Lesson 3.3: Shareholders’ Equity

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En provenance du cours de University of Illinois at Urbana-Champaign

Formal Financial Accounting

32 notes

University of Illinois at Urbana-Champaign

Formal Financial Accounting

32 notes

This course builds upon what you learned in Financial Accounting: Foundations and Financial Accounting: Advanced Topics and introduces you to formal foundations of financial accounting. The main purpose of the course is to familiarize you with technical terms in financial accounting, such as debit, credit and T-account. While knowledge on technical aspects of financial accounting is not necessary to understand and interpret financial statements, this knowledge is critical to be able to understand advanced topics in accounting. Formal Financial Accounting is a prerequisite course for the University of Illinois' iMSA program and the terminology we will cover will be used throughout the courses in iMSA program. The University of Illinois at Urbana-Champaign, consistently ranked as one of the nation's top three accounting programs, now offers a master’s in accounting at a very affordable tuition rate and is completely online. The iMSA is a full Master of Accountancy program and students graduate with a highly recognized master degree. Try an open course or two, then apply for admission into the credit-bearing version, as you may be eligible to take credit-bearing courses during the application process. If you are missing any prerequisites for the full degree, you can complete Coursera courses to demonstrate readiness and strengthen your application for the iMSA. For more information on this exciting online master's in accounting program, refer to this link: https://www.coursera.org/university-programs/imsa

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Module 3: Formal Financial Accounting for Liabilities and Shareholders’ Equity

The major sources of financing for many firms are liabilities and equity. Firms routinely finance their operations through various liabilities including accounts payables, bank loans, and bonds. They also raise funds from their investors through IPOs and SEOs. Finally, retained earnings (earnings earned but not distributed to investors) constitute a significant source of financing. Accounting for liabilities and shareholders’ equity will help you understand how formal financial accounting for liabilities and shareholders’ equity accounts are conducted.

Lesson 3.3: Shareholders’ Equity7:58

Rencontrer les enseignants

Oktay Urcan
Associate Professor of Accountancy
Department of Accountancy, College of Business

In lesson number three,

our focus will be on shareholders equity.

Here is our first example,

Illini Toy Shop issues 5,000 shares.

Each of these shares has a par value of one dollar from

seven dollar each on January 1, 2017.

So, what's going on in this transaction?

We are selling shares to the public from seven dollars each.

Therefore, there will be a cash increase.

What is the size of this cash increase?

It is seven dollars each times 5,000 shares.

It's going to be cash debit of $35,000.

What is the other side of this transaction?

Since we are selling shares to the public now

something needs to change in shareholder's equity accounts.

The first account that's going to be impacted,

because of this transaction is Common Stock Account.

Common Stock Account is used to record share issuance

but in common stock accounts just includes the par value of the shares issued.

Therefore, in this example,

common stock account will be credited by

5,000 times par value of each of the shares of one,

it is going to be 5,000 times one it's going to be just $5,000.

So, if we step back and think what's going on so far,

so far we have a debit of 35,000.

We have a credit of 5,000 so, it doesn't balance.

What is the balancing entry here?

It is going to be another shareholders equity account called Additional paid in capital.

And its value needs to be $30,000.

We use additional paid in capital account to

record excess money that we get from our shareholders.

It is excess of par value.

And if you look at the ledger accounts,

cash account is debited as 35,000.

Common stock account is credited as 5,000,

and additional paid in capital or APIC in short is going to be credited as $30,000.

Here is our next example.

Illini Cleaning cleans a house and earns $500 on April 1, 2017.

What is the journal entry associated with this transaction?

First of all we make cash of $500.

Therefore, cash will be going up.

Cash will be debited as $500.

What is the other side of this transaction?

Since we are earning some money,

revenues will be credited as $500 too, that's fine.

What's going on in the next two lines in this transaction is that,

as soon as we make a revenue or an expense,

it is going to be immediately transferred to the retained earnings.

Since, in this transaction we make revenues of $500,

we are going to transfer those revenues to retained earnings as follows.

Revenues will be debited is $500.

So, there is no more revenues.

And then it's going to be transfer to retain earnings account which is $500.

Again, it's going to be created.

What is the retained earnings account?

Retained earnings account is an account under shareholders equity that we

use to record all of the revenues and expenses that we earn so far.

Therefore, as soon as there is revenues and expenses,

it's going to be transferred to retained earnings.

One more time, revenues and expenses are transferred to

retained earnings at the end of the fiscal period.

Just like in this question,

as soon as we make revenues of $500,

it is going to be transferred to retained earnings.

Here's our next example.

Illini Cleaning pays $2,500 for June salary of the secretary on June 30, 2017.

What is the journal entry of this transaction?

First of all we pay salary.

Therefore, cash will be credited.

The cash will be going down by 2,500.

And then the other side of the journal entries,

you create a salary expense of 2,500.

Basic salary expense will be debited as 2500.

In the previous question we learned whenever there is the a revenue or an expense,

it is going to be transferred to retained earnings.

So, in the next two entry we are going to transfer this

2,500 of salary expense to retained earnings.

So, how are we going to do this? First of all you get rid of the salary expense.

To get rid of the salary expense you credit salary expense by

2,500 and then you debit retained earnings by 2,500.

And if you look at the ledger accounts,

cash account is 2,500 credit,

salary expense net is zero and retained earnings is a debit of 2,500.

Notice that retained earnings is

a shareholders equity account and it's normal balance is a credit one.

Basically, if you have a retained earnings of debit

2,500 means if you look at the retained earnings on balance sheet,

you are going to see a negative number.

Here is our next example.

Illini Toy Shop declares and pays two dollar per share dividends on December 31, 2017.

Illini Toy Shop has 5,000 outstanding shares at the time of this announcement?

What is the journal entry of this transaction?

First of all we pay some cash out.

What is the size of this cash out for?

It is 5,000 shares times two dollar per share dividends it's going to be $10,000.

Cash will be created as $10,000.

What is the other side of this journal entry?

Other side of this journal entry is retained earnings is debited as $10,000.

Why? Because dividends are paid out of retained earnings.

And because of this retained earnings notice that retained earnings they count as

debits are written in earnings numbers is going down.

Because normally retained earnings has a credit balance.

And if you look at the ledger account,

cash is created as $10,000.

Retained earnings is debit as $10,000.

One more time, return earnings is a shareholder's equity item.

It's normal balance is credit.

If you debit retain earnings it means that you're

reducing the amount of retained earnings.

In example 14, Illini Toy Shop repurchases 500 shares from

the stock market by paying $3,000 in total on September 15, 2017.

What's repurchasing?

Basically, Illini toy shop goes to stock market

and repurchase its own shares from the stock market.

In this question it looks like it's going to repurchase 500

of its own shares from the stock market for $3,000.

What is the journal entry of this transaction?

Of course there will be a cash out flow of $3,000.

Therefore, cash will be credited as $3,000.

What is the other side of this transaction?

You are going to create a new special account called treasury stock.

Treasury stock is a shareholders equity account that is

used just to keep track of repurchased shares.

And in this question its value will be $3,000 debit.

If you look at any balance sheet you are going to see

the treasury stock has a minus or negative balance.

And if you look at the ledger account,

cash will be credited as $3,000,

treasury stock will be debit as $3,000.

Normally, treasury stock has a debit balance although its a shareholder equity account.

Therefore, its sometimes also called as Contra Equity Account.

Look at any shareholders equity statement if you see

any treasure stock you will see that its value is always negative.

This concludes our discussion for module number three.

In this module we learned how to generalize liabilities and shareholders equity,

related financial transactions and how to post their journal entries on the ledger.

In the next module,

we will go through a comprehensive example which will

require generalizing and posting transactions about assets,

liabilities and shareholders equity.

Until that time. Take care.

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