Day 13 Summary of studying Financial Accounting(cont.)

Summary of studying Financial Accounting(cont.)

Chapter 14 outlines the last type of ownership - the company. A company is owned by the shareholders and managed by the board of directors. It has continuous life and limited liabilities to its shareholders. Distinguish from partnership, a company does not apply mutual agency. Although has these advantages, the company faces stricter government regulation and tax responsibilities. To form a company, we need to apply to the ASIC for the certificate of registration. The company shareholders’ equity are combined with two parts: the share capital plus the retained earnings. Whereas share capital is obtained by issuing ordinary/preference shares, and retained earnings come from profitable operations. The differences between ordinary and preference shares are: The preference have the advantage of getting paid first at a fixed dividend rate and may claim for the asset on company’s liquidation. However, the voting rights are normally withheld from them. Generally, ordinary shareholders face the greater investment risk than preference share holders, but have the potential of large returns if the company runs really well. In the share market, the company usually issues share by installment. At first it is open for applications for the down-payment, followed by another allotment payable. After that, it makes a call for the last payment of the share. When a share is too popular, the company will receive over subscriptions. The director may choose to reject the over subscription's amount or to keep the excess for future calls. If the shareholder fails to pay for the call when it's due, the company will forfeit the share capital of him. Of course, there can be a reissue of the forfeited shares take place, in that situation, a refund of the remaining amount in the forfeited share account( subtract the loss for the reissue) may be required by the legalization. Company pays the cash dividends by debit retained earnings and credit dividends payable account. There are three important dates of it: The declaration date, the date of record and the payment date. Most of the preference shares use cumulative dividend's method, which means when there is arrears from last year, then the dividends payable from this year must add that amount. The comparison of market value and book value of the share provides the investor the basic evaluation of the share performance. At last, this chapter briefly introduces the calculation of income tax expense( Profit payable before income tax* rate) and the income tax payable( total tax payable income* rate). The differences between them are reported as deffered tax liability/ future tax benefits.

Chapter 15 continuous on account in companies. It explains the concept of another form of dividends- share dividends. Share dividends follow the pattern of cash dividends, but credit against the shareholders' capital at payment. The share dividends occur when the business wants to reserve cash without sacrificing dividend's distribution. It also helps to reduce the share price, so the share can attract more investors. Nonetheless, the share splits, which increase the ordinary shares number based on the previous proportion of shares will also decrease the market price. On contrary to these two methods, a company may support their share price by the share buy-backs. The company purchases its own shares and retires them by canceling the shares. Ordinarily, the buy-back is recorded a debit against capital, but when the capital has a nil balance, it can debit against retained earnings. In business operation, the director may decide to transfer the retained earnings to a separate account for specific use or general reserve. This action will not affect the balance of the retained earnings, because the amount will be transferred back once the reserve is not needed. The company’s income statement must disclose the profit/loss from continuing/discontinued operations. The continuing operation is the profit earning activates that business carries period to period. The discontinued operations are the income not likely to reappear in the future, such as selling a business’ segment. Moreover, the company needs to report certain items on the statement of change in equity. For instance, change in Asset Revaluation Reserve, net exchange difference on conversion of foreign operation reports or income tax on items included directly in equity. At the end of chapter, the most widely used ratio is introduced. The Earnings per share ratio is calculated by (Net Profit- Preference dividends)/Weighted average number of ordinary shares issued. It relates the profit to one share, since indicates the profitability.

Chapter16 lectures another type of company financing, non-current borrowing. The debentures are the most common non-current liabilities inside a company. It is usually secured by a company’s asset, therefore it can be called mortgage debentures. There are two types of debentures: term and serial. The serial debenture pays it maturity value plus interest expense in installments. The market value is the present value for the principal amount adds the present value of nominal future interest. It represents as the quote(percentage) of the debenture maturity value. When the market interest rate > nominal interest rate, the debenture is issued in a lower price than principal. Hence there is a discount on debenture. In contrast, there will be a premium amount. These two amount need to be amortized through the debenture’s interest expense. The discount will be reported as an addition of interest expense. And the premium as a subtraction to the interest expense. The company shall use straight-line method or effective method to calculate the amortization amount. In fact, the interest expenses do not always fall on the date or recording, and consequently, the accrued interest payable needs to be adjusted. If the debenture is issued between its interest payment date, the company should collect the prior months’ interest and cumulative with the interest expense at the remaining months. Thereby, at the next interest payment date, the total amount can be paid out to the current owner of the debenture. The company will proceed a debenture's redemption with the aim to release interest pressure or to borrow at a lower rate. There may be a callable rate with the debenture, so the company may call back the debenture any time with that rate or the market rate, depends which one is lower. As a result, the redemption may create gain/loss on redemption. There is a type of debenture that can be converted to ordinary shares under agreement, which is really popular. The advantage and disadvantage of borrowing over shares are both related to interesting payments. Even though the interest payment is a burden on company’s cash flow, it also provides income tax deductions which can leads to higher earnings per share ratio. 

Chapter 17 overviews the accounting process when the business performing as an investor. Three ways of recording are used to adopt different situation. If the investment amount is less than 20% of the investigate holding shares, the fair-value shall be adopted. For the short-term trading investments, a revaluation of the investment to market value is carried out at the end of the year. So a gain/loss on short-term investment will occur under other gain/loss section of income statement. For the long-term available-for-sale investment, the allowance to adjust investment to market account is used for the revaluation. However, the changed value needs to be recorded as unrealized gain/loss on investment, because it is the result of market price variation. It is an equity in the balance sheet under the retained earnings. At the point of sale, the amount will be realized and become part of gain/loss on sales of available-for-sale investment. Furthermore, if the company holds the shares between 20% and 50%, the equity method should be applied. The reason of that is the inventory with that proportion of ownership has a significant influence on investee's management decisions. Under the equity method, the investment will be recorded at cost. The investor will share the business’ net profit in addition to the investment base on the proportion of the shares. On the other hand, the dividend revenue becomes a decrease in the investment. After these two adjustments, the gain/loss of sale the investment also needs to be re-evaluated. Whenever the investor's business holds more than 50% of shares in a company, it turns to being the holding company for investee.The business will need to provide consolidate a report which consists with all the subsidiary companies report to the parent. The net profit is calculated as the sum of the parent and the subsidiaries. If the investor is holding debentures, the amortization of discount/premium still needs to be recorded. The foreign currencies exchange gain/loss are included at last.

Chapter 18 reviews the cash flow statement. There are two formats on preparing cash flow statement: the direct and in-direct method. Both of them divided the cash flows into operating activities, investing activities and financing activities. The operating activities are related to current-assets current-liabilities and owner's equities that make up net profit. The investing activities involve buying/selling non-current assets. The financing activities obtain the cash through long-term liabilities or rising share capitals. Nevertheless, the interest revenue/loss and dividends' revenue are reported as operating activities due to, they affect net profit. Th dividend's payment is a financing activity. With the direct method, every cash-related account are listed below these three categories. The indirect method affects only the operating activities. It begins with net profit then add up depreciation expenses plus loss on sales of assets. After that, it adds all decrease in current assets, and all increase on current liabilities. Subtracts increase in current assets with all decrease in current liabilities. The formulas for calculating cash amounts in these activities are given as below: