2.10. Equity (2) – treasury stock and stock dividends

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Core Concepts of Accounting – Numbers and People

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Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

7 classificações

Curso 3 de 5 em Specialization Understanding Modern Finance

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

Na lição

Operational Assets. Depreciation. Short-Term Investments. Long-Term Liabilities. Shareholders’ Equity. Some Tax Issues

Week 2 is devoted to long-term assets and liabilities. We start with operational assets and see the role of depreciation and amortization in financial accounting and compare it to the way depreciation is used in valuation of investment projects. Then we discuss how financial investments in securities – stocks and bonds – are treated in accounting dependent upon goals and time horizon of holding and/or issuing of these securities. You will see how financial concepts (present values) are used in accounting for bond premium/discount amortization. Finally, an overview of the accounting approach to taxes is provided. On an example, you will study the core idea of deferred taxes.

2.1. Operational assets – types and accounting approach13:17

2.2. Depreciation11:14

2.3. Depreciation tax shield8:53

2.4. Intangible assets – accounting and amortization7:22

2.5. Short-term investments in bonds10:19

2.6. Short-term investments in stocks12:33

2.7. Bonds (1) – parameters and accounting approach10:31

2.8. Bonds (2) – amortization of premium/discount13:34

2.9. Equity (1) – accounting for common and preferred stock11:37

2.10. Equity (2) – treasury stock and stock dividends12:15

2.11. Accounting for taxes – an overview9:11

2.12. Deferred taxes – an example8:32

Conheça os instrutores

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Now let's proceed with shareholders equity.

So this will be like, shareholders equity part two,

although this is not comprehensive.

Let's talk about the kinds of common stock.

Because we talked about preferred before, so common stock maybe.

Authorized common stock, so this is how many shares of

common stock we can issue, and this is in the charter.

Let's say the company says that you can issue up to 500 million shares of stock.

Then there is actually issued common stock.

Let's say we issue, let's say we have

50,000 shares, and again,

as was before, we would use the PAR is $10 and

now the issue price will be 15.

Then we know what happens.

So the total is $750,000 of which to

common stock goes $500,000 and

then to additional paid-in capital, $250,000.

Now there's one more important type here.

This is outstanding common stock.

So this is all the stock that has been issued, fully paid for.

And so it's owned by the all shareholders and it's being traded.

Now the story is that I'm saying all that in the hope of introducing

one more special kind of stock that is called treasury stock.

And treasury stock is somewhat special.

It's, first of all, where does it come from?

So first the company issues some stock.

But then at some point in time,

may opt to repurchase part of its stock outstanding back to keep it for itself.

Why has it done so?

Well, one idea,

again, the details of share repurchases are studied in greater detail in our M and

D course, our fourth course, the final course of this specialization.

But the Idea for now is as follows.

You may wish to support the price

of your stock if you believe it's too low by producing some extra demand.

Or which is more, let's say, meaningful, is that if you use stock options

in your company as a means of compensation for your management, for example.

So you say that as part of the bonus,

you will receive some shares of stock of our company.

The question is, where will you take these shares of stock?

In order to be able to give it, you have to have it.

And if all stock is outstanding, so

it's sold by someone else, you have to take it from the market or issue.

In case you issue, you dilute and then sometimes if you have this stock option

program, you may repurchase some of them ahead of time and put them in your vault.

So treasury stocks, normal repurchase.

Then they have no dividends, no voting.

And in recording treasury stock is account recount to common stock.

So that's about treasury stock, just to keep this in mind.

It's important to see that it's no voting.

For example, if there is 1 million shares of stocks outstanding and

I bought back 80% of the stock,

it seems that I have the full control of the company.

No, because only the remaining 20 have the voting right.

Now let's move on and now say a few words about dividends.

Now the only source of cash dividends is retain earnings.

So basically if the company does not make any money of this period,

it cannot pay dividends.

Well you could say, in theory you could have borrowed and

could have paid that out as a special dividend.

Well, that happens very rarely because as,

we had the problem like that in corporate finance,

when it showed that that fundamentally increases the risk of the company.

But in this case the recording entry is as follows.

So we have foreign cash dividend.

We have then retained earnings that we debit by some amount.

And then we have dividends payable on same amount.

So that's our recording.

Then the next thing, we talked about cash dividend but there's always another way.

That's a stock dividend.

Let's say, whoever owns a, let's say, a hundred shares of stock.

We can declare, let's say, a 10% stock dividend.

That means that for each 100 shares you own, you receive 10 more.

Now what effect does it have on accounting of what interest must be made?

So this is stock dividend.

Well it's basically the proportional distribution of the stock to

existing shareholders.

Again, example 1A on this part.

So let's say that we have 20,000 shares outstanding and

then we declare a 10% stock dividend.

And if this is the case, and

then we'll also say that it's

important to add that the PAR is $10 and

then the market value is $16.

Now, what entries do we make?

The entries are as follows.

So although this is a stock dividend, but we put in this interest

the cash equivalent of that, so this is debit retained earning by how much?

So this will be 20,000.

Shares 10%, 2000 times 16.

So this is going to be $32,000.

And that is distributed between, Common stock here, common stock at the PAR.

So this is 20,000, and

then additional paid in capital, 12,000.

So this is example 1A.

But now I'll proceed with that.

And example 2B will deal with,

we will assume that there are two shareholders only.

Holding some number of shares in this company, and

we will see what happens will be holding.

So example, 2B.

Now, two shareholders, and the holdings are as follows.

So we have, this is shareholder A, this is shareholder B.

This had 15,000 shares and this had 5,000 shares.

And we declare, like I said, a 10% stock dividend.

So this person will receive +1,500 shares and

this one will receive +500 shares.

So the new holdings will be 16,500 for

A and 5,500 for B.

The total is 22,000 shares outstanding.

Now, let's analyze what happens with the market price of

that stock before the dividend was, as you remember, 16.

What's the new market price?

Well, we can say that before it was 16

times 20,000 must be equal to x times 22,000.

And therefore this new market price,

new market price, will be about $14.55.

Why is that?

Because nothing changed.

The assets, the cash generating generating capacity, nothing has changed.

Only the number of shares outstanding.

So before you had to divide among 20,000 shares, now, among 22.

Therefore, the market price goes down proportionally.

So there was an increase of 10% in the numbers of shares outstanding.

Now the drop in the market price from 16 to this is also 10%.

And the final thing that we'll have to mention here is the stock split

Let's say, we say that now there are 1 million shares outstanding and

we'll say we make a stock split one for two.

So every owner of one old share now receives two shares.

Again, that has no effect whatsoever on the total market value.

So if all shares before split were worth, let's say,

$15 and now it's 1 to 3 split, it will be $5 each.

And for that, we do not have to make any entry, only footnote.

And clearly an end to one split

is the same as 100% end stock dividend.

That's why I'm putting that clear.

But again, with these splits and

so you just have to be careful when you study financial statements of companies.

Over a long period of time, sometimes in these footnotes it says,

well, in five years ago, the company made these stock split.

And in order to properly follow through

the history of the stock performance you have to account for these splits.

Now we're wrapping up equity here and

in the final two episodes of this week we'll say a few words about taxes.

Again, this is not going to be a comprehensive

overview of the accounting for taxes.

But certain things we must keep in line.

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