Chapter 9 and 10 Review
Chapter 9 and 10 Review ACCT 2110 - 002
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ACCT 2110 - 002
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This 7 page Study Guide was uploaded by Callisa Ruschmeyer on Saturday April 30, 2016. The Study Guide belongs to ACCT 2110 - 002 at Auburn University taught by Elizabeth G Miller in Fall 2015. Since its upload, it has received 43 views. For similar materials see Principles of Financial Accounting in Accounting at Auburn University.
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Date Created: 04/30/16
Chapter 9- Long Term Liabilities Bond- financial instrument where the borrower promises to pay future interest and principal to a creditor in exchange for the creditor's cash today Types of bonds o Secured- specific assets pledge as collateral o Unsecured- no collateral can be pledged; usually have a higher interest rate Subgroup: junk bonds- high interest and very risky o Convertible bonds- you can convert them into common stock o Callable bonds- subject to retirement at a stated dollar amount- you can pay them off early Bond Vocabulary Face value- repaid at maturity of a bond; always state face value on a journal entry for bonds payable Stated interest rate- the contractual rate at which interest is paid to the creditor Maturity date- when face value must be repaid to the creditor Market (yield) rate of interest- the rate of return that investors in the bond markets demand for a bond of similar risk Discounts vs. Premiums Type Rates Journal Entry Specifics Cost of Interest over the Life Borrowing of the Bond Discount Stated < Debit- Discount on Bonds increases Interest Expense > market Payable Interest Paid Par Stated = Credit bonds at face value Interest Expense = market (no matter what) Interest Paid Premium Stated > Credit- Premium on Bonds decreases Interest Expense < market Payable Interest Paid Journal Entries needed for the Giving of bonds 1. Issuance- cash received when the bonds are issued Debit- Cash Credit- Bonds Payable (always at face value) Possible discount (debit) or premium (credit) if stated rate was different than market rate 2. Interest- makes sure to look at when its paid (annually, semi-annually, etc) Debit- Interest Expense Credit- Cash (at face value <-- you always pay the same to investors) Possible discount (credit) or premium (debit) 3. Repayment- repayment of the principle at maturity Debit- Bonds Payable Credit- Cash Recognizing Interest Expense and Repayment of Principle Requires interest amortization- which is the process used to determine the amount of interest to be recorded in each of the periods the liability is outstanding Interest amortization has two parts 1. Actual interest payment 2. Amortizing nay premium or discount Straight-Line Methods of Amortization Equal amount of interest expense and amortization of the discount or premium is recorded every time interest is paid Amount of amortization = (discount or premium) / number of interest periods Cost of borrowing = period interest expense X number of interest periods What to do in each situation Type Amount of FV Period Interest Expense Discount < 100% Total interest expense = total interest payments + the discount Par 100% of face Total interest expense = total interest payments value Premium > 100% Total interest expense = total interest payments - the premium Carrying Value Discount: carrying value = face value - unamortized discount Premium: carrying value = face value + unamortized premium At maturity: carrying value = face value Journal Entries to know o Discount Day issued Debit Cash (minus amortized discount) Discount on BP Credit Bonds Payable (at the face value) Interest Entry Debit Interest Expense (interest amount plus amortized discount) Credit Cash (for the entire interest amount) Discount on BP o Premium Day issued Debit Cash (plus amortized premium) Credit Bonds Payable (at face value) Premium on BP Interest Entry Debit Interest Expense (interest amount minus amortized premium) Premium on BP Credit Cash (for entire interest amount) o At maturity Debit: Bonds Payable (for face value) Credit: Cash Useful Formulas Amount of amortization = (discount or premium) / number of interest periods Cost of borrowing = period interest expense X number of interest periods Amount of payable interest = face value X interest rate X length of period Discount interest expense = interest payment + amortization of discount Premium interest expense = interest payment - amortization of premium Redeeming a Bond before Maturity Three steps when accounting for the early retirement of a bond 1. Update the carrying value of bonds 2. Calculate gain or loss on retirement 3. Record the retirement Gain or loss on redemption o Gain on redemption is when carrying value > call price The company is paying less than the value of the liability o Loss on redemption is when the carrying price < call price The company is paying more than the value of the liability Effective Interest Rate Discounts or premiums are amortized so that interest expense each period is a constant percentage of the bond's carrying value Journal entry for issuance of the bond is still the same as it would be under the straight-line method o Debit: Cash o Credit: Bonds Payable The total interest expense and the cost of borrowing is the same for both of these methods o The effective interest rate is just more accurate for each period o Cost of borrowing = addition of all interest expenses (that is the only way to equate the amount- is by simple addition) Yield rate = market rate Effective interest rate distinguishes between interest payments o Amortized interest = face value X stated rate X time Effective interest expense = carrying value X yield rate X timer With a discount, expense gets higher each year because carrying value increases each year o Interest expense increases each period; unamortized discount decreases; carrying value increases With a premium, expense gets lower each year because carrying value decreases each year o Interest expense decreases each period; unamortized premium decreases; carrying value decreases Leases Operating vs. capital o Operating is where the lessor retains substantially all of the risks and obligation of ownership (these are not liabilities) o Capital lease- agreement that is in substance a purchase of the leased asset (these are liabilities) Three conditions for a capital lease 1. Transfer of the lease at the end of a period of time at "bargain price" 2. Term for the lease is at least 75% of the economic life of the leased asset 3. The present value of the lease payments is at least 90% of the fair value of the leased asset Ratios Analyze a company's solvency Debit to equity = total liabilities / total equity Debt to total assets = total liabilities / total assets Long-term debt to equity = long-term debt / total equity Chapter 10- Stockholders' Equity Stockholders' Equity The owners' claims against the assets of a corporation This represent the equity section on the balance sheet Common sources of equity o Capital stock- both preferred and common And the associated additional paid-in capital o Retained earnings or deficit o Accumulated other comprehensive income o Treasury stock Stockholders are the investors who become owners of the corporation by purchasing stock Dividends can be in the form of stock as well Common Stockholders' Rights Common Stockholders have four rights 1. The right to vote 2. The right to participate proportionally in dividends 3. The right to participate proportionally in residual assets 4. The right of preemption (which is the right of first grabs on any stocks up for sale so that selling them doesn’t decrease their percentage in ownership Preferred Stock Receives one or more priorities over common stock o They get their dividends first Stocks usually sell at a higher price than common stock Accounting for Issuance of Common and Preferred Stock Par value- arbitrary monetary amount printing on each share of stock o Establishes a minimum price of the stock when issued o Does not determine its market value Par value is multiplied by the number of shares sold is recorded in an account that describes the type of stock Additional paid-in-capital- the amount received in excess of the par value recorded in an account Remember o Always credit shares at par o If there is a difference in the value of the stock and the par value, it is made up in the "additional paid in capital-common stock" account Treasury Stock Common stock that a company reacquires from stockholders Treasury stock are not considered outstanding One of the most common reasons to reacquire shares is to issue it to employees under the company's stock compensation plans Treasury shares are not entitled to dividends When you buy back shares, you debit the contra equity account- "treasury stock" Always leave stock accounts at the number originally issued at par value Balance Sheet Stockholders' Equity o Contributing Capital Common stock Add P/C o Retained Earnings o Less: Treasury Stock Dividends Cash- when cash is distributed to stockholders A. Date of declaration- board declares the dividend and a liability is created B. Date of record- date on which those who receive the dividends are identified No journal entry C. Payment date- when the dividend will be distributed o Assets decrease and stockholders equity decreases Stock- additional shares of stock are given to stockholders o Why stock and not cash A company may not have enough cash on hand, but wants to maintain a long and uninterrupted streak of declaring dividends OR, a company may want to reduce the market price of its stock to keep its stock price in an "affordable" range for the average investor o Decrease Retained Earnings; Increase Contributing Capital Assets and liabilities are not changed, just equity is shifted o Small vs. Large Stock Dividends Size Percentage Value Small < 25% Market Value Large > 25% Par Value Stock splits- transfer additional shares to stockholders without changing equity o Basically just an increase in a company's shares of stock according to a specified ratio o Stock splits make stocks more affordable o 2-for-1 split: shares from existing stockholders gets split into two- doubles the shares outstanding and, therefore, cuts the per share par value in half o No journal entry is needed: you only change the number of shares issued o Does not affect Retained Earnings or Contributing Capital Reminders o All dividends decrease retained earnings o Dividends affect stocks that are owned- which are labeled as outstanding shares o Always credit common stock at par Comparison of Stock Dividend vs. Stock Split What Is Affected Stock Stock Split Dividend Number of shares Increases Increases outstanding Par value per share No effect Decreases Total Contributed Capital Increases No Effect Retained Earnings Decreases No Effect Total Stockholders' Equity No Effect No Effect Market price per share Decrease Decrease Stock dividend has no effect on par value- but it does affect the balance sheet --> decreases retained earnings and increases contributing capital o But no effect on stockholders' equity- just moves money around Cash Dividends on Preferred Stock Cash id allocated to both preferred and common stock holders- but only on outstanding stock Cumulative preferred stock- receives current-year dividends and all unpaid dividends from prior years Dividends in arrears- the accumulated value of unpaid prior-year dividends Noncumulative preferred stock-carries the right to receive current-year dividends only Stockholder Profitability Ratios Return on common equity = (net income - preferred dividends) / average common stockholders' equity EPS = (net income - preferred dividends) / average common shares outstanding
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