Financial Accounting

UNIT 5: Investing and financing

activities. PPE, Liabilities and
Equity.

Juan Corberá Martínez

Felipe Sánchez Coll
ADE
November 2023
1st Year 2023 - 24
Workload

DATE SESSION READING CLASS INDIVIDUAL OTHER WORK

EXERCISES EXERCISES
Session 21 Concepts Chapter 8 (book) +
Slides
Sesion 22 Exercises Class exercises Homework
(Chapter 8) support
Session 23 Concepts Chapter 9&11 (book) +
Slides
Session 24 Exercises Class exercises Homework
(Chapter 9&11) support
Session 25 Test/Reinforcement Multiple choice test
class

2
Learning Objectives
- Investing activities: PPE and Intangible Assets. (Chapter 8)
- Acquisition and maintenance of assets
- Different depreciation methods
- Asset impairment
- Disposal of assets
- Intangible assets
- Fixed Assets Turnover Ratio
- Financing activities: Liabilities and Equity (Chapters 9 and 11)
- Current and noncurrent liabilities
- Estimated liabilities
- Equity, dividends

3
Transactions related with
acquisition and maintenance of
assets.

4
Classifying Long-Lived Assets

Tangible Intangible
Physical No Physical
Substance Substance

 Land  Patents
 Buildings, fixtures, and  Copyrights
equipment  Franchises
 Natural resources  Licenses
 Trademarks

5
Measuring and Recording
Acquisition Cost
Acquisition cost includes the purchase price and all
expenditures needed to prepare the asset for its intended use.
Acquisition cost does not include
financing charges and cash discounts.

Buildings
Buildings
•• Purchase
Purchase price
price
•• Renovation
Renovation andand repair
repair costs
costs
•• Legal
Legal and
and realty
realty fees
fees
•• Title
Title fees
fees Note - We say that the expenditures are capitalized
when they are recorded as an asset.

6
Measuring and Recording
Acquisition Cost
Equipment
Equipment Land
Land
•• Purchase
Purchase price
price •• Purchase
Purchase price
price
•• Installation
Installation costs
costs •• Real
Real estate
estate commissions
commissions
•• Modification
Modification toto building
building •• Title
Title insurance
insurance premiums
premiums
necessary
necessary toto install
install •• Delinquent
Delinquent taxes
taxes
equipment
equipment •• Surveying
Surveying fees
fees
•• Transportation
Transportation costs
costs •• Title
Title search
search and
and transfer
transfer fees
fees

Impuestos no
repercutibles

Gastos de Land is not depreciable.

prospección

7
Measuring and Recording
Acquisition Cost
Acquisition On January 1, Southwest Air Lines purchased aircraft for
for Cash $70,000,000 cash.

Acquisition On January 14, Southwest Air Lines purchased aircraft

for Debt for $1,000,000 cash and a $69,000,000 note payable.

8
Acquisition by construction

Asset
Asset cost
cost includes:
includes:

All materials and A reasonable Interest on debt

labor traceable to amount of incurred during
the construction. overhead. the construction.

9
Repairs, Maintenance and Additions

10
Repairs, Maintenance and Additions

To solve this problem, many companies have policies

regarding the expensing of all expenditures below a
certain amount according to the materiality constraint.

11
Depreciation methods

12
Depreciation Concepts
Depreciation
Depreciationisisaacost
costallocation
allocationprocess
processthat
thatsystematically
systematicallyand
and rationally
rationallymatches
matches
acquisition costs of operational assets with periods benefited by their use.
acquisition costs of operational assets with periods benefited by their use.

Balance Sheet Income Statement

Acquisition Cost
Expense
Cost
Allocation
(Unused) (Used)
Depreciation for
Depreciation the current year Income
Expense Statement

Total of depreciation
Accumulated to date on an asset Balance
Depreciation Sheet

13
Adjusting depreciation
An adjusting journal entry is needed at the end of each period to reflect the use
of buildings and equipment for the period:

Debit Credit
Depreciation Expense (+E, -SE) ….….……………………………………… x,xxx
Accumulated Depreciation (+XA, -A) …………………………………. x,xxx

Cost XX
Less Accumulated Depreciation - XX
Net Book Value XX

14
Depreciation Concepts
The calculation of depreciation requires
three amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.

Alternative
Alternative depreciation
depreciation methods:
methods:

Straight-line
Straight-line

 Units-of-production
Units-of-production

 Accelerated
Accelerated Method:
Method: Declining
Declining balance
balance
15
Straight – Line Method
Depreciation Cost - Residual Value
=
Expense per Year Life in Years

At the beginning of the year, Southwest purchased ground

equipment for $62,500 cash. The equipment has an estimated
useful life of 3 years and an estimated residual value of $2,500.

Depreciation $62,500 - $2,500

=
Expense per Year 3 years

Depreciation
= $20,000
Expense per Year
16
Straight – Line Method

Residual Value

More companies use the straight-line

method of depreciation in their financial
reports than all other methods combined.
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Units of Production Method
Step 1:
Depreciation = Cost - Residual Value
Rate Life in Units of Production
Step 2:
Number of
Depreciation Depreciation
= × Units
Expense Rate
Produced
for the
At the beginning of the year, Southwest purchased Year
ground
equipment for $62,500 cash. The equipment has a 100,000
miles useful life and an estimated residual value of $2,500.

If the equipment is used 30,000 miles in the first year, what is

the amount of depreciation expense?
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Units of Production Method
Step 1:
Depreciation = $62,500 - $2,500 = $.60 per
Rate 100,000 miles
mile
Step 2:
Depreciation
Expense = $.60 per mile × 30,000 miles = $18,000
Accumulated Undepreciated
Depreciation Depreciation Balance
Year Miles Expense Balance (book value)
$ 62,500
1 30,000 $ 18,000 $ 18,000 44,500
2 50,000 30,000 48,000 14,500
3 20,000 12,000 60,000 2,500
100,000 $ 60,000
Residual Value
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Accelerated Depreciation
Accelerated depreciation matches higher
depreciation expense with higher revenues
in the early years of an asset’s useful life
when the asset is more efficient.

Depreciation Repair
Expense Expense
Early Years High Low
Later Years Low High

20
Declining – Balance Method
Net Book Value

2
Depreciation
Expense
= (Cost – Accumulated ×
Useful Life
Depreciation)

Annual
Annualcomputation
computationignores
ignoresresidual
residualvalue.
value.

At the beginning of the year, Southwest purchased equipment for $62,500 cash. The equipment has
an estimated useful life of 3 years and an estimated residual value of $2,500.
Calculate the depreciation expense for the first two years.

21
Declining – Balance Method

Annual Net 2
Depreciation
expense
= Book
Value
× ( Useful Life in )
Years

Year 1 Depreciation:
2
$62,500 × ( 3 years ) = $41,667
Year 2 Depreciation:
2
($62,500 – $41,667) × ( 3 years ) = $13,889
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Declining – Balance Method

Below residual value

Year 3 Depreciation:
2
($62,500 – $55,556) × ( 3 years ) = $4,629
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Declining – Balance Method

Depreciation expense is limited to the amount that

reduces book value to the estimated residual value.

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Changes in Depreciation Estimates
Depreciation Expense is based on . . .
ESTIMATED
ESTIMATED useful
useful ESTIMATED
ESTIMATED
life
life residual
residual value
value

If
If the
the estimates
estimates change,
change, the
the book
book value
value less
less any
any residual
residual
value
value at
at the
the date
date of
of change
change is
is depreciated
depreciated over
over the
the
remaining
remaining useful
useful life.
life.

Southwest
Southwest purchased
purchased an an aircraft
aircraft for
for $60,000,000.
$60,000,000. The The aircraft
aircraft isis
depreciated
depreciated usingusing the
the straight-line
straight-line method
method with
with aa useful
useful life
life of
of 20
20 years
years andand
an
an estimated
estimated residual
residual value
value of
of $3,000,000.
$3,000,000.
In
In year
year 5,
5, Southwest
Southwest changed
changed the the estimated
estimated useful
useful life
life to
to 25
25 years
years and and
lowered
lowered the
the residual
residual value
value toto $2,400,000.
$2,400,000. Calculate
Calculate depreciation
depreciation expense
expense
for
for the
the fifth
fifth year
year using
using the
the straight-line
straight-line method.
method.

25
Changes in Depreciation Estimates

26
Asset impairment

27
Asset impairment
• An asset’s book value is impaired when the asset is not expected to generate
sufficient cash flows (probable future benefits) at least equal to its book value.
• Step 1: Test for Impairment. Impairment occurs when events or changed
circumstances cause the estimated future cash flows (future benefits) of these assets
to fall below their book value.
• If net book value > Estimated future cash flows, then the asset is impaired

• Step 2: Computation of Impairment Loss For any asset considered to be

impaired, companies recognize a loss for the difference between the asset’s book
value and its fair value (a market concept). The asset is written down to fair value.
• Impairment Loss = Net Book Value – Fair Value

28
Asset impairment
• Assume that Southwest did a review for asset impairment and identified an
aircraft with the following information:

• Step 1: Because the net book value of $10 million exceeds the estimated
future cash flows of $8 million, the asset is impaired.

• Step 2: The loss is calculated as $2,500,000 ($10,000,000 net book value less
$7,500,000 fair value). The following journal entry would be recorded:

Debit Credit
Loss due to impairment (+E, −SE) 2,500,00
0
Flight equipment (−A) 2,500,000

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Disposal of assets

30
Disposal of Property, Plant, and
Equipment  Update depreciation
to the date of disposal.

 Journalize disposal by:

Recording cash Recording a

received (debit) gain (credit)
or paid (credit). or loss (debit).

Writing off accumulated Writing off the

depreciation (debit). asset cost (credit).
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Disposal of Property, Plant, and
Equipment
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Southwest
Southwest Airlines
Airlines sold
sold flight
flight equipment
equipment
for
for $5,000,000
$5,000,000 cash cash at at the
the end
end of
of its
its
17th
17th year
year of
of use.
use. The
The flight
flight equipment
equipment originally
originally cost
cost
$20,000,000,
$20,000,000, and
and was
was depreciated
depreciated using using the
the straight-line
straight-line
method
method with
with zero
zero residual
residual value
value
and
and aa useful
useful life
life of
of 20
20 years.
years.
Let’s
Let’s answer
answer thethe following
following questions.
questions.

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Disposal of Property, Plant,
and Equipment
The amount of depreciation expense
recorded at the end of the 17th year to
bring depreciation up to date is:

a. $0. Annual Depreciation:

b. $1,000,000. ($20,000,000 - $0) ÷ 20
c. $2,000,000. Years.
= $1,000,000
d. $4,000,000.

33
Disposal of Property, Plant,
and Equipment

After updating the depreciation,

the equipment’s book value at the end of the
17th year is:
Accumulated Depreciation =
a. $3,000,000.
(17yrs. × $1,000,000) = $17,000,000
b. $16,000,000.
c. $17,000,000. BV = Cost - Accumulated Depreciation
d. $4,000,000. BV = $20,000,000 - $17,000,000
= $3,000,000

34
Disposal of Property, Plant,
and Equipment
The
The equipment’s
equipment’s sale
sale resulted
resulted in:
in:

a.
a. aa gain
gain of
of $2,000,000.
$2,000,000.
b.
b. aa gain
gain of
of $3,000,000.
$3,000,000.
c.
c. aa gain
gain of
of $4,000,000.
$4,000,000.
d.
d. aa loss
loss of
of $2,000,000.
$2,000,000.
Gain = Cash Received - Book Value
Gain = $5,000,000 - $3,000,000 = $2,000,000

35
Disposal of Property, Plant,
and Equipment
Prepare the journal entry to record Southwest’s sale
of the equipment at the end of the 17th year.

Description Debit Credit

Cash (+A) $ 5.000.000,00
Accumulated Depreciation (-XA+A) $ 17.000.000,00
Gain on Sale (+Gain, +SE) $ 2.000.000,00
Flight Equipment (-A) $ 20.000.000,00

36
Intangible assets

37
Acquisition and Amortization of
Intangible Assets
Noncurrent
Noncurrent assets
assets Often
Often provide
provide
without
without physical
physical exclusive
exclusive rights
rights
substance.
substance. or
or privileges.
privileges.
Intangible
Assets Usually
Usually acquired
acquired
Useful
Useful life
life is
is
often
often difficult
difficult for
for operational
operational
to
to determine.
determine. use.
use.

Record at current cash equivalent cost, including

purchase price, legal fees, and filing fees.
38
Acquisition and Amortization of
Intangible Assets
Definite Life Indefinite
Indefinite Life Life
• Amortize over shorter of •• Not
economic life or legal life, Not amortized.
amortized.
subject to rules specified by •• Tested
Tested atat least
least annually
annually for
for
GAAP. possible
possible impairment,
impairment, and and
• Use straight-line method. book
book value
value is is reduced
reduced to
to
• Most companies does not fair
fair value
value ifif impaired.
impaired.
estimate a residual value.

Amortization is a cost allocation process

similar to depreciation.

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Common Intangible Assets (1/2)
• Goodwill:
• Only recorded as an asset when one company buys another business.
• Equals the purchase price of the company less the fair market value of the net assets
(assets minus liabilities).
• Not amortized but reviewed annually for impairment.

Trademarks :
• A special name, image or slogan identified with a product or company.
• Rarely seen on balance sheets because they are only recorded if purchased.

Copyrights:
• The exclusive right to publish, use, and sell a literary, musical, or artistic work.
• Legal life is the life of the creator plus 70 years.

Licenses and operating rights:

• These intangible assets are the permissions to use a product or service according to
specific terms and conditions.

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Common Intangible Assets (2/2)
Technology:
• Website development: Capitalize the costs of acquiring a domain name and developing graphics.
• Software: Capitalize the direct costs of developing software (coding and testing) after the software
is technologically feasible. Costs incurred during the preliminary concept phase should be
expensed. Amortize as a general expense or as cost of goods sold if the software is to be sold to
customers.

Patents:
• Exclusive right granted by the federal government for 20 years for inventions and new processes.
• Owner can use, manufacture, and sell both the subject of the patent and the patent itself.
• Only registration fees and legal costs are capitalized if developed internally. Research and
development costs are expensed.

Franchises:
• Rights granted by the government or a company to provide a product or service.
• The investment made by the franchisee is accounted for as an intangible asset.
• The life of the franchise agreement depends on the contract and can be for a single year or
indefinite period.
41
Acquisition and Amortization of
Intangible Assets
Goodwill

Occurs when one Only purchased

company buys goodwill is an
another company. intangible asset.

The amount by which the purchase price exceeds

the fair market value of net assets acquired.

Goodwill
Goodwill is
is not
not amortized.
amortized. Its
Its value
value must
must be be reviewed
reviewed
at
at least
least annually
annually for
for possible
possible impairment,
impairment, and and the
the
book
book value
value is
is reduced
reduced to
to fair
fair value
value if
if impaired.
impaired.

42
Acquisition and Amortization of
Intangible Assets
Arpec Company paid $2,000,000 to purchase
all of Utek Company’s assets and assumed liabilities of $400,000.
The acquired assets were appraised at a fair value of $1,800,000.

What
What amount
amount of
of goodwill
goodwill should
should be
be
recorded
recorded on
on Arpec
Arpec Company
Company books?
books?

a.
a. $200,000
Assets (Fair Value)
$200,000 $ 1.800.000
Debt Assumed 400.000
b.
b. $400,000
$400,000
Net Assets (Fair Value) 1.400.000
c.
c. $600,000
$600,000
Purchase Price 2.000.000
d.
d. $800,000
Goodwill
$800,000 $ 600.000

43
Topical issue

44
Fixed Asset Turover Ratio

45
Fixed Asset Turnover Ratio
SOUTHWEST AIRLINES CO.
Consolidated Balance Sheets (partial)
December 31, 2017 and 2016
Assets (dollars in millions) 2017 2016
Current assets: (summarized) $ 4,815 $ 4,498
Property and equipment, at cost:
Flight equipment 21,368 20,275
Ground property and equipment 4,399 3,779
Deposits on flight equipment purchase contracts 919 1,190
Assets constructed for others 1,543 1,220
28,229 26,464
Less allowance for depreciation and amortization 9,690 9,420
Total property and equipment 18,539 17,044
Goodwill 970 970
Other assets 786 774
Total assets $25,110 $23,286

46
Fixed Asset Turnover Ratio
Fixe d Asse t Ne t Sale s or Ope rating Re ve nue s 
=
Turnove r Ave rag e Ne t Fixe d Asse ts

The 2017 ratio for Southwest is (dollars in millions): This ratio measures the
sales dollars generated by
Operating Revenues $21,171 each dollar of fixed assets
 1.19 times
$17, 044  $18,539  2 used. A high rate
suggests effective
management.
COMPARISONS OVER COMPARISONS WITH
TIME COMPETITORS Delta United
Southwest
2017 2016Airlines
2015 2017 Continental 2017
Holdings
1.19 1.25 1.33 1.62 1.64

47
Liabilities and equity

48
Understanding the business
The acquisition of assets is financed
from two sources:

Debt - funds Equity -

from creditors funds from
owners

49
Liabilities

50
Liabilities Defined and Classified
Defined
Defined as
as probable
probable debts
debts or
or obligations
obligations of
of the
the
entity
entity that
that result
result from
from past
past transactions,
transactions, which
which
will
will be
be paid
paid with
with assets
assets or
or services.
services.

Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities

51
Liabilities Defined and Classified
Liabilities are
measured at their
current cash
equivalent (the
amount a creditor
would accept to
cancel the debt)
at the time
incurred.
52
Current Liabilities
Account Also
Name Called Definition
Trade Obligations to pay for goods and
Accounts
Accounts services used in the basic operating
Payable
Payable activities of the business.
Obligations related to expenses that
Accrued Accrued
have been incurred, but will not be
Liabilities Expenses
paid until the subsequent period.
Notes Obligations due supported by a formal
N/A
Payable written contract.
Obligations arising when cash is
Deferred Unearned
received prior to the related revenue
Revenues Revenues
being earned.

53
Working capital and cash flows

Working Capital = Current Assets - Current

Liabilities

Changes in working capital accounts are

important to managers and analysts
because they have a direct impact on cash
flows from operating activities reported on
the statement of cash flows.

54
VAT on purchase and sale transactions
VAT is a tax on consumption and is intended to be imputed by final consumers.
Companies, in addition to imputed VAT on their purchases, pass VAT on their
sales, acting as collectors for the Public Treasury.

PGC Accounts
• Registration of input VAT (472) on
4700. Hacienda Pública, deudora por IVA
acquisitionsDuty to the Treasury (asset)
472. Hacienda Pública, IVA soportado
• Registration of output VAT (477) on sales
4750. Hacienda Pública, acreedora por IVA
 Liability to the Treasury (liabilities)
477. Hacienda Pública, IVA repercutido

Closing statement
(VAT settlement)

Output VAT > Input VAT Output VAT < Input VAT
VAT account payable (4750) VAT account receivable (4700)

55
VAT on purchase and sale transactions
Debit Credit
Inventory (+A)
Input VAT Input VAT (+A)
Cash/Account payable (+L)
In each
Debit Credit transaction
Cash/Account receivable (+A)
Output VAT Sales/Revenues (+R, +SE)
Output VAT (+L)

Debit Credit
Output VAT > Input VAT Output VAT (-L)
VAT account payable Input VAT (-A)
Account payable to Public Treasury (+L) When close
Debit Credit the period
Output VAT < Input VAT Account receivable from Public Treasury (+A)
VAT account receivable Output VAT (-L)
Input VAT (-A)

56
Factoring
The company transfers its credits to another company (factoring company) which is
responsible for managing the collection of debtors. The factoring company can advance the
amount of the collection, discounting a commission and interest for the amount advanced.

With recourse

The factoring company is vicariously liable for payment but no retain the
risk of insolvency; the company retains the risks and benefits of the
receivables.
Types of
factoring No recourse

The factoring company runs the risk of insolvency, so it can be

understood that accounts receivable and credit risk have been
transferred.

57
Factoring (entries)
At the date of transferring the credit Debit Credit
Interest expenses for factoring (+E, −SE)
Cash (+A)
Account payable for factoring (+L)
With recourse
At the maturity date Debit Credit
Account payable for factoring (+L)
Accounts receivable (-A)

At the date of transferring the credit Debit Credit

Interest expenses for factoring (+E, −SE)
No recourse
Cash (+A)
Accounts receivable (-A)

58
Confirming
Confirming is a financial product offered by a financial institution to facilitate its customers the
management of payments to its suppliers. Through this service, the financial institution pays the invoice
of the company that hires the service, even before the date of its expiration, so it will charge interest.
Confirming is a factoring of suppliers and can also be with or without recourse.

• With recourse. The financial institution takes charge of the collection rights of the
suppliers, discounting the amount of the invoices and charging a commission for
advancing the payment to the supplier. The discount commission can be shared with
the customer to give him part of the business. These discounts are recorded by the
client company by using the account “Other management income. With recourse (+R,
Types of +SE)”.
Confirming
• No recourse. The financial institution is limited to being an intermediary, paying the
supplier once the maturity has arrived. The customer will have to record in his
accounts the amount of the commission as an expense (Banking and similar services
(+E, +SE)).

59
Confirming (entries)
Point of view At the date of accepting the confirming Debit Credit
Interest expenses for confirming (+E, −SE)
of the seller
Banking and similar services (+E, +SE)
Input VAT (+A)
Cash (+A)
Account payable for confirming (+L)
With recourse
At the maturity date Debit Credit
Account payable for confirming (-L)
Accounts receivable (-A)

At the date of accepting the confirming Debit Credit

Interest expenses for confirming (+E, −SE)
Banking and similar services (+E, +SE)
No recourse
Input VAT (+A)
Cash (+A)
Accounts receivable (-A)

60
Confirming (entries)
Point of view At the date the client use the confirming Debit Credit
of the buyer Account payable (-L)
Account payable for confirming (+L)
In case the bank
Cash (+A) share the discount
commission
Interest revenue for confirming (+R, +SE))
With recourse
At the maturity date Debit Credit
Account payable for confirming (-L)
Cash (-A)

At the maturity date Debit Credit

No recourse Accounts payable (-L)
Cash (-A)

61
Lease Liabilities
Operating Lease Capital Lease

Short-term lease; No Long-term lease; Meets any of

liability or asset 5 criteria; Results in recording
recorded an asset and a liability
Capital Lease Criteria
1. Lease term is 75% or more of the asset’s expected economic life.
2. Ownership of asset is transferred to lessee at end of lease.
3. Lease permits lessee to purchase the asset at a price that is lower than its
fair market value.
4. The present value of the lease payments is 90% or more of the fair market
value of the asset when the lease is signed.
5. Assets has specialized nature that is expected to have no alternative use to
the lessor at the end of the lease term.

62
Lease Liabilities accounting
Accounting for leases differs depending on whether the lease is a short term or long term lease.

Long term leases (both Finance and Operating):

• Require recognition of a lease asset and lease liability.
• Amount recognized is the current cash equivalent of the required future lease payments.
• More details discussed in advanced accounting courses

Entry to record initial long term lease Debit Credit

Lease asset (+A) 250,000
Lease liability (+L) 250,000

Short term leases:

• No lease asset or liability is recorded.
• Lessee records lease expense over the life of the lease.

Entry to record lease expense Debit Credit

Lease expense (+E, −SE) 10,000
Cash (−A) 10,000

63
Account Payable Turnover Ratio

64
Account Payable Turnover Ratio
Accounts = Cost of ÷ Average
Payable Goods Sold Accounts
Turnover Payable

• Measures how quickly management is paying its suppliers.

• A high accounts payable ratio normally suggests that a company is paying
its suppliers in a timely manner.

The ratio is more intuitive by dividing it into the number of days in a year:
Average Days to pay payables = 365 Days ÷ Accounts Payable Turnover Ratio

65
Account Payable Turnover Ratio
The 2017 accounts payable turnover ratio for Starbucks was:

$9,038.20 ÷ $756.55 (*) = 11.95

(*) (782.50 + 730.60) ÷ 2

In 2017 the average number of days to pay its accounts payable was:
365 days ÷ 11.95 = 30,55 days

This means that, on average Starbucks took between 30 and 31 days to pay its
suppliers in 2017.

66
Equity

67
Authorized, issued and Outstanding
Shares Authorized shares are the maximum
number of shares of capital stock that
can be sold to the public.

Issued Unissued
shares are shares are
authorized authorized
shares of shares of
stock that stock that
have been never have
sold. been sold.

68
Authorized, issued and Outstanding
Shares
Outstanding shares are issued
shares that are owned by
Authorized shares stockholders.

Outstanding
Shares: Unissued
Issued Common Shares
Shares Preferred
Treasury shares are issued
Treasury
shares that have been
Shares reacquired by the
corporation.

69
Earnings per share (EPS)
Net Income*
EPS =
Average Number of Shares
Outstanding for the Period
*If there are preferred dividends, the amount is subtracted from net income.

Earnings
Earnings per
per share
share is
is probably
probably the
the single
single
most
most widely
widely watched
watched financial
financial ratio.
ratio.

Sonic’s
Sonic’sincome
incomefor
for2006
2006 is
is$78,705,000
$78,705,000 and
and the
theaverage
averagenumber
numberof
of shares
shares
outstanding is 86,260,000.
outstanding is 86,260,000.

$78,705,000
EPS = = $0.91 per share
86,260,000 Shares
70
Common Stock
• Common stock is held by investors who are the owners of a corporation.
• Stockholders have the right to:
• Vote
• Share in profits of the business
• Elect the board of directors who hire and monitor the executives who manage a company’s
activities on a day-to-day basis

• Par value is the nominal value per share, established in the corporate charter.*

• Par Value ≠ Market Value

• Legal capital is the amount of capital, required by the state, that must remain invested in the
business.

71
Common Stock
Par Value: A nominal value per share
established in the corporate charter.


Market Value: The value of a company according to the stock market
price. Market value is calculated by multiplying a company's shares
outstanding by its current market price.

72
Priority ladder for ownership
structure Deuda emitida por un
agente económico de la
mejor calidad crediticia

In case of
bankruptcy,
Preferred is
above common
stock. Senior
debt is far
safer.

Instrumento de
renta fija emitido
por entidades
financieras

73
Accounting for capital stock
Two primary sources of
stockholders’ equity

Contributed Retained
capital earnings

Common Capital in
stock, par excess of
value par value
74
Sale and issuance of Capital Stock
Initial public Seasoned new
offering (IPO) issue

The first time a Subsequent sales

corporation sells of new stock to the
stock to the public. public.

Sonic
Sonic issues new
stock.
75
Sale and issuance of Capital Stock
• An initial public offering, or IPO, involves the very first sale of a company’s stock to
the public (i.e., when the company first “goes public”).
• Additional sales of new stock to the public are called seasoned offerings.

Assume IBM sold 100,000 shares of its $0.20 par value common stock for $150 per share.
The company would record the following journal entry:

Debit Credit
Cash (+A) (100,000 × $150) 15,000,000
Common stock (+SE) (100,000 × 20,000
$0.20)
Additional paid-in capital (+SE) 14,980,000

Stockholders’
Assets = Liabilities + Equity
Cash +15,000,000 Common stock +20,000
Additional paid- +14,980,000
in capital
76
Secondary Markets
• When a company sells stock to the public, the transaction is between the issuing
corporation and the investor (primary market).
• Subsequent to the initial sale, investors can sell shares to other investors
without directly affecting the corporation (secondary market).
– The corporation is not a part of the transaction and therefore does not receive or pay
anything.

Top: ©Roman Malanchuk/123RF; Left: ©Image Source; Right: ©Ariel

Skelley/Blend Images LLC; Bottom: ©Tupungato/Getty Images

77
Treasury Stock
When stock is reacquired, the corporation records the treasury stock at
cost. Treasury stock has no voting or dividend rights. Treasury stock is
not an asset. It is a contra equity account.

IBM reacquired 100,000 shares of its

common stock when it was selling for $140 per share.

Debit Credit
Treasury stock (+XSE, −SE) (100,000 × 14,000,000
$140)
Cash (−A) 14,000,000

Treasury Stock is a contra-equity account, not an

asset!

78
Treasury Stock
IBM reissued 10,000 shares
of treasury stock at $150 per share.
Debit Credit
Cash (+A) (10,000 × $150) 1,500,000
Treasury stock (−XSE, +SE) (10,000 × 1,400,000
$140)
Additional paid-in capital (+SE) 100,000

IBM reissued 10,000 shares of treasury stock at $130 per share.

Debit Credit
Cash (+A) (10,000 × $130) 1,300,000
Additional paid-in capital (−SE) 100,000
Treasury stock (−XSE, +SE) (10,000 × 1,400,000
$140)

79
Dividends on Common Stock
Declared by board of Not legally
directors. required.

Creates liability at Requires sufficient Retained

declaration. Earnings and Cash.

Declaration date
• Board of directors declares the dividend.
• Record a liability.
GENERAL JOURNAL
Date Description Debit Credit
Retained earnings (-SE) XXX
Dividends payable (+L) XXX

80
Dividend Dates
Date of Record
• It is the date on which the corporation prepares the list of current
Stockholders who will receive the dividend payment. Only
Stockholders holding shares on this date will receive the dividend.
(No entry)

Date of Payment
• Record the dividend payment to stockholders.

GENERAL JOURNAL
Date Description Debit Credit
Dividends payable (-L) XXX
Cash (-A) XXX

81
Stock Splits
Stock splits change the par value per share,
but the total par value is unchanged.

Assume that a corporation had 3,000

shares of $2 par value common stock
outstanding before a 2–for–1 stock split.

Before After
Split Split
Increase
Common Stock Shares 3,000 6,000
Decrease
Par Value per Share $ 2.00 $ 1.00

No Change
Total Par Value $ 6,000 $ 6,000

82
Preferred Stock

83
Dividends on Preferred Stock
Current Dividend Preference: The current
preferred dividends must be paid before paying
any dividends to common stock.
Cumulative Dividend Preference: Any unpaid
dividends from previous years (dividends in
arrears) must be paid before common dividends
are paid.

If
If the
the preferred
preferred stock
stock is
is noncumulative,
noncumulative, anyany dividends
dividends not
not declared
declared
in
in previous
previous years
years are
are lost
lost permanently.
permanently.

84
Dividends on Preferred Stock
Kites, Inc. has the following stock outstanding:
Common stock: $1 par, 100,000 shares
Preferred stock: 3%, $100 par, cumulative, 5,000
shares
Preferred stock: 6%, $50 par, noncumulative, 3,000
shares
Dividends were not paid last year. In the current year,
the board of directors declared dividends of $50,000.
How much will each class of stock receive?

85
Dividends on Preferred Stock
Total dividend declared $ 50,000
Preferred stock (cumulative)
Arrearage ($100 par × 3% × 5,000 shares) $ 15,000
Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000
Remainder $ 20,000
Preferred stock (noncumulative)
Current Yr. ($50 par × 6% × 3,000 shares) 9,000
Remainder $ 11,000
Common stock
Current Yr. ($11,000 Remainder) 11,000
Remainder $ 0

86
Required Reading: Chapters 8, 9 y 11

Robert Libby, Patricia Libby and

Frank Hodge (2020) “Financial
Accounting” 10th Edition.

87