Financing Decisions - 1

FINANCING DECISIONS Creditors and Investors

Financing Decisions - 2

REPORTING LIABILITIES
Short-term liabilities Long-term Bonds Payable
Issuance Accounting for premium or discount

Other liabilities
Long-term Leases Contingencies Pensions & Postretirement Benefits

Income taxes

Financing Decisions - 3

Definition of a Lease A 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

Financing Decisions - 4

Economic Advantages of Leasing

For the Lessee:
No (or low) down payment Avoid risks associated with ownership

For the Lessor:

Increased sales Ongoing business relationship with the lessee Residual value retained

Flexibility

Technological obsolescence Physical deterioration Changing economic conditions

Diamond Chapter 13

Financing Decisions - 5

Lease Types
Capital leases are accounted for as if the lease agreement transfers ownership of the asset to the lessee
The lease is equivalent to a financed purchase An asset and liability must be recorded on lessees books

Operating leases are accounted for as rental agreements, with no transfer of effective ownership associated with the lease
Lease payments are recorded as rent expense by the lessee and rent revenue to the lessor
Diamond Chapter 13

Financing Decisions - 6

Lease Classification Criteria

A lease is classified as a capital lease if any one of the following criteria are met:
1. 2. 3. The lease transfers ownership of the property to the lessee by the end of the lease term The lease contains a bargain purchase option The lease term is equal to 75% or more of the estimated economic life of the leased property

4.

The present value of the minimum lease payments equals or exceeds 90% of the fair market value of the property
Diamond Chapter 13

Financing Decisions - 7

Accounting for Leases

DATA On 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 $13,870

Accounting treatments compared operating lease capital lease

For illustration purposes only Classification is not elective

Terms of the lease dictate classification

Diamond Chapter 13

Financing Decisions - 8

Accounting for Operating Lease

Lessee
Nothing is recorded on January 1, 2006 Each December 31, record rent expense No asset; no liability

Lessor
Continues to carry as an asset Continues depreciation

Diamond Chapter 13

Financing Decisions - 9

Lessee Accounting for Capital Leases

Records the equipment as an asset and records an associated liability
The asset and liability are recorded at the present value of the lease payments using an appropriate rate of interest

Makes annual payments that are divided between interest and principal Depreciates the asset over a 5-year period

Diamond Chapter 13

Financing Decisions - 10

Lessee Accounting for Capital Leases

12% Annual Interest Principle Lease Date Payment Expense Reduction Liability 01-Jan-06 50,000 31-Dec-06 13,870 6,000 7,870 42,130 31-Dec-07 13,870 5,056 8,814 33,316 31-Dec-08 13,870 3,998 9,872 23,443 31-Dec-09 13,870 2,813 11,057 12,387 31-Dec-10 13,870 1,483 12,387 (final interest expense adjusted for rounding)

The interest amount for each year is based on 12% of the balance of the liability at the beginning of the year Annual depreciation is $10,000 ($50,000 5 years)
Diamond Chapter 13

Financing Decisions - 11

STOCKHOLDERS EQUITY
Contributed capital
Par value issues Common vs. Preferred stock

Retained earnings
Cash dividends Stock dividends

Other issues
Stock splits Treasury stock

Financing Decisions - 12

Corporations: An Overview
Fewer in number than sole proprietorships and partnerships, yet ... Generate greatest dollar volume of sales revenues Largest in terms of total assets and owners equity

MISSION STATEMENT

Financing Decisions - 13

Characteristics of a Corporation
Separate legal entity Continuous life/transferability of ownership Lack of mutual agency Stockholder limited liability Separation of ownership and management Subject to double-taxation Regulated by government

Financing Decisions - 14

STOCKHOLDERS RIGHTS
Stockholders generally have rights to: Vote on important matters Receive dividends Share in net assets upon liquidation Maintain proportionate ownership interest in corporation

VOTE TO ELECT DIRECTORS

Financing Decisions - 15

Paid-in Capital and Retained Earnings

Owners Equity is comprised of 2 elements

Financing Decisions - 16

Paid-in Capital and Retained Earnings

Paid-in Capital (Contributed Capital)

Total amount investors have contributed to corporation

Financing Decisions - 17

Paid-in Capital and Retained Earnings

Retained Earnings
Corporations accumulated earnings and losses since its first day of operations

Earnings not distributed back to stockholders in the form of dividends

Financing Decisions - 18

Classes of Stock

PREFERRED Generally fewer rights of stock ownership Less risky than common stock First to receive corporate dividends Second claim against net assets in event of liquidation COMMON 4 rights of stock ownership More risk than preferred stock Dividends not guaranteed Residual claims on net assets upon liquidation

Financing Decisions - 19

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

Financing Decisions - 20

Treasury Stock
Shares of its own stock which the corporation has reacquired from investors Similar to unissued stock No dividends paid on treasury stock Company does not own itself Treasury Stock is a contraequity account

Financing Decisions - 21

TREASURY STOCK
1. Use shares for employee compensation
Stock option/bonus plans

2. Reduce number of shares outstanding

Might create increase in market price of shares

3. Wait until market price of stock rises

Subsequently re-issue shares to increase total owners equity

4. Withdraw shares from secondary market as defense against corporate takeover

Financing Decisions - 22

Purchase of Treasury Stock

Reacquiring shares does not reduce total number of shares issued It does reduce total number of shares outstanding Also reduces total stockholders

equity

Financing Decisions - 23

Ethical Issues and Treasury Stock Transactions

Would 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 - 24

Sale of Treasury Stock

No 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 - 25

Retained Earnings
Retained 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 - 26

Retained Earnings
Rather, retained earnings is a claim of the company Cash Inventory Plant assets, etc.

against all assets

Financing Decisions - 27

Dividends
Distribution, to stockholders, of assets acquired through profitable operations Board of Directors declares dividends
Retained Earnings balance must be sufficient to support the declaration

But to pay cash dividends...

Cash balance must be adequate

Financing Decisions - 28

Dividend Dates
Declaration date Date of record Date of Distribution

Financing Decisions - 29

Dividends on Cumulative and Noncumulative Preferred Stock

CUMULATIVE Previous years dividends owed on preferred stock which havent been paid must be paid before common stockholders can receive any dividends NONCUMULATIVE Similar in character to common stock; no claim to previous years unpaid dividends

Financing Decisions - 30

Stock Dividends
Shares of corporate stock given in lieu of cash dividends Shareholders receive shares in proportion to their current level of stock ownership Distribution doesnt increase or decrease total stockholders equity Nor does it affect total corporation assets

Financing Decisions - 31

Why issue stock dividends?

Financing Decisions - 32

Stock Dividends
Allow corporation to retain cash for reinvestment 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 - 33

Stock Splits
Increase in number of shares authorized, issued, and outstanding Corresponding par value

proportional decrease in stocks

Stimulates more active trading of stocks with very high market prices

Financing Decisions - 34

Similarities and Differences Between Stock Dividends and Stock Splits

STOCK DIVIDENDS Increase # shares owned and outstanding Doesnt change total equity or stockholders investments Leaves par value unchanged Shifts amounts from retained earnings to paid-in capital

STOCK SPLITS Increase # shares owned and outstanding Doesnt change total equity or stockholders investments Decreases par value of stock Doesnt shift amounts from one account to another

Financing Decisions - 35

ANOTHER CHAPTER CLOSED!