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Like accounting English is can be confusing to learn Just shows that you can t expect everything to make sense at first These words don t rhyme Bough Comb o Cough Tomb Dough Bomb Rough And these do Read Tried Deed o Cede Dyed INDIANA UNIVERSITY General Overview of A312 Chapter 20 Pensions Chapter 15 Stockholders Equity Chapter 16 Dilutive Securities amp EPS What s Next Certification httpwww investopediacomarticlesprofess ionaleducationOQaccountinqfinance certificationsasp CPA CMA CIA and more INDIANA UNIVERSITY Defined Contribution Plan A formula determines the amount of the current contribution by the employer Employee s retirement depends on how much the contributions earn between now and retirement The emplovee i not the firm bears the risk if the return on the contributions f The benefits received by the employee are not guaranteed by the employer they are a function of the contributions and the return on these contributions If you are offered a retirement plan with a job it will likely be part of a defined contribution plan Remember to take advantage of any employer match since it s free money INDIANA UNIVERSITY Defined Benefit Plan The employer bears the risk payments are guaranteed so the employer has to come up with this money Most pension plans that arise from collective bargaining ie union agreements are defined benefit Minimum benefits are guaranteed by the Pension Benefit Guarantee Corporation a government entity Defined Benefit plans have been in the news because many states cannot meet the financial obligations promised to workers due to overoptimistic expected investment returns and must now raise taxes or cut benefits which have already vested INDIANA UNIVERSITY Accounting for Pensions What is the pension obligation that a company should report in the financial statements The employer s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan 1 Projected Benefit Obligation PBO use future salaries FASB 2 Accumulated Benefit Obligation ABO use current salaries 3 Vested Benefit Obligation VBO already earned current salaries PBO gt ABO gt V80 4 What is the pension expense for the period Intermediate Financial Accounting INDIANA UNIVERSITY Pension Expense Periodic pension expense is the net cost of six components IService cost Ilnterest cost IExpected return on plan assets IAmortization of prior service cost can be or IRecognized portion of cumulative gains or losses can be or IAmortization of transition asset or liability can be or The first two components always increase pension expense The third component always decreases pension expense The remaining three components can either increase or decrease pension expense depending on the situation INDIANA UNIVERSITY Funded Status Afirm s funded status is the difference between a plan s PBO and the plan s assets at fair value Many consider this the critical measure of a plan s health If PBO gt Plan Assets the plan is referred to as underfunded If PBO lt Plan Assets the plan is referred to as overfunded Pension plan assets and liabilities PBO were not fully reflected on the balance sheet before SFAS 158 which was issued in Sept of 2006 Priorto SFAS 158 firms only gradually reflected a portion of the funded status on the balance sheet SFAS 158 now requires the entire funded status to appear on the balance sheet as a pension liability or pension asset INDIANA UNIVERSITY Pension components reported within the Financial Statements include I Pension expense I Pension Asset Liability most often I Components of Accumulated Other Comprehensive Income Prior service costs Actuarial gains and losses INDIANA UNIVERSITY Using a Pension Worksheet I The balance in the Pension Asset Liability column should equal the net balance in the memo record this is the quotnet funded position of the pension plan Pension liability credit balance Pension asset debit balance I For each transaction or event the debits must equal the credits Intermediate Financial Accounting INDIANA UNIVERSITY Pension Work Sheet GENERAL JOURNAL ENTRIES MEMO RECORD Other Comprehensive Income OCI Prior Pension Projected Pension Service Asset l Benefit Plan Items Expense Cash Costs PSC GainLoss Liability Obligation Assets k k J 39f Y The General Journal Entries columns The Memo Record determine the journal entries to be recorded columns maintain balances in the formal general ledger 1 for the pension items v The ending balance of the pension asset or liability equals the difference between the P80 and the Plan Assetsllll INDIANA UNIVERSITY Pensions in the Financial Statements Companies do not recognize two main items in the accounts and in the financial statements I Projected benefit obligation I Pension plan assets These are kept track of with an outside plan management entity memo record on worksheet Disclosed only in notes to the financial statements but not in the body of the financials The pension assetliability equals the difference between the P30 and the Plan Assetsllll INDIANA UNIVERSITY Projected Benefit Obligation PBO Beginning PBO Balance Service cost PV of benefits earned in pd nterest cost increase due to time passage Actuaria GL change in assumptions Prior service cost plan amendments Benefits paid Ending PBO Balance INDIANA UNIVERSITY Change in Plan Assets Beginning Plan Assets Balance Employer Contributions Return on Assets Actual Benefits paid Ending Plan Assets Balance III INDIANA UNIVERSITY Prior Service Cost gives credit for work done in the past before the plan went into effect Prior service cost is amortized over the remaining service period of those employees active at the date of the amendment who are expected to receive bene ts under the plan The employer may amortize the costs via one of two methods D StraightLine Method PSC is amortized over the average remaining service period of the employee group Yearly Amortization Percentage 1 Average Remaining Service Period gt Service Method PSC is amortized by the percentage of remaining service years completed in a given year Yearly Amortization Percentage Service Years Just Completed Total Number of Service Years INDIANA UNIVERSITY Gains and Losses Unexpected swings in pension expense can result from 1 Changes in the market value of plan assets and 2 Changes in actuarial assumptions that affect the amount of the projected benefit obligation Due to the potential negative impact on Net Income of these unexpected swings the FASB decided to reduce the volatility with smoothing techniques to record the market changes after time has elapsed to show trends not just up and down swings INDIANA UNIVERSITY Record the difference between the expected return and the actual returns in Net Gain or Loss account PBO GainsLosses Increases in PBO are losses Decreases are gains Plan Asset GainsLosses Loss occurs when actual return lt expected return Gain when actual gt expected return Amortize amount in excess of corridor to pension expense over the average remaining service period of active employees expected to receive bene ts under the plan INDIANA UNIVERSITY Changes in Assumptions Look for changes in discount rate estimated compensation increases and expected return on plan assets Effect of Increase on NI Discount Rate Decrease Service cost Increase Interest cost Net Effect Expected Return Compensation Rate INDIANA UNIVERSITY US GAAP vs IFRS Must amortize actuarial Can elect to report actuarial gainslosses into pension gainslosses in other expense comprehensive income Pension expense must be Pension expense can be reported as one income item in separated into components the income statement interestERR financing PSC amortized over average PSC amortized until vested service life expensed more quickly Must report funded status in Funded status not required in balance sheet SFAS 158 balance sheet unrecognized De ned contribution plan must Items remain off balance sheet have individual accounts Defined contribution plan not required to have individual accounts INDIANA UNIVERSITY Three primary forms of business organization Proprietorship Partnership Corporation Special characteristics of the corporate form 1 Influence of state corporate law a Corporation must submit articles of incorporation to the state in which incorporation is desired b Accounting for stockholders equity follows the provisions of each states business incorporation act 2 Use of capital stock or share system INDIANA UNIVERSITY Types of Stock varying ownership interests Common stock represents basic ownership interest 0 Bears ultimate risks of loss 0 Receives the benefits of success 0 Not guaranteed dividends nor assets upon dissolution Preferred stock is created by contract when stockholders sacrifice certain rights in return for other rights or privileges usually dividend preference Treasury stock reacquired shares INDIANA UNIVERSITY Disclosure of Treasury stock Reduction of stockholders39 equity Stockholders39 equity Common Stock par Additional paid in capital Retained earnings Less Treasurv stock Total Stockholders39 equity Not an asset INDIANA UNIVERSITY What happens when Treasury stock is sold Atlantic acquired 10000 shares of its treasury stock at 11 per share It now sells 1000 shares at 15 per share on March 10 Atlantic records the sale of treasury stock as Cash 15000 Treasury stock 11000 Paid in capital from treasury stock 4000 III INDIANA UNIVERSITY TYPES OF DIVIDENDS 1 Cash dividends 2 Property dividends Dividends paid in assets other than cash 3 Liquidating dividends Any dividend not based on earnings will reduce corporate paidin capital 4 Stock dividends Issuance of own stock to stockholders on a pro rata basis without receiving any consideration Important dates associated with dividends Declaration record payment Intermediate Financial Accounting I l INDIANA UNIVERSITY Stock Dividend Dividend distributed by issuing more stock ISharehoders receive additional shares of stock in proportion to existing holdings IReaIy just reolassifying earned capital to contributed capital INDIANA UNIVERSITY Stock Dividend Two classifications of stock dividends Small Stock Dividend a stock dividend in shares less than 2025 of the firm s total outstanding shares use the MarketValue Method record the transaction at fair market value of the stock Larqe Stock Dividend a stock dividend greater than 2025 of the firm s outstanding shares use the Par Value Method record the transaction at the stock s par value INDIANA UNIVERSITY Stock Split A company may declare a stock split in order to reduce the market value of its stock to make it more affordable to investors A stock split 1 increases the number of shares outstanding 2 decreases the par value of the stock INDIANA UNIVERSITY Differentiate Stock Split and Stock Dividend There is no journal entry made for stock splits only a memo noting the change in shares and par value lfthe stock dividend is large it has the same effect on market price as a stock split There is really no difference between a 2for1 stock split and a 100 stock dividend However a Journal Entry is made for a dividend but only a memo notation for a split IlI INDIANA UNIVERSITY BOOK VALUE PER SHARE The amount each share would receive ifthe company were liquidated on the basis of amounts reported on the balance sheet The computation becomes more complicated if a company has preferred stock Stockholders equity Preferred Common Preferred stock 5 300000 Common stock 400000 Excess of issue price over par of common stock 37500 Retained earnings 162582 Totals 300000 600082 Shares outstanding 4000 Book value per share 15002 Intermediate Financial Accounting I l INDIANA UNIVERSITY Preferred stock Preferred stock has preferences specific rights as compared to common stock In exchange for these preferences preferred stockholders often sacrifice certain rights such as voting rights Typical preferences might include oCumulative or noncumulative dividends Nonparticipating partially participating or fully participating with common stockholders in dividends in excess of the stated preferred dividend oPriority claim on the firm s assets in the event of liquidation Preferred shareholders given right to assets up to a prespecified amount Any remaining assets are distributed to the common stockholders Convertibility into common stock Convertibility privileges must be disclosed in the notes to the financial statements Optional redemption The preferred shareholder may have the option to put the shares back to the firmhave them redeemed at a specified date and price INDIANA UNIVERSITY Cumulative vs Noncumulative Dividends Dividends are not required to be paid out every year However no common stock may be paid until preferred stock dividends are paid Cumulative preferred stock gives the shareholders the right to all unpaid dividends lf dividends are passed over in a year ie the full amount of the dividend is not paid then the dividends accumulate The total accumulated amount called dividends in arrears must be paid before the common stockholders can be paid any dividends Noncumulative preferred stock gives shareholders no claim on passed over dividends The firm may pay dividends to common stockholders once it has paid the current year s preferred dividend ie it no longer has an obligation for the past skipped payments Few preferred stock issues are noncumulative INDIANA UNIVERSITY Participating Preferred Stock Nonparticipatinq preferred stock is only entitled to the preferred stock s stated dividend Partiav participatinq preferred stockholders participate ratany with common stockholders in any dividend distribution beyond the preferred rate up to a specified level Fuv participatinq preferred stockholders participate ratably with common stockholders in any dividend distribution beyond the preferred rate INDIANA UNIVERSITY Participating Preferred Stock Steps for determining prorata dividends per share 1 Calculate the total par value of all outstanding common Pvalc and all preferred shares Pvalp outstanding Pvalc of common sharesxCS par value per share PvalIo of preferred sharesxPS par value per share 2 Calculate the amount required to pay the periodic preferred dividend and any dividends in arrears Regular preferred dividend PvalpxPreferred Dividend 3 If dividend left calculate the corresponding dividend payout for the common shares Matching common shares dividend PvalcxPreferred Dividend 4 Remaining dividend is paid out in proportion to the total par values until the preferred stocks partial limit is hit if one exists 5 If a preferred stock limit exists and is reached then the remainder ofthe dividend is paid out to the common stock shareholders INDIANA UNIVERSITY Liability or Equity Equity or net assets is the residual interest in the assets of an entity that remains after deducting the liabilities Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events Which is represented by preferred stock INDIANA UNIVERSITY Mandatorily Redeemable Preferred Stock The firm promises to pay back the preferred stock at a stated price in the future Characteristics of both debt and equity Fixed cumulative dividend payments are similar to interest payments Fixed redemption date and price are similar to principal payments for debt The SEC ruled that redeemable preferred stock is not equity but did not state that is debt 80 companies put the securities between liabilities and equity on the balance sheet mezzanine INDIANA UNIVERSITY What is the effect of SFAS 150 Many of these securities have gone away httpwww fasb orqs ummarystsum 1 50 shtml The FASB with the IASB is working on a comprehensive standard for instruments with characteristics of liabilities and equity The objective of this joint project is to improve and simplify the nancial reporting requirements for nancial instruments with characteristics of equity httpwww fasborqfi with characteristics of equity shtml Give investors with more decision useful information INDIANA UNIVERSITY Employee Stock Option Plans Compensatory Stock Plans Companies sometimes give employees shares of stock stock options or compensation based on price appreciation Aligns goals of employee with those of the shareholder Provides compensation without using cash Stock Options 0 Employee has the right to buy stock at a prespecified amount exercise price Stock Appreciation Rights 0 Employee receives stock or cash in the amount equal to the value of the stock over a preset value INDIANA UNIVERSITY Computing Option Value Under SFAS 123R Options are priced using complex option pricing models such as the BIackScholes model or the binomial model All option pricing models require six inputs 1 Exercise price The higher the exercise price the lower the option value 2 Term of the option The longer the term the higher the option value 3 Market price of stock The higher the current market price the greater the value of the option 4 Expected dividend yield The higher the expected dividend payout rate the lower the value of the option 5 Riskfree rate of return The higher the riskfree rate of return the higher the option value 6 Volatility of stock price The higher the volatility the higher the option value INDIANA UNIVERSITY Computing Option Value Under SFAS 123R Estimated Total Compensation Cost TCC TCC FV N1 FRSP Fair value of each option FV using an option pricing model Number of options awarded N Expected annual rate of option forfeiture FR due to employees leaving the firm prior to vesting Service period SP in years INDIANA UNIVERSITY NonQualified Plans By far the most common type of plan offered to employees I Can be issued in or out of the money I Market price at exercise exercise price x shares exercised is considered taxable income for employees when the options are exercised The firm likewise recognizes M Pexercise EP x shares exercised as a taxable expense Nonqualified plans therefore have tax advantages for firms WiII create a Deferred Tax Asset DTA INDIANA UNIVERSITY STOCK APPRECIATION RIGHTS Developed as executive compensation option SAR s give the holder a payment of either cash or equivalent shares of stock equal to the increase in the firm s stock price FMV over a pre established set price SAR s avoid having employees pay the exercise price to receive the option benefits Intermediate Financial Accounting III INDIANA UNIVERSITY EARNINGS PER SHARE Net Income by itself is not an appropriate performance measure since it ignores the amount of contributed capital used to generate earnings Reporting earnings per share allows investors a means of evaluating the amount of capital that was necessary to generate a firm s income EPS therefore gives a better sense of the return on investment Analysts compare EPS perhaps subjectively adjusted to market price per share to evaluate investment potential of company These priceearnings ratios calculated on a pershare basis receive intensive scrutiny in the market Intermediate Financial Accounting I l Ill INDIANA UNIVERSITY EARNINGS PER SHARE With this dilutive effect in mind GAAP requires two EPS numbers to be disclosed for firms with quotcomplexquot capital structures Basic EPS based upon weighted average of shares actually outstanding Diluted EPS based upon revised calculations of earnings and weighted average shares outstanding as if all possible dilutive conversions or option exercises that would reduce EPS occurred as of the beginning of the year A complex capital structure is any capital structure that contains financial instruments which allow the holder to purchase common stock at prespecified price that is potentially less than the market value For example convertible preferred stock convertible bonds or employee stock options Intermediate Financial Accounting I l III INDIANA UNIVERSITY STEPS TO CALCULATE DILUTED EPS Step 1 Calculate basic earnings per share for continuing operations Step 2 Calculate the marginal EPS effect ME of each potentially dilutive security and contract assuming the occurrence of the specified hypothetical event and rank order the securities and contracts based on the size of their ME s from the one that is most dilutive to the one that is least dilutive Step 3 Use basic EPS from continuing operations as the first tentative measure of diluted earnings per share Recalculate the current tentative diluted EPS by adjusting the earnings and shares for the most next most dilutive hypothetical transaction using the numbers in the numerator and denominator of the marginal effect calculation Ifthe recalculated EPS goes down the recalculated number is the new tentative measure of diluted earnings per share Go to next most dilutive security Ifthe recalculated EPS goes up quit If the conversion of a security is antidilutive the security conversion should not be included in the calculation ofdiluted EPS Intermediate Financial Accounting I l INDIANA UNIVERSITY DILUTED EPS Note that diluted EPS uses income from continuinq operations as its reference not net income Therefore if a potentially dilutive security would reduce overall EPS but not the EPS from continuing operations it is not included For example a firm with negative EPS from continuing operations but a positive net income due to extraordinary items would not include the effects of any dilutive securities Intermediate Financial Accounting ll INDIANA UNIVERSITY REQUIRED EPS DISCLOSURE Firms with simple capital structures must disclose Basic EPS on the face of the income statement net of tax for the following Income from continuing operations Net Income Firms with a complex capital structures must disclose both Basic EPS and Diluted EPS on the face of the income statement net of tax and with equal prominence for the following Income from continuing operations Net Income Intermediate Financial Accounting INDIANA UNIVERSITY WHAT S ON THE EXAM Concepts 12 MC 20 Computations 12 MC 20 Pension Problem 20 Stockholders Equity 20 EPS Problem 20 Intermediate Financial Accounting INDIANA UNIVERSITY When and where is the exam Graduating seniors BU 307 911 AM Friday May 6 Everyone else Be in this room 245445 on Friday May 6 Intermediate Financial Accounting