CorporationsChapter
1313
McGraw-Hill/Irwin
13-2
© The McGraw-Hill Companies, Inc., 2005
Learning objectivesLearning objectives
1. Corporate form of organization
2. Common Stock
3. Preferred Stock
4. Dividends
5. Treasury Stock
6. Reporting Income and Equity
7. Decision analysis: • BPS• Dividend yield• PE ratio
• Case: Pfizer, Johnson & Johnson, Eli Lilly
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Privately HeldPrivately HeldPrivately HeldPrivately Held
Publicly HeldPublicly HeldPublicly HeldPublicly Held
Ownership can be
1. Corporate Form of Organization1. Corporate Form of Organization
Existence is separate from
owners.
Existence is separate from
owners.
An entity created by law.
An entity created by law.
Has rights and privileges.
Has rights and privileges.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Advantages
Separate Legal Entity
Limited Liability of Stockholders
Transferable Ownership Rights
Continuous Life
Stockholders Are Not Corporate Agents
Ease of Capital Accumulation
Disadvantages
Governmental Regulation
Corporate Taxation
Advantages
Separate Legal Entity
Limited Liability of Stockholders
Transferable Ownership Rights
Continuous Life
Stockholders Are Not Corporate Agents
Ease of Capital Accumulation
Disadvantages
Governmental Regulation
Corporate Taxation
1. Corporate Form of Organization - Characteristics of Corporations
1. Corporate Form of Organization - Characteristics of Corporations
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
StockholdersStockholders
Board of DirectorsBoard of Directors
President, Vice-President, President, Vice-President, and Other Officersand Other Officers
Employees of the CorporationEmployees of the Corporation
1. Corporate Form of Organization- Organizing and Managing a Corporation
1. Corporate Form of Organization- Organizing and Managing a Corporation
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
C orpo ra te O rgan iza tion C hart
Secretary V ice P residentF inance
V ice P residentP roduction
V ice P residentMarketing
President
Board of D irectors
S tockholdersUltimate Ultimate control.control.
Ultimate Ultimate control.control.
Stockholders Stockholders usually meet usually meet once a year.once a year.
Stockholders Stockholders usually meet usually meet once a year.once a year.
Organizing and Managing a CorporationOrganizing and Managing a Corporation
Selected by a Selected by a vote of the vote of the
stockholders.stockholders.
Selected by a Selected by a vote of the vote of the
stockholders.stockholders.
Overall Overall responsibility responsibility for managing for managing the company.the company.
Overall Overall responsibility responsibility for managing for managing the company.the company.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Vote at stockholders’ meetings.Sell stock. Purchase additional shares of stock.Receive dividends, if any.Share equally in any assets remaining
after creditors are paid in a liquidation.
Vote at stockholders’ meetings.Sell stock. Purchase additional shares of stock.Receive dividends, if any.Share equally in any assets remaining
after creditors are paid in a liquidation.
Rights of StockholdersRights of Stockholders
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Each unit of ownership is
called a share of stock.
A stock certificate serves as proof
that a stockholder has purchased
shares.
Each unit of ownership is
called a share of stock.
A stock certificate serves as proof
that a stockholder has purchased
shares.
1. Corporate Form of Organization - Stock Certificates and Transfer
1. Corporate Form of Organization - Stock Certificates and Transfer
When the stock is sold, the stockholder
signs a transfer endorsement on the back of the
stock certificate.
When the stock is sold, the stockholder
signs a transfer endorsement on the back of the
stock certificate.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
1. Corporate Form of Organization - Basics of Capital Stock
1. Corporate Form of Organization - Basics of Capital Stock
Total amount of stock that a Total amount of stock that a corporation’s charter authorizes it to sell.corporation’s charter authorizes it to sell.
Total amount of stock that a Total amount of stock that a corporation’s charter authorizes it to sell.corporation’s charter authorizes it to sell.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Basics of Capital StockBasics of Capital Stock
Total amount of stock that has been Total amount of stock that has been issued to stockholders.issued to stockholders.
Total amount of stock that has been Total amount of stock that has been issued to stockholders.issued to stockholders.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Par valuePar value is an is an arbitrary amount arbitrary amount assigned to each assigned to each
share of stock when share of stock when it is authorized.it is authorized.
Par valuePar value is an is an arbitrary amount arbitrary amount assigned to each assigned to each
share of stock when share of stock when it is authorized.it is authorized.
Market priceMarket price is the is the amount that each amount that each share of stock will share of stock will
sell for in the market.sell for in the market.
Market priceMarket price is the is the amount that each amount that each share of stock will share of stock will
sell for in the market.sell for in the market.
Selling (Issuing) StockSelling (Issuing) Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
• Par ValuePar Value• No-Par ValueNo-Par Value• Stated ValueStated Value
Classes of StockClasses of Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Record:1. The cash received.
2. The number of shares issued × the par value per share in the Common Stock account.
3. The remainder is assigned to Contributed Capital in Excess of Par.
Record:1. The cash received.
2. The number of shares issued × the par value per share in the Common Stock account.
3. The remainder is assigned to Contributed Capital in Excess of Par.
2. Common Stock - Issuing Par Value Stock2. Common Stock - Issuing Par Value Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Issuing Par Value StockIssuing Par Value Stock
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Sept. 1 Cash 2,500,000 Common stock, $2 par value 200,000
Contributed capital in excess of par value 2,300,000
Sold and issued 100,000 shares of common stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Issuing Par Value StockIssuing Par Value Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Record:1. The asset received at its market value.
2. The number of shares issued × the par value per share in the Common Stock account.
3. The remainder is assigned to Contributed Capital in Excess of Par.
Record:1. The asset received at its market value.
2. The number of shares issued × the par value per share in the Common Stock account.
3. The remainder is assigned to Contributed Capital in Excess of Par.
Issuing Stock for Noncash AssetsIssuing Stock for Noncash Assets
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Issuing Stock for Noncash AssetsIssuing Stock for Noncash Assets
Sept. 1 Land 2,500,000 Common stock, $2 par value 200,000
Contributed capital in excess of par value 2,300,000
Exchanges 100,000 common shares for land
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions.
Distribution of assets in case of liquidation.
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions.
Distribution of assets in case of liquidation.
Usually has a stated dividend rate.
Usually has a stated dividend rate.
Normally has no voting rights.
Normally has no voting rights.
3. Preferred Stock3. Preferred Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Vs. NoncumulativeCumulativeDividends in arrears must be paid before
dividends may be paid on common
stock.
Dividends in arrears must be paid before
dividends may be paid on common
stock.
Undeclared dividends from current and
prior years do not have to be paid in future
years.
Undeclared dividends from current and
prior years do not have to be paid in future
years.
3. Preferred Stock - Cumulative or Noncumulative Dividend3. Preferred Stock - Cumulative or Noncumulative Dividend
Most preferred stock is cumulative.
Most preferred stock is cumulative.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Example: Consider the following partial Statement of Stockholders’ Equity
The Board of Directors did not declare or pay dividends in 2004. In 2005, the Board of Directors
declare and pay cash dividends of $42,000.
Cumulative or Noncumulative DividendCumulative or Noncumulative Dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Cumulative or Noncumulative DividendCumulative or Noncumulative Dividend
If Preferred Stock is Noncumulative: Preferred CommonYear 2004: No dividends paid. -$ -$
Year 2005:1. Pay 2005 preferred dividend. 9,000$
2. Remainder goes to common. 33,000$
If Preferred Stock is Cumulative: Preferred CommonYear 2004: No dividends paid. -$ -$
Year 2005:1. Pay 2004 preferred dividend in arrears. 9,000$ 2. Pay 2005 preferred dividend. 9,000 3. Remainder goes to common. 24,000$
Totals 18,000$ 24,000$
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Vs. NonparticipatingParticipatingDividends may exceed a stated
amount once common
stockholders receive a dividend equal to the preferred stated
rate.
Dividends may exceed a stated
amount once common
stockholders receive a dividend equal to the preferred stated
rate.
Dividends are limited to a maximum amount
each year. The maximum is usually the stated dividend
rate.
Dividends are limited to a maximum amount
each year. The maximum is usually the stated dividend
rate.
Participating or Nonparticipating DividendParticipating or Nonparticipating Dividend
Most preferred stock is
nonparticipating.
Most preferred stock is
nonparticipating.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Reasons for Issuing Preferred StockReasons for Issuing Preferred Stock
To raise capital without sacrificing control.
To boost the return earned by common stockholders through financial leverage.
To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.
To raise capital without sacrificing control.
To boost the return earned by common stockholders through financial leverage.
To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
To pay a cash dividend the
corporation must have:
1. A sufficient balance in retained earnings and
2. The cash necessary to pay the dividend.
Cash Dividend Types and Frequency
73%
23%
0%
20%
40%
60%
80%
100%
Common Preferred
4. Dividends - Cash Dividends4. Dividends - Cash Dividends
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Regular cash dividends provide a return to investors and almost always affect the
stock’s market value.
Dividends
Stockholders
June30
Cash DividendsCash Dividends
Corporation
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Three important datesThree important dates
Date of Declaration
Record liabilityfor dividend.
Dividends
Date of Record
No entryrequired.
Date of Payment
Record payment ofcash to stockholders.
Entries for Cash DividendsEntries for Cash Dividends
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Date of Declaration
Record liabilityfor dividend.
Dividends
On January 19, a $1 per share cash On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. 10,000 common shares outstanding.
The dividend will be paid on March 19 to The dividend will be paid on March 19 to stockholders of record on February 19.stockholders of record on February 19.
Entries for Cash DividendsEntries for Cash Dividends
Jan. 19 Retained earnings 10,000 Common dividend payable 10,000
Declared $1 per share cash dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Date of Record
No entryrequired.
Entries for Cash DividendsEntries for Cash Dividends
On January 19, a $1 per share cash On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. 10,000 common shares outstanding.
The dividend will be paid on March 19 to The dividend will be paid on March 19 to stockholders of record on February 19.stockholders of record on February 19.
No entry required on February 19.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Date of Payment
Record payment ofcash to stockholders.
Entries for Cash DividendsEntries for Cash Dividends
On January 19, a $1 per share cash On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. 10,000 common shares outstanding.
The dividend will be paid on March 19 to The dividend will be paid on March 19 to stockholders of record on February 19.stockholders of record on February 19.
Mar. 19 Common dividend payable 10,000 Cash 10,000
Paid $1 per share cash dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Created when a company incurs cumulative losses or pays dividends greater than total profits earned
in other years.
Deficits and Cash DividendsDeficits and Cash Dividends
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
The corporation distributes additional shares of its own stock to its stockholders without
receiving any payment in return.
The corporation distributes additional shares of its own stock to its stockholders without
receiving any payment in return.
Stockholders
4. Dividends - Stock Dividends4. Dividends - Stock Dividends
Why a stock dividend?
•Can be used to keep the market price on the stock affordable.
•Can provide evidence of management’s confidence that the company is doing well.
Why a stock dividend?
•Can be used to keep the market price on the stock affordable.
•Can provide evidence of management’s confidence that the company is doing well.
100 Shares
$1 par value
HotAir, Inc.Common Stock
100 shares
$1 par
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Small Stock DividendDistribution is 25% of the previously
outstanding shares.Capitalize retained earnings for the market
value of the shares to be distributed.
Small Stock DividendDistribution is 25% of the previously
outstanding shares.Capitalize retained earnings for the market
value of the shares to be distributed.
Stock DividendsStock Dividends
Large Stock DividendDistribution is > 25% of the previously
outstanding shares.Capitalize retained earnings for the minimum
amount required by state law, usually par or stated value of the shares.
Large Stock DividendDistribution is > 25% of the previously
outstanding shares.Capitalize retained earnings for the minimum
amount required by state law, usually par or stated value of the shares.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend.
Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend.
Recording a Small Stock DividendRecording a Small Stock Dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On December 31, 2005, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2006. Let’s make
the December 31 entry.
On December 31, 2005, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2006. Let’s make
the December 31 entry.
Recording a Small Stock DividendRecording a Small Stock Dividend
100,000 × 2% = 2,000 × $10 = $20,000100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,0002,000 × $1 par = $2,000
100,000 × 2% = 2,000 × $10 = $20,000100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,0002,000 × $1 par = $2,000
Dec. 31 Retained earnings 20,000 Common stock dividend distributable 2,000 Contributed capital in excess of par value 18,000
Declared a 2,000 shares (2%) stock dividend
McGraw-Hill/Irwin
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Before theBefore thestockstock
dividend.dividend.
After theAfter thestockstock
dividend.dividend.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Router, Inc. shows the following stockholders’ equity section just prior to
issuing a large stock dividend.
Router, Inc. shows the following stockholders’ equity section just prior to
issuing a large stock dividend.
Recording a Large Stock DividendRecording a Large Stock Dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On December 31, 2005, Router declared a 40% stock dividend, when the stock was selling
for $8 per share. State law requires that large stock dividends be capitalized at par
value per share.
On December 31, 2005, Router declared a 40% stock dividend, when the stock was selling
for $8 per share. State law requires that large stock dividends be capitalized at par
value per share.
50,000 × 40% = 20,000 shares × $1 par value = $20,00050,000 × 40% = 20,000 shares × $1 par value = $20,00050,000 × 40% = 20,000 shares × $1 par value = $20,00050,000 × 40% = 20,000 shares × $1 par value = $20,000
Recording a Large Stock DividendRecording a Large Stock Dividend
Dec. 31 Retained earnings 20,000 Common stock dividend distributable 20,000
Declared a 20,000 shares (40%) stock dividend
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
A distribution of additional shares of stock to stockholders according to their percent
ownership.
A distribution of additional shares of stock to stockholders according to their percent
ownership.
Common Stock
$10 par value
100 shares
OldShares
NewShares Common Stock
$5 par value
200 shares
Stock SplitsStock Splits
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Thomas, Inc. has the following stockholders’ Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split.equity section just prior to a 2-for-1 stock split.Thomas, Inc. has the following stockholders’ Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split.equity section just prior to a 2-for-1 stock split.
Stock SplitsStock Splits
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
After the 2-for-1 split the stockholders’ equity section After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this . . .of the balance sheet looks like this . . .
After the 2-for-1 split the stockholders’ equity section After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this . . .of the balance sheet looks like this . . .
No accountingentry is made.No accountingentry is made.
Stock SplitsStock Splits
McGraw-Hill/Irwin
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Corporations acquire shares of their own stock.
Why would acompany do
that?
Why would acompany do
that?
Use the shares to acquireUse the shares to acquirecontrol of another corporation.control of another corporation.
To avoid a hostile takeover.To avoid a hostile takeover.
Use the shares forUse the shares foremployee stock options.employee stock options.
To maintain a strong market forTo maintain a strong market forits stock or show managementits stock or show managementconfidence in the current price.confidence in the current price.
Use the shares to acquireUse the shares to acquirecontrol of another corporation.control of another corporation.
To avoid a hostile takeover.To avoid a hostile takeover.
Use the shares forUse the shares foremployee stock options.employee stock options.
To maintain a strong market forTo maintain a strong market forits stock or show managementits stock or show managementconfidence in the current price.confidence in the current price.
5. Treasury Stock5. Treasury Stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for
$8,000.
On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for
$8,000.
5. Treasury Stock - Purchasing Treasury Stock5. Treasury Stock - Purchasing Treasury Stock
Treasury stock is shown as a reduction in totalTreasury stock is shown as a reduction in totalstockholders’ equity on the balance sheet.stockholders’ equity on the balance sheet.
Treasury stock is shown as a reduction in totalTreasury stock is shown as a reduction in totalstockholders’ equity on the balance sheet.stockholders’ equity on the balance sheet.
May 8 Treasury stock, common 8,000 Cash 8,000
Purchase 2,000 treasury shares at $4 per share
McGraw-Hill/Irwin
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On June 30, Whitt sold 100 shares of its treasury stock for $4 per share.
On June 30, Whitt sold 100 shares of its treasury stock for $4 per share.
5. Treasury Stock - Selling Treasury Stock at Cost5. Treasury Stock - Selling Treasury Stock at Cost
$8,000 ÷ 2,000 shares = $4 cost per treasury share$8,000 ÷ 2,000 shares = $4 cost per treasury share
June 30 Cash 400 Treasury stock, common 400
Sold 100 shares of treasury for $4 per share
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per
share.
On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per
share.
Selling Treasury Stock Above CostSelling Treasury Stock Above Cost
July 19 Cash 4,000 Treasury stock, 2,000 Contributed capital, treasury stock 2,000
Sold 500 treasury shares for $8 per share
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per
share.
On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per
share.
Selling Treasury Stock Below CostSelling Treasury Stock Below Cost
Aug. 27 Cash 600
1,000 Treasury stock, 1,600
Sold 500 treasury shares for $1.50 per share
Contributed capital, treasury stock
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
On October 21, Whitt sold an 1000 shares of its treasury stock for $2 per share.
On October 21, Whitt sold an 1000 shares of its treasury stock for $2 per share.
Selling Treasury Stock Below CostSelling Treasury Stock Below Cost
Oct. 21 Cash 2,000
1,000
1,000
Treasury stock, common 4,000
Sold 1000 treasury shares for $2 per share
Contributed capital, treasury stock
Retained Earning
McGraw-Hill/Irwin
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Net IncomeNet IncomeNet IncomeNet Income
6. Reporting Income and Equity6. Reporting Income and Equity
DiscontinuedSegments
Changes inAccounting
Principle
ExtraordinaryItems
ContinuingOperations
McGraw-Hill/Irwin
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Revenues, expensesRevenues, expensesand income generatedand income generated
by the company’sby the company’scontinuing operations.continuing operations.
Revenues, expensesRevenues, expensesand income generatedand income generated
by the company’sby the company’scontinuing operations.continuing operations.
6. Reporting Income and Equity - Continuing Operations6. Reporting Income and Equity - Continuing Operations
Net IncomeNet IncomeNet IncomeNet IncomeContinuingOperations
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Income from operating the discontinued segment prior Income from operating the discontinued segment prior to its disposal to its disposal andand gain or loss on the sale of the net gain or loss on the sale of the net
assets of the segment.assets of the segment.
Income from operating the discontinued segment prior Income from operating the discontinued segment prior to its disposal to its disposal andand gain or loss on the sale of the net gain or loss on the sale of the net
assets of the segment.assets of the segment.
6. Reporting Income and Equity - Discontinued Segments6. Reporting Income and Equity - Discontinued Segments
Net IncomeNet IncomeNet IncomeNet Income
DiscontinuedSegments
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
A gain or loss thatA gain or loss thatis is unusualunusual in nature in nature
and and infrequentinfrequent in inoccurrence.occurrence.
A gain or loss thatA gain or loss thatis is unusualunusual in nature in nature
and and infrequentinfrequent in inoccurrence.occurrence.
6. Reporting Income and Equity - Extraordinary Items6. Reporting Income and Equity - Extraordinary Items
Net IncomeNet IncomeNet IncomeNet Income
ExtraordinaryItems
McGraw-Hill/Irwin
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The increase or The increase or decrease in income decrease in income when changing fromwhen changing from
one generally acceptedone generally acceptedaccounting principle to accounting principle to
another.another.
The increase or The increase or decrease in income decrease in income when changing fromwhen changing from
one generally acceptedone generally acceptedaccounting principle to accounting principle to
another.another.
6. Reporting Income and Equity - Changes in Accounting Principles6. Reporting Income and Equity - Changes in Accounting Principles
Net IncomeNet IncomeNet IncomeNet Income
Changes inAccounting
Principle
McGraw-Hill/Irwin
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Campus, Inc. prepared the following schedule in connection with its change from double-
declining balance to straight-line depreciation for an asset purchased in 2003.
Campus is subject toa 20% income tax rate.Campus is subject toa 20% income tax rate.
Changes in Accounting PrinciplesChanges in Accounting Principles
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2005
Campus, Inc. prepared the following schedule in connection with its change from double-
declining balance to straight-line depreciation for an asset purchased in 2003.
The change from DDB to SL would result in
an after-tax increase in 2005’s net income of
$48,000.
The change from DDB to SL would result in
an after-tax increase in 2005’s net income of
$48,000.
Changes in Accounting PrinciplesChanges in Accounting Principles
McGraw-Hill/Irwin
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Earnings per share is one of the most widely cited items of accounting information.
Earnings per share is one of the most widely cited items of accounting information.
6. Reporting Income and Equity - Earnings Per Share6. Reporting Income and Equity - Earnings Per Share
Basicearningsper share
= Net income - Preferred dividends Weighted-average common shares outstanding
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Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with
10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with
10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
Calculating Shares OutstandingCalculating Shares Outstanding
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EPS = EPS = $75,000 - $10,000 $75,000 - $10,000
12,50012,500 = = $5.20$5.20
Earnings Per ShareEarnings Per Share
Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with
10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with
10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
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The right to purchase common stock at a fixed price over a specified period of time. As the
stock’s price rises above the fixed option price, the value of the option increases.
The right to purchase common stock at a fixed price over a specified period of time. As the
stock’s price rises above the fixed option price, the value of the option increases.
Optionpurchaseprice $30 per share.
6. Reporting Income and Equity - Stock Options6. Reporting Income and Equity - Stock Options
Marketprice of
stock $75 per share.
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Options are given to key employees to motivate them to:
focus on company performance,take a long-run perspective, andremain with the company.
Options are given to key employees to motivate them to:
focus on company performance,take a long-run perspective, andremain with the company.
Stock OptionsStock Options
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Total cumulative amount of reported net income less any net losses and dividends declared
since the company started operating.
Total cumulative amount of reported net income less any net losses and dividends declared
since the company started operating.
6. Reporting Income and Equity - Statement of Retained Earnings6. Reporting Income and Equity - Statement of Retained Earnings
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LegalLegal ContractualContractual
Most states restrictthe amount oftreasury stock
purchases to theamount of retained
earnings.
Most states restrictthe amount oftreasury stock
purchases to theamount of retained
earnings.
Loan agreementscan include
restrictions on paying
dividends below acertain amount ofretained earnings.
Loan agreementscan include
restrictions on paying
dividends below acertain amount ofretained earnings.
Restricted Retained EarningsRestricted Retained Earnings
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A corporation’s directors can voluntarily limit dividends because of a special need for cash
such as the purchase of new facilities.
A corporation’s directors can voluntarily limit dividends because of a special need for cash
such as the purchase of new facilities.
Appropriated Retained EarningsAppropriated Retained Earnings
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Correction of material errors in past years’ financial statements. If an amount is incorrectly
expensed, add amount to Retained Earnings.
Prior Period AdjustmentsPrior Period Adjustments
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(In millions) Retained
Shares Amount Earnings TotalBalance at January 1, 2005 821 2,500$ 9,500$ 12,000$ Stock sales 17 500 500 Stock repurchases and retirement (17) (260) (925) (1,185) Cash dividends declared (150) (150) Other, net 70 70 Net income 5,100 5,100 Balance at December 31, 2005 821 2,740$ 13,595$ 16,335$
Common stock and capital in excess of par
Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2005
(In millions) Retained
Shares Amount Earnings TotalBalance at January 1, 2005 821 2,500$ 9,500$ 12,000$ Stock sales 17 500 500 Stock repurchases and retirement (17) (260) (925) (1,185) Cash dividends declared (150) (150) Other, net 70 70 Net income 5,100 5,100 Balance at December 31, 2005 821 2,740$ 13,595$ 16,335$
Common stock and capital in excess of par
Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2005
6. Reporting Income and Equity - Statement of Stockholders’ Equity6. Reporting Income and Equity - Statement of Stockholders’ Equity
This is a more inclusive statement than the statement of retained earnings.
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Records amount of stockholders’ equity applicable to common shares on a per
share basis.
Records amount of stockholders’ equity applicable to common shares on a per
share basis.
7. Decision Analysis - Book Value per Share—Common7. Decision Analysis - Book Value per Share—Common
Book value per Book value per common sharecommon share
==
Stockholders’ equity applicable to common shares
Number of common shares outstanding
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Records amount of stockholders’ equity applicable to preferred shares on a per
share basis.
Records amount of stockholders’ equity applicable to preferred shares on a per
share basis.
Book Value per Share—PreferredBook Value per Share—Preferred
Book value per Book value per preferredpreferred share share
==
Stockholders’ equity applicable to preferred shares
Number of preferred shares outstanding
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Tells us the annual amount of cash dividends distributed to common stockholders relative to
the stock’s market price.
Tells us the annual amount of cash dividends distributed to common stockholders relative to
the stock’s market price.
7. Decision Analysis - Dividend Yield7. Decision Analysis - Dividend Yield
DividendDividendYieldYield
== Annual cash dividends per share Annual cash dividends per share
Market value per shareMarket value per share
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This ratio reveals information about the stock market’s This ratio reveals information about the stock market’s expectations for a company’s future growth in expectations for a company’s future growth in
earnings, dividends, and opportunities.earnings, dividends, and opportunities.
This ratio reveals information about the stock market’s This ratio reveals information about the stock market’s expectations for a company’s future growth in expectations for a company’s future growth in
earnings, dividends, and opportunities.earnings, dividends, and opportunities.
If earnings go up,will the market priceof my stock follow?
7. Decision Analysis - Price Earnings7. Decision Analysis - Price Earnings
Price-Price-EarningsEarnings ==
Market value per shareMarket value per share Earnings per shareEarnings per share
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Case- Pharmaceutics IndustryCase- Pharmaceutics Industry
1. Industry Background
• Technology intensive
• Strict Patent protection in US
• Highly profitable
• Non-cyclical at all
2. Key success factor
• R&D capability
• Marketing capability to Medical Doctors
• Blockbuster medicines are key
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Stock Price & EarningsStock Price & EarningsPri ce & EPS
0. 00
0. 50
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3. 50
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Year
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EPS Pri ce
What drive the
stock price?
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Volatility of Price Earnings RatioVolatility of Price Earnings RatioPE Rati o
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PE Rati o Pri ce