Financing Decisions - *FINANCING DECISIONS Creditors and Investors

Financing Decisions - *REPORTING LIABILITIESShort-term liabilitiesLong-term Bonds PayableIssuanceAccounting for premium or discount

Other liabilitiesLong-term Leases

Contingencies

Pensions & Postretirement Benefits

Income taxes

Diamond Chapter 13Financing Decisions - *Definition of a LeaseA lease is a contractual agreement between the lessor (owner of the property) and the lessee (user of the property), giving the lessee the right to use the lessors property for a specific period in exchange for stipulated cash payments

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Economic Advantages of LeasingFor the Lessee:No (or low) down paymentAvoid risks associated with ownershipTechnological obsolescencePhysical deteriorationChanging economic conditionsFlexibilityFor the Lessor:Increased salesOngoing business relationship with the lesseeResidual value retained

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Lease Types Capital leases are accounted for as if the lease agreement transfers ownership of the asset to the lesseeThe lease is equivalent to a financed purchase An asset and liability must be recorded on lessees booksOperating leases are accounted for as rental agreements, with no transfer of effective ownership associated with the leaseLease payments are recorded as rent expense by the lessee and rent revenue to the lessor

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Lease Classification CriteriaThe lease transfers ownership of the property to the lessee by the end of the lease termThe lease contains a bargain purchase optionThe lease term is equal to 75% or more of the estimated economic life of the leased propertyThe present value of the minimum lease payments equals or exceeds 90% of the fair market value of the propertyA lease is classified as a capital lease if any one of the following criteria are met:

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Accounting for LeasesDATAOn January 1, 2006, Scully Corporation (lessee) enters into a lease with Porter Company (lessor) to lease a piece of equipment for five equal annual year-end installments of $13,870Accounting treatments comparedoperating leasecapital leaseFor illustration purposes onlyClassification is not electiveTerms of the lease dictate classification

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Accounting for Operating LeaseLesseeNothing is recorded on January 1, 2006Each December 31, record rent expenseNo asset; no liabilityLessorContinues to carry as an assetContinues depreciation

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Lessee Accountingfor Capital LeasesRecords the equipment as an asset and records an associated liabilityThe asset and liability are recorded at the present value of the lease payments using an appropriate rate of interestMakes annual payments that are divided between interest and principalDepreciates the asset over a 5-year period

Diamond Chapter 13

Diamond Chapter 13Financing Decisions - *Lessee Accountingfor Capital LeasesThe interest amount for each year is based on 12% of the balance of the liability at the beginning of the yearAnnual depreciation is $10,000 ($50,000 5 years)

Diamond Chapter 13

JEs

Tx #Account TitlesRefDebitCredit

Bond Issuance

1/1/06Cash100,000

Bonds Payable100,000

First Interest Payment

7/1/06Interest Expense6,000

Cash6,000

Year-End Adjusting Entry

12/31/06Interest Expense6,000

Interest Payable6,000

Payment of Accrued Interest

1/1/07Interest Payable6,000

Cash6,000

38079Accts Rec (fc)320,000

Sheet1

Company (Ticker)CouponMaturityLast PriceLast YieldEst $ Vol. (000s)

General Motors (GM)8.375July 15, 2033105.4697.892075,139

Sheet2

face100,000.00eventCash IntInt ExpAmortP/D BalCarrying

face rate12%issue7,582107,582

term5int 112,00010,7581,2426,340106,340

mkt rate10%int 212,00010,6341,3664,974104,974

PV107,581.57int 312,00010,4971,5033,471103,471

int 412,00010,3471,6531,818101,818

int 512,00010,1821,8180100,000

face100,000.00eventCash IntInt ExpAmortP/D BalCarrying

face rate12%issue(6,866)93,134

term5int 112,00013,039(1,039)(5,827)94,173

mkt rate14%int 212,00013,184(1,184)(4,643)95,357

PV93,133.84int 312,00013,350(1,350)(3,293)96,707

int 412,00013,539(1,539)(1,754)98,246

int 512,00013,754(1,754)(0)100,000

Sheet6

DateAnnual Payment12% Interest ExpensePrinciple ReductionLease Liability

1-Jan-0650,000

31-Dec-0613,8706,0007,87042,130

31-Dec-0713,8705,0568,81433,316

31-Dec-0813,8703,9989,87223,443

31-Dec-0913,8702,81311,05712,387

31-Dec-1013,8701,48312,3870.0

(final interest expense adjusted for rounding)

Sheet5

Payment NumberCash Interest PaymentInterest ExpenseReduction in PremiumBond Carrying Value1

Beginning Balance107,721

16,0005,386614107,107

26,0005,355645106,462

36,0005,323677105,786

46,0005,289711105,075

56,0005,254746104,329

66,0005,216784103,545

76,0005,177823102,722

86,0005,136864101,858

96,0005,093907100,951

106,0005,049951100,000

(final interest expense adjusted for rounding)

Sheet4

Interest Expense:

Bond Carrying Value ($92,976 + 508)$93,484

Effective Semiannual Rate7%

6,544

Cash Interest6,000

Reduction (amortization) of bond discount$544

Sheet3

60606060606060606060semi-ann int

1,000principal

Financing Decisions - *STOCKHOLDERS EQUITYContributed capitalPar value issuesCommon vs. Preferred stock

Retained earningsCash dividendsStock dividends

Other issuesStock splitsTreasury stock

Financing Decisions - *Corporations: An OverviewFewer in number than sole proprietorships and partnerships, yet ... Generate greatest dollar volume of sales revenuesLargest in terms of total assets and owners equity MISSIONSTATEMENT

Financing Decisions - *Characteristics of a CorporationSeparate legal entityContinuous life/transferability of ownershipLack of mutual agencyStockholder limited liabilitySeparation of ownership and managementSubject to double-taxationRegulated by government

Financing Decisions - *STOCKHOLDERS RIGHTSStockholders generally have rights to:Vote on important mattersReceive dividendsShare in net assets upon liquidationMaintain proportionate ownership interest in corporation

Financing Decisions - *Owners Equity is comprised of 2 elementsPaid-in Capital and Retained Earnings

Financing Decisions - * Paid-in Capital (Contributed Capital)Total amount investors have contributed to corporationPaid-in Capital and Retained Earnings1

Financing Decisions - *Retained EarningsCorporations accumulated earnings and losses since its first day of operations

Earnings not distributed back to stockholders in the form of dividendsPaid-in Capital and Retained Earnings2

Financing Decisions - *Classes of StockPREFERREDGenerally fewer rights of stock ownershipLess risky than common stock First to receive corporate dividendsSecond claim against net assets in event of liquidationCOMMON4 rights of stock ownershipMore risk than preferred stock Dividends not guaranteedResidual claims on net assets upon liquidation

Financing Decisions - *Par ValuePar value - minimum legal capital of the corporation below which Stockholders Equity cannot fallPar value is randomly chosen Generally very low in amount - $.01, $.10, or $1.00

Financing Decisions - *Treasury StockShares of its own stock which the corporation has reacquired from investorsSimilar to unissued stockNo dividends paid on treasury stockCompany does not own itselfTreasury Stock is a contra-equity account

Financing Decisions - *1.Use shares for employee compensationStock option/bonus plans2.Reduce number of shares outstandingMight create increase in market price of shares3.Wait until market price of stock risesSubsequently re-issue shares to increase total owners equity 4.Withdraw shares from secondary market as defense against corporate takeoverTREASURY STOCK

Financing Decisions - *Purchase of Treasury StockReacquiring shares does not reduce total number of shares issuedIt does reduce total number of shares outstandingAlso reduces total stockholders equity

Financing Decisions - *Ethical Issues and Treasury Stock TransactionsWould it be ethical for a corporation to reacquire its common stock in the week prior to announcing record-breaking financial operating results for the accounting period?

Financing Decisions - *Sale of Treasury StockNo gain or loss is recognized when corporation re-issues (sells) treasury stock to investors Sale might be made at price above or below that paid by corporation to reacquire its stock

Financing Decisions - *Retained EarningsRetained earnings represents investors claims against assets acquired through reinvestment of net income

Balance in Retained Earnings account is NOT the same as cash

Financing Decisions - *Retained EarningsRather, retained earnings is a claim against all assets of the companyCashInventoryPlant assets, etc.

Financing Decisions - *DividendsDistribution, to stockholders, of assets acquired through profitable operations

Board of Directors declares dividendsRetained Earnings balance must be sufficient to support the declaration

But to pay cash dividends...Cash balance must be adequate

Financing Decisions - *Dividend DatesDeclaration date

Date of record

Date of Distribution

Financing Decisions - *NONCUMULATIVESimilar in character to common stock; no claim to previous years unpaid dividendsCUMULATIVEPrevious years dividends owed on preferred stock which havent been paid must be paid before common stockholders can receive any dividendsDividends on Cumulative and Noncumulative Preferred Stock

Financing Decisions - *Stock DividendsShares of corporate stock given in lieu of cash dividends Shareholders receive shares in proportion to their current level of stock ownershipDistribution doesnt increase or decrease total stockholders equityNor does it affect total corporation assets

Financing Decisions - *Why issue stock dividends?

Financing Decisions - *Stock DividendsAllow corporation to retain cash for re-investment in operations or acquire long-term assets (PP&E) to be used for business activities

Stockholders still receive some form of distribution from corporation

Financing Decisions - *Stock SplitsIncrease in number of shares authorized, issued, and outstanding

Corresponding proportional decrease in stocks par value

Stimulates more active trading of stocks with very high market prices

Financing Decisions - *Similarities and Differences Between Stock Dividends and Stock SplitsSTOCK SPLITSIncrease # shares owned and outstandingDoesnt change total equity or stockholders investmentsDecreases par value of stockDoesnt shift amounts from one account to anotherSTOCK DIVIDENDSIncrease # shares owned and outstandingDoesnt change total equity or stockholders investmentsLeaves par value unchangedShifts amounts from retained earnings to paid-in capital

Financing Decisions - *

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