Does Issuing New Stock Affect Retained Earnings?

Content

• How Are Retained Earnings Different From Revenue?
• Fallacy 3: Stock Option Costs Are Already Adequately Disclosed
• Return On Common Equity
• Analyzing An Income Statement
• Stock Options

“Within rather broad parameters,” says Peat, Marwick, Mitchell partner James Weir, choosing the functional currency is basically a management call. The Brazilian subsidiary of a U.S. parent purchased land does common stock affect net income at the end of 1984 for 10,000,000 cruzeiros (Cr$) when the exchange rate was $0,001 per Cr$. The temporal method requires translating fixed assets acquired at different times at different exchange rates.

The corporation transfers retained earnings to the stock’s capital accounts to pay for the stock dividend. Parent companies can hedge balance sheet exposure by using a derivative financial instru­ment, such as a forward contract or foreign currency option, or a non-derivative hedging instru­ment, such as a foreign currency borrowing. To illustrate, assume that SWISSCO’s functional currency is the Swiss franc; this creates a net asset balance sheet exposure. USCO believes that the Swiss franc will depreciate, thereby generating a negative translation adjustment that will reduce consolidated stockholders’ equity. USCO could hedge this balance sheet exposure by borrowing Swiss francs for a period of time, thus creating an offsetting Swiss franc liabil­ity exposure.

How Are Retained Earnings Different From Revenue?

As an alternative to the Swiss franc borrowing, USCO might have acquired a Swiss franc put option to hedge its balance sheet exposure. A put option gives the company the right to sell Swiss francs at a predeter­mined strike price. Looking at SWISSCO’s translated balance sheet in Exhibit 10.5, note that all assets and liabilities are translated at the current exchange rate. Common stock and additional paid-in capital are translated at the exchange rate on the day the common stock was originally sold. Exposure to translation adjustment is referred to as balance sheet, translation, or accounting exposure.

As a result, both retained earnings and shareholders’ equity are closely watched by investors and analysts since these funds are used to pay shareholders via dividends. Retained contra asset account earnings are reported under the shareholder equity section of the balance sheetwhile the statement of retained earnings outlines the changes in RE during the period.

• A net liability balance sheet exposure exists when liabilities translated at the current exchange rate are higher than assets translated at the current exchange rate.
• With a completely liquid stock, an otherwise unconstrained investor could entirely hedge an option’s risk and extract its value by selling short the replicating portfolio of stock and cash.
• He has authored articles since 2000, covering topics such as politics, technology and business.
• Adding up all of your gross income for the year gives you your annual gross income.
• Income is ordinary in cases where the debt is an open receivable and capital gain if evidenced by a formal note.

Those who hold common stock have voting rights in a company, which means that they have a say in corporate policy and decisions. Preferred stockholders, by contrast, do not have voting rights, though they have a higher claim on earnings than holders of common stock. Common stockholders can make money by collecting dividends, which are a portion of a company’s earnings that it chooses to share.

If a complex situation comes up, tackle it right away, not 10 years down the road when information and memories are incomplete. Consider saving all Schedules K-1 to the company’s permanent file in case basis needs to be re-created or reviewed. Finally, consider adding language to engagement letters addressing the basis tracking responsibilities so clients are aware of recordkeeping obligations.

It is indeed true that, in general, an instrument’s lack of liquidity will reduce its value to the holder. But the holder’s liquidity loss makes no difference to what it costs the issuer to create the instrument unless the issuer somehow benefits from the lack of liquidity. And for stock options, the absence of a liquid market has little effect on their value to the holder. The great beauty of option-pricing models is that they are based on the characteristics of the underlying stock. That’s precisely why they have contributed to the extraordinary growth of options markets over the last 30 years. The Black-Scholes price of an option equals the value of a portfolio of stock and cash that is managed dynamically to replicate the payoffs to that option. With a completely liquid stock, an otherwise unconstrained investor could entirely hedge an option’s risk and extract its value by selling short the replicating portfolio of stock and cash.

Fallacy 3: Stock Option Costs Are Already Adequately Disclosed

The ultimate effect of cash dividends on the company’s balance sheet is a reduction in cash for $250,000 on the asset side, and a reduction in retained earnings for $250,000 on the equity side. Cash dividends affect the cash and shareholder equity on the balance sheet; retained earnings and cash are reduced by the total value of the dividend.

Cash-related activities involving creditors and owners are recorded in the financing section. Therefore, when you issue stock for cash, the cash flow statement shows an increase in cash under financing activities. Conceptually, when the current rate method is employed income statement items can be translated at either the average or the current exchange rate. Retained earnings represent the portion of a company’s net income during a given accounting period that isn’t paid out to stockholders as dividends, but rather, is retained to reinvest in the business. Retained earnings are recorded under shareholders’ equity on a company’s balance sheet. A company might choose to retain its earnings to develop new technology, upgrade its software, or acquire smaller competing companies. Retained earnings are calculated by taking the beginning net earnings balance during an accounting period, adding the company’s net income during that period, and subtracting the amount of dividends paid to stockholders.

If basis is unknown or incorrect, a shareholder might incorrectly deduct losses he or she is not entitled to deduct. Note that in general, credits are not limited to basis, so in a given year, a taxpayer would not be able to enjoy the tax benefit of a loss without basis but would be able to enjoy the benefit of a credit regardless of basis. However, in some instances credits can affect basis, directly or indirectly, so be sure to review the rules regarding specific credits carefully.

A weighted average number is used instead of a year-end number because the number of common shares frequently changes throughout the year. You can earn a capital gain on pretty much any asset you sell for more than you paid for it. However, in many cases, you won’t have to pay capital gains tax on a profit from a home sale. In summary, net income is a company’s total earnings or profit, and net revenue is the amount of income generated from the sales of goods or services related to a company’s core business.

Income is ordinary in cases where the debt is an open receivable and capital gain if evidenced by a formal note. Common basis increases include capital contributions, ordinary income, investment income and retained earnings gains; common decreases include Sec. 179 deductions, charitable contributions, nondeductible expenses and distributions. That’s not to say, of course, that entrepreneurs should never get option grants.

The first step in translating foreign currency financial statements is to determine the func­tional currency. Assuming that the Swiss franc is the functional currency, the income statement and statement of retained earnings are translated into U.S. Under the current rate method, the QuickBooks ending inventory reported on the foreign currency balance sheet is translated at the current exchange rate regardless of whether it is carried at cost or a lower market value. A corporation can issue new shares to existing shareholders through stock dividends and stock splits.

As is true in the consolidation of domestic subsidiaries, the investment account, the sub­sidiary’s equity accounts, and the effects of intercompany transactions must be eliminated. The excess of fair value over book value at the date of acquisition also must be allocated to the appropriate accounts . More and more corporations are hedging their translation exposure—the recorded value of inter­national assets such as plant, equipment and inventory—to prevent gyrations in their quarterly accounts. Though technically only paper gains or losses, translation adjustments can play havoc with balance-sheet ratios and can spook analysts and creditors alike. In addition to differences in amounts reported in the consolidated financial statements, the results of the SWISSCO illustration demonstrate several conceptual differences between the two translation methods.

With compounding, this equates to an average of approxi­mately 26 percent per year for three years in a row. Countries that have met this definition at some time after SFAS 52 implementation include Argentina, Brazil, Israel, Mexico, and Turkey. In any given year, a country may or may not be classified as highly inflationary, depending on its most recent three-year experience with inflation.

You can figure your company’s net income for the year based on the company’s change in net income. However, dividends paid count towards the company’s net income, so you have to account for dividends paid out.

Return On Common Equity

Additional paid-in capital reflects the amount of equity capital that is generated by the sale of shares of stock on the primary market that exceeds its par value. The par value of a stock is the minimum value of each share as determined by the company at issuance. If a share is issued with a par value of $1 but sells for $30, the additional paid-in capital for that share is $29.

Because the British pound has been determined to be the functional currency, this translation uses the current rate method. The historical exchange rate for translating Bradford’s common stock and January 1, 2008, retained earnings is the exchange rate that existed at the acquisition date—$ 1.51. As the Swiss franc depreciates the U.S. dollar value of the Swiss franc borrowing decreases and USCO will be able to repay the Swiss franc borrowing using fewer U.S. dollars. This generates a foreign exchange gain, which offsets the negative translation adjustment aris­ing from the translation of SWISSCO’s financial statements.

Analyzing An Income Statement

Translate the net asset balance of the subsidiary at the beginning of the year at the exchange rate in effect on that date. The translation adjustment can be derived as the amount needed to bring the balance sheet back into balance. During 2009, SWISSCO purchased property and equipment, acquired a patent, and pur­chased additional inventory, primarily on account. It negotiated a five-year loan to help finance the purchase of equipment. It generated income after taxes of CHF 470,000 and declared dividends of CHF 150,000 on October 1, 2009. Companies objected to making inflation adjustments, however, because of a lack of reli­able inflation indices in many countries.

Dollars using the temporal method with translation adjustments reported as remeasurement gains and losses in income. When a foreign currency is the functional currency, foreign cur­rency balances are translated using the current rate method and a translation adjustment is reported on the balance sheet. To keep the accounting equation in balance, the increase in liabilities must be offset by a decrease in owners’ equity , giving rise to a negative translation adjustment. Liabilities translated at the current exchange rate when the foreign currency has appreciated generate a negative translation adjustment. The increase in dollar value of the Land due to the vilsek’s appreciation creates a positive translation adjustment. This is true for any asset on the Gualos subsidiary’s balance sheet that is translated at the current exchange rate. Assets translated at the current exchange rate when the foreign currency has appreciated generate a positive translation adjustment.

Stock Options

Only the current period’s dividends should be considered, not any dividend in arrears. For non-cumulative preferred shares, the dividends should only be deducted if the dividend’s been declared. If you didn’t sell any stocks in the current tax year, you won’t pay capital gains tax but you may still have to pay tax on dividend income from stocks you own. Then, deduct the cost of doing business, which includes materials, rent or mortgage payment, the salaries you pay your employees, utility bills, and so on. Gross income shows up on your income statement as a starting figure. It’s then reduced by discounts, price adjustments, returns, and any other deductions to determine net income or net earnings.

In that case, the Swiss franc financial statements must be remeasured into U.S. dollars using the temporal method and the remeasurement gain or loss reported in income. To ensure that the remeasurement gain or loss is reported in income, it is easiest to remeasure the balance sheet first (as shown in Exhibit 10.7). Investing and financing activities are translated at the exchange rate on the day the activity took place.

How Do You Calculate A Company’s Equity?

As the accrual method is used for the Balance sheet and Income statement this records income and expenses when income is earned and when an expense is made. This ensures that depreciation is recorded in both the Income statement and the balance sheet. I—Eliminates the amount of equity income recognized by the parent in the current year and included in the Investment in Bradford account under the equity method.