1. Financing Decisions - 1 FINANCING DECISIONS Creditors and Investors

2. 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

3. Diamond Chapter 13 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 lessor’s property for a specific period in exchange for stipulated cash payments

4. Diamond Chapter 13 Financing Decisions - 4 Economic Advantages of Leasing  For the Lessee:  No (or low) down payment  Avoid risks associated with ownership –Technological obsolescence –Physical deterioration –Changing economic conditions  Flexibility  For the Lessor:  Increased sales  Ongoing business relationship with the lessee  Residual value retained

5. 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 lessee’s 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

6. Diamond Chapter 13 Financing Decisions - 6 Lease Classification Criteria 1.The lease transfers ownership of the property to the lessee by the end of the lease term 2.The lease contains a bargain purchase option 3.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 A lease is classified as a capital lease if any one of the following criteria are met:

7. 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

8. 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

9. 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

10. Diamond Chapter 13 Financing Decisions - 10 Lessee Accounting for Capital Leases 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)

11. 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

12. 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

13. 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

14. 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

15. Financing Decisions - 15 Owners’ Equity is comprised of 2 elements Paid-in Capital and Retained Earnings

16. Financing Decisions - 16 Paid-in Capital (Contributed Capital)  Total amount investors have contributed to corporation Paid-in Capital and Retained Earnings 1

17. Financing Decisions - 17 Retained Earnings  Corporation’s accumulated earnings and losses since its first day of operations  Earnings not distributed back to stockholders in the form of dividends Paid-in Capital and Retained Earnings 2

18. 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

19. 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

20. 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 contra- equity account

21. Financing Decisions - 21 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 TREASURY STOCK

22. 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

23. 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?

24. 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

25. 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

26. Financing Decisions - 26 Retained Earnings  Rather, retained earnings is a claim against all assets of the company  Cash  Inventory  Plant assets, etc.

27. 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

28. Financing Decisions - 28 Dividend Dates  Declaration date  Date of record  Date of Distribution

29. Financing Decisions - 29 NONCUMULATIVE  Similar in character to common stock; no claim to previous years’ unpaid dividends CUMULATIVE  Previous years’ dividends owed on preferred stock which haven’t been paid must be paid before common stockholders can receive any dividends Dividends on Cumulative and Noncumulative Preferred Stock

30. 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 doesn’t increase or decrease total stockholders’ equity  Nor does it affect total corporation assets

31. Financing Decisions - 31 Why issue stock dividends?

32. Financing Decisions - 32 Stock Dividends  Allow 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

33. Financing Decisions - 33 Stock Splits  Increase in number of shares authorized, issued, and outstanding  Corresponding proportional decrease in stock’s par value  Stimulates more active trading of stocks with very high market prices

34. Financing Decisions - 34 Similarities and Differences Between Stock Dividends and Stock Splits STOCK SPLITS  Increase # shares owned and outstanding  Doesn’t change total equity or stockholders’ investments  Decreases par value of stock  Doesn’t shift amounts from one account to another STOCK DIVIDENDS  Increase # shares owned and outstanding  Doesn’t change total equity or stockholders’ investments  Leaves par value unchanged  Shifts amounts from retained earnings to paid-in capital

35. Financing Decisions - 35 “ANOTHER CHAPTER CLOSED!”