Principles of Accounting II Assignment III (This assignment is continuation from the previous assignment)

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Course Learning Outcomes for Unit III Upon completion of this unit, students should be able to:

1. Prepare corporate financial statements. 1.1 Recognize a stockholder’s equity account. 1.2 Infer capital stock transactions.

2. Interpret financial statements.

2.1 Compare retained earnings and dividend policy.

4. Interpret corporate accounting. 4.1 Discuss capital structure and the retained earnings role on the balance sheet.

Course/Unit Learning Outcomes

Learning Activity

1.1

Unit Lesson Chapter 13, pp. 13-1 to 13-18 Chapter 14, pp. 14-1 to 14-20 Webpage: Forming a Corporation Video: Corp 101: The Basics of Corporate Structure Video: Business Organizations-Corporations-Characteristics Unit III Case Study

1.2

Unit Lesson Chapter 13, pp. 13-1 to 13-18 Chapter 14, pp. 14-1 to 14-20 Webpage: Forming a Corporation Video: Corp 101: The Basics of Corporate Structure Video: Business Organizations – Corporations – Characteristics Unit III Case Study

2.1

Unit Lesson Chapter 13, pp. 13-1 to 13-18 Chapter 14, pp. 14-1 to 14-20 Video: How Investing Works: Dividends Unit III Case Study

4.1

Unit Lesson Chapter 13, pp. 13-1 to 13-18 Chapter 14, pp. 14-1 to 14-20 Video: Stockholders’ Equity on the Balance Sheet Unit III Case Study

Required Unit Resources Chapter 13: Corporations: Organization and Capital Stock Transactions, pp. 13-1 to 13-18 Chapter 14: Corporations: Dividends, Retained Earnings, and Income Reporting, pp. 14-1 to 14-20 In order to access the following resources, click the links below. Internal Revenue Service. (n.d.). Forming a corporation. https://www.irs.gov/businesses/small-businesses-

self-employed/forming-a-corporation

UNIT III STUDY GUIDE

Accounting: Corporations

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For the video resources below, transcripts and closed captioning are available upon accessing the videos. Business Roundtable. (2010, February 1). Corp 101: The basics of corporate structure [Video]. Cielo24.

https://c24.page/vfssku3k3qjy8rqtzg3shcqzsq CNBC. (2018, February 27). How investing works: Dividends [Video]. Cielo24.

https://c24.page/gbb7ux2wrcme5pk42xdxcgkzx2 Hclaw002. (2012, March 6). Business organizations – Corporations - Characteristics [Video]. Cielo24.

https://c24.page/wbrgzx66kspqr4un6e7ubybmby Jacobsen, R. (2017, December 4). Stockholders’ equity on the balance sheet [Video]. Cielo24.

https://c24.page/8a4fd468v6c8ybuynanzkwu72d

Unit Lesson

Introduction This unit will focus on the corporate form. Today, there are mixed views on the corporation. While some see significant benefit from this entity and its ability to scale, others view such large organizations as dangerous to our markets and our society. After working through this unit, regardless of your opinion, you should be well prepared to participate in a meaningful conversation about different corporations. Consider the questions below as you proceed through this lesson.

1. Would you seek employment from a corporation? 2. Would you invest in a corporation?

A Corporation

Many U.S. corporations have become household names and span a wide variety of industries. For example, consider the following corporations, which are very well-known: Johnson & Johnson (healthcare), United Airlines (transportation), Verizon (communications), Macy’s and Walmart (retail), Ford (automobiles), and Amazon (online retail). Lesser-known firms that are vital to our economy are those firms that service other businesses (i.e., business to business, which is also known as B2B markets). Examples are Oracle (software), Cummins Engine (transportation), FedEx (air delivery), Intel (computers), and Schlumberger (oil well servicing). Not to be ignored are the major consumer-focused electronic firms, such as Microsoft, Apple, Google, Netflix, and Facebook. None of these companies could exist without the corporate form.

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Characteristics of a corporation include their separate legal standing (unlike a proprietorship or partnership); the limited liability of owners; longevity; ability to raise large amounts of capital; professional management (separate from the owners); and, of course, regulation and taxation.

Stocks Stock, also known as equity, represents ownership in a corporation. More than half of the population owns stock in individual companies or mutual funds and exchange-traded funds (ETFs). Some of us own stock directly and others through retirement savings plans (individual retirement accounts [IRAs], 401[k] investments) and some in variable annuity or life insurance. As with any investment, it is wise to do your homework. The approach most favored for the long-term is called fundamental analysis. To start, you must know your risk tolerance. This is a measure of your concern or willingness to “lose some to gain some” (i.e., gain more than you lose). Some cannot afford any loss and forego stock or equity investing in favor of fixed income securities (bonds), or they pay a financial manager to handle their savings portfolio and pay the adviser for the service.

Types of Stock So, what are the forms of stock? Our textbook discusses common stock and preferred stock. Separately or together, they provide a wide spectrum of companies from which to choose. Most investors choose common stock, as it provides specific ownership rights (Weygandt et al., 2018). Preferred stock is just as it is labeled— preferred. It enjoys a priority over common for dividends and assets. In exchange, its return is limited and generally has no vote in the corporation’s management.

Treasury Stock Less understood is treasury stock. Simply, it is stock owned by the corporation. It had previously been issued (owned in the marketplace) and was bought back by the firm. Why do companies do that? The basic reason is that the board of directors believe that the market has undervalued the firm’s stock and that purchasing it is a good, if not the best, use of company funds. Critics may argue that a better choice is to issue dividends to reward all current stockholders. Both actions will generally create a higher stock price in the market. Of course, another option, which is chosen by many growth companies, is to invest in the firm through capital purchases or by acquiring another firm. The transactions to account for organization formation, stock issuance, and repurchase are illustrated in your textbook on pages 13-10 to 13-16.

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As noted in prior units, using the most recent financial statements for a company that you have an interest in is a great way to understand accounting. You will see all of the stockholders’ equity quantified in the balance sheet, and you will see an explanation as to how the firm valued them in the notes to the financial statements. These immediately follow the statements in the 10-K.

Corporations: Dividends, Retained Earnings, and Income Reporting In exchange for their investment, corporation owners have opportunities (not promises) for rewards. When a corporation achieves a profit (net income), which is the bottom line of the income statement (revenues exceeding expenses), the business can either keep the profits (invest internally [i.e., retained earnings]) or distribute them to stockholders (dividends). In reality, most businesses do both. A mature company, such as utilities and many consumer firms (e.g., Proctor & Gamble, CVS, Macy’s) will pay dividends as some percent of their net income. This is known as the dividend payout ratio. In all cases, businesses will keep some of their earnings to invest internally. Businesses in the rapid growth stage (e.g., high-tech companies) may reinvest all of their net income in retained earnings and forego dividends to a later time (when mature). Reviewing a business’s balance sheet will show you the specifics for any public company. The illustration below shows the debits and credits to retained earnings. Retained earnings will increase if a business allocates a portion of its profits to internal investment and decrease if the business has a new loss or pays out some of its income to stockholders.

Dividends and Stock Splits

Dividends reward existing stockholders. They are a return of earnings in proportion to ownership (e.g., the owner of 50 shares will receive 50 times the reward of the owner of one share). Dividends can be in the form of cash or stock and, in rare cases, company products. When evaluating an investment, many, if not most, consider whether a company distributes a dividend, how much it is, and its history of providing them. After all, the investor may realize rewards for their investment through appreciation (increase) in the stock price or dividends. As noted earlier, there is no guarantee that a company’s stock price will increase, even if it has in the past. Note that dividends are one area where preferred stockholders have priority over common stockholders. Although their dividend may be lower, in exchange for the lower risk, they get theirs first. As to price appreciation, the market price is determined by the demand and supply of shares, just like other commodities in our economy. A stock split is another way to reward the stockholder. When shares are split (in half, by a quarter, or some other amount), it reduces the price per share as more shares are now in circulation. Many believe it is easier for a low-priced stock to appreciate (increase) than a high-priced stock, which is one reason for the split. It should be noted that a stock dividend also increases the number of shares, but generally, it is a lesser amount and has a lesser impact.

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Reporting Earnings and Retained Earnings Earnings are the bottom line of the income statement (i.e., net income). The earnings that the firm returns to current stockholders are the dividends. The earnings that are kept by the firm are called retained earnings. The corporation can invest these earnings into the firm by purchasing equipment, or buildings, or by acquiring another firm that supplements or complements their strategy.

Stockholders’ Equity and the Retained Earnings Statement The stockholders’ equity section of the balance sheet contains information on both types of earnings. The retained earnings statement, which can be seen on page 14-13 of the textbook, illustrates the changes made in the retained earnings account as a result of the yearly (period) income (or loss). It transitions from the income statement to the balance sheet accounts; see pages 14-14, 14-15, and 14-16 of the textbook for additional information and illustrations. As consumers, you have your own retained earnings and stockholder equity information. Most accounting professionals call it savings for the last period and add it into the net worth from prior years.

Analyzing Corporation Performance If you are going to invest (or work for) a corporation, you ought to know how it is performing from a financial point of view. After you have completed this course, you can do the analysis yourself. All of the data necessary, with the exception of the current market price of a share, are in the company’s 10-K. The free report is available for all corporations on the U.S. Securities and Exchange Commission (SEC), Yahoo, Google, and Bloomberg websites and on the firm’s website as well. There are a variety of metrics used to evaluate corporate financial performance. You will explore these metrics further in Unit IV. As a precursor, these metrics are listed below:

 dividends (amount, payout ratio),

 return on stockholders’ equity (ROE),

 earnings per share (EPS), and

 book value per share. The corporate form allows large organizations to grow and function—all across the globe in many cases. Several large companies, whose services or products we may use every day, did not exist 20–25 years ago (e.g., Facebook, Twitter, Amazon, Starbucks). Others have a history of more than a century (e.g., Ford, IBM, Macy’s, General Electric). As separate legal entities, these firms are subject to regulation and taxation. From a financial point of view, the SEC supervises external financial reporting. From a tax point of view, the Internal Revenue Service (IRS) does the same. In 2017, a tax reform act reduced the amount of corporate taxation to closely match the rates of other industrialized countries. As a result, many politicians have complained that these firms get favorable tax treatment. If you know someone in one of these organizations, you could engage them in a discussion to hear their side of the story.

Conclusion Can you now answer the two questions posed at the beginning of this lesson? Go back, and check! Unit IV will discuss how companies plan for investments, financial statements, and the statement of cash flows (SCF).

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Reference Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting principles (13th ed.). Wiley.

https://online.vitalsource.com/#/books/9781119411017

Suggested Unit Resources In order to access the following resources, click the links below. For the video resources below, transcripts and closed captioning are available upon accessing the videos. The following video provides an introduction to stock splits and stock dividends. Bhatnagar, C. S. (2012, March 27). Stock splits and stock dividends [Video]. Cielo24.

https://c24.page/5c2rcbwtag25jc6uzn44s2e7zn The video below explains how a corporation works with an investment bank to raise capital. Corporate Finance Institute. (2018, June 15). Capital raising process (underwriting) [Video]. Cielo24.

https://c24.page/cdb4u7w7j33jej8zfs2hdrthnh The following video explains how corporations issue and account for stock. Paulsen, P. (2014, February 23). Corporations & issuing stock [Video]. Cielo24.

https://c24.page/ba2fvq978yfxxejfgbvqugt743 The video below discusses corporate dominance, legal rights, and if corporations are good for democracy. Thought Monkey. (2017, January 27). How corporations became so powerful in 6 minutes [Video]. Cielo24.

https://c24.page/8x2c62eb9h5ps84rw3txfgdnxk

Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. This is an opportunity for you to express your thoughts about the material you are studying by writing about it. Conceptual thinking is a great way to study because it gives you a chance to process what you have learned, and it increases your ability to remember it. In order to practice what you have learned, please attempt the exercises and problems below, which can be found in your textbook. Chapter 13:

 Brief Exercises (BE13.2), page 13-24

 Brief Exercises (BE13.7), page 13-25

 Brief Exercises (BE13.8), page 13-25

 Exercises (E13.3), page 13-26

 Exercises (E13.9), page 13-27

 Exercises (E13.15), page 13-29

 Problems: Set A (P13.6A), page 13-31

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Chapter 14:

 Brief Exercises (BE14.2), page 14-26

 Brief Exercises (BE14.7), page 14-27

 Exercises (E14.1), page 14-28

 Exercises (E14.9), page 14-30

 Exercises (E14.15), page 14-31

 Problems: Set A (P14.3A), page 14-33 If you have any questions or do not understand a concept, contact your professor for clarification. Completing these practice exercises and problems will give you practice, which will be helpful as you complete the assignment for this unit.