Equity Financing Notes.docx

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Department
Accounting and Management Info
Course
ACCTMIS 2200
Professor
John Smith
Semester
Spring

Description
Equity Financing – Module 1 Debt Financing • Loans; repay, with interest • Liable for amount of loan • Relationship ends with repayment Equity Financing • No responsibility to repay • Investor takes risk • Investor rewarded by company’s future success Two Categories of Equity: - Contributed Capital – this is the amount that owners have contributed through the purchase of stock • Capital Stock - Retained Earnings – this is the net income earned by the company not paid out as dividends Two Types of Capital Stock 1. Preferred Stock • Has dividend preference – means if a dividend is paid the preferred stockholders must be paid in full before common stockholders can receive a dividend • The preferred stock dividend is set at a fixed percentage • Preferred stockholders typically do not have voting rights 2. Common Stock - Common stockholders have voting privileges • Election of board of directors • Vote on significant activities of management Page 1 - Dividend rates are determined by the board of directors based on the corporations profitability - Receive dividends after preferred stockholders Note: the accounting for preferred and common stock is exactly the same way. Par Value - A monetary amount assigned to each class of stock for accounting purposes only - Has NO relationship to market value - Accounting rule: • When stock is sold to owners (stockholders), the stock account is only recorded at par value – the excess of the selling price of the stock over the par value is recorded in the equity account called:  Paid-in Capital What we have learned thus far EXAMPLE: On May 1, Hyrdro-Slide Inc., issues 10 shares of @2 par value common stock for $5 per share. Debit  Cash for $50.00 Credit  Common Stock for only par value $20.00 (10 x $2 per share) Credit  Paid-in Capital – Common $30.00 (identify what this is related to, here it is labeled common because it is related to the entry ‘common stock’ Equity Financing – Module 2 Example #1: On March 8, XYZ Company issued 5,000 shares of its $10 par value common stock for $14 per share. Debit  Cash (5000 shares x 14) 70,000.00 Credit  Common Stock (5000 shares x 10) 50,000.00 Credit  Paid-in Capital – common 20,000.00 Q. How does the above transaction effect net income?? A. It doesn’t have any effect on net income Note: Transactions involving our own stock never effect the income statement (net income) Assets Increased by 70,000 and Equity increased by 70,000 Income Statement Impact Page 2 NONE – transactions involving our own stock never affect the income statement Balance Sheet Impact Increase assets (by amount of cash received) and increase equity (both common stock and paid-in capital Cash Flow Impact Proceeds from issuance are a financing cash inflow On November 17, XYZ Company issued 3,000 shares of its $100 par value preferred stock for $112 per share. Debit  Cash (3,000 shares x $112) $336,000.00 Credit  Preferred Stock (3,000 shares x $100) $300,000.00 Credit  Paid-in Capital – Preferred $36,000.00 Q. How does the above transaction effect net income? A. It DOES NOT Each Class of Stock has Three Types of Shares 1. Authorized Shares – the total number of shares of stock that the company is allowed to sell to the public 2. Issued Shares – the total number of shares that have been sold to the public 3. Outstanding Shares – the total number of shares actually in the hands (i.e.,owned) of stockholders. Q. What is the difference between issued and outstanding shares?? A. The difference between issued & outstanding shares represents shares of stock issued by the company and then reacquired by the company (i.e. the company buys back the stock) Key Point: Stock that has been reacquired is called treasury stock Treasury Stock – is a corporation’s own stock that had been issued but was subsequently reacquired. - Why would a corporation reacquire its own stock?? • To reduce the shares outstanding and thus increase the market value per share • Because the market price is low Page 3 • To remove shares from the market to avoid a hostile takeover • To use in employee stock option programs • To give cash back to existing shareholders • To increase the reported earnings per share. Equity Financing – Module 3 Treasury stock – represents shares of a company’s own stock that had been issued but was then reacquired by the company. • Results in a decrease to total stockholders’ equity on the balance sheet. • Classified as a contra equity account. • Normal balance is a debit • Treasury stock is considered issued stock but not outstanding stock Does not have voting rights. Cannot receive dividends. • Treasury stock is recorded at its reacquisition cost (i.e. the amount paid to buy it back) • Treasury stock is not recorded at par value • No gains or losses are ever recognized from these equity transaction - transactions involving own stock never affect the income statement. Income Statement Impact NONE – Transactions involving our own stock never affect the income statement Balance Sheet Impact Decrease Assets (by amount of cash paid to reacquire the stock) and Decrease Equity (Since the account treasury stock is a contra-equity account). Cash Flow Impact Cash paid to reacquire stock is a financing cash outflow. Example #2 Page 4 The Angelfish corporation issued 10,000 shares of $12 par value common stock for $18 per share. Record the transaction Debit  Cash (10,000 shares x $18) $180,000.00 Credit  Common Stock (10,000 shares x $12) $120,000.00 Credit  Paid-in Capital – Common $60,000.00 Issued Shares ??? 10,000 shares Outstanding Shares??? 10,000 shares (none bought back) as of January 21 st The Angelfish Corporation reacquired 8,000 of the common shares issued on January 21 for $20 per share. Record the transaction. Debit  Treasury Stock (8,000 shares x $20) $160,000.00 Credit  Cash (8,000 shares x $20) $160,000.00 Issued Shares?? 10,000 shares (Still) Outstanding Shares?? 2,000 shares (8,000 have been bought back) Q. How does the entry to record the reacquisition of treasury stock affect net income? A. There is no effect on net income. Transactions involving our own stock never impact the income statement. Assets and equity on the balance sheet are decreased. The cash paid to reacquire the stock is financing cash outflow on the statement of cash flows. Equity Financing – Module 4 Treasury Stock – represents shares of a company’s own stock that had been issued but was then reacquired by the company. Q. What happens when the shares that we reacquired are re-issued? A. the accounting treatment depends on the relationship between the re-issue price and the reacquisition price. [Re-issuance of treasury stock  Re-issue price > Reacquisition cost] Record the excess in the equity account Paid-in Capital – Treasury. Key Point: When treasury stock is re-issued, always remove the treasury stock from the balance sheet at its reacquisition cost Example #2 Page 5 The Angelfish Corporatio re-issued 2,500 of the treasury shares for $22 per share. Record the transaction. Note the re-issue price ($22) > reacquisition cost ($20) Debit  Cash (2,500 shares x $22) $55,000.00 Credit  Treasury Stock (2,500 shares x $20) $50,000.00 Credit  Paid-in Capital - Treasury $5,000.00 Note: The $5,000 credit is NOT A GAIN on sale of treasury stock. Rather, it is part of equity. Issued Shares 10,000 shares (still, unique has at one time sold to public) Outstanding Shares 4,500 shares (currently in the hands of stockholders) [Re-issuance of treasury stock  re-issue price < Reacquisition cost] Reduce Paid-in Capital – Treasury by debiting the account for the difference. However, the account cannot be debited for more than its balance. If a deficit still exists after debiting the Paid-in Capital – Treasury account, reduce Retained Earnings for the reaming deficit. The Angelfish Corporation re-issued 3,000 of the treasury shares for $16 per share. Record the transaction. Note the re-issue price ($16) < reacquisition cost ($20). Debit  Cash (3,000 shares x $16) $48,000.00 Debit  Paid-in Capital – Treasury (from 8/26 transaction) $5,000.00 Debit Retained Earnings $7,000.00 Credit  Treasury Stock (3,000 shares x $20) $60,000.00 Note: when the credit balance in Paid-in Capital - Treasury is depleted, the difference is debited to RETAINED EARNINGS. Issued Shares 10,000 shares (unique shares sold to stockholders) Outstanding Shares 7,500 shares (currently in hands of stockholders) Redo the last transaction, except now assume the Angelfish Corporation reissued 3,000 of the treasury shares for $19 per share. Record the transaction. The re-issue price ($16) < Reacquisition cost ($20). Debit  Cash (3,000 shares x $19) $57,000.00 Debit  Paid-in Capital – Treasury (from 8/26) $3,000.00 Credit  Treasury Stock (3,000 shares x $20) $60,000.00 Page 6 NO NEED TO REDUCE RETAINED EARNINGS AT ALL Equity Financin
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