6. Equity Flashcards
(45 cards)
How are common stock and preferred stock different in terms of equity classification?
Common stock represents ownership with voting rights and variable dividends, while preferred stock typically has fixed dividends and no voting rights but priority over common stock in case of liquidation.
What is the role of retained earnings in shareholders’ equity?
Retained earnings represent the cumulative profits of a company that have not been distributed as dividends but reinvested in the business, contributing to the growth of shareholders’ equity.
How does the purchase of treasury stock affect shareholders’ equity?
Treasury stock is a contra-equity account, reducing total shareholders’ equity as it represents shares that a company repurchases from the market.
What are the main components of equity reported in financial statements?
The main components include common stock, preferred stock, retained earnings, capital surplus, treasury stock, other comprehensive income, and non-controlling interests.
How does a share repurchase impact earnings per share (EPS)?
A share repurchase reduces the number of outstanding shares, increasing earnings per share (EPS) since net income is divided among fewer shares.
How do transaction costs affect equity when repurchasing shares?
Transaction costs associated with share repurchases reduce shareholders’ equity as they are typically recorded as a reduction in the additional paid-in capital or retained earnings.
What is capital surplus and how is it reported in equity?
Capital surplus, also known as additional paid-in capital, represents the excess amount paid by investors over the par value of the stock and is reported under shareholders’ equity.
How does other comprehensive income (OCI) affect equity?
Other comprehensive income reflects unrealized gains and losses that are not included in net income but still affect shareholders’ equity, such as foreign currency translation adjustments or unrealized gains on investments.
How do share transactions, such as issuing new shares, impact shareholders’ equity?
Issuing new shares increases shareholders’ equity by adding the proceeds from the share issuance to common stock and additional paid-in capital.
What are the motives for a company to repurchase its own shares?
Companies repurchase shares to return excess cash to shareholders, improve financial ratios like EPS, or to signal confidence in the company’s future performance.
How does repurchasing shares at a price above book value impact shareholders’ equity?
When a company repurchases shares at a price above book value, it reduces retained earnings and increases treasury stock, leading to an overall reduction in shareholders’ equity greater than the amount of treasury stock recorded.
How does the issuance of preferred stock affect the financial structure of a company compared to issuing common stock?
Issuing preferred stock provides financing without diluting voting rights, but it increases the company’s obligation to pay fixed dividends, unlike common stock, which may offer more flexibility in dividend payments.
How do you account for share repurchases when the treasury stock is later reissued at a different price?
When treasury stock is reissued at a price different from the repurchase price, the difference is recorded in additional paid-in capital; if the reissue price is lower, retained earnings are reduced if there is insufficient additional paid-in capital.
How does a company decide whether to distribute dividends or retain earnings?
A company considers factors like growth opportunities, the desire to reinvest in the business, cash flow needs, and shareholder preferences when deciding between distributing dividends or retaining earnings to fund future operations.
How does the accounting treatment for treasury stock under the cost method affect financial statements?
Under the cost method, treasury stock is recorded at its repurchase price as a contra-equity account, reducing total shareholders’ equity and does not directly affect net income or retained earnings unless the stock is resold.
What is the impact of share repurchases on a company’s debt-to-equity ratio?
Share repurchases decrease shareholders’ equity, increasing the debt-to-equity ratio, which can make the company appear more leveraged and affect its financial risk profile.
How do other comprehensive income (OCI) items like unrealized gains/losses affect equity without impacting net income?
OCI items bypass the income statement and directly affect shareholders’ equity through the OCI account, ensuring that unrealized gains and losses do not distort net income but still adjust total equity.
How do changes in non-controlling interests affect the overall equity of a company?
Changes in non-controlling interests, resulting from acquisitions or disposals of minority stakes, adjust the portion of equity attributable to minority shareholders, altering the total equity on the balance sheet.
How do share repurchases influence a company’s return on equity (ROE), and what are the potential risks?
Share repurchases reduce equity, thereby increasing ROE if net income remains constant. However, the risk lies in overleveraging, which can lead to financial instability if the company faces declining profits or increased borrowing costs.
How would you assess the effects of a share issuance on existing shareholders in terms of ownership dilution and value?
Issuing new shares dilutes ownership and voting power for existing shareholders, but it can also raise capital for growth opportunities, potentially increasing the company’s value if the proceeds are used effectively.
How do treasury stock transactions impact key financial ratios, such as EPS and book value per share?
Treasury stock reduces the number of outstanding shares, boosting EPS and possibly improving market perception. However, it also reduces book value per share as equity declines, which may negatively affect financial ratios if not managed properly.
How would you analyze the long-term effects of retaining earnings versus distributing dividends on shareholder wealth?
Retaining earnings can lead to reinvestment in profitable projects, enhancing long-term shareholder value, but may not immediately satisfy income-seeking shareholders. On the other hand, dividend distributions provide immediate returns but might limit the company’s growth potential.
How would you interpret a company’s decision to reissue treasury stock at a price below its original repurchase cost?
Reissuing treasury stock at a price below the repurchase cost results in a loss that reduces additional paid-in capital or retained earnings, potentially signaling weak demand for the company’s stock and a negative market perception.
How do changes in other comprehensive income (OCI) from foreign currency adjustments or unrealized gains/losses reflect a company’s financial health?
Changes in OCI from foreign currency adjustments or unrealized gains/losses indicate volatility in assets or liabilities, which can reflect economic uncertainties or market risks. Analyzing these changes helps assess potential future impacts on the company’s financial stability.
