Universidade de Illinois em Urbana-ChampaignUniversidade de Illinois em Urbana-Champaign

Financial Accounting: Advanced Topics

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Curso 2 de 7 em Specialization Financial Management

In this course, you will explore advanced topics in financial accounting. You will start your journey with accounting for assets with more than one-year life. You will learn in detail how firms account for fixed assets. You will then move to financing of assets and discuss accounting for liabilities. The course will continue with an in-depth exploration of shareholders’ equity. Finally, you will critically evaluate preparation, components, and analysis of cash flows statement. Upon successful completion of this course, you will be able to: • Account for fixed assets • Understand accounting for liabilities • Evaluate shareholders’ equity section of a balance sheet • Understand preparation and information provided by cash flows statement This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

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Module 3: Shareholders’ Equity

One of the major sources of financing for many firms is contributions from shareholders. The shareholders’ equity section of a balance sheet shows details of investments of shareholders. Accounting for shareholders’ equity will help you understand the amount of shareholder investment, the number of shares issued in return by the firm for shareholders, the amount of earnings earned by the firm but not distributed to shareholders, and information about the amount of shares repurchased by the firm from the stock market.

M3L3V1: Shareholders' Equity: Distributions3:31

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Oktay Urcan
Associate Professor of Accountancy
Department of Accountancy, College of Business

The third reason why shareholders' equity

could change within a years is distributions.

There are two main types of distributions that firms can make.

The first one is dividends.

Under dividends, firms distribute the same amount of cash to each common share.

The second way distributions can work is stock repurchases.

Under stock repurchases, firms go ahead to the stock market and

repurchase some of their own shares back.

Let's see how we are going to do the accounting for

these type of distributions.

Let's start with dividends and here's a small example.

We have a firm with 10,000 shares outstanding, declares and

pays $1 per share as dividends.

In terms of accounting, there is a reduction of $10,000,

which is 10,000 shares times $1 each as a dividend.

There is a $10,000 decrease in cash.

At the same time, there will be $10,000 decrease from retained earnings.

The important detail here is dividends are paid from retained earnings.

Does this make sense?

It does make sense, if you remember from the previous slides, retained earnings is

the total amount of profits earned by firms but not distributed to shareholders.

Then these profits are distributed to shareholders because normal debt,

there should be a reduction in retained earnings.

Here is an example about share repurchases.

We have a firm repurchasing 100 shares from the stock market

by paying $1,500 in total.

How do we do the accounting for this?

Notice that first of all,

we are paying $1,500, therefore there is a cash reduction of 1,500.

But at the same time, we created a very special account

under shareholders' equity and this account is called treasury stock.

Treasury stock has a negative balance because it's recorded under

shareholders' equity and it's an account used to record repurchased shares.

The question here is why have they repurchased some of these shares?

There are many reasons.

The first one is, the firm is signaling that look, we have lots of money.

We can do a lot of other things but instead, we trust our firm and

to show our trust, we're repurchasing some of our shares back.

In other words, the firm is giving confidence to the marketplace and because

of this confidence, it's possible that stock market price of shares can go up.

Second reason is repurchased shares

are not counted with an outstanding number of shares.

An outstanding number of shares is an important number that we are going to see

in the next lesson when we are calculating earnings per shares.

Basically, by repurchasing shares, firms can reduce the outstanding number of

shares and can increase earnings per share and

as I said, we are going to see an example about this soon.

The third reason is that repurchased shares can be used by firms as

a compensation to employees.

It's a big hassle in terms of legal fees, etc., to print shares.

Instead of printing shares, firms can just go ahead and either repurchase shares

from the market and distribute those to employees as a form of compensation.