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Unit 5: Corporate Accounting
Performance Indicators:
5.1 Discuss the nature of corporate bonds (SP)
5.2 Discuss the issuance of stock from a corporation (SP)
5.3 Explain methods to account for the issuance of equity (MN)
5.4 Account for the issuance of equity (MN)
5.5 Explain forms of dividends (SP)
5.6 Compute dividends payable on stock (MN)
5.7 Account for equity transactions (e.g., cash dividend, stock dividend, treasury stock, etc.) (MN)
Unit Assessment:
FI:523 Discuss the nature of corporate bonds
Curriculum Planning Level: SP
Objectives:
Define the term corporate bond.
Identify different types of corporate bonds.
Discuss reasons why corporations issue bonds.
Explain corporate bond ratings.
Discuss risk when investing in corporate bonds.
Discuss the benefits and drawbacks of corporate bonds.
Explain how to buy/sell corporate bonds.
Activity:
Assign the Kami Document as an activity 5.1 Assignment
5.1 Discuss the nature of corporate bonds (SP)
Discussion Guide
Performance Indicator: Discuss the nature of corporate bonds
THINK ABOUT IT
Let’s say you want to purchase new equipment to expand your piano store, but you don’t have the available funds.
Well, you might want to look into corporate bonds!
Keep reading to learn why businesses issue bonds, the benefits and risks of investing in corporate bonds, and more.
KEY CONCEPTS
Slide #1 Reasons Why Corporations Issue Bonds
Corporate bonds are debt instruments that are issued by a business and sold to investors to raise money.
You can think of a corporate bond as an IOU the company issues to its investors.
Investors lend their money and in return the company commits to pay a pre-established number of interest payments, then return the principal, or the original investment, when the bond reaches maturity.
Corporate bonds are a form of debt financing and thus a main source of capital for many companies.
Businesses often use corporate bonds to raise money for expansions and acquisitions, purchase new equipment, invest in research and development, and refinance debt.
Even if the company runs into financial trouble, it is still obligated to pay the bond’s interest and principal.
Slide #2 Types of Corporate Bonds
Corporate bonds are classified a few different ways, including by:
Maturity, or the length of time before the company pays back the principal.
Maturities can be short-term (usually less than three years), medium-term (four to 10 years), or long-term (more than 10 years).
Longer-term bonds offer higher interest rates, but can be riskier.
Credit rating, or investment grade issued by credit rating agencies.
These categories include investment grade and junk bonds, which are based on credit quality.
They range from AAA (or Triple A) to not rated.
Interest rates, which dictate the type of interest payment the bond offers.
Interest payments are known as coupon payments, and interest rate is known as coupon rate.
Fixed rate bonds provide the same interest payment until maturity.
Floating rate bonds have variable interest rates that reset periodically based on U.S. Treasury benchmarks and market interest rates.
Zero coupon bonds withhold interest payments until the bond matures, then the company issues a single payment.
Convertible bonds allow companies to pay investors with shares of stock instead of cash.
Slide #3 Corporate Bond Ratings
Before companies can issue them to investors, bonds must be reviewed by at least one of the three well-known rating agencies: Standard and Poor’s Global Ratings, Moody’s Investor Services, and Fitch Ratings.
These agencies assign a grade that signifies the bond’s credit quality and its overall stability.
When determining ratings, agencies consider the company’s financial strength, its ability to pay the principal and interest on time, and its future outlook.
Bond ratings help to differentiate between investment grade bonds, which offer more security but lower yields and range from AAA to BBB-, and junk bonds, which are higher risk but offer higher yields and range from BB+ to D to not rated.
Bond ratings impact interest rates, investment enthusiasm, and pricing.
Slide #4 Benefits, Drawbacks, and Risks
Corporate bonds offer a variety of benefits.
They tend to be less risky and less volatile than stocks.
There is a wide variety to choose from each year so investors can build a diverse portfolio that meets their needs.
They also provide a steady income stream.
Corporate bonds are relatively liquid, and many are traded in the secondary market.
Corporate bonds also have some drawbacks.
The advantage of their lower risk usually means lower returns over time on average.
Corporate bonds also carry credit risk and interest rate risk.
Credit risk, also called default risk, means if the company goes out of business, the investor may lose interest payments and their principal investment.
Bonds with lower ratings have a higher risk for defaulting.
Interest rate risk, also called market risk, is the possibility of losses resulting from interest rate fluctuations that can reduce the bond’s market value.
Slide #5 Buying and Selling Corporate Bonds
There are three ways to buy and sell corporate bonds: new issue, secondary market, and bond funds.
With new issue bonds, the investor typically pays a broker or bond trader in the primary market, then the company receives the funds.
The secondary market is where individuals sell and buy already-issued bonds before maturity.
Bond funds are where individuals can invest in a group of bonds for a lower investment price.
All corporate bonds are issued in $1,000 blocks, unless otherwise specified.
Investors typically purchase bonds to balance out riskier investments in their portfolio.
FI:526 Discuss the issuance of stock from a corporation
Curriculum Planning Level: SP
Objectives:
Define the following terms: stock, share.
Explain reasons why corporations issue stock.
Discuss benefits and drawbacks of issuing stock.
Identify the different types of stock.
Discuss why corporations choose to issue different types of stock.
Discuss the required documentation and approval process for issuing stock.
Explain the difference between authorized stock and issued stock.
Identify where stocks are purchased and sold.
Activity:
In groups of 3 or 4 student map out the issuance of stock from a corporation.
Create a how-to guide with series of steps, beginning with the company deciding to issue a specific number of shares and ending with the sale of stock.
5.2 Discuss the issuance of stock from a corporation
Discussion Guide
Performance Indicator: Discuss the issuance of stock from a corporation
THINK ABOUT IT
Your bicycle manufacturing company wants to raise money quickly to fund a new production facility, but you can’t afford to take out another loan.
What could be the answer to your problem?
Issuing corporate stock!
Read on to learn more about the benefits, drawbacks, and types of stock.
KEY CONCEPTS
Slide #1 Why Corporations Issue Stock
A stock is a security that represents ownership of part of a corporation.
A share is a unit of stock.
An investor who purchases stock is referred to as a stockholder or shareholder.
The shareholder is authorized to a proportion of the company’s assets and earnings that is equal to the amount of stock they own.
In other words, the shareholder holds proportionate ownership in the corporation.
Investors can purchase shares of stock through a business’s Initial Public Offering (IPO) in the primary market, or they can purchase shares through stock exchanges in the secondary market.
Corporations typically issue stock to raise money or grow the business.
Issuing stock is a form of equity financing, in which shareholders provide money in exchange for voting rights and company profits.
Debt financing involves issuing bonds or taking out loans.
Companies often choose to issue stock if they can’t afford or don’t want additional debt, plan to grow quickly, have credit issues, need more cash, or lack the necessary assets for debt financing.
Corporations issue stock to develop new products, increase inventory, reduce debt, purchase new equipment, prepare for mergers or acquisitions, improve the company’s value, and more.
Slide #2 Types of Stock
There are two main types of stock: common and preferred.
Common stock is the most basic and widely used form.
Anyone can purchase common stock, and these shares provide voting rights at a company’s annual shareholders’ meeting.
However, since these shares do not guarantee dividends, investors must rely on the company’s performance.
The growth potential is greater since there is not a cap on dividends, but common shareholders have the risk of losing their entire investment if a company goes out of business.
Preferred stock represents ownership in the business as well, and it is generally more secure than common stock.
Most preferred stock comes with a promised dividend payment, and if a company goes out of business, these shareholders have a right to the company’s assets.
However, preferred stock does not provide shareholder voting rights.
Within those types, stock can be classified further, including by company size (e.g., large cap, mid-cap, small-cap), industry or sector, geographic location, and style (e.g., growth, value).
Stocks can also be divided into classes (e.g., A, B) to differentiate shareholder voting rights.
Authorized stock refers to the number and type of shares a corporation has the right to issue, as stated in its Articles of Incorporation.
Issued stock refers to shares the corporation has actually issued to shareholders.
Authorized shares commonly range from 10 to 15 million, while issued shares usually range from five to 10 million.
Companies typically decide not to issue all their authorized shares in order to generate funds in the future, retain control over the organization, and prevent the chance of a hostile takeover.
Slide #3 Deciding Which To Issue
When a company is deciding which type of stock to issue, it should consider its goals.
If it’s trying to raise funds and can pay consistent dividends, preferred stock is an excellent choice.
If it wants to avoid paying dividends or wants to depend on the company’s performance, then common stock would be a great option.
A company should balance its types of stocks to optimize performance and ensure it maintains control over the business.
Slide #4 Documentation and Purchasing
When issuing stock, companies should follow these procedures.
Reference the Articles of Incorporation to ensure they don’t exceed authorized shares.
The board of directors must provide written approval and authorization for the issuing of shares.
Document all processes and transactions clearly.
Utilize a lawyer to help value stock, create agreements, issue shareholder certificates, and ensure compliance with state and federal securities laws and regulations.
Stocks are typically purchased and sold on stock exchanges, like the Nasdaq or New York Stock Exchange (NYSE), although there are private sales, too.
Investors usually use a brokerage account to purchase different stocks.
Stock prices are impacted by supply and demand in the market.
Slide #5 Benefits and Drawbacks
There are both benefits and drawbacks to issuing stock.
Advantages include high liquidity, avoiding debt liabilities (including high interest payments and looking risky to investors), cash to grow the business, and attracting investors.
Disadvantages include less control over the company, diluted ownership, potentially expensive dividend payments, and legal risks (including fines and lawsuits).
FI:471 Explain methods to account for the issuance of equity
Curriculum Planning Level: MN
Objectives:
Define the following terms: equity, par value, no-par value.
Explain the relationship between stock and equity.
Identify costs incurred during the issuance of equity.
Explain differences between the issuance of common stock and preferred stock.
Describe which accounts are affected by the issuance of equity.
Identify where to record the issuance of equity.
Activity:
Research the differences between common stock and preferred stock, then prepare a response of their choice (e.g., written response, infographic, slide presentation, poster, etc.) comparing the two.
Include the differences between issuing common stock and issuing preferred stock, the importance of par values, and identify where to record stock issuances.
5.3 Explain methods to account for the issuance of equity
Discussion Guide
Performance Indicator: Explain methods to account for the issuance of equity
THINK ABOUT IT
When a business decides to issue equity, it’s important to understand all the processes involved. Read on to learn about equity issuance costs, par values, and differences between stock types.
KEY CONCEPTS
Slide #1 Stock and Equity
You may see the terms stock and equity used interchangeably.
The term equity is used to describe ownership.
In relation to a company’s balance sheet, equity, which is often referred to as shareholders’ equity, represents the value that would return to the shareholders if all company assets were liquidated and all debt was paid.
This number is also known as the company’s book value, and the figure is used in key financial calculations.
When related to stock, equity still describes a form of ownership.
The term equities is typically used as another name for stocks.
A stock is a single unit of ownership share, and stocks are tradable versions of equity.
Stocks enable investors to participate in business equity transactions.
Simply put, buying stocks involves purchasing equity in a company from someone who is selling their ownership stake in that company.
The more stock a person owns, the greater their equity in the company.
The main difference is that all stock is related to equity, but not all forms of equity are stocks.
Smaller business ventures like partnerships and sole proprietorships, while they hold equity value that can be divided among owners, are not designed to sell stocks.
Instead, companies and corporations are the main entities that sell stocks.
As we are discussing corporate accounting in this unit, we will use the terms equity and stocks interchangeably, as both refer to company ownership.
Slide #2 Recording and Accounts
Stock issuances impact the cash account, stock account, and paid-in capital in excess of par account on the balance sheet.
The total amount of issued shares, or stocks the company has sold, is recorded on the balance sheet in the stockholders’ equity section.
The number of issued shares is also known as capital stock.
The total of outstanding shares, or all shares issued by a company, is filed with the Securities and Exchange Commission (SEC) and recorded on the company’s annual report.
Slide #3 Equity Issuance Fees
When a business decides to issue stocks, or securities, into the market, the company incurs a variety of costs.
These equity issuance fees typically include the following:
Clerical fees, including administrative costs for preparing forms for regulatory filing and registration.
Underwriting and commission fees, including costs for the underwriters, who can be individuals or investment banks, who make securities available to investors. They also include the sales commissions, or fees, for selling these stocks to investors.
Professional fees, including charges for attorneys and certified public accountants.
Filing fees, including costs to register with the SEC.
Marketing fees, including charges to advertise and promote the securities to investors.
There are two ways companies can account for issuance fees.
They can debit paid-in capital, which treats issuance costs as part of financing activities, not typical operations costs.
Or they can treat them as organizational costs, which views them as an intangible asset that is written off over time.
Slide #4 Common vs. Preferred Stocks
As we’ve learned, the number of authorized shares is defined in a company’s Articles of Incorporation.
The Articles of Incorporation also describe how much money will be paid for each share of stock.
The par value is the set value the Board of Directors assigns to each share.
This amount is the minimum price for which the share can be sold, and the stock certificate reflects the par amount.
A stock with no-par value has no set price or value for which it must be sold.
The Board or company’s management decides how much investors pay for no-par stock each time it is issued.
The worth of no-par stock depends on the value of the company and the amount investors will pay—this gives a company flexibility.
When it comes to issuing stocks, it is up to the company to decide the stock type, amount, and price that best supports its goals.
Many businesses decide to issue a majority of common stock.
Companies may decide to issue some preferred stock to limit stockholder control (as they don’t provide voting rights) while delivering regular dividends.
The accounting procedures are the same for both common and preferred stock.
The differences lie with accounting for various par amounts.
FI:703 Account for the issuance of equity
Curriculum Planning Level: MN
Objectives:
Define the following terms: fair market value, market value, stated value.
Explain the importance of accounting for the issuance of equity.
Describe the impact of the issuance of equity on the stockholders’ equity account.
Distinguish among journal entries for shares issued at par value, above par value, below par value, and no-par value.
Differentiate between journal entries for issuance in exchange for cash and issuance in exchange for asset or service.
Demonstrate how to record the issuance of equity.
Activity:
Get into a group of 3 or 4 students.
You instructor will assign you one of the following:
Shares issued at par value in exchange for cash
Shares issued at par value in exchange for asset/service
Shares issued above par value in exchange for cash
Shares issued above par value in exchange for asset/service
Shares issued below par value in exchange for cash
Shares issued below par value in exchange for asset/service
Shares issued with no-par value in exchange for cash
Shares issued with no-par value in exchange for asset/service
Prepare a presentation to teach the class on how to record the journal entryies for you transiction.
5.4 Account for the issuance of equity (MN)
Discussion Guide
Performance Indicator: Account for the issuance of equity
THINK ABOUT IT
Let’s say your software company issues certain stocks above par value, others at par value, and still more are exchanged for legal services instead of cash.
If you want your company to succeed, you’ll be responsible for accurately recording all equity issuances at your business.
Read on to learn more.
KEY CONCEPTS
Slide #1 Importance
Accountants are responsible for tracking and recording all business stock issuances.
Companies often deal with a wide variety of share values, so it is vital their financial information is organized and up to date.
Keeping orderly records is also important to ensure the company is in compliance with Securities and Exchange Commission (SEC) requirements and other government regulations.
Accurate recordkeeping helps management keep the business in good financial standing.
Slide #2 Stockholders’ Equity Account
The stockholders’ equity account is located on a company’s balance sheet.
This account, sometimes referred to as the stockholders’ equity section, comprises the value of a company’s assets minus its liabilities.
In other words, it includes all the accounts that involve monetary ownership of the company.
The stockholders’ equity account increases when a business issues shares of stock.
In general, this sizable account includes the following smaller accounts: common stock, additional paid-in capital on common stock, preferred stock, additional paid-in capital on preferred stock, retained earnings, and treasury stock.
Slide #3 Recording Equity Issuance
Businesses record separate journal entries for each issuance of equity, and these entries always need to balance, meaning the total credits must equal the total debits.
On the balance sheet, Generally Accepted Accounting Principles (GAAP) requires that certain items must be disclosed in the stockholders’ equity section.
For each class of stock, it must include the account name, par value or stated value, number of shares authorized, number of shares issued, number of shares outstanding, and dividend rate for preferred stock.
Slide #4 Journal Entries for Par Values
To begin, it’s important to understand the difference between market value and par value.
Market value refers to the price at which the stock trades on the stock market.
Corporations don’t use market value in their accounting records or financial statements—instead, they use par value.
Par value doesn’t reflect a stock’s economic or market value.
Its main purpose is to provide accountants with a constant amount to record the company’s stock issuances.
Par value is used for internal accounting, which is why we’ll be focusing on these amounts.
Stock issuance at par value for cash:
Debit Cash account for total cash received
(Shares Issued x Price per Share)
Credit Common or Preferred Stock account for par value
(Par Value x Number of Shares)
Stock issuance above par value for cash:
Debit Cash account for total cash received
(Shares Issued x Price per Share)
Credit Common or Preferred Stock account for par value
(Par Value x Number of Shares)
Credit Paid-in Capital in Excess of Par Value – Common or Preferred Stock account for additional proceeds
[(Sales Price – Par Value) x Number of Shares]
Stock issuance below par value for cash:
Debit Cash account for total cash received
(Shares Issued x Price per Share)
Credit Common or Preferred account for par value
(Par Value x Number of Shares)
Debit Discount on Common or Preferred Stock account for difference
(Par Value – Amount Received)
Sometimes, a company’s board of directors will orally assign a value to no-par stock, which is then called the stated value.
Stated value stock is recorded similarly to par value stock.
Stock issuance of no-par value for cash:
Debit Cash account for total cash received
(Shares Issued x Price per Share)
Credit Common or Preferred Stock account for par value or stated value
(Par Value or Stated Value x Number of Shares)
Credit Paid-in Capital in Excess of Stated Value – Common or Preferred Stock account for additional proceeds (if applicable)
[(Sales Price – Stated Value) x Number of Shares]
Slide #5 Exchange for Asset or Service
There are instances in which businesses may decide to issue stock in exchange for assets or services instead of cash.
In these cases, companies must determine the dollar value of the asset (e.g., legal service, equipment, land, etc.).
Accountants can record the transaction at the fair market value, or cash equivalent price, of either the stock or the asset or services received.
It depends on which amount is more evident or can be more clearly established.
To record the exchange, the business would debit the respective asset account (e.g., Construction services expense), then credit the respective equity accounts (e.g., Common or Preferred Stock account, Paid-in Capital in Excess of Par Value – Common or Preferred Stock account).
It’s also helpful to include a note clarifying the issuance (e.g., “To record the issuance of $2 par value preferred stock in exchange for construction services provided.”).
FI:346 Explain forms of dividends
Curriculum Planning Level: SP
Objectives:
a. Define the term dividend.
b. Explain why companies pay dividends.
c. Identify types of dividends.
d. Differentiate among types of dividends.
e. Describe why companies may choose to distribute one form of dividend over another.
Activity:
Get into a small group.
Create a video script (just the script—not the actual video) for a brief presentation that teaches middle school students about dividends. OR CREATE A 3 Minute Video
Each script should explain why businesses decide to pay dividends, identify different dividend forms, and describe how businesses decide between different forms of dividends. When finished, groups should submit their scripts for review.
5.5 Explain forms of dividends
Discussion Guide
Performance Indicator: Explain forms of dividends
THINK ABOUT IT
When a business earns profits, what does it do with retained earnings?
Often, companies decide to distribute dividends to their investors.
Read on to learn more about the different types of dividends, their purpose, and how they function as an important part of business operations.
KEY CONCEPTS
Slide #1 What Is a Dividend?
When a business generates a profit, its board of directors must decide what to do with those earnings.
Often, businesses reinvest earnings back into the business for continued growth.
The board may also decide to distribute dividends.
A dividend is a sum of money paid to an investor or stockholder as earnings on an investment.
Dividends can be distributed on a recurring (such as monthly, quarterly, or annually) or nonrecurring schedule, and payout rates can vary as well.
Most businesses pay dividends to maintain investor trust, indicate good company well-being, and demonstrate optimism for future profits.
If a business has historically paid dividends, it may choose to continue doing so because a reduction or elimination in dividend payout may cause investors unease, although lack of dividend payouts does not always signal that a business is in trouble.
Slide #2 Types of Dividends
There are several different types of dividends.
Cash dividends are by far the most common, but the business may choose to issue a different form of dividend if it doesn’t have the necessary funds available at that time.
Here are common forms of dividends:
Cash dividends are cash payments, usually bank deposits, made to investors.
Cash dividends are paid by share—the more shares you have, the more money you receive.
Stock dividends are new shares that are issued to investors depending on how many shares the investor already owns.
The investor does not pay for these new shares.
Property dividends are paid in the form of assets, such as equipment, real estate, vehicles, inventory, etc., instead of cash or shares.
The dividend would be recorded against the fair market price of the given asset.
Scrip dividends are notes issued by the company that promise to pay dividends to shareholders when funds become available.
Think of scrip dividends as “IOUs.”
Liquidating dividends are made when the board of directors returns the capital the investor originally invested in the business.
This is often done as a result of business closure.
FI:474 Compute dividends payable on stock
Curriculum Planning Level: MN
Objectives:
Define the following terms: dividends payable, dividend payout ratio, dividend per share, dividend yield.
Explain why companies pay dividends.
Identify important dividend dates (e.g., declaration date, ex-dividend date, record date, payment date).
Compare cash dividends with stock dividends.
Differentiate among common stock dividends, preferred stock dividends, and special dividends.
Calculate dividend payments for different types of dividends.
Activity:
Activity:
Assign the Kami Document as an activity 5.6Assignment
5.6 Compute dividends payable on stock
Discussion Guide
Performance Indicator: Compute dividends payable on stock
THINK ABOUT IT
If a business decides to declare and pay dividends to its shareholders, it’s important to know how to calculate those payments.
Read on to learn why companies pay dividends, differences between dividend types, and formulas for computing dividends payable.
KEY CONCEPTS
Slide #1 Why Companies Pay Dividends
A dividend is a sum of money paid to an investor or stockholder as earnings on an investment.
Paying dividends benefits both the company and the investors.
Investors are happy to receive the extra income as a reward or return on their investments.
Businesses use dividends to maintain investor trust, reflect the company’s stability and financial wellbeing, and demonstrate optimism for future profitability.
Dividends payable are dividends that a company's leadership has declared due to its shareholders, but have not yet been paid.
Businesses distribute dividends according to the type of stock and numbers of shares their investors own.
When distributing dividends, the board of directors makes decisions regarding the dividend form, payout rate, and timeline.
Companies are not required to calculate dividends a certain way, pay a specific amount, or even pay on a consistent basis.
Dividend payout decisions are informed by a company’s net income or free cash flow.
Some well-established companies will issue dividends on a regular basis, while others will only pay dividends during times of economic growth.
Slide #2 Important Dividend Dates
There are four important dividend dates that affect companies and their investors:
Declaration date, which is the date when a company’s board of directors announces a dividend payment.
This announcement includes the dividend amount and other key dates.
Ex-dividend date, which is set by the stock exchange, is the first day a stock trades without a dividend.
Investors who purchase shares on or after this date are not eligible to receive a dividend.
This date is usually two to three days before the record date, which leaves two to three business days for financial market trades to settle.
Record date, which is set by the company, is the date when an investor must be registered with the company to receive a dividend.
Payment date, which is the date the dividend is mailed or deposited in a shareholder’s account.
Slide #3 Cash vs. Stock Dividends
Businesses typically issue either cash or stock dividends.
Cash dividends come in the form of electronic transfer or check, and they are paid by share—the more shares you own, the more money you receive.
For a company to pay cash dividends, it must have enough cash available in its retained earnings to make those payments.
When a company issues cash dividends, this causes the share price to drop by approximately the same amount.
For example, if a company’s cash dividend is 5% of the stock price, investors will see a 5% loss in their share prices.
This is called economic value transfer.
Shareholders must pay taxes on cash dividends, but they are free to do whatever they want with the income, including reinvesting in the company.
On the other hand, businesses can issue stock dividends.
When issuing stock dividends, a company increases its number of shares and distributes those new shares among shareholders.
Stock dividends are also known as bonus shares.
Companies usually offer stock dividends when they don’t have liquid funds available for cash dividends.
Stock dividends also decrease the company’s price per share.
For example, if a company issues a 5% stock dividend and you own 100 shares, you will have 105 shares for the price of 100 shares.
Owning more shares is positive if the company continues to grow, but can be risky if the company doesn’t perform well.
Shareholders only pay taxes on stock dividends if they decide to sell the extra stocks.
Slide #4 Dividend Payments
In terms of dividend payments, preferred stockholders take priority over common stockholders.
Investors who own preferred shares receive preferential treatment.
Dividends for preferred stocks are predetermined based on par value and dividend rates.
If a company declares and pays dividends, it must pay its preferred stockholders first.
This means a company cannot pay its common shareholders unless it pays its preferred shareholders.
After businesses pay their preferred stockholders, then they can issue dividend payments to their common stockholders.
Sometimes, companies issue special dividends, also known as extra dividends, at irregular intervals.
These nonrecurring dividends, usually in cash form, are larger than other dividends.
They’re often linked to a special company event, like excellent business performance, a major acquisition or sale, or an important milestone.
Slide #5 Calculating Dividend Payments
Businesses use several formulas to calculate dividend payments.
An important metric for investors is dividend per share (DPS).
Dividend per share is the total amount of declared dividends distributed by a company for every share outstanding.
This amount reflects the income an investor received on a per-share basis.
The formula for DPS is
Dividend Per Share = Total Dividends Paid / Shares Outstanding
The dividend payout ratio (DPR) shows the amount of dividends paid in relation to the money a company makes.
In other words, it is the percentage of a business’s net income that is distributed in dividends.
This measurement is helpful in determining a company’s ability to keep paying dividends.
The formula for DPR is
Dividend Payout Ratio = Total Dividends Paid / Net Income
Another financial ratio is dividend yield, which measures dividend value relative to market value per share.
Simply put, dividend yield measures the amount a business pays in dividends in relation to its current stock prices.
This value rises and falls in line with stock prices (e.g., dividend yield decreases when stock price increases).
The formula for dividend yield is
Dividend Yield = Dividend Per Share / Market Value Per Share
FI:704 Account for equity transactions (e.g., cash dividend, stock dividend, treasury stock, etc.)
Curriculum Planning Level: MN
Objectives:
Define the following terms: retained earnings, treasury stock.
Discuss how dividend payments impact retained earnings.
Explain how to acquire treasury stock.
Describe the relationship between dividends and par value.
Identify where to record equity transactions.
Demonstrate procedures for accounting for equity transactions (e.g., cash dividends, stock dividends, treasury stock).
Activity:
Get into a group of 3 - 4 students.
Visit Accounting in the Headlines’ blog post What happens from an accounting standpoint when FNB Bancorp issues a stock dividend?,
Teachers
Provide a copy of the presentation to the students: FNP Bancorp
5.7 Account for equity transactions (e.g., cash dividend, stock dividend, treasury stock, etc.)
Discussion Guide
Performance Indicator: Account for equity transactions
THINK ABOUT IT
Properly recording and accounting for equity transactions is a vital skill with which any accounting student should be familiar.
Keep reading to learn about retained earnings, treasury stock, and accounting for a variety of dividend transactions.
KEY CONCEPTS
Slide #1 Retained Earnings
Retained earnings is the amount of money, or net income, a company has left over after paying all its obligations.
Retained earnings is also known as earnings surplus.
Businesses use these profits to pay off debt, reinvest back into the company, and pay dividends to its shareholders.
Put another way, retained earnings is the money a company has left over after paying dividends.
Both cash and stock dividends reduce a company’s retained earnings.
Cash dividends are recorded as net reductions because they are cash outflows.
They reduce the value of a company’s assets on the balance sheet, which, in turn, impacts retained earnings.
Stock dividends transfer a portion of the business’s retained earnings to its common stock account.
Paying stock dividends decreases share value, which affects a company’s capital accounts and its retained earnings.
Slide #2 Treasury Stock
Treasury stock is previously issued, outstanding stock that a company repurchases from its shareholders.
Treasury stock is also known as reacquired stock or treasury shares.
Businesses decide to purchase treasury stock for several reasons, including to resell in the future, regain controlling interest and prevent a hostile takeover, boost share prices, and improve financial ratios.
For the most part, companies acquire treasury stock to sell later, simply hold as treasury stock, or retire permanently.
Treasury shares don’t include voting rights or eligibility to receive dividends, and the total amount a company can repurchase is governed by the Securities and Exchange Commission (SEC).
Treasury stock reduces, or is subtracted from, stockholders’ equity on the balance sheet, which means it is a contra-equity account.
Generally Accepted Accounting Principles (GAAP) allows two methods of treasury stock accounting: the cost method and the par value method.
Following are journal entries to account for treasury stock transactions using the cost method:
Repurchase:
Debit Treasury Stock account by amount paid to repurchase stock.
Credit Cash account for amount paid to repurchase stock.
Reissue above cost:
Debit Cash account.
Credit Treasury Stock account.
Credit Additional Paid-In Capital—Treasury Stock account for the difference between selling price and repurchase price.
Reissue below cost:
Debit Cash account.
Credit Treasury Stock account.
Debit Additional Paid-In Capital—Treasury Stock account for the difference between selling price and repurchase price.
If difference exceeds Additional Paid-In Capital—Treasury Stock account, then debit Retained Earnings account for remainder.
Following are journal entries to account for treasury stock transactions using the par value method:
Repurchase:
Debit Treasury Stock account for total par value of repurchased shares.
Debit Additional Paid-In Capital—Common Stock account by amount originally paid in excess of par value by stockholders.
Credit Cash account for total paid by company. Credit or debit Additional Paid-In Capital—Treasury Stock account depending on repurchase price.
If difference exceeds Additional Paid-In Capital—Treasury Stock account, then debit Retained Earnings for remainder.
Reissue above cost:
Debit Cash account.
Credit Treasury Stock account.
Credit Additional Paid-In Capital—Treasury Stock account for difference between cash and total par value.
Reissue below cost:
Debit Cash account.
Credit Treasury Stock account.
Debit Additional Paid-In Capital—Treasury Stock account for difference between cash and total par value.
If difference exceeds Additional Paid-In Capital—Treasury Stock account, then debit Retained Earnings for remainder.
Slide #3 Cash and Special Dividends
When accounting for cash dividend transactions, there are two important dates:
Declaration:
Debit Retained Earnings account.
Credit Dividends Payable account.
Payment:
Debit Dividends Payable account.
Credit Cash account.
Cash dividends are recorded on the balance sheet.
Although they are also reported as payments in the financing activities section of the cash flow statement, cash dividends do not impact the income statement.
Journal entries for special dividend transactions are recorded similarly to cash dividends.
Slide #4 Stock Dividends
Stock dividends are classified by size.
Small dividends occur when the number of shares outstanding increases by less than 25% after the dividend distribution.
Large dividends occur when the number of shares outstanding increases by more than 25%.
Small dividends are recorded using market value, while large dividends are recorded using par value (or stated value).
They are accounted for differently because large stock dividends have a greater effect on a stock’s market value than small dividends.
Following are journal entries for small stock dividend transactions:
Declaration:
Debit Retained Earnings account for market value of shares.
Credit Common Stock Dividends Distributable for par value of stock.
Credit Additional Paid-In Capital—Common Stock for excess of market value above par.
Payment:
Debit Common Stock Dividends Distributable account.
Credit Common Stock account.
Following are journal entries for large stock dividend transactions:
Declaration:
Debit Retained Earnings account for par value of shares.
Credit Common Stock Dividends Distributable for par value of shares.
Payment:
Debit Common Stock Dividends Distributable account.
Credit Common Stock account.
Total stockholders’ equity is the same before and after a stock dividend payment.
Stock dividends don’t cause any asset changes on the balance sheet.
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