Face value of bond: 1000, stated interest rate: 10%, if market rate 8% (market value of bond more, coupon rate more than market rate) - bond issued at premium, if market rate 12% (market value of bond is less, coupon rate less than market rate) - bond issued at discount. Payment (calculated using coupon rate and face value)/discounted or premium value of bond=market interest rate Interest calculation straight line method: Interest= Principal*rate*time (in years) APR=interest paid/ (money available to use*time in years) in straight line money available to use= principal amount Interest calculation-discount basis: only difference during calculating APR: money available= Principal- Interest Entry to record accrued interest: Dr. Interest expense, Cr. Interest payable. For discounted basis to record entry: Dr. Cash +880, Dr Discount on short term debt: 120, Cr. Short term debt: 1000 As interest is incurred, entry record: Dr Interest expense and Cr discount on short-term debt Amortization (each interest is accrued) for discount: Dr Interest expense, Cr discount on bonds payable Amortization (each interest is accrued) for premium: Dr Premium on bonds payable, Cr Interest expense Typical accounts in stockholders equity: Paid-in Capital- Preferred stock (sometimes issued), Common stock (always issued), additional paid-in capital, retained earnings (accumulated deficit if negative), accumulated other comprehensive income (loss), less: treasury stock Preferred stock: limited claim on assets in case of liquidation, no voting privilege, and dividend payment has preference over common stock holders. Common stock: residual ownership, claim to all assets that remain after all liabilities and preferred stock claims, common stockholders is limited to the amount they have invested in the stock, cannot be forced by creditors to invest additional amounts to make up for losses, elect members to the board of directors, approve changes to the corporate charter. Preemptive right: right to purchase additional shares from any new share issuances in proportion to their present percentage of ownership. Par value (stated value): nominal amount assigned to each share when the corporation is organized. Represents legal capital of the corporation. Difference between par value and the amount realized from the sale of the stock is additional paid in capital. Common stocks: disclosures- no. of shares authorized, issued and outstanding Preferred stock: disclosures- par value and dividend rate, liquidation or redemption value, no. of shares authorized, issued and outstanding. Authorized shares: max. no. of shares that the corporation is legally authorized to issue. Issued shares: no. of shares of stock that have actually be transferred from corporation to stockholders Outstanding: the number of shares issued minus the number of shares held in the treasury. Additional paid in capital (capital in excess of par value, capital surplus): excess of amount received from the sale of preferred or common stock over par (or stated) value. Dividends= percent*par value*outstanding shares*time (in years) Declaration: Dr Retained Earnings, Cr Dividends payable, date of record: no entry, date of payment: Dr dividends payable, Cr Cash To issue cash dividends, company must have retained earnings, enough cash to pay dividends and board of directors must declare it. If firm has agreed to maintain certain minimum standards of financial health, dividends should not affect it. Stock dividends: Preserve cash, Decrease market price of stock, Reduce retained earnings. No change in par value of stock or in total stockholders equity. Stock split: Increase the number of shares outstanding, Decrease the par value per share. No change to total stockholders equity. No journal entry required. Calculate stock dividends: 2% stock dividend on 500,000 common shares outstanding, par value $1/share and mrket value $17. Dr retained earnings= 170,000 (minus it from SE), cr common stock: 10,000 (add to SE), cr additional paid in capital=160,000(add to SE) Stock split: 300,000 shares outstanding, $1 par value, 2 for 1 split. After split-no. of shares=300,000*2/1, par value=1*1/2, market value= old market value*1/2, earnings per share=old earnings per share*1/2, no economic change. The only journal entry needed for a stock split is amemo entryto note that the number of shares has changed and that thepar valueper share has changed. However, a typical journal entry withdebitsandcreditsis not needed since the total dollar amounts for the par value and other components of paid-in capital and stockholders' equity do not change. Stock repurchasesare often used as a tax-efficient method to put cash into shareholders' hands, rather than payingdividends. Sometimes, companies do this when they feel that their stock is undervalued on the open market. Other times, companies do this to provide a "bonus" to incentive compensation plans for employees. Another motive for stock repurchase is to protect the company against a takeover threat. Any transaction involving treasury stock cannot increase the amount ofretained earnings. If the treasury stock is sold for more than cost, then the paid-in capital treasury stock is the account that is increased, notretained earnings. Buy treasury stock: decreases equity, sell for more than bought increases equity or vice versa. Treasury stock is contra-stockholders equity account. Treasury stock is deducted from sum of paid-in capital and retained earnings. Income statement never affected. If acquired-recorded at cost. When sold-any difference recorded in additional paid-in capital. To record purchase: Dr treasury stock, cr cash. To record sale: Dr cash=ts*price sold for. Cr treasury stock, cr additional paid in capital. Cash dividends issued on outstanding shares, not paid on TS. Stock dividends and stock splits based on shares issued, affect TS. Basic earnings per share: A rough measurement of the amount of a company's profit that can be allocated to one share of its stock. = net income available for common stock/ weighted average number of shares of common stock outstanding- Find the number of shares of common stock outstanding at the beginning of the year. Identify all transactions that changed the number of shares outstanding throughout the year. Determine how each transaction impacted the total number of shares. Multiply time*no of outstanding shares. Ad no.of months. Add all months*shares. Months*shares/no.of months Diluted Earnings Per Share (diluted EPS)is a company'searnings per share(EPS) calculated using fully dilutedshares outstanding(i.e. including the impact ofstock optiongrants andconvertible bonds). (Profit or loss attributable to common equity holders of parent company+ After-tax interest on convertible debt + Convertible preferred dividends)/(Weighted average number of common shares outstanding during the period + All dilutive potential common stock) Operating income (income from operations): difference between gross profit and operating expenses. Net income (net loss): arithmetic sum of revenues and gains minus the expenses and losses. Gains: increases in an entitys net assets resulting from incidental transactions or nonoperating activities-usually not included with revenues at the beginning of the income statement. Losses which are decreases in an entitys net assets resulting from incidental transactions or nonoperating activities. Not included with expenses. Unusual items on income statements: discontinued operations: segment, or major portion of a business is disposed of-disclose separately the impact that the discontinued operations has had on current operations of the firm as well as impact on any previous year results. Extraordinary items: unusual in nature and occurs infrequently qualifies, if the amount involved has a significant after-tax income statement effect. (Pension plan terminations, some litigation settlements, and utilization of tax loss carry forwards, natural disasters financial effects). Noncontrolling interest in earnings of subsidiaries Revenue is realized when the product or service has been exchanged for cash, claims to cash, or an asset that is readily convertible to a known amount of cash. Revenue is earned when the firm has completed, or substantially completed, the activities it must perform to be entitled to the revenue benefits. To be recognized: revenues should be earned, realized or realizable. Gross profit is the excess of sales over cost of goods sold. Gross profit ratio = Gross profit Net sales, Selling price = Cost of product (1 Desired gross profit ratio)Uses of gross profit ratio: manager uses it to estimate whether the firm is operating at a level of sales that will lead to profitability in the current period, used to estimate cost of goods sold and ending inventory for periods in which a physical inventory has not taken place, to set selling prices Notes to the Financial Statements: Depreciation method used, Inventory valuation method used, Basis of consolidation of subsidiaries, Reconciliation of taxes paid to tax expense, The cost of employee benefit plans, Treatment of goodwill and intangible assets, Earnings per share information, Stock option and stock purchase plans, Accounting changes, Business combinations, Contingencies and commitments, Events subsequent to the balance sheet date, Impact of inflation, Segment information. The companys management bears ultimate responsibility for the financial statements and notes, not the auditors who express an opinion on the fairness of the presentation of the financial statements. Management Discussion and Analysis (MD&A): Nature of operations, Economic outlook for the company, Important factors that may influence profitability, Summary of operating results. Auditors Report: Introductory Paragraph Describes the financial statements audited and states that management is responsible for the financial statements and that the auditors task is to express an opinion about the financial statements. Scope Paragraph Describes the nature and extent of the audit process. Auditors wish to obtain reasonable assurance that the financial statements are free from material misstatements. Opinion Paragraph Auditors express an opinion on the fairness of the financial presentation. Corporations wish to receive an unqualified report. Internal Control Opinion Paragraph Auditors make reference to the internal control effectiveness audit and the opinion issued by the auditors that accompanies the auditors report as required by the Public Company Accounting Oversight Board (PCAOB). Provides relevant information about the cash receipts and cash payments of an enterprise during a period. This statement shows why cash and cash equivalents changed during the period by reporting net cash provided or used by operating activities, investing and financing activities. Cash Inflows: Operating activities: CA decreasing from the beginning of the year and CL increasing from beg of year, investing activities: Sale of operational assets, Sale of long term investments, Collections of long term loans, financing activities: Issuance of stock, Issuance of bonds and notes. Cash outflows: operating activities: CA increasing from beginning of the year and CL decreasing from beginning of the year, investing activities: Purchase of operational assets, Purchase of long term investments and Long term loans to others, financing activities: Payment of dividends, Repurchase of stock & Repayment of debt. Depreciation and amortization do not affect cash. Net income is reduced by these items, but cash flows remain unaffected. Dr warranty expense Cr estimated warranty liability, dr estimated warranty liability, cr cash Dr cash Cr unearned revenue, Dr unearned revenue, Cr Revenue Bond given on discount, interest expense increases Dr interest expense, cr discount on bonds payable, bond premium interest expense decreases, dr premium on bonds payable, Cr interest expense. Liquidity refers to a firms ability to meet its current obligations and is measured by relating its current assets and current liabilities. Working capital: excess of a firms current assets over is current liabilities. Current ratio 2.0 useful for judging current bill-paying ability. Acid test ratio 1.0- firms ability to meet its current obligations if none of the inventory can be sold. Profitability measure: ROI: This ratio describes the rate of return management was able to earn on the assets that it had available during the year. Net income/sales*sales/avg total assets Profitability measure: ROE: Stockholders are interested in expressing the profits of the firm as a rate of return on the amount of stockholders' equity.net income/avg stockholders equity Activity measures: Focus primarily on relationships between asset levels and sales. Accounts receivable turnover: Sales/Avg Accounts receivables. A measure of how many times a company converts its receivables into cash each year. Inventory turnover: cost of goods sold/Avg Inventories. A measure of the number of times merchandise inventory is sold and replaced during the year. Days in accounts receivables=Accounts receivables at year end/Annual sales/365. A measure of how many days it takes, on average, to collect an account receivable. Days sales in inventory= Inventory at year end/annual costs of goods sold/365. A measure, on average, of the number of times inventory is sold and replaced. Profitability P/E ratio=market price of common stock/diluted earnings per share of common stock. A measure often used by investors as a general guideline in gauging stock values. Profitability: Dividend yield: annual dividend per share/market price per share of stock. Identifies the return, in terms of cash dividends, on the current market price of the stock. Profitability: Dividend payout ratio: Annual dividend per share/diluted earnings per share. A gauge of the portion of current earnings being paid out in dividends. Investors seeking current income would like this ratio to be high. Profitability: Preferred dividend coverage ratio: net income/preferred dividend requirement. A measure of the margin of safety for preferred shareholders. Financial leverage measures: debt ratio= total liabilities/total liabilities and stockholders equity. Measures the percent of assets being provided by creditors. Financial leverage involves acquiring assets with funds at a fixed rate of interest. Debt equity ratio=total liabilities/total stockholders equity. Measures the relative proportion of contribution from owners and creditors. Financial leverage (frequently called just leverage ) refers to the use of debt (and, in the broadest context of the term, preferred stock) to finance the assets of the entity. Leverage adds risk to the operation of the firm because if the firm does not generate enough cash to pay principal and interest payments, creditors may force the firm into bankruptcy. However, because the cost of debt (i.e., interest) is a fixed charge regardless of the amount of earnings, leverage also magnifies the return to the owners (ROE) relative to the return on assets (ROI). Highly leveraged firms mean those with lots of debt relative to stockholders equity. Times interest earned=earnings before interest and taxes/interest expense Common size financial statement: A company financial statement that displays all items as percentages of a common base figure. This type of financial statement allows for easy analysis between companies or between time periods of a company. Formatting financial statements in this way reduces the bias that can occur when analyzing companies of differing sizes. It also allows for the analysis of a company over various time periods, revealing, for example, what percentage of sales is cost of goods sold and how that value has changed over time. Common size balance sheet: each asset expressed as a % of total assets and each liability and stockholders equity amount is expressed as a % of that total. Income statement, sales amount set at 100% and each item on income statement is expressed as % of sales. A variable cost is one that changes in total as the volume of activity changes. Manufacturing labor charges, supplies used in production, shipping costs, sales commissions, warranty costs, Raw materials, Direct labor, Factory utilities Fixed cost: does not change in total as the volume of activity changes. Supervisors salary, factory rent, advertising, property taxes, sales managers salary, Insurance, depreciation. As activity changes, total fixed cost constant, total variable cost changes directly, fixed cost per unit changes inversely and variable cost per unit remains constant.Revenue, variable expense and contribution margin on per unit basis and volume.Contribution margin per unit*volume=total contributionFixed expenses, subtract fixed expenses from total contribution and get operating income.Contribution margin ratio=contribution margin per unit/per unit selling price or unit sales price/unit variable cost. Contribution margin covers fixed costs and provides for income. Breakeven point in units= fixed costs/ contribution margin per unit, unit sales= fixed costs + desired income/contribution margin per unit Breakeven point in dollars=fixed costs/contribution margin ratio, dollar sales== fixed costs + desired income/contribution margin ratio. Record common stock issuance transaction: Dr cash (shares*price), Cr common stock (shares*par value), Cr Additional paid in capital (additional amount) Treasury Stock is contra stockholders equity account