Stockholders Equity

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Components of Shareholders\' Equity . Stockholders\' Equity. Paid-in Capital. Retained Earnings. Amounts invested by shareholdersPreferred StockCommon StockStock Warrants (Treasury Stock). Other Comprehensive Income. Amounts earned by corporation but not distributed. Gains/Losses not yet recognized in Net Income Available for Sale Secur. Pension G/L, PSC Currency adjustment Cash flow hedges.
Stockholders Equity

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1. Stockholders? Equity Chapter 15

2. Components of Shareholders? Equity

4. The Nature of Shareholders? Equity Assets ? Liabilities = Shareholders? Equity

5. Common Stock The basic voting stock of the corporation. Dividends determined by the board of directors. Preferred Stock Has a dividend and liquidation preference. Generally does not have voting rights. Usually has a par or stated value. Fixed dividend payout (unless participating). May be cummulative or non-cummulative. May be callable, redeemable and/or convertible. Types of Capital Stock

6. Authorized Issued / Un-issued Treasury Outstanding Par Value - Legal Capital Par value stock Designated dollar amount per share stated in the corporate charter. Par value has no relationship to market value. May be required by state law (of incorporation). No-par stock Dollar amount per share not designated in corporate charter. Corporations can assign a stated value per share (treated as if par value for accounting purposes). Stock Shares Terminology

7. Share Issue Costs Contrast to debt, where costs are deferred and amortized over the life of the debt. Never an expense here.Contrast to debt, where costs are deferred and amortized over the life of the debt. Never an expense here.

8. Yale Company STOCK SOLD FOR CASH Yale Company issues 10,000 shares of $1 par value stock for $100,000. Issue costs of $8,000 are incurred. What is the journal entry to record this transaction? What if stock is ?no par? common stock? Par value is recorded in the common stock account, amount over is recorded in the ?APIC? account.Par value is recorded in the common stock account, amount over is recorded in the ?APIC? account.

9. Penn Company STOCK SOLD ON CREDIT (Subscribed) Penn issues 10,000 shares of $1 par value stock for $100,000. $70,000 is received at the time the shares are issued and the remaining $30,000 is in the form of a note due in six months . What is the journal entry to record this transaction? GAAP allows a subscription receivable to be classified as an asset or contra equity (PIC). SEC rules require firms to classify the receivable as a contra equity.GAAP allows a subscription receivable to be classified as an asset or contra equity (PIC). SEC rules require firms to classify the receivable as a contra equity.

10. Columbia Company STOCK SOLD FOR NONCASH CONSIDERATION Columbia issues 10,000 shares of $1 par value stock in exchange for a piece of equipment without a clear market value. Columbia?s stock is currently trading at $12 per share. What is the journal entry to record this transaction? General hierarchy of value. General hierarchy of value.

11. Reacquired Shares A corporation might reacquire shares of its stock to . . . Distribute for stock option plans. Support the market price. Increase earnings per share. Issue as a stock dividend. Use in mergers and acquisitions. Thwart takeover attempts.

12. Reacquired Shares Initially, firms issue shares from authorized shares From issued (and outstanding) shares, firms may reacquire the shares Once reacquired: Shares may be held in the treasury and later reissued: these shares are called Treasury Stock. Treasury stock are authorized shares that are issued, but not outstanding. When resold, treasury stock becomes outstanding stock. Shares may be retired and removed from the books. Retired shares have the status of authorized and un-issued shares.

13. Treasury Stock Usually does not have: Voting rights. Cash dividend rights (will get stock dividends). Preemptive rights. Liquidation rights. Purchase of Treasury Stock reduces both assets and stockholders? equity. Two methods of accounting are allowed. Cost Method - most popular Par value Method (not covered) Reasons for cash and stock dividend treatment. Never a gain or loss - increase in APIC or decrease in REReasons for cash and stock dividend treatment. Never a gain or loss - increase in APIC or decrease in RE

14. Harvard Company TREASURY STOCK: COST METHOD Harvard issues 10,000 shares of $25 par value stock for $260,000 Harvard buys back 2,000 shares at $28 per share Harvard resells 500 shares of treasury stock at $30 per share Harvard resells 500 shares of treasury stock at $19 per share What are the journal entries to record these transactions under the cost method? What is the journal entry if Harvard decides to retire the remaining 1,000 shares of treasury stock?

15. Dividends Important dates u Declaration date by BOD (create liability) v Ex-dividend date (no entry) w Record date (no entry) x Payment date (record payment)

16. Types of Dividends Cash dividends - may not be cancelled Scrip dividends Liquidating dividends [return of capital] Property dividends - may not be cancelled Stock dividends - may be cancelled Often called stock split - but slight technical differences actually exist. Dividend - par value not adjusted Split - par value adjusted Accounting Terminology on splits seems backwards Any large dividend is a ?stock split-up? in SFAS terms. If par not adjusted - ?issued in the form of a stock dividend?

17. Cash Dividend On 6/1/02, Brown declares a cash dividend of $1 per share on its 20,000 common shares to be paid on 10/1/02. What are the journal entries to record these events?

18. Property Dividend Brown is a candy company. On 6/1/02, Brown declares a property dividend of one candy bar per share of common stock payable on 10/1/02. The candy bars have a book value of $1 per bar and a market value of $2 per bar and there are 20,000 shares outstanding. What are the journal entries to record these events? Added step of marketing property to market before declaration of dividend. No affect on equity but more accurate portrayal of value of dividend.Added step of marketing property to market before declaration of dividend. No affect on equity but more accurate portrayal of value of dividend.

19. Stock Dividends

20. Stock Dividends Reasons for stock dividends: To preserve cash. To decrease market price of stock. To reduce existing balance in Retained Earnings.

21. Accounting for Stock Dividends

22. Small Stock Dividend Princeton declares and distributes a 20% stock dividend on 20,000 common shares. Par value is $1 and market value is $20. What is the journal entry to record these events?

23. Stock Splits Stock Split Company increases its issued shares, much as with a stock dividend. Example: after a 2-for-1 stock split, 100 million shares, $1 par per share, would be 200 million shares, $0.50 par per share. Reverse Stock Split A reverse stock split occurs when a company decreases, rather than increases, its issued shares. Example: after a 1-for-4 reverse stock split, 100 million shares, $1 par per share, would be 25 million shares, $4 par per share. No journal entry is necessary [only memo record].

24. Preferred Dividends Cummulative vs. non-cummulative For non-cummulative preferred stock only the current year preferred dividend must be paid before common dividends For cummulative preferred stock when no dividend is declared it is held in arrears. Current year and dividends in arrears must be paid before common dividends. Arrears are disclosed in a note to the financial statements but not recorded until declared.

25. Preferred Dividends Participating vs. non-participating For non-participating preferred stock they receive their standard dividend regardless of the amount paid to common stockholders For participating preferred stock when common dividends are paid higher than the standard rate on the preferred stock, the preferred will share in it ratably. Pay standard preferred dividend Pays standard preferred rate to common stock to match Excess shared equally based on relative par value or stated value.

26. Dartmouth Preferred Dividend Example On 12/1/07 Dartmouth Co. has 400,000 of 6% preferred stock and 600,000 of common stock outstanding. No dividends have been declared or paid since 12/31/05. Determine the amounts paid in 2007 if dividends are declared and paid based on the following scenarios: Preferred is non-cumulative and non-participating, amount paid 10,000, 24,000, 36,000, 50,000 and 100,000. Preferred is cumulative and non-participating, amount paid 10,000, 24,000, 36,000, 50,000 and 100,000. Preferred is non-cumulative and fully participating, amount paid 36,000, 60,000 and 100,000. Preferred is cumulative and fully participating, amount paid 36,000, 60,000 and 100,000. Preferred is non-cumulative, half participating with a cap of 12%, amount paid 100,000 and 200,000.

27. Dilutive Securities and EPS Chapter 16

28. Dilutive Securities Convertibles Convertible Bonds Convertible Preferred Stock Stock Options/Warrants Stock Rights Stock Warrants Stock Options Others Stock Appreciation Rights (SAR?s) Employee Stock Purchase Plans (ESPP?s) Restricted Stock

29. Issuance: Accounting parallels accounting for straight debt. Conversion initiated by security holder. Conversion: Typically the book value of the bonds is removed and replaced with common stock. Exception: Fair value of inducement is expensed in the period of conversion and added to issue value of the stock. Convertible Bonds How are conversions quoted, price vs. number of sharesHow are conversions quoted, price vs. number of shares

30. Oxford issues one $1,000 bond at a $45 premium. The bond is convertible into 10 common shares with a par value of $10. At conversion the unamortized premium is $30 and the market value of the common stock is $120. Record the conversion using the book value method. If the market price of the stock instead falls to $60 and the company offers an inducement of a $50 conversion price, determine the required journal entry. Oxford Company Example

31. Issuance: Accounting parallels accounting for preferred stock. Convertible preferred stock is usually equity. Mandatory redeemable preferred stock is now considered debt. Conversion is an equity transaction: hence, no gains or losses are recognized. If converted, valuation is based on the book value of the preferred stock (even if induced). Convertible Preferred Stock

32. Oxford issues 10,000 shares of preferred stock (par value $5) for $100,000. The preferred stock is convertible into 10,000 shares of common stock ($1 par value). What would be the journal entry to record this issue and conversion if all 10,000 shares are converted when the market price is $20 per share of common stock? Oxford Company Example

33. Stock warrants entitle the holder to acquire additional common stock (# of shares) within a stipulated period (expiration time) at a specified price (strike/exercise price). Cash is received by issuer upon exercise. May be issued independently or with another security. Stock warrants are also commonly referred to as stock options. Finance and accounting literature use the terms warrant and option with different distinctions (who issues them vs. who gets them). So be careful if reading technical literature. Stock Warrants/Options

34. Stock rights give existing shareholders preemptive rights to buy shares. Unlike warrants, rights are of short duration. If the discount is small (less than normal stock issue costs) and the time to exercise is short, no journal entries are made when rights are issued. Otherwise treated as a stock option using fair value method (debit to Retained Earnings - like a dividend). When stock rights are exercised, corporation usually receives cash and stock is issued at the sales price plus the value of the rights if recorded. Stock Rights Mention similar treatment of ESPP?sMention similar treatment of ESPP?s

35. Stock warrants may be: non-detachable - only sold with other security. detachable - can be trade separately. If warrants are non-detachable, no allocation to warrants is made. If warrants are detachable, value is allocated to the warrants (a paid in capital account), determined by: proportional method incremental method Stock Warrants Issued With Other Securities

36. Oxford sells at 101 bonds with a par value of $10,000 and detachable warrants. The bonds? FMV without the warrants is $9,800. The FMV of the warrants is $400. Provide the journal entry to record this transaction. Provide the journal entry to record this transaction if the market price of the bonds without the warrants is undeterminable. Oxford Company Example

37. Provide employee incentives, align management and owners, and may be: Stock option plans Performance stock plans Restricted stock Stock appreciation rights Stock Compensation Plans

38. Stock Option Dates

39. Fair value method (SFAS 123R): Compensation expense is: the fair value of the options on grant date that are expected to vest. option pricing models may be used to estimate fair value. Black Scholes, Binomial, Lattice, Jump Diffusion, ? Performance options: # of shares optioned and/or the strike price are not known at the grant date Measurement date occurs after the grant date No longer need to recalculate continuously Accounting for Stock Options

40. On January 1 2001, Oxford grants options to four key executives. Each executive may purchase 1,000 shares of the company?s $2 par value common stock for $57 per share within the next five years, but not before December 31 2003 (vesting date). The market value of Oxford?s stock on January 1, 2001 was $57 per share. Using the Black-Scholes option pricing model the firm estimates the fair value of the options to be $30. At the time of grant it is expected that 75% of the options will vest. All of the options actually vest. Two of the executives exercise all of their options on January 23, 2004. The market price of Oxford?s common stock on this date is $82. Provide the journal entry to record these events using the fair value method. Oxford Company Example Expense annually and set into stock options.Expense annually and set into stock options.

41. Option-like Instruments Restricted Stock Shares may not be sold or transferred until vested Accounting similar to options, fair value is usually close to stock value (option with zero exercise price). Stock Appreciation Rights (SAR?s) Avoids cash flow problem to exercisers of options, payoff is made is stock or cash Record liability for portion earned to date of the current payout amount - measurement date = exercise date Enters EPS calculations if it can settle in stock

46. Net income (after tax) ? Preferred dividends Weighted average outstanding common stock

47. Compute the weighted average number of shares of common stock outstanding and basic EPS. The firm reported net income of $100,000. ? Basic EPS Calculations

48. Cambridge Company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value non-cumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS Would be? ? Basic EPS Calculations

49. STEP 1: Compute basic EPS STEP 2: Determine, for each dilutive security, the per share effect assuming exercise / conversion (D/A ratio). Use if-converted method for convertibles and treasury method for options, contingent shares, etc. STEP 3: Rank the results from step 2 from smallest to largest earnings effect per share (i.e., rank the results from most dilutive to least dilutive, lowest D/A to highest D/A ratio). STEP 4: Beginning with basic EPS, recalculate EPS by adding the smallest per share effect from step 3 (can determine by comparing D/A to EPS). If the results from this recalculation are less than basic EPS the security is dilutive, proceed to the next smallest per share effect and recalculate EPS. Steps to Compute Diluted EPS

50. The conversion of the securities into common stock is assumed to occur at the beginning of the year or date of issue, if later (time weight on both numerator and denominator). Convertible bonds: The interest expense (net of tax) is added back to net income. Convertible preferred: No tax deduction for preferred dividends. Add back preferred dividend amount subtracted in Basic EPS numerator. The weighted average number of shares is increased by the additional common shares assumed issued. If-converted Method

51. Applies to options and warrants (and their equivalents). The exercise price per share must be less than the average market price per share for dilution to occur (must be ?in the money?). Options and warrants are assumed exercised at the beginning of the year or date of issue, if later. The proceeds from the exercise of options are assumed to be used to buy back common shares at the average market price. Treasury Stock Method

52. Contingent shares are issuable in the future for little or no cash consideration upon the satisfaction of certain conditions. Contingent shares are considered outstanding common shares and are included in basic EPS as of the date that all necessary conditions have been satisfied. Shares issued merely due to the passage of time. Shares issued when a target (like a certain earnings level) has been met and is expected to be met at the end of the period. Contingently Issuable Shares

53. Odd items Mandatorily convertible securities after they become convertible are included in diluted EPS calculations using the ?if-converted? method even when they are anti-dilutive. Contracts that may be settled in either cash or stock (usually SAR?s) are always assumed to be settled in stock, no matter what past practice has been.

54. Comprehensive EPS Example The following information relates to Cambridge Corporation on 12/31/02: Net Income for 2002 $500 million Common Stock on 1/1/02 150 million shares Shares retired for cash on 2/1/02 24 million shares Shares sold for cash on 9/1/02 18 million shares 2-for-1 stock split on 7/23/02 Preferred stock, 8%, $50 par, cumulative, convertible into 4 million shares of common stock $100 million Bonds Payable, 12.5%, convertible into 20 million shares of common stock $200 million Common stock warrants outstanding for 4 million shares of common stock, with an exercise price of $15. Additional Information: The market price of the stock averaged $20 during 2002. Preferred stock and bonds were issued in 2000 at par. Income tax rate for 2002 was 40%. Compute basic and diluted EPS for year ended 12/31/02

55. Accounting for Taxes Chapter 19

56. Financial Reporting ? Tax Reporting Financial Reporting Rule Makers Goals Process Enforcement Income Before Taxes Tax Reporting Rule Makers Goals Process Enforcement Taxable Income

57. Financial Income ? Taxable Income Two types of differences: Permanent differences Temporary differences Originating Reversing Which do we need to account for? Permanent change effective tax rate. Temporary create Deferred Tax assets and liabilities.

58. Methods of Dealing with Temporary Differences Ignore (pre 1962) tax expense = taxes payable Deferral Method (1962-1988) tax expense = effective tax rate * income before taxes (adjusted for permanent differences) Deferred Tax Asset/Liability is a plug value Asset/Liability Method* Deferred Tax Asset/Liability determined based on future reversal of temporary differences. Tax expense is a plug value Quick example - why deferral method.Quick example - why deferral method.

59. Computing Deferred Taxes?Key Steps Calculate income taxes payable Based on taxable income for the current year. Different from financial income due to permanent and temporary differences. Calculate deferred tax liability and/or asset at period end Based on future reversals of temporary differences that have already originated. Determine adjustment from beginning to ending balances Create journal entry Calculate income tax expense (the plug)

60. Pepperdine Company 2003 In 2003, Pepperdine had pretax financial income of $362,000 and taxable income of $300,000. The difference is due to the use of different depreciation methods for tax and accounting purposes. The enacted tax rate is 30%. Compute the amount to be reported as income taxes payable at December 31,2003? Does Pepperdine have a deferred tax asset or liability? Prepare the journal entry to record income tax expense for 2003. Prepare the income tax expense section of the income statement for 2003 beginning with the line ?Income Before Income Taxes.?

61. Yale Company 2003 Assume that Yale recognize $12,000 gross profit from installment sales for financial reporting in 2003. This profit will be taxable when cash is received. The company expects to receive $4,000 in 2004 and the remaining $8,000 from this installment sale in 2005. Pretax financial income and taxable income for the 3 years are as follows: 2003 2004 2005 Pretax Financial $25,000 $10,000 $10,000 Taxable $13,000 $14,000 $18,000 The enacted tax rate for all years is 40%. Compute income tax payable for all 3 years? Prepare the journal entry to record income tax expense for Yale for all three years. Prepare the income tax expense section of the income statement for 2003 beginning with the line ?Income Before Income Taxes.?

62. Yale Company 2003 Assume that Yale recognize $12,000 gross profit from installment sales for financial reporting in 2003. This profit will be taxable when cash is received. The company expects to receive $4,000 in 2004 and the remaining $8,000 from this installment sale in 2005. Pretax financial income and taxable income for the 3 years are as follows: 2003 2004 2005 Pretax Financial $25,000 $10,000 $10,000 Taxable $13,000 $14,000 $18,000 Assume everything stays the same except for the enacted tax rate, which changes in the following way? 2003: 40% 2004: 35% 2005: 30% Prepare the journal entry to record income tax expense for Yale for all three years. Use enacted tax rates for future periods.Use enacted tax rates for future periods.

63. Dartmouth Company 2003 Dartmouth accrues a loss and a related liability of $50,000 in 2003 for financial reporting purposes because of pending litigation. This amount is not deductible for tax purposes until the period the liability is paid, which is expected to be 60% in 2004 and 40% in 2005. Further assume: 2003 2004 2005 Enacted rate 40% 35% 35% Taxable income $150,000 $140,000 $120,000 Compute income tax payable for all 3 years? Prepare the journal entry to record income tax expense for Dartmouth for all three years. Prepare the income tax expense section of the income statement for 2003 beginning with the line ?Income Before Income Taxes.?

64. Deferred Tax Asset - Valuation Allowance A deferred tax asset only has value if there will be future taxable income to reduce. A valuation allowance account is required when it is more likely than not (50/50) that some portion of the deferred tax asset will not be realized. The deferred tax asset is then reported at its net realizable value. Use a valuation allowance - similar to allowance for doubtful accounts reducing accounts receivable Compare to accounts receivable.Compare to accounts receivable.

65. Determining the Valuation Allowance First consider negative evidence History of losses or tax assets expiring Losses expected in the short run Unsettled circumstances that affect profitability Short carry-forward remaining Next consider positive evidence Future taxable income expected Future reversals of taxable temporary differences Carry-back availability Tax planning strategies

66. Dartmouth Company 2003 After careful review of all available evidence, Dartmouth decides that 20% of its deferred tax asset at the end of 2003 will not be realized. Prepare the journal entry to record this information. What is Dartmouth?s total income tax expense for 2003?

67. Net Operating Losses (NOL) Net operating loss is a tax terminology. A net operating loss occurs when tax deductions for a year exceed taxable revenues. NOL for each tax year is computed The NOL of one year can be applied to offset taxable income of other years, possibly resulting in tax refunds NOL?s can be: Carried back/forward Carried forward

68. NOL Rules

69. Princeton Company Princeton Corporation has a pretax financial income (or loss) equal to taxable income (or loss) from 1995 through 2003 as follows: ? Pretax financial income (loss) and taxable income (loss) were the same for all years since Princeton has been in business. Assume the carryback provision is employed for net operating losses. In recording the benefits of a loss carryforward, assume that it is more likely than not that the related benefits will be realized.

70. Princeton Company Assume we are currently at the end of 1999. What entries for income taxes should be recorded for the year? Indicate what the income tax expense portion of the income statement for 1999 would look like. Move forward two year to 2001. What entries for income taxes should be recorded for the year? Indicate what the income tax expense portion of the income statement for 2001 would look like. Move forward to 2003. What entries for income taxes should be recorded for the year? Indicate what the income tax expense portion of the income statement for 2003 would look like.

71. Balance Sheet Presentation The deferred tax classification (as current or non-current) relates to its underlying asset or liability. If no underlying, then reversal date determines Will end up with one current and one non-current item. Classify the deferred tax amounts as current or non-current. Net the various deferred tax assets and liabilities classified as current. Net the various deferred tax assets and liabilities classified as non-current.

72. Income Statement Presentation Income tax expense, is allocated to: Continuing operations Discontinued operations Extraordinary items Accounting changes Prior period adjustments Disclose other significant components, such as: current tax expense, deferred tax expense/benefit, etc.

75. FIN 48 Issues FIN 48 was created to address uncertain tax positions. All tax positions in all jurisdictions for all years open must be considered and documented (lots of work for tax professionals). Benefits of a position may only be recognized if they are more likely than not to be received. All positions must be considered independently - assuming tax authority has all relevant information.

78. Accounting for Pensions Chapter 20 Note: The material has changed dramatically from the original printed version of the text. Download the new chapter 20 from the website if your text is not the updated version. (to check look for minimum liability rules, these are now gone)

79. Basics of Post Employment Benefits What are pensions? Why do we pay them? Historical Accounting for Pensions What is ERISA? Who is the PBGC? Pensions vs. Other Post Employment Benefits (OPEB)

80. Two Types of Pension Plans Defined contribution plan Defined benefit plan How is employer contribution determined and when? Who bears the risk? Popularity Contributory vs. Non-contributory Most contributory are also defined contribution.

81. Alaska Airlines 2007 Annual Report Note 8: Defined Contribution Plans The defined-contribution plans are deferred compensation plans under section 401(k) of the Internal Revenue Code. All of these plans require Company contributions. Total expense for the defined-contribution plans was $26.4 million, $24.4 million, and $22.9 million in 2007, 2006, and 2005, respectively.

82. Defined Benefit Plans Alaska Airlines 2007 annual report - the other 4 1/2 pages of footnote 8. Three key components: Employer?s obligation Plan assets Pension expense

83. Funding Status of Pension Plan Assets OVERFUNDED Fair value of plan assets exceeds the Obligation. PA > PBO

84. Alternate Measures of Pension Obligation

85. PBO Calculation - Example Suzie begins working for ABC company on 1/1/01 when she is 40 years old. Her starting salary is $40,000. Her expected retirement date is 12/31/20 and her expected date of death is 12/31/40. ABC company has a defined benefit plan which pays 2% of final salary per year worked to a max of 60% of final salary. Payment are made annually at the beginning of the year. Expectations Average salary increase of 3% per year Settlement rate on similar annuities is 9%

86. PBO Calculation - Example On 1/1/01 PBO is $0 Suzies expected final salary 40,000 x FV of $1(19 years, 3%) 1.7535 70,140 Suzies expected pension 70,140 x 2% x 20 = $28,056 per year PV of pension annuity on 12/31/20 28,056 x PV of annuity (20 years, 9%) 28,056 x 9.9501 = $279,160

87. PBO Calculation - Example PBO on 12/31/01, end of 1st year. PV of future benefit earned to date PV of $1(19 years,9%) x 279,160 x 1/20 .1945 x 13,958 $2,714.83

88. PBO Calculation - Example PBO on 12/31/02, end of 2nd year. PV of future benefit earned to date PV of $1(18 years,9%) x 279,160 x 2/20 .2120 x (13,958 + 13,958) $2,959.10 + 2,959.10 = $5,918.20

89. PBO Calculation - Example Increase in PBO 5,918.20 - 2,714.83 = $3,203.39 Why did PBO increase Suzie earned more by working another year $2,959.10 Amount earned last year is closer to payment (PV) 2,714.83 x 9% = $244.30 2,714.83 + 244.30 = $2,959.10

90. Components of the PBO Change PBO at beginning of the year Service cost (+) Interest cost (+) Prior service cost grants (+) Loss or gain on PBO (+ / ?) Benefits paid to retired employees (?) PBO at end of year Relate to Suzie exampleRelate to Suzie example

91. Components of the Plan Assets Change (at Fair Value) Plan Assets at beginning of the year Employer contributions (+) Actual earnings on assets (+/-) Benefits paid to retired employees (?) Plan Assets at end of year

92. Components of the Pension Expense Net cost of: Service cost (+) Interest cost (+) Amortization of unrecognized prior service cost (+) Expected return on plan assets (? / +) Text does this as actual return adjusted for new gain or loss, with same net effect. Amortization of unrecognized net gain or loss (+ / ?)

93. Components of the Pension Expense Service cost: The increase in PBO attributable to employee services rendered during the current year. Interest cost: The accrued interest on the PBO during the current year. PBObeg x interest rate (called the settlement rate) PBObeg must reflect prior service cost additions

94. Harvard Company 2000 The following pertain to the pension plan of Harvard for fiscal 2000: Plan assets, January 1, 2000, are $200,000 Projected benefit obligation , January 1, 2000, is $200,000 Annual service cost, $18,000 Settlement (discount) rate = 10% Annual return on plan assets is $20,000, same as expected return. Contributions (funding) are $16,000 Benefits paid to retirees during the year: $14,000

95. Harvard Company 2000 Provide Harvard?s 2000 pension expense journal entry? What does the account ?Prepaid / Accrued cost? represent? Is it a liability or asset? Is the plan under-funded or over-funded?

96. Delayed Recognition Items that affect PBO or Fair Value of PA but do not get reflected in the pension expense immediately Prior Service Costs Gain/Losses from estimate changes Gain/Losses from actual vs. expected returns Prior to FAS 158 they received delayed recognition on both the balance sheet and income statement, now it is only on the income statement.

97. Components of the Pension Expense Amortization of prior service cost: Prior service costs results from changing the pension benefit formula or the terms of the pension plan. Amortization methods: Service method (preferred) Straight-line method

98. Yale 2003 Yale company institutes a retroactive change in their defined benefit plan effective 1/1/03. The retroactive effect of the change on PBO is a $150,000 increase. Yale has 100 employees covered under the plan with expected future service lives as follows: 5 years, 20 employees 7 years, 30 employees 10 years, 25 employees 15 years, 20 employees 20 years, 5 employees Compute the possible amortization schedules.

99. Harvard Company 2001 On January 2001, Harvard grants prior service costs having a present value of $56,000. Annual service cost is $19,000. Settlement (discount) rate is 10%. Amortization of prior service cost using the service method is $23,800. Actual return on plan assets is $20,000. The expected rate of return is 10%. Annual contributions (funding) are $40,000. Benefits paid to retirees during the year are $16,000. Provide Harvard?s 2001 pension expense journal entry?

100. Components of the Pension Expense Amortization of net gain / loss: Expected return: Expected return on plan assets is estimated each year to determine the amount of funds to set aside to pay retirement benefits as they are due. Based on market related value of plan assets Actual return: the dividends, interest, and capital gains generated by the fund during the period. Based on fair value of plan assets. Discuss how actual return is usually measured.Discuss how actual return is usually measured.

101. Amortization of Net Gain or Loss: Actual return is used to adjust plan assets balance and accrued liability/prepaid asset. Expected returns reduce pension expense. Difference is recorded in ?other stockholders equity?. Subsequent amortization of the gain/loss reduces the ?other stockholders equity? and changes pension expense.

102. Amortization of Unrecognized Net Gain or Loss:

103. Amortization is not required if the net unrecognized gain or loss at the beginning of the period is within a minimum amount (corridor limit + or -). If the beginning net unrecognized gain or loss exceeds the 10% corridor limit, the minimum amortization that must be recognized is . . . Amortization of Unrecognized Net Gain or Loss:

104. Gain or Loss Amortization Simple example PBO on 1/1/02 = $265,000 PA on 1/1/02 = $254,000 Unrecognized gain on 1/1/02 = $28,000 Average remaining service life per employee is 2002 = 10 yrs. Is there a need to amortize the unrecognized gain in 2002?

105. Harvard Company 2002 Annual service cost is $26,000. Settlement (discount) rate is 10%. Actual return on plan assets is $20,000. The expected earnings rate is 15%. Amortization of PSC is $22,000. Annual contributions (funding) are $42,000. Benefits paid to retirees during the year are $21,000. Changes in actuarial assumptions establish a loss on PBO at the end of the year of $20,000. Provide Harvard?s 2002 pension expense journal entry?

106. Harvard Company 2003 Service cost is $30,000. Settlement rate is 10%. Actual return on plan assets is $36,840. The expected rate of return 10%. Amortization of unrecognized prior service cost is $10,000. Annual contributions (funding) are $40,000. Benefits paid to retirees during the year are $23,000. Average service life of all covered employees is 10 years. Fair value and market related value of plan assets are the same. Provide Harvard?s 2003 pension expense journal entry?

107. Market Value vs. Fair Value of Plan Assets Fair value is a single day value. Determining funding position - change disclosed Actual returns based on fair value Market related value is a moving average which can be up to 5 years. Expected returns based on market related value Corridor test for gains/losses based on market related value

108. Pension disclosures Components of net period pension expense and amortizations of AOCI. Schedule showing changes in the benefit obligation, plan assets and AOCI (Accumulated Other Comprehensive Income). Weighted-average assumed discount rate, projected compensation rate, expected rate of return. Allocation of pension plan assets by category (stock, real estate, etc.). Expected benefit payments for each of the next 5 years and total for the 5 years following that. Estimate of next years contribution to the plan.

113. Settlements and Curtailments Asset Reversions Settlement Curtailment Termination Benefits Gains/losses recognized immediately. Unrecognized amounts flushed out at the same time.Gains/losses recognized immediately. Unrecognized amounts flushed out at the same time.

114. Leftovers Multiple Pensions Plans for employers Multi-Employer Pension Plans Multiple plans - underfunded netted and overfunded netted. Multiple employers - treated like defined contribution plans.Multiple plans - underfunded netted and overfunded netted. Multiple employers - treated like defined contribution plans.

115. OPEB Often not contractually required Generally no plan assets Not covered by ERISA - thus not required No tax benefit to early funding Greater variablity in estimation What has to be forecast - healthcare costs.What has to be forecast - healthcare costs.

116. OPEB Accounting Attribution Period: time over which the liability is accrued. Generally begins on the date of hire and ends on full eligibility date. Obligation measures EPBO - The present value as of a particular date of all benefits a company expects to pay after retirement to employees and their dependents. APBO - The present value of future benefits attributed to employees? services rendered to a particular date. APBO = EPBO for retirees and active employees fully eligible for benefits.

117. OPEB Accounting Components of postretirement benefit cost: Service cost Interest cost Actual return on plan assets Amortization of prior service costs Gains and losses

118. Accounting Changes and Errors Chapter 22

119. Types of Accounting Changes Changes in Reporting Entity (cover briefly) Changes in Principal Changes in Estimates

120. Two Approaches, Which to Do?

121. Modified Retrospective Approach No cumulative adjustment is made. Change in Entity Presenting consolidated statements in place of individual companies. Changing subsidiaries in a group for which consolidate financial statements are presented. Changing companies included in combined statements. Changing cost, equity (different in some cases) or consolidation for subs. Does not include a combination under purchase method, creation, cessation or FIN 46 consolidation. Change in Entity Presenting consolidated statements in place of individual companies. Changing subsidiaries in a group for which consolidate financial statements are presented. Changing companies included in combined statements. Changing cost, equity (different in some cases) or consolidation for subs. Does not include a combination under purchase method, creation, cessation or FIN 46 consolidation.

122. A change in principle involves a change from one generally accepted principle to another. A change to a generally accepted principle (from an incorrect principle) is a correction of an error. Changes in Principles Need at least two accepted methods: Inventory accounting, LIFO, FIFO, Moving average Revenue Recognition, Point of sale vs. Installment Sale, Percentage Completion vs. Completed Contract Development costs, successful efforts vs. full costNeed at least two accepted methods: Inventory accounting, LIFO, FIFO, Moving average Revenue Recognition, Point of sale vs. Installment Sale, Percentage Completion vs. Completed Contract Development costs, successful efforts vs. full cost

123. Changes are appropriate when the new principle is preferable to the existing accounting principle. The new principle should result in improved financial reporting. A change is considered preferable if a FASB standard: creates a new accounting principle, or expresses preference for a new principle, or rejects a specific accounting principle When are changes in accounting principles appropriate? If a new principle is created the transition guidelines in the new standard are used, not change in principle. Changes in economic conditions, ability to forecast etc. can lead to changes.If a new principle is created the transition guidelines in the new standard are used, not change in principle. Changes in economic conditions, ability to forecast etc. can lead to changes.

124. Retrospective Approach Cumulative adjustment is reported as an adjustment to retained earnings of the earliest year reported, beginning balance.

125. When is the retrospective approach required? For changes in accounting principle retrospective is the preferred method. Consistency issues vs. Current Method If information necessary to apply the retrospective approach is not available then the prospective approach is used.

126. UW had used the LIFO method of costing inventories but at the beginning of 2003 decided to change to the FIFO method. The tax rate is 40%. What is the journal entry required to reflect this change and how would the change appear on the comparative income statements and balance sheets for 2003, 2002 and 2001? UW Company Example

127. Prospective Approach No cumulative adjustment is made.

128. UW estimate bad expense as 2% of credit sales. After a review during 2002, UW determined that 3% of credit sales is a more realistic estimate of its collection experience. Credit sales in 2002 are $300 million. The effective tax rate is 40%. What is the journal entry required to reflect this change and how would the change appear on the comparative income statements for 2002 and 2001? UW Company Example

129. Accounting Errors Examples include: Use of inappropriate principles Mistakes in applying GAAP Arithmetic mistakes Fraud or gross negligence in reporting (irregularities)

130. Error Analysis Determine what accounting entry was done. Include closing entries since the original entry. Determine what accounting should have been done. Including closing entries since the original entry. Determine the relative account balances. Determine what accounting is necessary to transform what was done to what should have been done. What entries are necessary and what disclosures on the financial statements are needed?

131. Error Analysis Errors can occur in the following financial statements: Balance sheet (e.g., classifying N/P as A/P) Income statement (e.g. improper classification of Rev & Exp. accounts) Balance sheet and income statement (e.g. inventory errors for Inventory and COGS) Errors can be: Counterbalancing (or self-correcting over two accounting periods): ending physical inventory errors Non-counter-balancing (more than two periods needed)

132. Corrections of Accounting Errors Prepare a journal entry to correct any balances. Retrospectively restate prior years? financial statements that were incorrect. Report error as a prior period adjustment to the beginning retained earnings balance of the earliest year reported, if retained earnings is one of incorrect accounts affected. Include a disclosure note.

133. In 2002 the bookkeeper for UW discovered that in 2002 the company failed to record in the accounts $20,000 of deprecation expense on a newly constructed building. What is the journal entry required to correct this error? UW Company Example

134. In 2001 UW erroneously recorded a notes receivable of $10,000 as an accounts receivable? What is the journal entry required to correct this error in 2002? UW Company Example

135. In 2006 the bookkeeper for UW discovered that in 2001 the company recorded the purchase of fixtures as the purchase of inventory in the amount of 10,000. The fixtures had a 10 year life, no salvage value and used straight line depreciation. What additional information would you need to correct this error? As a result of this error, which accounts in 2006 are misstated? What is the journal entry to correct the error? How will the 2006 financial statements reflect the above? UW Company Example

136. Cash Flows Chapter 23

137. Statement of Cash Flows Lists inflows and outflows of cash and cash equivalents by category (operating, investing and financing). Explains the change in cash during the period. Is required by SFAS 95 (1988).

138. Microsoft?s 2002 Annual Report

139. Three sections of the statement of cash flows

140. Operating: Captures the cash effects of transactions that enter into the determination of net income. Investing: Generally involves long-term assets (especially the buying and selling of PP&E and investments) Financing: Generally involves liability and stockholders? equity items. Three Sections of the Statement of Cash Flows

141. For the direct and indirect methods the sections reporting investing and financing activities are the same. The net inflows or outflows for each section (under the two methods) are identical. The operating activities are reported differently. Direct vs. Indirect Method

142. Determine the change in cash. Determine the net cash flow from operating activities. Determine the net cash flows from investing and financing activities. Preparing the Statement of Cash Flows

143. Common non-cash activities include: Disclosure of Significant Non-cash Transactions

144. Approaches to Cash Flow Creation T - Accounts Good for learning, but very slow Formulas Fastest but least intuitive. Easy to miss accounts. Change in Balance Sheet Reasonable combination. May use T-Accounts for trickier areas.

145. T-Account Method Create a T-Account for every account on the balance sheet and income statement. Enter in beginning and ending balances. Starting with the income statement create journal entries that get from beginning to ending using your knowledge of transaction accounting. For instance with sales, credit sales debit A/R; with COGS debit COGS and credit inventory. Move to balance sheet. Close out to other balance sheet accounts - eventually to cash. For instance with A/R, collections debit cash credit A/R; with Inventory, purchases debit inventory credit A/P, then for A/P payments debit A/P credit Cash Once all done, use Cash T-Account entries to create a direct method statement.

146. Formula Method Memorize a ton of formula?s Payment to suppliers = COGS + Increase in Inventory - Increase in Accounts Payable. Collections from customers = Sales - Increase in Accounts Receivable + Increases in Unearned Revenue. Etc.

147. Balance Sheet Changes Change in cash = change in liabilities + change in equity - change in non-cash assets. Make up a list of the changes in all non-cash balance sheet accounts. Use additional info to determine inflow and outflow on accounts that can?t be netted: Sale of Fixed Assets and Purchase of Fixed Assets Retained Earnings, Net Income and Dividends Declared Accumulated Depreciation., Sale of Assets and Depreciation Expense Treasury Stock purchases and sales Assign all the items to categories - yields an indirect method statement.


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