AC113 Seminar Unit 9 – Chapter 8

Financing Operations Businesses must finance operations through one of two ways: –Debt Financing – includes all liabilities owed by a business. –Equity Financing – investments from owners of the business. Stock is issued to represent ownership interest.

Liabilities Debts owed to others. Current liabilities – due within a short time, usually 1 year. Long-term liabilities – due beyond 1 year. Some liabilities are contingent on the outcome of future events.

Current Liabilities Usually arise from two basic transactions: –Receiving goods or services prior to making payment (e.g., Accounts Payable). –Receiving payment prior to delivering goods or services (e.g., Unearned Rent).

Notes Payable Longer and more formal than accounts payable. Usually bear interest. Issued to creditors when merchandise or other assets are purchased.

Assume that a business issues a 90-day, 12% note for $1,000, dated August 1, 2008.

Income Taxes Include federal income taxes and possibly state and local income taxes. Most corporations are required to pay federal income taxes in four installments throughout the year.

Taxable Income vs. Income Before Taxes Taxable Income – determined according to federal tax laws (IRS Code). Income Before Taxes – determined according to generally accepted accounting procedures (GAAP). Differences between the two may need to be allocated between various financial statement periods.

Contingent Liabilities Arise from past transactions. Must be recorded if the liability is probable and can be estimated. Future events determine the amount that will be paid. Example: liability for warranty repairs.

Payroll The amount paid to employees for services they provide during a period. –Salary – payment for managerial, administrative, or similar services. –Wages – payment for manual labor, both skilled and unskilled. Payroll and related taxes significantly impact the net income of most businesses.

Payroll Taxes Employer Taxes FICA Federal and State Unemployment Taxes Employee Taxes FICA Federal and State Income Taxes Payroll 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.

Bonds A form of interest-bearing note. Bonds include interest (paid annually, semi- annually, or quarterly), and the face value must be repaid at maturity. Bond indenture – 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 $1,000 per bond.

Calculating the Bond Issue Price Based on the price buyers are willing to pay. Depends on three factors: –The face amount of the bonds due at the maturity date. –The periodic interest to be paid on the bonds – stated in the bond indenture. Is called the contract or coupon rate. –The market (effective) rate of interest.

Bonds Issued at Face Value Coupon and effective interest rates will be the same. Assume that a business issues $100,000 of 12%, 5-year bonds, with interest of $6,000 payable semiannually.

Bonds, continued

Bonds Not Issued at Face Value Discount on Bonds Payable –Market rate of interest > contract rate. –Buyers are not willing to pay face value for the bonds. Premium on Bonds Payable –Market rate of interest < contract rate. –Buyers are willing to pay more than face value for the bonds.

Stock Major means of equity financing. Shares –Authorized – total number allowed to issue. –Issued – shares issued to shareholders. –Outstanding – shares currently in the hands of stockholders.

Shares of Stock Can be issued with or without a monetary amount: –Par – monetary value stated on stock certificate. –No-par – some states might require a stated value. Legal Capital –Minimum stockholder contribution required by some states.

Stock Rights 1.Right to vote in matters concerning the corporation. 2.Right to share in distributions of earnings. 3.Right to share in assets on liquidation.

Common and Preferred Stock If only one class of stock, it is called common stock – each share has equal rights. Corporations can offer one or more classes of stock with various preference rights – usually called preferred stock. Preferred dividend rights are usually stated in monetary terms or a percentage of par.

Issuance of Stock The price at which stock can be sold 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.

Stock Issuance Assume that a corporation issues $2,000 shares of $1 par value common stock for $55 per share.

Reacquired Stock Treasury Stock –Stock that a corporation has issued and then reacquires. –Balance at year-end is reported as a reduction of stockholders’ equity.

Cash Dividends Cash distribution of earnings by a corporation to its shareholders. Most common form of dividends. Usually three conditions: –Sufficient retained earnings –Sufficient cash –Formal action by the board of directors

Cash Dividends Assume a company declares the following cash dividend:

Stock Dividends Distribution of stock to stockholders (usually common shares). No distribution of cash or other assets. Requirements: –Sufficient retained earnings –Formal action by board of directors Amount transferred for small stock dividends (<25% of outstanding shares) is market value per share.

Stock Splits Reduce the par value per share. Increase the number of shares outstanding. Major objective is to reduce the stock’s market price per share in order to attract more investors.

Stock Splits

Financial Reporting of Liabilities and Equity Liabilities –Current are due within 1 year. –Long-term 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.

Example

Earnings Per Share Major profitability measure reported in the financial statements. Followed closely by the financial press Net Income – Preferred Dividends Number of Common Shares

Exercise 8-1 Take a look at Exercise 8-1 at the end of the chapter. When you calculate the total current liabilities, what do you get?

Exercise 8-1 Answer:

Exercise 8-14 Take a moment to look over Exercise 8-14 at the top of page 294 in your textbook. May 1: Issued the bonds for cash at their face amount. How would this impact our financial statement accounts?

Exercise 8-14, continued May 1:

Exercise 8-14, continued November 1: Paid the interest on the bonds How would this impact our financial statements?

Exercise 8-14, continued November 1:

Exercise 8-14, continued December 31: Recorded accrued interest for two months. How would this impact the financial statement accounts?

Exercise 8-14, continued *30,000,000 × 6% × 2/12 = $300,000

Questions Does anyone have any questions???