Finance Chapter: Debt and Equity

Chapter Objectives

• Able to describe the characteristics of debt and equity
• Able to describe the components of Shareholders' Equity
• Able to account for stock issuance and repurchase (Treasury Stock)
• Able to explain stock dividends and stock splits
• Able to discuss Other Comprehensive Income items
• Able to describe basic and diluted EPS

How to Finance a Corporation

• Borrow: Examples include notes, bonds, and leases. Debt holders are legally entitled to repayment of interest and principal.
• Issue Equity: Includes common and preferred stock. Shareholders have various rights, limited liability, and a residual interest in corporate assets. Internally generated cash also funds corporations.

Debt versus Equity

Pfizer's Stockholders' Equity

• Provided data on preferred stock, common stock, additional paid-in capital, treasury stock, retained earnings, and accumulated other comprehensive loss for Pfizer as of December 31, 2020. The data is in millions, except for preferred stock issuance and per common-share data.

Contributed Capital

• Represents the cumulative cash inflows from issuing various classes of stock.
• Less the net cash paid to repurchase a company's own stock in the market.
• Includes two classes of stock, common and preferred stock, and additional paid-in capital (also called Paid-in capital in excess of par).

Earned Capital

• Represents the cumulative profits and losses of a company, less any dividends paid to shareholders.
• Includes Other Comprehensive Income (OCI) which is changes to equity that are not part of the income statement and not reflected in retained earnings

Retained Earnings

• Represents the cumulative profit retained by the company.
• Increased by net income.
• Decreased by net losses.
• Decreased by dividends paid to shareholders.
• Affected by other events.

Common Stock

• The primary ownership unit in a company.
• Common shareholders have voting rights.
• Par value: An arbitrary value assigned to each share of stock. It is specified in the corporate charter when the company is formed and determines the allocation of proceeds from stock issuance on the balance sheet.

Numbers of Shares of Stock

• Authorized Shares: The upper limit on the number of shares a corporation can issue. It is established in the articles of incorporation and can be increased by a shareholder vote.
• Issued Shares: The actual number of shares issued to shareholders.
• Outstanding Shares: The number of issued shares, less the number of shares repurchased as treasury stock.

Preferred Stock

• Generally has preference or priority over common stock.
• Typical preferences: Dividend preference (preferred shareholders receive dividends before common shareholders), and liquidation preference (company assets first go to debtors, then preferred shareholders, then common).

Accounting for Stock Issuances

• Used to obtain cash and other assets for business use.
• Creates an increase in assets and stockholders' equity.
• Common and/or preferred stock increases by par value multiplied by the number of shares sold.
• Additional paid in capital increases by the remainder of the issue price.
• No effect on the income statement.
• The first issuance of stock is called an initial public offering (IPO).

Stock Repurchase (Treasury Stock)

• A company buys its own stock from investors.
• Reasons for repurchase:
  • To reduce outstanding shares, which can increase the market value of remaining shares
  • To offset the dilution effect of employee stock option programs

Accounting for Treasury Stock

• Never results in a gain or loss on the income statement.
• Differences between purchased and resold stock prices adjust additional paid-in capital.
• Treasury stock is a contra stockholder's equity account. It's deducted from the total stockholders' equity amount on the balance sheet.

Cash Dividends

• Reasons for dividend payments vary.
• Most are paid in cash.
• Most are paid quarterly.

Stock Dividends and Splits

• Additional shares of stock are distributed to shareholders.
• Stock dividends: Retained earnings is reduced; contributed capital increases.
• Stock splits: No financial statement effects.

Other Comprehensive Income (OCI)

• Includes foreign currency adjustments, unrealized gains/losses on available-for-sale securities/derivatives, and adjustments to pension and other benefit plans.
• OCI is displayed separately on the balance sheet, under the stockholders' equity section,.

Earnings per Share (EPS)

• Reported on the face of the income statement.
• At least one EPS amount is required; potentially two.
  • Basic EPS: Always required.
  • Diluted EPS: Required with complex capital structures.

Complex Capital Structure

• Exists if dilutive securities, convertible securities that can be converted into common stock and reduce/dilute earnings per share.
• Three primary types: Stock options, convertible debt, and convertible preferred stock.
• Requires diluted EPS, which is calculated and reported in addition to basic EPS.

Calculating EPS

• Basic EPS: Earnings available for common shareholders / weighted average number of common shares outstanding.
• Preferred dividends and noncontrolling interests are subtracted.
• Diluted EPS considers the effect of potential conversion of convertible securities or stock options into additional shares, increasing available shares, and thus reducing EPS.

Basic EPS Example/Diluted EPS Example

• Provide examples of calculations using net income adjusted for preferred dividends and common dividends. These examples illustrate how to calculate earnings per share both basic and diluted. These include the impact of treasury stock and common shares.

Pfizer's EPS

• Shows the basic and diluted EPS for Pfizer for the years ending December 31, 2020, and 2019, providing financial data and analysis for the company's income statement. Data includes earnings per common share, both basic and diluted. It shows how the company's earnings are distributed, considering the weighted average number of shares outstanding for both basic and diluted EPS.

This quiz covers the fundamentals of debt and equity financing in corporations. You will learn about the characteristics, components, and accounting practices related to stock issuance, repurchase, dividends, and earnings per share. Test your understanding of how corporations manage their finances through debt and equity.