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Accounting Exam 3 review sheet ( Chapters 8.5-11.

5) Estimating Bad Debt Expense Two Methods o Aging of accounts receivable method(the balance sheet approach) Uses one balance sheet account(accounts receivable) to estimate the appropriate amount for another balance sheet account (allowance for doubtful accounts) Estimates bad debts on the age of each amount in accounts receivables three steps Prepare an aged listing of accounts receivable o Totals for each aging category Estimate bad debt loss percentages for each category o Varies according to company circumstances o The longer an account remains unpaid the less likely it is so be repaid o Compute the total estimate by multiplying the totals in step one by the percentages in step two and then summing across all aging categories Produces the desired balance Allowance for doubtful accounts in a permanent account must take previous balance into account when determining adjustment o Percentage of credit sales method (income statement approach) Uses one income statement account (sales revenue) to estimate the appropriate amount for another income statement account (Bad debt expense) Other Issues Revising Estimates o Bad debt estimates will always differ from the amount that is later written off as uncollectible o Revise bad debt estimates for the current period Account recoveries o Recovery collection of money previously written off o Put receivable back on the books by recording the opposite of the write off o Record collection of the account Dr accounts receivable Cr allowance for doubtful accounts Cash Accounts receivable Alternative Methods o Direct write off method Violates conservatism and matching principles

Not approved by GAAP IRS uses this method for tax purposes

Notes Receivables and Interest Calculating Interest o Must consider three variables Principle initial amount of the note The interest rate charged on the note Time period covered in the interest calculation interest rates are always stated as an annual percentage, even if the note is for less than a year o interest formula Interest = Principal x interest rate x time Reporting Interest on Notes Receivables o Interest is earned daily but usually only collected once or twice a year o Must accrue interest revenue and interest receivable at the end of each accounting period o Four key events happen with every note Establishing the note Accruing interest earned but not received Recording interest payments received Recording principle payments received Recording Notes Receivable and interest revenue o Nov 1, 2007. Loan 100,000 6 percent interest due on October 31, 2008 o establishing a Note Receivable dr. Note Receivable 100,000 Cash 100,000 o Accruing interest earned (December 31, 2007) Interest= principal x Interest Rate x Time 1000 = 100,000 x .06 x 2/12 interest receivable 1,000 interest revenue 1,0000 o Recording Interest Received Oct 31, 2008 received 6,000 Includes interest already recording plus what was earned in 2008 Dr cash 6,0000 Interest Receivable 1,000 Interest revenue 5,000 o Recording Principal received Cash 100,000 Note receivable 100,000 Accounting for Uncollectible Notes

o When a company believes a note receivable will not be collected they should record an allowance for doubtful accounts against the notes receivables Receivable Turnover Analysis Managers, directors, investors, and creditors evaluate the effectiveness of a companys credit-granting and collection activities by conducting a receivables turnover analysis Receivables turnover process of selling and collecting o Net Sales revenue/ average net receivables o Repeated over and over during each accounting period o The higher the ratio the fast the company collects receivables The faster the collection the shorter the operating cycle o Channel stuffing process of recording sales that customers are likely to return later or is lengthening credit periods to entice customers to buy as much as possible o Days to collect 365/receivables turnover analysis Comparison to Benchmarks By calculating days to collect you can compare a companys collection performance to its stated collections policy Compare number of days to collect to the length of the credit period = whether customers are complying with the stated policy If customers are disregarding may mean they are dissatisfied with the companys product Other companies o Receivables turnover ratios and number of days to collect vary across industries o Should compare ratios only with companies in the same vertical markets or from prior periods Speeding up Collections Factoring receivables o Hounding customers for payment Drawbacks It is time consuming and costly It can annoy customers and force them to take business elsewhere o Factoring selling outstanding accounts receivable to another company Your company gets money for receivables it sells to the factor (minus factoring fee) Factor then has right to collect the outstanding amounts Factoring fee usually recorded as selling expense

Credit card sales o Credit card receipts can be deposited directly into a companys bank account o Credit card companies charge a fee, usually 3% Included in selling expenses on income statement

Chapter 9 Reporting and Interpreting Long-Lived Tangible and Intangible Assets Definition and classification of long-lived assets Long lived assets business assets acquired for use over one or more years Not intended for resale productive assets - allow business to produce the goods or services that are sold to customers o Tangible Assets (fixed assets) Long-lived assets that have physical substance Land, buildings, machinery, vehicles, office equipment, and furniture Usually grouped into Property, Plant and equipment on balance sheet o Intangible assets Have special rights but no physical substance Existence indicated by legal documents Brand names, trademarks, licensing rights Tangible Assets Two not talked about o Land improvements Differ from land in that land improvements deteriorate over time, land doesnt Sidewalks, pavement, and landscaping o Construction in progress Cost of constructing new buildings and equipment Moved from this account to the applicable building or equipment account when the construction is complete Acquisition of tangible assets o All reasonable and necessary costs of acquiring and preparing asset for use should be recorded as a cost of the asset o Capitalizing process of recording costs as assets Land includes legal fees, fees for land surveyors and title searches on other pieces of land equipment purchase/construction cost sales tax

transportation costs installation and start up costs Buildings Purchase/construction costs Legal fees Appraisal fees Architect fees Not all fixed assets are capitalized Staplers and hole punch so small = expense All expenditures less than 1000 usually expensed Insurance, interest on loans to purchase fixed assets, ordinary repairs and maintenance o Basket Purchases Land, buildings and equipment may be purchased all together Total cost must be split between each asset in proportion to the market value of the assets as a whole 10 million for hotel and and o hotel = 60% o land = 40% o record hotel for 6 million and land for 4 million Use of Tangible Assets Maintenance costs incurred during Time of Use o Most tangible assets require substantial expenditures over the course of life to maintain or enhance their ability to operate o Ordinary repairs and Maintenance Expenditures for routine maintenance and upkeep of long lived assets Do not directly lengthen the useful life of the asset Recorded as expense o Extraordinary repairs, maintenance and additions Occur infrequently and involve large amounts and increase economic usefulness of assets Greater efficiency or longer life Additions, major overhauls, complete reconditioning and complete replacement Capitalized as assets Depreciation Expense o The allocation of existing costs that have been previously recorded as long lived tangible assets o Following the matching principle, a portion of the assets cost is moved from the balance sheet to the income statement as an expense in the period the asset is used to generate revenue o Total amount of depreciation recorded since acquisition of asset recorded

o o o

on income as accumulated depreciation Difference between assets cost and accumulated depreciation is book value or carrying value some companies report depreciation expense as a separate type of operating expense, many include it in selling, general, and administrative expenses for external reporting purposes to calculate Depreciation expense = 3 things Asset Cost Includes all the costs capitalized for the asset, which can include purchase cost, sales tax, legal fees, and other costs needed to acquire and prepare asset for use Residual Value An estimate of the amount that the company will get when it disposes of the asset Useful Life Estimate of the assets useful economic life to the company May be expressed in terms of years or units of asset capacity Land is the only tangible asset thats assumed to have an unlimited (indefinite) useful life o Land is not depreciated Depreciable Cost difference between asset acquisition cost and residual value Depreciation is recorded each year of assets useful life until its total accumulated depreciation equals its depreciable cost, after that point no additional depreciation is reported even if the company continues to use the asset

Depreciation Methods Straight Line o An equal amount of depreciation is reported in each period of the assets estimated useful life o Cost residual x 1/useful life o Depreciation expense is a constant amount each year o Accumulated depreciation increases by an equal amount each year o Book value decreases by the same equal amount each year Units of Production o Assigns assets depreciable cost to each period of its useful life o Based it on the amount of asset production o Cost-residual value x (Actual production/Estimated total production) o The depreciation expense, accumulated depreciation, and book value vary from period to period, depending on the number of units produced Declining Balance(accelerated depreciation method) o Depreciation is higher in the early years of an assets life and lower in the

later years o Not used for financial reporting purposes in the US used in financial reporting in other countries uses book value, not depreciable cost sometimes called double-declining balance method uses the accumulated depreciation at the beginning of each year be careful not to depreciate assets below their book value o asset cost-accumulated depreciation x 2/useful life summary o different methods of depreciation can be used for different types of assets, provided that they are used consistently o straight-line is the most preferred because its the easiest to use and understand does a good job matching depreciation expense to revenues when assets are used evenly over useful lives o units of production typically is used when asset use fluctuates significantly from period to period o declining balance most useful to assets that are valuable early Tax Depreciation o Most public companies use two different depreciation methods for reporting to stockholders and determining income taxes o Financial reporting Objective of financial reporting is to provide economic information about a business that is useful in projecting future cash flows of the business o Tax reporting (Internal revenue Code) Objective of Internal revenue Code is to raise sufficient revenues to pay for the expenditures of the federal government and to encourage certain social and economic behaviors Allow companies to deduct larger amounts of tax depreciation in early years of asset life reduces company income taxes Doesnt allow companies to depreciate assets below its depreciable cost Least and the Latest Rule all taxpayers want to pay the least tax that is legally permitted, and at the latest possible date

Asset Impairment Losses Since depreciation I not intended to report assets t their current value, its possible that the declining book valu of long lived tangible assets could exceed their current value- particularly if them become impaired Impairment occurs when events or changed circumstances cause the estimated future cash flows from using these assets to fall below their book value If an assets estimated future cash flow are less than the book value the assets book value should be written down to what its worth (called fair value)

o Amount of write down recorded as an impairment loss Typically included in other expenses, reported below the income from operations line in the bottom part of income statement Disposable of Tangible Assets Usually requires two adjustments o Update the depreciation expense and accumulated depreciation accounts If asset is disposed of halfway into the year record half the annual depreciation o Record the Disposal Cost of the asset and any accumulated depreciation at the date of disposal must be removed from the accounts Difference between any resources received on disposal of an asset and its book value at the date of disposal is treated as a gain or a loss Reported on the income statement Usually recorded below income from operations line because it arises from peripheral activities Reduce both the asset and accumulated depreciation accounts for their full cost and accumulated depreciation(updated to the time of disposal) Intangible Assets long lived assets that lack physical substance existence is indicated by legal documents o Trademarks Special name, image, or slogan identified with a product or a company o Copyrights Gives the owner the exclusive right to publish, use and sell a literary, musical, artistic, or dramatic work for a period not exceeding 70 years after authors death o Patents Exclusive right granted by the federal government for a period of 20 years Typically given to whoever invents a new product or process o Licensing Rights Limited permissions to use something according toe specific terms and conditions Colleges get licensing rights for software and computer programs o Franchises Contractual right to sell certain product or services, use certain trademarks, or perform activities in a geographical region

o Goodwill Tops the charts as most frequently reported intangible asset Favorable location, established customer base, great reputation, successful business operations GAAP doesnt allow it to be reported as an intangible asset on the balance sheet unless it has been purchased from another company Acquisition, Use, and Disposal Acquisition the cost of intangible assets are recorded as assets only if they have been purchased If an intangible asset is being self constructed or internally developed it is reported as research and development expense Recorded as an expense because it is easy to say that your company has developed a value asset Companies pay more for a company that would for individual assets because they want to obtain goodwill Goodwill also called cost in excess of net assets acquired difference between the purchase price o a company as a whole and the fair market value of its net assets o Purchase price fair market value of identifiable assets, net of liabilities Use of Intangible Assets must determine if asset has limited or unlimited life o limited Life assets with limited life is spread on a straight-line basis over each period in a process called amortization (similar to depreciation) most companies do not estimate a residual value or their intangible assets because intangibles usually have no value at the end of their useful lives amortization name given to allocating the cost of intangible assets over their limited useful lives recorded as an expense each period on the income statement and is subtracted directly from the applicable intangible asset accounts on the balance sheet Patents, copyrights, licensing right, franchises o Unlimited Life Trademarks and goodwill Not amortized Tested for possible impairment just like long lived tangible assets If it is impaired its book value is written down to its fair value Disposal of Intangible Assets Result in gains (or losses) if the amounts received on disposal are greater than their book values

Management Decisions Managers have difficulty in forecasting the right amount to invest in long lived assets o If they underestimate amount needed to produce goods or provide services for customers, they will miss an opportunity to earn revenue o If they overestimate the amount needed, their companies will incur excessive costs that will reduce profitability Turnover Analysis Fixed Asset Turnover Analysis Net Sales Revenue/Average fixed net assets Dollars of sales generated for each dollar invested in (tangible) fixed assets A higher ratio implies greater efficiency Impact of Depreciation Differences Differences arise from different methods, different estimated useful lives, or different estimated residual values o Useful lives vary for several reasons Type of equipment used by each company Frequency of repairs and maintenance Frequency and duration of use Degree of conservatism in managements estimates Financial statement analysts try to sidestep possible differences in depreciation calculations by focusing on financial measures that exclude the effects of depreciation EBITDA earnings before interest, taxes, depreciation and amortization Chapter 10 Reporting and Interpreting Liabilities Decisions Related to Liabilities How much does the person or company owe to other? For what? Can you expect the person or company to repay each of its debts? When? Reporting Liabilities Current Liabilities short-term obligations that will be paid with current assets within the current operating cycle of the business or within one year of the balance sheet date, whichever is longer o most business operating cycle is shorter than a year Measurement of Liabilities dollar amount reported for liabilities is the result of three things o the initial amount of the liability liability is initially recorded at its cash equivalent, which is the

amount of cash that a creditor would accept to settle the liability immediately after the transaction or event occurred cash equivalent excludes interest o additional amounts owed to the creditor liabilities are increased whenever a company acquires additional goods or services on credit, or interest is charged on its unpaid balances o payments or services provided to the creditor liabilities are reduced whenever the company makes payments to the creditor Current Liabilities Accounts Payable o Companies usually buy products on credit o Involves three steps Order the goods/services Receive the goods/services Pay for the goods/services o Record the liabilities at the stage that obligates the company to give up assets or services o Creditors do not charge interest on accounts payable unless it is overdue Accrued Liabilities Often businesses incurs expenses in one accounting period and makes a cash payment in a later period Adjusting entry needed to account for this activity Companies record accrued liabilities for various expenses, including electricity, salaries, taxes, and interest Accrued Salaries End of each accounting period, employees usually will have earned salaries that hav not yet been paid Accrued Payroll Taxes Business must account for a variety of payroll taxes, including federal, state and local income taxes, Social Security Taxes, and federal and state unemployment taxes o Employee income taxes withheld Government requires employers to withhold income taxes for each employee Amount of income tax withheld is recorded by the employer as a current liability on the day it is deducted from employees pay o FICA taxes withheld Amounts paid for Medicare and Social Security as required by Federal Insurance Contributions Act

FICA rate for employers is equal to that for employees

Accrued Income Taxes Corporations pay taxes on income they earn Corporate tax return form 1120, similar to the companys income statement, except it calculates taxable income by subtracting tax allowed expenses from revenues Taxable income multiplied by the tax rate, usually 35% Notes Payable Record and increase in cash when the note is created, as well as reductions in cash when interest and principle are paid to citigroup Under the matching principle, general mills will need to adjust its records to account for the interest incurred each accounting period o Note is issued and cash is received Debit cash Credit Note Payable o Interest is owed at the end of the accounting period Interest = Principal x interest x time o Payments are made to the lender Current Portion of Long Term Debt if loan is taken with an agreement to pay in two years it is originially classified as long-term debt after a year however it becomes a current liability take the amount of principal to be repaid in the upcoming year of total long term debt and report it as a current liability called current portion of long term debt reclassification necessary so that the balance sheet accurately reports the dollar amount of existing liabilities that will be paid in the next year Additional Current Liabilities Sales Tax Payable o Retail companies required to charge a sales tax in all but five states (Alaska, Delaware, Montana, New Hampshire , and Oregon) o Collect tax at time of the sale and forward it to the government Unearned Revenue o Airlines are paid in advance of providing flights, retailers receive cash for gift cards that can be used for future purchases o This is a liability because the company that receives the money is obligated to provide goods or services in the future Long Term Liabilities Companies take out long term loans when they need large, substantial amounts of financing

Borrow money through long term loans or issue more shares of stock Usually obtained by o Private loan agreement Find lender Set loan terms Borrow money (note payable) o Publicly issued debt certificates Used when the company needs more money than any one lender can provide Set loan terms Find lenders borrow money (bonds payable) The terms of these loans, such as interest rate and the date on which the debt is to be paid are outlined in bond certificate Interested lenders buy a companys bond certificate on a bond market

Bonds Payable Bond states interest payments, maturity date and the amount that is to be paid at maturity Interest rates are usually made once (annually) or twice (semiannually_ Face value the amount paid on the maturity date is often 1000 per bond certificate Accounting for Bonds Issued at face value Financial effects arise when o Bonds are first issued o Additional amounts are owed to lenders for interest o Payments are made to the lenders o The bond liability is paid off Issue Bonds and receive cash Owe interest at the end of the accounting period o Matching principle requires that interest expense be recorded in the period that the bonds payable liability is outstanding o Accrual and recording of interest payments will continue until the maturity date Pay the lenders Bonds Issued Above or Below Face Value (par value) Borrow sets the terms of the loan before finding a lender o Leads to possibility that interest rate of borrower is different than what the lender will agree to o If borrower sets a stated interested rate, such as 6%, that is less than what lenders want, say 8%, lenders wont be attracted to the bond

Lenders pay less money up front - they get a discount From the borrowers point of view, a discount on a bond has the effect of increasing the interest cost Bonds will be issued at amounts differing from their face value if the interest rates of the borrowers and lenders do not agree Issue price the amount the borrower actually receives when a bond is issued Present value based on a mathematical calculation that determines the amont that one or more payments made in the future are worth today Bond dealers and news reports typically quoate the bond issue price as a percentage of the face value of the bond o 1000 bond issued at a price of 95 means bond issued for 950 o the interest rate that lenders in the bond market demand from a bond (and use in their present value calculations to determine the bond issue price) is called the market Interest Rate (yield, discount rate, effective-interest rate market interest rate is the rate that would emerge if borrower and lenders were to directly negotiate the terms of the bond it is the rate the lenders would earn if they invested in bonds of similar companies represents the companies true cost of borrowing

Accounting for Bonds Issued at a Discount borrower receives less money up front borrower still makes interest and face value payments according to the terms stated on the face of the bond contra liability account - discount on bonds payable in order to comply with the matching principle, amounts must be taken out of discount on bonds payable and added to the interest expense (call amortizing the discount) o two methods to amortize the discount straight-line effective interest required by GAAP unless straight line produces numbers that are not different Accounting for Bonds Issued at a Premium borrower receives more up front than the face value of the bond on the day of the issue the company owes more than just the face value of the bond the effect of the premium is to provide the borrower with more than it is required to repay at maturity, which reduces the total cost of borrowing o premium on interest is spread over each interest period o reduces both premium on bonds payable and interest expense

Early Retirement of Debt companies with large amounts of cash can retire debt early to reduce future interest payments companies without cash may even retire early if interest rates have declined by retiring early and reissuing at a lower rate they can save money on interest expense early retirement of debt has three financial effects cash is paid by the borrower borrowers bond liability is eliminated either a gain arises or a loss is incurred o a gain arises if the cash that must be paid to retire the bonds is less than the carrying value of the bonds o loss is incurred if the company has to pay more than the carrying value of the bond Assessing Companies Liabilities Current Ration o Whether current assets are sufficient to pay current liabilities Higher ration means greater ability to pay Current Assets/Current Liabilities Evaluates Liquidity Ability to pay liabilities as they come due in the short run Times Interest earned Ration o Whether sufficient resources are generated to cover interest costs o A higher number means greater coverage o Net income+Interest Expense+Income Tax Expense/Interest Expense o Divides net income bfore interest and taxes by interest expense to determine the extent to which earnings before taxes and financing costs are sufficient to cover interest incurred on debt Common Features of Debt To reduce the risk of a loan a lender can require a borrower to offer specific assets as security to the lender o Called secured Debt Allow lenders to revise loan terms if certain ratios, calculated using the borrowers financial statements, get out wack can reduce risk o Loan covenants Loan Terms o Security Gurantees that the borrowers assets will be given to the lender if the borrower doesnt pay o Loan Covenants Conditions that, if violated, allow the lender to renegotiate loan

terms o Seniority Debt designated as senior is paid first in the event of bankruptcy, followed by subordinated debt o Convertibility Gives the lender an option to accept the borrowers stock as payment for the outstanding loan o Callability Gives the borrower control over the decision to fully repay the lender before the loans maturity date Unrecorded Liabilities Contingent Liabilities o Potential liability (and loss) that arises as a result of past transactions or events, but the company is unable to determine whether it actually will be liable (or for what amount) until a future event occurs or fails to occur Lawsuit until closure the contingent liabilities are reported only in the companys notes to their financial statements Chapter 11 Reporting and Interpreting Stockholders equity Corporate Ownership Corporations account for 85% of the total sales in US Corporations are expensive to start but worth it in long run o Easily raise large amounts of funds o Easy to gain ownership in corporations Shares of stock can be purchased in small amounts Owner in sonic in 2006 by buying share of stock for $22 Ownership interests are transferable Shares of public company are bought and sold on established markets such as NYSE Stockholders are not liable for corporations debts Creditors have to legal claim on personal assets of stockholders like they do on personal assets of sole proprietorships and partnerships If company goes bankrupt you lose what you paid to buy that stock but not responsible for the millions in debt owed by the company Recognized as separate legal entity o Owns assets o Incurs liabilities o Expand and contract in size o Sue others and be sued o And inter into contracts independent of ownership

o Doesnt die when owners die, Thomis Edison died 1931 but GE hasnt Formation of corporation o Strictly regulated by law to protect everyones rights o Application submitted to the state If approved state issues a charter (articles of incorporation) Includes the name, address, nature of business and ownership structure o Ownership Structure Organizational structure Stockholders (elect) o Board of directors (appoints) Officers (select) Vps Varies between corporations but all corporations must have common Stock( basic voting stock issued by a corporation) Owners of common stock enjoy following benefits o Voting rights For each share owned you get a set number of votes on major issues Certain classes of common stock grant different number of votes o Dividends Stockholders receive a portion of corporate profits when distributed as dividends o Residual claim If company ceases operations, stockholders share in any assets remaining after creditors have been paid o Preemptive rights May be given first chance ton buy newly issued stock before offered to others

Equity vs. Debt Financing Issuing new stock (equity financing) o Advantages Equity does not have to be repaid Debt must be repaid or refinanced Dividends are optional Interest must be paid on debt Borrow money from lenders (debt financing) o Advantages Interest on debt is tax deductible Dividends on stocks are not

Debt does not change control of stockholders Stock issue gives new stockholders the right to vote and share in earnings, diluting existing stockholders control

Common Stock Transactions Types of stockholders equity accounts o Contributed Capital Reports amount of capital company received from investors contributions, in exchange for company stock Sometimes called paid-in-capital o Retained earnings Reports cumulative amount of net income earned by the company less the cumulative amount of dividends declared Referred to as earned capital o Treasury Stock Reports shares that were previously owed by stockholders but have been bought back and are now held by the corporation Authorization, Issuance, and Repurchase of Stock Corporate charter indicates maximum number of shares of stock that the corporation is allowed to issue Issued Stock will forever be owned by one person or another, unless the company buys back Outstanding Stock issued stock that has not been bought back by the corporation Treasury stock stock shares that have been bought back by the corporation o During time treasury stock is held, the shares do not carry voting, dividend or other stockholders rights Stock Authorization Before issuing stock, specific rights and characteristics must be authorized and defined in corporate charter Does not affect accounting records Par Value an insignificant value per shae of capital stock specified in charter o Old concept introduced to prevent stockholders from removing contributed capital of businesses that were about to go bankrupt No par value stock just like stock with par value except it does not have a specified legal value per share Stock Issuance Stock issuance sale of stock from the corporation to an investor Initial Public Offering (IPO) the very first sale of a companys stock Seasoned New Issue new issuing of stock of stock has already been issued previously

Stock Sold Between Investors Individual investors can sell shares to each other without affecting corporation Stock Issued to Compensate Employees Many pay packages include stock options o Allows employees to buy stock at a predetermined price during a specified time period o If employees work hard = rise in stock prices They can then purchase at lower predetermined price and sell at higher market value Repurchase of Stock Corporations may wish to repurchase stock because o Distribute excess cash to stockholders o To send signals to investors that the company believes its own stock is worth purchasing o Obtain shares that can be reissued as payment for purchases of other companies o Obtain shares to reissue to employees as part of employee stock option plans Because of SEC regulations it is generally less costly for companies to give employees repurchased stock than to issue new ones Most companies record purchase of treasury stock based on the cost of the shares when they are purchased by the company (cost method) Treasury stock is not an asset, its a contra-equity account that is subtracted from total stockholders equity If treasury stock were reissued below its purchases price the difference between the repurchase (25) and the reissue (23) is recorded as a reduction in additional paid in capital Dividends on Common Stock Investors buy common stock because they expect a return on their investment o Comes from dividends and increases in stock prices Some investors prefer to invest in stock that pay little or no dividends (growth investments) o Companies that reinvest majority of their earnings tend to increase their future earnings potential, along with stock prices Some investors prefer stock that issue consistent dividends ( income investment) Three important dates of Dividend Payments o Declaration date Date on which the board of directors officially approves the dividend As soon as board approves, the company records an increase in

liabilities and a corresponding increases in the dividends Declared account Dividends Declared is closed to retained earnings and decreases it Dividends are distributions of a companys accumulated prior earnings reported on statement of retained earnings Not reported on income statement because they are not an expense of the current period o Date of Record Date on which the corporation finalizes its list of current stock holders Not journal entry is made on this date o Date of Payment Decreases dividends payable and decreases cash Two important requirements that the board of directors must consider when declaring a cash dividend o Sufficient Retained Earnings Must have accumulated a sufficient amount of retained earnings to cover the dividend State incorporation laws usually restrict cash dividend payments to the balance of retained earnings o Sufficient Cash Must have sufficient cash to pay the dividend and meet the operating needs of the company Money earned from pervious actions may have already be spent by the time of the dividend

Stock Dividends and Stock Splits Stock Dividends Distributions of additional shares of stock to its stockholders on a pro rate basis at no cost to stockholders o Pro rata each shareholder receives new amount of stock relative to current ownership in company Each shareholder holds exactly the same percentage of stock has before the dividend distribution Stock prices fall proportionally to the increase of stock issuance Accounting for Stock Dividends o Dividend results in reduction of Retained Earnings and an an increase in common stock o Amount recorded depends on size of the dividend declared Large = more than 20-25 % of currently outstanding shares Amount recorded is based on the par value Small = less than 20-25% of currently outstanding shares Amount recorded based on current market value

Stock Splits Not dividends Total number of authorized shares is increased by a specified amount, such as 2for-1 Cash is not affected by stock splits Involves revising corporate charter to reduce per-share par value of all authorized shares so total par value across shares is not changed