ch05 - MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING...

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MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS Baginski & Hassell
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Chapter 5
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FINANCING DECISIONS (Reducing Outstanding Equity and Debt) Topics Identify conditions leading to reduction of equity financing Identify methods of equity reduction Review of Statement of Owners’ Equity Identify conditions leading to reduction of debt financing Identify methods of debt reduction
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Reasons for Reducing Equity Financing Available free cash flow is used to pay dividends Corporation desires to shift the mix of debt and equity financing Stock buy-backs can be used as a signal of higher future earnings expectations Repuchase to support stock price
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Methods of Equity Reduction Liquidating dividends Retire common stock Purchase treasury stock
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Liquidating Dividends Normally, regular dividends are limited to the amount of free and unappropriated retained earnings. Regular dividends are considered a return on capital. “Dividend distributions” that are greater than the free and unappropriated retained earnings are designated as a liquidating dividends . Liquidating dividends are considered a return of capital. What is the debit after retained earnings hits zero?
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Retire Common Stock When common stock shares are acquired and retired … The par value and original premium over par value are written off. Any “economic gain/loss” is credited/charged directly to the premium account , if any, in the stockholders’ equity section. The shares revert to the status of unissued.
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The following two slides indicate the “before & after” balance sheet of Beneish Co. that acquired and retired (cancelled) 10,000 shares of its common stock (for $56 per share.)
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Retire Common Stock Example Stockholders’ Equity [before] Common stock, $10 par; 10,000,000 shares authorized; 500,000 shares issued and outstanding $ 5,000,000 Additional paid-in capital 25,000,000 Retained earnings 42,000,000 Total stockholders’ equity $72,000,000 Note: The average price per share received by Beneish = $60 ($30,000,000 in common stock and additional paid-in capital ÷ 500,000 shares)
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Acquire and Retire Common Stock: Stockholders’ Equity Results Stockholders’ Equity [after] Common stock, $10 par; 10,000,000 shares authorized; 490,000 shares issued and outstanding $ 4,900,000 Additional paid-in capital 24,540,000 Retained earnings 42,000,000 Total stockholders’ equity $71,440,000 Note: Both cash and total stockholders’ equity decrease by $560,000 (10,000 shares × $56).
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SUPP0RTING COMPUTATIONS: Beneish realizes $40,000 “economic gain” on combination of two transactions , issuing stock and retiring stock: Originally received 10,000 shares × $60 (average price) = $600,000 Repurchase price was $560,000 Economic gain = $40,000
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Common stock decreases $100,000: 10,000 shares × $10 par Additional [original] paid in capital in excess of par decreases by $500,000: 10,000 shares ×
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ch05 - MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING...

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