Tuesday, 8 September 2009
Intermediate Accounting - 11th Edititon
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Accounting Principles (Kieso)
Accounting Principles - 8th Edititon
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Friday, 4 September 2009
Theories & Further Information about Shareholder's Equity
The shareholder's equity is often an important part of the capital that funds the net assets.
The share capital may be made up of both ordinary and preference shares, though preference shares are much less popular these days for tax reasons. However, in the notes to the accounts there may also be a figure for Authorised Share Capital. This may be very different to the Issued Share Capital. The authorised capital is the maximum amount of money that the shareholders have decided that the company can issue in shares and will usually be considerably larger than the issues share capital as the company wants to retain the option of issuing more shares in the future to raise more capital - perhaps to fund an expansion.
The reserves will include retained profit from the past. That is profits that the firm has kept for itself and not issued to shareholders in the form of a dividend. They may also include share premiums. As mentioned in the explanation of shareholder's equity, this is where shares are issued at more than their face value. The face value of the share may be, say £1, but they may be issued at £3.50 because the market has risen in the meantime and the shares are now worth much more. The £1 will be included as part of the issued share capital (see above), but the other £2.50 will be called a share premium. A final part of reserves may be something called revaluations. If the company's assets have risen in value - perhaps because of inflation - this is effectively a source of funds for the shareholders and so also needs to be recorded on the bottom half of the balance sheet. This situation can occur particularly with property companies such as hotel operators where the value of the properties rises with a booming property market.
The shareholder's equity is shown on the balance sheet as part of the balancing figure - the one that matches the net assets. It is therefore a key part of the capital financing of the business.
The share capital may be made up of both ordinary and preference shares, though preference shares are much less popular these days for tax reasons. However, in the notes to the accounts there may also be a figure for Authorised Share Capital. This may be very different to the Issued Share Capital. The authorised capital is the maximum amount of money that the shareholders have decided that the company can issue in shares and will usually be considerably larger than the issues share capital as the company wants to retain the option of issuing more shares in the future to raise more capital - perhaps to fund an expansion.
The reserves will include retained profit from the past. That is profits that the firm has kept for itself and not issued to shareholders in the form of a dividend. They may also include share premiums. As mentioned in the explanation of shareholder's equity, this is where shares are issued at more than their face value. The face value of the share may be, say £1, but they may be issued at £3.50 because the market has risen in the meantime and the shares are now worth much more. The £1 will be included as part of the issued share capital (see above), but the other £2.50 will be called a share premium. A final part of reserves may be something called revaluations. If the company's assets have risen in value - perhaps because of inflation - this is effectively a source of funds for the shareholders and so also needs to be recorded on the bottom half of the balance sheet. This situation can occur particularly with property companies such as hotel operators where the value of the properties rises with a booming property market.
The shareholder's equity is shown on the balance sheet as part of the balancing figure - the one that matches the net assets. It is therefore a key part of the capital financing of the business.
What is Shareholder's Equity?
The shareholder's equity comes in the bottom half of the balance sheet and is part of the overall financing of the business. The shareholder's equity is a part of the overall level of capital that finances the net assets.
As well as the shareholder's equity the net assets may be financed by:
•Retained profit & reserves
•Loans & debentures
There may also be other more detailed sources of capital shown on a balance sheet. These may include the "share premium account". This is where the shares are issued at above their face value. The amount raised from the sale of shares is then split into two - the share capital (the face value of all the shares) and the share premium account (the surplus over and above the face value).
The shareholder's equity may also be known as the equity capital. The reward to the shareholders for investing this money in the business is a share of the profit - a dividend . The amount of the dividend clearly depends on the profitability of the business.
As well as the shareholder's equity the net assets may be financed by:
•Retained profit & reserves
•Loans & debentures
There may also be other more detailed sources of capital shown on a balance sheet. These may include the "share premium account". This is where the shares are issued at above their face value. The amount raised from the sale of shares is then split into two - the share capital (the face value of all the shares) and the share premium account (the surplus over and above the face value).
The shareholder's equity may also be known as the equity capital. The reward to the shareholders for investing this money in the business is a share of the profit - a dividend . The amount of the dividend clearly depends on the profitability of the business.
Theories & Further Information about Dividends Payable
When it's considering how much of its profit to pay in dividends, the company is up against various conflicting interests. The shareholders clearly want a share of the profit in return for their investment in the shares, but they also (unless they're very short-sighted!!) want the company to grow in the future. To grow in the future, the company needs to invest a proportion of the profit. Whatever is invested can't then be paid to shareholders as dividends.
It is the job of the Board of Directors to try to take account of all these conflicting interests and to decide on the level of dividend they are going to recommend is paid. This recommendation is then considered at the Annual General Meeting of the company. The Directors should be in the best position to decide what needs to be re-invested and therefore how much can be spared to be paid out as dividends.
For more detail about how much of its profit a company is paying out in dividends, shareholders or potential investors could look at the DIVIDEND COVER or the DIVIDEND YIELD RATIOS. There is more detail on these in the reported earnings per share and the reported dividend per share pages.
It is the job of the Board of Directors to try to take account of all these conflicting interests and to decide on the level of dividend they are going to recommend is paid. This recommendation is then considered at the Annual General Meeting of the company. The Directors should be in the best position to decide what needs to be re-invested and therefore how much can be spared to be paid out as dividends.
For more detail about how much of its profit a company is paying out in dividends, shareholders or potential investors could look at the DIVIDEND COVER or the DIVIDEND YIELD RATIOS. There is more detail on these in the reported earnings per share and the reported dividend per share pages.
Theories & Further Information about Dividends Payable
When it's considering how much of its profit to pay in dividends, the company is up against various conflicting interests. The shareholders clearly want a share of the profit in return for their investment in the shares, but they also (unless they're very short-sighted!!) want the company to grow in the future. To grow in the future, the company needs to invest a proportion of the profit. Whatever is invested can't then be paid to shareholders as dividends.
It is the job of the Board of Directors to try to take account of all these conflicting interests and to decide on the level of dividend they are going to recommend is paid. This recommendation is then considered at the Annual General Meeting of the company. The Directors should be in the best position to decide what needs to be re-invested and therefore how much can be spared to be paid out as dividends.
For more detail about how much of its profit a company is paying out in dividends, shareholders or potential investors could look at the DIVIDEND COVER or the DIVIDEND YIELD RATIOS. There is more detail on these in the reported earnings per share and the reported dividend per share pages.
It is the job of the Board of Directors to try to take account of all these conflicting interests and to decide on the level of dividend they are going to recommend is paid. This recommendation is then considered at the Annual General Meeting of the company. The Directors should be in the best position to decide what needs to be re-invested and therefore how much can be spared to be paid out as dividends.
For more detail about how much of its profit a company is paying out in dividends, shareholders or potential investors could look at the DIVIDEND COVER or the DIVIDEND YIELD RATIOS. There is more detail on these in the reported earnings per share and the reported dividend per share pages.
What are Dividends Payable?
Any profit that the firm makes belongs to the owners of that firm. They are the shareholders. The amount of the profit that each shareholder should receive depends on how many shares they own. The more shares they own, the larger the proportion of the company they own and therefore the more of the profit they should receive. This share of the profit is known as a dividend and to spread out fairly, the dividend is normally expressed as an amount per share.
The size of the dividend depends on two things. First it depends on the amount of profit that has been made, but secondly it depends on how much of the profit is distributed to the shareholders. Profit is a vital source of funds for investment for a company and so if they were to distribute too much to the shareholders, they would damage their long-term performance. However, at the same time the shareholders are entitled to a share as the reward for the risk they have taken in investing in the company.
The Board of Directors has to balance up these two demands on the total profit, and will then recommend the size of the dividend they think is appropriate. This will then be put to the firm's AGM for the shareholders to vote on.
Profit attributable to shareholders = Dividends paid + Retained profit
For further details about profit, you could look at the section on operating profit or the Financial Ratios section.
The size of the dividend depends on two things. First it depends on the amount of profit that has been made, but secondly it depends on how much of the profit is distributed to the shareholders. Profit is a vital source of funds for investment for a company and so if they were to distribute too much to the shareholders, they would damage their long-term performance. However, at the same time the shareholders are entitled to a share as the reward for the risk they have taken in investing in the company.
The Board of Directors has to balance up these two demands on the total profit, and will then recommend the size of the dividend they think is appropriate. This will then be put to the firm's AGM for the shareholders to vote on.
Profit attributable to shareholders = Dividends paid + Retained profit
For further details about profit, you could look at the section on operating profit or the Financial Ratios section.
What is Interest Payable?
When a firm borrows money, it has to pay interest. Interest is the return to the lender for the service of having lent money and the associated risk. The level of interest payable is therefore the total amount of interest the firm has to pay on all its borrowings, whether short-term or long-term.
The amount of interest payable will depend on how much money the firm has borrowed, and for how long it has borrowed it. The rate of interest will vary according to the level of risk (the higher the risk the higher the rate of interest) and the length of time the money is borrowed for (short-term, unpredictable borrowing such as overdrafts will command higher rates of interest).
Interest payable is usually subtracted from the operating profit to give the profit on ordinary activities before taxation. It is not considered to be a part of the trading profit, as this measures the profit the firm has made on its mainstream activity of selling its product or service.
The amount of interest payable will depend on how much money the firm has borrowed, and for how long it has borrowed it. The rate of interest will vary according to the level of risk (the higher the risk the higher the rate of interest) and the length of time the money is borrowed for (short-term, unpredictable borrowing such as overdrafts will command higher rates of interest).
Interest payable is usually subtracted from the operating profit to give the profit on ordinary activities before taxation. It is not considered to be a part of the trading profit, as this measures the profit the firm has made on its mainstream activity of selling its product or service.
What is Cost of Goods Sold?
Cost of goods sold is also sometimes phrased as COST OF SALES.
The cost of goods sold is the costs actually incurred in producing the product or service. It is the direct costs of production. It does not include the indirect costs, which may be things like administration and marketing costs. These cannot be directly attributed to producing the product and so are not included.
The cost of goods sold for a production company will include things like raw materials, energy and labour used to produce the product. For a retail company such as Marks and Spencer it will be the total amount they have paid to their suppliers for the products they sell on the shelves.
The cost of goods sold is the costs actually incurred in producing the product or service. It is the direct costs of production. It does not include the indirect costs, which may be things like administration and marketing costs. These cannot be directly attributed to producing the product and so are not included.
The cost of goods sold for a production company will include things like raw materials, energy and labour used to produce the product. For a retail company such as Marks and Spencer it will be the total amount they have paid to their suppliers for the products they sell on the shelves.
What is Operating Profit?
Profit is often a misunderstood term. Profit is the surplus in money terms that a firm has made after paying all the costs associated with producing and selling that product. It should not be muddled with sales revenue which is the money the firm has received from selling the product.
There are various types of profit that are measured by accountants in the firm's profit & loss account. Operating profit is the profit after both the direct and indirect costs have been paid.
Sales revenue - Cost of goods sold = GROSS PROFIT
Gross Profit - marketing & admin. costs = OPERATING PROFIT
Operating profit is sometimes also known as TRADING PROFIT.
There are various types of profit that are measured by accountants in the firm's profit & loss account. Operating profit is the profit after both the direct and indirect costs have been paid.
Sales revenue - Cost of goods sold = GROSS PROFIT
Gross Profit - marketing & admin. costs = OPERATING PROFIT
Operating profit is sometimes also known as TRADING PROFIT.
What is Sales Revenue?
Sales revenue is the total amount of money that the firm has earned from the sale of all its goods and services during a given time period. This is usually six months or a year. If a firm produced just one product or service the sales revenue would be the price of the product multiplied by the number of the product sold. In the case of more than one product or service the revenue from each needs to be added together.
The figure for sales revenue in the profit & loss account does not necessarily mean that the firm has received all that money because although they may have sold that quantity of the product they may still be owed some of the money as debtors. The figure for sales revenue is the figure for the total amount of their product or service, in money terms, that they have sold not the amount of money they have received.
Sales revenue is also often phrased in a profit & loss account as TURNOVER.
The figure for sales revenue in the profit & loss account does not necessarily mean that the firm has received all that money because although they may have sold that quantity of the product they may still be owed some of the money as debtors. The figure for sales revenue is the figure for the total amount of their product or service, in money terms, that they have sold not the amount of money they have received.
Sales revenue is also often phrased in a profit & loss account as TURNOVER.
What are Long-term Liabilities?
A liability is something which a firm owes to a person or another firm. It may be in the form of creditors - people or firms who have sold you goods which you have not yet paid for, or it may be money borrowed from a financial institution - loans.
As the title of the variable suggests, we are looking in this case for liabilities that are owed in the long-term. This is generally taken in accounting terms to be more than a year. This therefore tends to mean that most trade creditors (except in exceptional circumstances) are not long-term but current liabilities. Long-term liabilities thus tend to be bank loans.
They are usually shown on the top half of the balance sheet, and are subtracted from the fixed assets and the net current assets to show net assets.
As the title of the variable suggests, we are looking in this case for liabilities that are owed in the long-term. This is generally taken in accounting terms to be more than a year. This therefore tends to mean that most trade creditors (except in exceptional circumstances) are not long-term but current liabilities. Long-term liabilities thus tend to be bank loans.
They are usually shown on the top half of the balance sheet, and are subtracted from the fixed assets and the net current assets to show net assets.
Debentures, Mortgages and Long-Term Loans
As we saw from the explanation of long-term liabilities, they are liabilities that the firm has which are due in over a year. There are various possibilities for this:-
•Debentures
•Mortgages
•Long-term loans
Debentures
A debenture is a form of borrowing by a firm. It may issue debentures of a fixed value - say £1000 or £5000 - at a certain rate of interest. These debentures may be bought by individuals or by financial institutions. The debentures will have a fixed time period, after which they will be paid back. This may be 5 or 10 years or in some cases even longer. In some cases they carry perks with them. Much of the new number 1 court at Wimbledon was funded by issuing debentures in return for which people get preferential deals on tickets.
They are often attractive because they tend to be a secure investment, and because the interest will have to be paid, whatever the level of profit. This makes them less risky than ordinary shares. For the firm they can be a good way of raising money because they are predictable. It can plan ahead the cash requirement for paying the interest, and knows exactly when they will have to be redeemed.
Mortgages
A mortgage is also a form of long-term loan. However, it will usually tend to be on property or some other fixed asset. It will be what is known as a secured loan. This means that the loan is secured to the asset it was borrowed for. If the money was borrowed, for example, to finance the purchase of a plot of land and the firm fails to make the required loan payments, then the lender can start legal proceedings to repossess the asset. This means that they will then own it, and can sell it to get their money back. Any surplus would of course be returned to the firm.
The rate of interest may be fixed for a period or it may vary with market rates of interest.
Long-term loans
Other long-term loans may, unlike the mortgages, be unsecured loans. This means that the bank or financial institution that lent the money does not have any title over any of the firms assets, and they would have to go through the courts to get any money back. This can prove to be a lengthy and expensive process. An unsecured loan will therefore tend to attract a higher rate of interest then a secured one where the lender is more certain of recovering their money in the event of a problem.
All these long-term liabilities will be shown on a balance sheet and subtracted off the net current assets to give the net assets. They may alternatively be shown as a part of the firm's source of funds in the bottom half of the balance sheet. Where they are shown is simply an accounting convention and does not alter their meaning at all.
•Debentures
•Mortgages
•Long-term loans
Debentures
A debenture is a form of borrowing by a firm. It may issue debentures of a fixed value - say £1000 or £5000 - at a certain rate of interest. These debentures may be bought by individuals or by financial institutions. The debentures will have a fixed time period, after which they will be paid back. This may be 5 or 10 years or in some cases even longer. In some cases they carry perks with them. Much of the new number 1 court at Wimbledon was funded by issuing debentures in return for which people get preferential deals on tickets.
They are often attractive because they tend to be a secure investment, and because the interest will have to be paid, whatever the level of profit. This makes them less risky than ordinary shares. For the firm they can be a good way of raising money because they are predictable. It can plan ahead the cash requirement for paying the interest, and knows exactly when they will have to be redeemed.
Mortgages
A mortgage is also a form of long-term loan. However, it will usually tend to be on property or some other fixed asset. It will be what is known as a secured loan. This means that the loan is secured to the asset it was borrowed for. If the money was borrowed, for example, to finance the purchase of a plot of land and the firm fails to make the required loan payments, then the lender can start legal proceedings to repossess the asset. This means that they will then own it, and can sell it to get their money back. Any surplus would of course be returned to the firm.
The rate of interest may be fixed for a period or it may vary with market rates of interest.
Long-term loans
Other long-term loans may, unlike the mortgages, be unsecured loans. This means that the bank or financial institution that lent the money does not have any title over any of the firms assets, and they would have to go through the courts to get any money back. This can prove to be a lengthy and expensive process. An unsecured loan will therefore tend to attract a higher rate of interest then a secured one where the lender is more certain of recovering their money in the event of a problem.
All these long-term liabilities will be shown on a balance sheet and subtracted off the net current assets to give the net assets. They may alternatively be shown as a part of the firm's source of funds in the bottom half of the balance sheet. Where they are shown is simply an accounting convention and does not alter their meaning at all.
What are Net Assets?
Assets are anything which the firm owns or has title to (in other words ownership of). The term net then means all assets net of liabilities. Net assets are therefore:-
NET ASSETS = Total Assets - Total Liabilities
The total assets are made up of fixed assets (plant, machinery and equipment) and current assets which is the total of stock, debtors and cash.
The total liabilities are made up in much the same way of long-term liabilities and current liabilities.
The net assets figure therefore can be used as a measure of the value of the business. It is the value of everything the business owns after all the debts have been taken account of. For more detail of how this can be used as a measure of the value of a business try going to the theory section of the worksheet below.
NET ASSETS = Total Assets - Total Liabilities
The total assets are made up of fixed assets (plant, machinery and equipment) and current assets which is the total of stock, debtors and cash.
The total liabilities are made up in much the same way of long-term liabilities and current liabilities.
The net assets figure therefore can be used as a measure of the value of the business. It is the value of everything the business owns after all the debts have been taken account of. For more detail of how this can be used as a measure of the value of a business try going to the theory section of the worksheet below.
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