Liabilities and
Stockholders’ Equity
CHAPTER 8
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Learning Objectives
After studying this chapter, you should be able to:
• Describe how businesses finance their operations
• Describe and illustrate current liabilities, notes
payable, taxes, contingencies, and payroll
• Describe and illustrate the financing of operations
through issuance of bonds
• Describe and illustrate the financing of operations
through issuance of stock
• Describe and illustrate the accounting for cash and
stock dividends
(continued…)
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Learning Objectives
After studying this chapter, you should be able to:
• Describe the effects of stock splits on the financial
statements
• Describe financial statement reporting of liabilities
and stockholders’ equity
• Analyze the impact of debt or equity financing on
earnings per share
• Financial Analysis: Describe and illustrate the use of
the ratio of liabilities to total assets and the priceearnings ratio in assessing a company’s financial
condition and prospects for future performance
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 1
Describe how businesses finance their
operations
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Financing Operations
• Businesses must finance operations through
one of the two ways:
• ________ Financing – includes all liabilities owed
by a business
• ________ Financing – includes investments from
owners of the business
• Proprietorship or partnership: obtains equity
financing from ____________________
• Corporation: obtains equity financing by
____________________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 2
Describe and illustrate current liabilities,
notes payable, taxes, contingencies, and
payroll
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Liabilities
• Debts owed to others
• _______ liabilities – due within a short time,
usually 1 year
• _______ liabilities – due beyond 1 year
• _______ liability – in some cases a company
incurs a liability if certain events occur in the
future
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Notes Payable
• Notes payable are often issued to:
• Satisfy an account payable
• Purchase merchandise or other assets
• ______: Issuer of the note
• ______: party receiving the note
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Notes Payable
• Assume that a business issues a 90-day, 6% note for
$1,000, dated August 1 to satisfy an account payable
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Notes Payable
• Assume that a business issues a 90-day, 6% note for
$1,000, dated August 1 to satisfy an account payable
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Income Taxes
• Includes federal income taxes and possibly state
and local income taxes
• Most corporations are required to pay ______
_____ taxes in four installments throughout the
year
• Taxable income of a corporation is determined
according to the __________
• Income before taxes reported on the income
statement is usually different from ______
income
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Income Taxes
• Assume that a corporation, with a calendar-year
accounting period, estimates its income tax expense for
the year as $84,000
• The effect on the accounts and the financial statements
of the first of the four estimated tax payments of $21,000
(1/4 of $84,000) is as follows:
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Taxable Income vs.
Income Before Taxes
• Taxable Income – determined according to
__________________ (IRS Code)
• Income Before Taxes – determined according to
__________________
• Differences between the two may need to be allocated
between various financial statement periods
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Accounting for Temporary Differences
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Contingent Liabilities
Accounting Treatment of Contingent Liabilities
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Payroll
• Amount paid to employees for services they
provide during a period
• ______ – payment for managerial, administrative,
or similar services
• ______ – payment for manual labor, both skilled
and unskilled
• Payroll and related taxes significantly impact the
net income of most businesses
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Recording Payroll
• Assume that McDermott Co. had a gross payroll of
$13,800 for the week ending April 11. Assume that the
FICA tax was 7.5% of the gross payroll and that federal
and state withholding were $1,655 and $280,
respectively
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Payroll Taxes
Employer
Taxes
• ________
• ________
Employee
Taxes
• ________
• ________
• ___________ become a liability when the
related payroll is paid to employees
• The liability is relieved when the taxes are paid
to the appropriate agencies
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Recording Payroll Taxes
• The effect on the accounts and financial
statements of McDermott Co. of recording the
payroll tax liabilities for the week follows:
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 3
Describe and illustrate the financing of
operations through issuance of bonds
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Bonds
• A form of interest-bearing note
• Bonds include ______ that must be paid on a
regular basis
• Bonds’ _______ must be repaid at maturity
• ____________: Contract between the company
issuing the bonds and the bondholders
• A bond issue is normally divided into several
individual bonds
• The most common face value is _____ per bond
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Calculating the Bond Issue Price
• The price that buyers are willing to pay for the
bonds depends on three factors:
• ___________ of the bonds due at the maturity
date
• ___________ to be paid on the bonds – stated in
the bond indenture
• This is called the ________ or ________ rate
• _____/_____ rate of interest
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Recording Bond Issuance
• Assume that a business issues $100,000 of 6%,
5-year bonds, with interest of $3,000 payable
semiannually. The market rate of interest at the
time the bonds are issued is 6%
Issuance of bonds payable at face amount on January 1.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Recording Bond Issuance
• Assume that a business issues $100,000 of 6%,
5-year bonds, with interest of $3,000 payable
semiannually. The market rate of interest at the
time the bonds are issued is 6%
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Recording Bond Issuance
• Assume that a business issues $100,000 of 6%,
5-year bonds, with interest of $3,000 payable
semiannually. The market rate of interest at the
time the bonds are issued is 6%
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Bonds Not Issued at Face Value
• Market Rate = _______ Rate
Selling Price = _______________
• Discount on Bonds Payable
• Market rate of interest __ contract rate
• Buyers are only willing to pay ____ than the face
value for the bonds
• Premium on Bonds Payable
• Market rate of interest __ contract rate
• Buyers are willing to pay ____ than the face value
for the bonds
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 4
Describe and illustrate the financing of
operations through issuance of stock
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Stock
• _______ – total
number allowed to
issue
• _______ – shares
issued to shareholders
• _______ – shares
currently in the hands
of stockholders
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Shares of Stock
• Can be issued with or without assigning a
monetary amount:
• _____: monetary value stated on stock certificate
• _____: some states might require a stated value
• Legal Capital
• Minimum stockholder contribution required by
some states
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Stock Rights
• Right to _____ in matters concerning the
corporation
• Right to share in distributions of ______
• Right to share in assets on ______
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Common and Preferred Stock
Common
Stock
• Each share has
________ rights
• Each share has
________ rights
Preferred
Stock
• Has preference
rights over
__________
• ______ rights
stated in monetary
terms or as % of
par
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Issuance of Stock
• The price at which stock sells depends on a
variety of factors:
• The financial condition, earnings record, and
dividend record of the corporation
• Investor expectations of the corporation’s
potential earning power
• General business and economic conditions and
prospects
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Issuance of Stock
• Assume that a corporation issues 2,000 shares
of $1 par value common stock for $55 per share
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Reacquired Stock
• ____________
• Stock that a corporation has issued and then
reacquired
• Balance at year-end is reported as a _______ of
stockholders’ equity
• A corporation may reacquire (purchase) its own
stock for a variety of reasons
• To provide shares for ______ to employees
• To reissue as bonuses to ______
• To support the __________ of the stock
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 5
Describe and illustrate the accounting for
cash and stock dividends
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Dividends
• _____ dividend: When a board of directors
authorize the distribution of cash to stockholders
• _____ dividend: When a board of directors
authorize the distribution of its stock to the
stockholders
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cash Dividends
• Cash distribution of earnings by a corporation to
its ___________
• Most common form of dividend
• Usually three conditions:
• ______________
• ______________
• Formal action by the ___________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Dates in Dividend Announcement
_________
_________
_________
____
_________
_________
_______
_________
_________
_________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cash Dividends
• Assume a company declares the following cash
dividend on December 1 for payment on February 2:
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Stock Dividends
• Distribution of stock to __________
• No distribution of cash or other assets
• Requirements:
• _________________
• Formal action by ___________
• Amount transferred for small stock dividends
(<25% of outstanding shares) is _________ per
share
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Stock Dividends
• To illustrate, assume a stockholder owns 1,000 of a
corporation’s 10,000 shares outstanding. If the
corporation declares a 6% stock dividend, the
stockholder’s proportionate interest will not change,
as shown below:
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 6
Describe the effects of stock splits on the
financial statements
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
_____ _____
• Process by which a corporation reduces the par
or stated value of its common stock and issues a
proportionate number of additional shares
• Major objective is to _____ the stock’s market
price per share in order to attract more investors
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Stock Splits
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 7
Describe financial statement reporting of
liabilities and stockholders’ equity
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Reporting Liabilities and
Stockholders’ Equity
• Liabilities
• _______ liabilities are due within 1 year
• _______ liabilities are due beyond 1 year
• Stockholders’ Equity
• Part of the balance sheet
• Details of the changes in stockholders’ equity are
disclosed in a separate statement
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Balance Sheet
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Statement of Stockholders’
Equity
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 8
Analyze the impact of debt or equity
financing on earnings per share
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Earnings Per Share
• Measures the income earned by each share of
_________
• Major profitability measure reported in the
financial statements
Earning per Share =
_________ – _____________
_______________________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Effect of Alternative Financing Plans
Plan 1:
100% financing from issuing common stock, $10 par value
Plan 2:
50% financing from issuing 4% preferred stock, $50 par value
50% financing from issuing common stock, $10 par value
Plan 3:
50% financing from issuing 6% bonds
25% financing from issuing 4% preferred stock, $50 par value
25% financing from issuing common stock, $10 par value
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
LEARNING OBJECTIVE 9
Financial Analysis: Describe and illustrate
the use of the ratio of liabilities to total
assets and the price-earnings ratio in
assessing a company’s financial condition
and prospects for future performance
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Ratio of Liabilities to Total Assets
• Useful in assessing a company’s financial
condition and risk
• Indicates the percent of a company’s total _____
that are financed with _____
• A high ratio indicates the company is financing
its operations with a high percent of debt.
• Also, a high ratio indicates that the company may
not be able to easily borrow additional funds
Ratio of Liabilities to Total Assets =
___________
___________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Ratio of Liabilities to Total Assets
• The following data (in millions) were taken from
two of Lowe’s recent financial statements
Ratio of Liabilities to
Total Assets
Year 1 ($______ ÷ $______)
_______
Year 2 ($______ ÷ $______)
_______
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Ratio of Liabilities to Stockholders’ Equity
Ratio of Liabilities to
Stockholders’ Equity
=
____________
________________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Ratio of Liabilities to Stockholders’ Equity
• The following data (in millions) were taken from
two of Lowe’s recent financial statements
Ratio of Liabilities to
Stockholders’ Equity
Year 1 ($_____ ÷ $______)
Year 2 ($_____ ÷ $______)
______
______
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Price-Earnings Ratio
• Indicates the market’s assessment of the future
earnings potential of a company
Price-Earnings Ratio =
_____________________________
_____________________________
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Price-Earnings Ratio
Market Price per Share of Common Stock
Earnings per Share of Common Stock
Year 2
Year 1
$38.44
$26.35
$1.43
$1.42
Price-Earnings Ratio
Year 1 ($_____ ÷ $_____)
Year 2 ($_____ ÷ $_____)
______
______
• The higher a company’s price-earnings ratio, the more
favorable the market’s assessment of the future earnings
potential and growth of the company
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
End of Chapter 8
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.