Equity Financing 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 2 categories of EQUITY Contributed Capital The amount of money that the owners have contributed through the purchase of stock Capital Stock Retained Earnings The net income earned by the company not paid out as dividends Two types of Capital Stock NOTE The accounting is identical Preferred Stock Has Dividend Preference IF a dividend is paid then the preferred stock holders must be paid in full before the common stockholders can receive a dividend The preferred stock dividend is a set fixed Preferred stockholders typically do not percentage have voting rights Common Stock Has Voting Rights Election of board of directors Vote on significant activities of management Dividend rates are determined by the board of directors based on the corporation s profitability Receive dividends after preferred stockholders Most preferred stock is cumulative Preferred stockholders must be paid both current and prior years unpaid dividends before common stockholders can receive any dividends These prior years are called Dividends in Arrears Not liability Must be disclosed in the notes to the Financial Statements Par Value a monetary amount assigned to each class of stock Used 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 its par value The excess of the selling price of the stock over the par value is recorded in the equity account called Paid in equity account The total number of shares of stock that the company is allowed to sell to the public Each class of stock has 3 types of Shares Authorized Shares Issued Shares Outstanding Shares The total number of shares that have been sold to the public The total number of shares actually in hands owned of stockholders KEY POINT Difference between issued and outstanding Stock that has been reacquired is called Treasury Stock Treasury Stock Corporation s own stock that had been issued but was subsequently reacquired Never affect income statement Account Characteristics of Treasury Stock Results in a decrease to total stockholders equity on the balance sheet Classified as a contra equity account Normal balance is a debit Other Information Considered issued stock but not outstanding stock Does not have voting rights Cannot receive dividends Recorded at its reacquisition cost buy back cost NOT recorded at par value No gains or losses are ever recognized from these equity transactions Why o Reduce shares outstanding and thus increase the market value per share o Because the market price is low o To remove shares from the market to avoid a hostile takeover o To use in employee stock option o To give cash back to shareholders o To increase the reported earnings per programs share Journal Entries for shares that were reacquired and are re issued Re issue price Record excess in Equity Account Paid Reacquisition cost in Capital Treasury Always remove the treasury stock from the balance sheet at its reacquisition cost Re issue price Reduce Paid in capital Treasury until it Reacquisition cost is at zero If there is extra then reduce Retained earnings Reviewed Terms Retained Earnings Dividends Cash Dividends Net Income earned by the company not paid out as dividends Distribution to the owners stockholders of a corporation Cash distribution of earnings to stockholders Cash Dividends Dividends must be declared by board of directors before they can be paid Once a dividend is declared the liability is created Important Dates for Dividends 1 Date of Declaration Board of directors formally announces that to pay a dividend BUT The corporation is not legally 2 Date of Record required to declare and subsequently pay dividends Dividends are not considered expense Thus do not impact net income Contra Equity reduces retained earnings Normal balance of dividend is a debit Require sufficient cash and retained earnings to cover dividend Date which ha stockholder must own the stock in order to receive the declared dividend 3 Date of Payment The date on which a corporation pays dividends to its stockholders Preferred Stock Dividend par value x Total Preferred Stock dividend par value x x shares outstanding NOTE Dividends are only paid on outstanding shares Thus no dividends are paid on treasury stock Important Equity Ratios Return on Equity Measures the amount of profit earned per dollar of invested capital Net Income Average Equity Overall Company performance Higher is better Earnings per share EPS The amount of Net Income that is associated with each share of common stock of Common shares Outstanding Higher is better How much of the company s income belongs to an investor PE ratio Price Earnings Shows relationship between the market value of a company and that company s current earnings Measures investors expectations regarding the growth potential and earnings stability of a company share Higher is better Net Income Preferred stock Dividends Market Price per share Earnings per Financial Statement Effects from Equity Transactions Balance Sheet Statement of Cash Flows Income Statement NONE NONE Issuance of Equity Buying Shares Back Increase Assets Cash Increase Equity Common Stock Paid in Capital Decease Assets Cash Decrease Equity Treasury Stock contra equity Financing Inflow Financing Outflow