Week #2 Flashcards
Convertible bonds
Bonds that may be convertible into shares of stock at the option of the bondholder. This feature is not common, but sometimes you do see that with bonds.
Callable Bonds
This is where the company that issues the bonds has the option to require that the bonds be redeemed before the maturity date. The reason this happens is because the company, let’s say, is paying 5% interest on those bonds and suppose that the interest rates have gone down to 2%. By calling in those bonds, they can then issue new bonds and only have to pay 2% interest instead of 5%. At any rate, when bonds are called-in, there’s usually a gain or a loss on this early retirement.
Gain/Loss of Retirement (what does it refer to?)
Refers to what happens to a Callable Bond:
If the cash that’s paid to the bondholders is more than the carrying value of the bonds, then a Loss on Retirement is recorded, whereas if the cash paid to the bondholders is less than the carrying value of the bonds, then a Gain on Retirement is recorded. These gains or losses appear on the income statement, the gains increasing the net income, the losses decreasing the net income.
Name four key differences between Bonds and Capital Stock
1) bonds must be repaid to the bondholders
2) bonds need to pay interest to the bondholders
3) interest is reported as an expense and therefore reduces net income (stocks: dividends are not expenses, they’re merely distributions of earnings. They do not reduce net income)
4) no dilution of ownership for bonds (new bonds issues won’t affect the percentage of ownership of company)
Stock: If a stockholder owns 1% of the company and the company issues additional shares of stock and that stockholder doesn’t buy any, then that stockholder will subsequently own less than the 1% that he had before, so there’s a dilution.
Why would one want Preferred stock over Common stock and vice versa?
Preferred stock holders get paid dividends and liquidation before common stockholders (in liquidation creditors get paid first)
Common stock holders have voting rights and thus true owners
What is a par value (aka stated value) of capital stock?
nominal value assigned to and printed on the face of each share of corporation’s stock. It is NOT tied to the market vlaue
Where does the amount above par value of a stock go on a balance sheet?
Paid-in capital aka Additional Paid in Capital (see page 39)
How can a company increase earnings per share?
Recall that earnings per share is the net income divided by the number of shares outstanding. One way of increasing earnings per share is to increase net income. The other way is to reduce the number of shares outstanding. That is, reduce the denominator by buying back shares of stock from shareholders.
What is treasury stock, and is it an asset?
No. buying back shares of the company’s own stock is not considered an asset. Instead, it’s a deduction in the stockholders’ equity section of the balance sheet and therefore it’s called a contra-equity account
What is contra-equity?
it’s a deduction in the stockholders’ equity section of the balance sheet. It is not an asset. It refers to stock buy back (treasury stock)
What happens when treasury stock is reissued
the FASB does not want companies affecting their net income by engaging in transactions involving their own stock, so no gain or loss is recognized when treasury shares are reissued.
Contrary to ASSETS: when a company sells assets, as we’ve seen in an earlier session, there very often have a gain or a loss reported on the income statement.
What is the Date of Declaration, Date of Record, and Date of Payment
relates to cash dividends
There are three important dates to discuss in relation to cash dividends. The first is the date of declaration. That’s when the board of directors votes to pay dividends, and it is at that time that the dividend payment becomes a liability of the corporation, and so it’s on that date that the liability for dividends would appear on the company’s balance sheet. Let’s skip over to the third date, which is the date of payment. That’s when the cash dividends are actually paid out by the company. The middle date, called the date of record, just indicates who is to receive the dividends. So for example, if a company declared dividends on October first, and they paid the dividends on November first, then the question becomes what happens if there is a sale of shares of stock, between October first and November first – who gets the dividends? The date of record, which is established by the board of directors on the date of declaration, determines who receives the dividends. So, for my example, suppose the date of record was established as October 20th. So, whoever owns the stock on October 20th is the one that receives dividends, and everybody knows this, so that’ll be reflected in the price of the stock if it is sold between the declaration date and the payment date.
Explain Current Dividend Preference vs Cumulative Dividend Preference
Current Dividend Preference; This is where the preferred stockholders get a percentage of total par, that percentage being called dividend rate, and then the common stockholders get the remainder of whatever has been declared. So as an example, suppose a company has 10,000 shares of 5% preferred stock, the 5% being the dividend rate, having a par value of $10 per share. We calculate the current dividend preference by taking 5% of 10,000 times $10 – 10,000 times $10 would be $100,000 – that is the total par – and 5% of that would be $5,000. So if the company declared dividends in the amount of $4,800, the preferred shareholders would get it all, and the common shareholders would get nothing. If the company declared dividends of $5,500, the preferred shareholders would get 5,000, and the common shareholders would get the remaining $500. Suppose a company were to declare $1,000,000 in dividends. The preferred shareholders would get only $5,000, and the common shareholders would get the remaining $995,000.
Cumulative Dividend Preference:
This is where the preferred stockholders get the current dividend preference, plus they also get any dividends in arrears. Arrears refers to the missed dividends from past years,. Common shareholders get the remainder
example) 4 times $5,000 would be $20,000 – this is the amount of cumulative dividend preference. Suppose the company declared dividends in the amount of $18,000. The preferred shareholders would get it all, and then $2,000 would remain in arrears.
What are dividends in arrears? How do they appear in the balance sheet?
Arrears refers to the missed dividends from past years, the dividends that they would’ve gotten had the company declared dividends in the amount of the dividend rate.
they do not represent actual liabilities and thus they’re not recorded in the accounts and they’re not put on the balance sheet. The reason for this is that the company really never has to declare dividends, they never have to pay dividends, and so therefore these dividends in arrears, while they’re likely to be paid in the future, there’s no legal obligation to do so, and therefore, there’s no actual liability. However, the amount of dividends in arrears does need to be disclosed in the notes to the financial statements.
What is a stock dividend? Why do companies do it?
Not cash dividend. Stock dividends are distributions of additional stock in proportion to the shareholder’s current holdings.
So, for example, if a company declared a 10% stock dividend and a shareholder currently has 100 shares to stock, then the shareholder would receive an additional 10 shares.
Why do companies give stocks instead of cash?
- not have enough cash
- used cash for investments
What are the effects of Stock Dividends? What do they not effect?
page 44 Week 2
they increase the number of shares outstanding and secondly, they transfer retained earnings to paid-in capital. Note that the total stockholders’ equity’s not changing. Stock dividends have no effect on assets. They also have no effect on the percentage ownership of stock by the shareholders.
What are Stock Splits?
These are designed to increase the number of shares of stock and reduce the par value per share, so that there will be no effect on the accounts, specifically no effect on the common stock or the preferred stock account that appears on the balance sheet.
total amount of paid-in capital would stay the same.
Nividia - make it easier for everyday person to buy the stock
What are reverse stock splits?
This decreases the number of shares of stock and increases the par value per share.
Why?
if a company’s stock price is projected to be going below a dollar, to avoid being de-listed, they might do a reverse stock split to prop up the market value per share
Meet minimum pension fund rules
Non-controlling interests and where does it appear?
appears in Stock Holder Equity Balance Sheet
when a company owns more than 50% of another company. The non-controlling interest would be, in these consolidated balance sheets, the portion of owners’ equity that’s not controlled by the parent.
Stock-Based Compensation, where does it appear?
Nowadays, however, stock-based compensation must be expensed, much to the chagrin of many companies
What are accounts receivable (A/R) How is it different from accounts payable?
How to deal with bad debt expense?
Matching principle
allowance methods. This is where we estimate losses. These estimates require consideration of historical loss experience, adjusted for current conditions, trends in customer payment frequency, and judgments
Accounts Receivable
A/R (net) = AR - Allowance for bad debts
What are Contra-asset accounts?
1) Allowance for bad debts
This allowance for bad debts is referred to as a contra-asset account because it is a deduction from the asset, accounts receivable, to get the net amount of accounts receivable
A/R (net) = AR - Allowance for bad debts
How do you estimate bad debt expense and the allowance amount? Name two methods
1) Percentage of Credit Sales Method (simply by taking a percentage of credit sales, typically based on the company’s past history. does not consider anything about accounts receivable or what’s already in the allowance for bad debt accounts.)
2) Percentage of Receivables Method
= New Allowance for Bad Debts minus Percentage(s) of ending balance in A/R
Does bad debt expense carry over to the next year?
No. bad debt expense is an account that appears on the income statement, so it does not carry over from one year to the next.
The allowance account is a balance sheet account, and as such, it does carry over from one year to the next.
What are notes receivable? Where are they on the balance sheet?
formal contracts
These contracts will specify due dates for the payments, they’ll specify interest that must be paid, the interest rates and these are classified as current or long term depending on the due date.
Difference between notes receivable and accounts receivable
Notes receivable and accounts receivable are both assets representing amounts owed to a creditor. However, notes receivable are based on formal, interest-bearing promissory notes while accounts receivable are informal amounts owed by customers in the normal course of business: Debtors repay accounts receivable according to the invoice’s billing terms and don’t incur interest charges when paid on time.
Accounts receivable are current assets because they usually have a single, short-term due date, such as 30 or 60 days from invoice date. Notes receivable usually have longer terms, with payments made over regular intervals during the note’s term or in full at the maturity date. Notes receivable can be classified as current or long-term assets or both: Amounts due within 12 months are classified as short-term and any amounts beyond that are classified as long-term.
How do you calculate interest rate ( for notes recievable)
Interest = Principal * Interest Rate * Time (usually out of a year)
