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102 Accounting Demystified need to deliver stock to fulfill the company’s obligation to a stock option or bonus plan. In any event, the stock repurchased by the company is called treasury stock. If there is a difference between the number of shares issued and the number of shares outstanding, it is because of treasury stock. Once the stock has been issued to the public, it is counted as issued, but if it is repurchased by the company and held as treasury stock, it is not included in the total of the stock outstanding. If a company has no treasury stock, then the figures for the issued and outstanding shares will be the same. The following example will illustrate: Example A Number of shares authorized: Number of shares issued Number of treasury shares 1,000,000 shares 500,000 shares 0 shares Therefore, the number of shares outstanding is 500,000 shares (500,000 shares issued – 0 shares in treasury). Example B Number of shares authorized Number of shares issued Number of treasury shares 1,000,000 shares 500,000 shares 200,000 shares Therefore, the number of shares outstanding is 300,000 shares (500,000 shares issued  200,000 shares in treasury). Recording the Issuance No matter whether the stock is par value, no par value but stated value, or no par value, the debit part of the transaction 103 Stockholders’ Equity is always what the company receives. Usually this is cash. The credit side depends on the type of stock: whether it is par value, no par value but stated value, or no par value. If there is a par value or a stated value, there will be a credit to an account called Common stock for the number of shares issued multiplied by the par or stated value. If this is less than the amount received, there will be another credit to an account called Additional paid-in capital or sometimes Paid-in capital in excess of par. So let us assume that a company has stock with a par value of $0.01. The company sells 100,000 shares on February 22, 2002, for a total price of $500,000. The entry would be: 2/22/02 Cash Common stock 500,000 1,000 (A) (B) 499,000 (C) Additional paid-in capital To record issuance of stock (A) is the amount received (B) is 100,000 times $0.01 (C) is the amount needed to balance the journal entry If the stock issued were no par value, the entry would be: 2/22/02 Cash 500,000 Common stock 500,000 To record issuance of stock Treasury Stock When a company buys its own stock in the open market, the entry is fairly straightforward. The company records the 104 Accounting Demystified amount paid as a debit to Treasury stock (which is a reduction in the stockholders’ equity section) and a credit to Cash for the amount paid for the stock. Let’s assume that on December 11, 2002, a company repurchases 1,000 shares of its stock in the open market at a price of $4.00 per share. The entry to record the repurchase is: 12/11/02 Treasury stock 4,000 Cash 4,000 To record purchase of treasury stock The stockholders’ equity section of the balance sheet will appear as follows: Stockholders’ equity Common stock (1,000,000 shares authorized, 500,000 issued, and 499,000 outstanding; par value of $0.01) $ 5,000 Additional paid-in capital 495,000 Subtotal 500,000 Less: Treasury stock 4,000 Total contributed capital Retained earnings 496,000 250,000 Total stockholders’ equity $746,000 Dividends A company will generally issue dividends in the form of cash. Sometimes it will issue additional shares of its stock as a dividend (called a stock dividend) when it wants to issue a dividend but does not have the cash available for a cash dividend. Only the board of directors of a company may declare a divi- 105 Stockholders’ Equity dend. Once a dividend is declared, it cannot be rescinded. The declaration of a dividend by the board of directors legally binds a company to pay that dividend. There are many dates associated with the dividend. The date on which the dividend is declared by the board of directors is called the declaration date. On the declaration date, the company will make a journal entry to record the declaration of the dividend. It does this by debiting the Dividends account and recording a liability to pay the dividend. If there were 1,000,000 shares outstanding on December 18, 2002, and the board of directors declared a $1.00 dividend, the entry would be: 12/18/02 Dividends 1,000,000 Dividends payable 1,000,000 To record the declaration of a dividend (1,000,000 shares outstanding  $1.00 per share) When the company declares the dividend, it will indicate a record date. Whoever owns the shares at the close of business on the record date will be entitled to the dividend. The record date enables the company to determine which shareholders get the dividend. Since the stock may be traded constantly, specifying the record date allows the public to know who will get the dividend. There is no journal entry needed on the record date. The payment date is the date on which the company will send out the checks. Using the figures from the previous example, if the payment date is December 30, 2002, the entry will be: 106 Accounting Demystified 12/30/02 Dividends payable Cash 1,000,000 1,000,000 To record the payment of dividends No dividends are paid on treasury shares. If a company has treasury stock, these shares do not receive the dividend. If a company has 1,000,000 shares authorized, 500,000 issued, and 499,000 shares outstanding, then the declaration of a $1.00 per share dividend on December 19, 2002, would result in the following entry: 12/19/02 Dividends 499,000 Dividends payable 499,000 To record declaration of dividends (499,000 shares outstanding  $1.00 per share) C H A P T E R 17 Merchandising Companies The examples we have used so far have not discussed some characteristics that are specific to merchandising companies. Service companies offer a service to the public, such as accounting, bookkeeping, legal, architecture, billing, or consulting services. They derive their revenue by providing these services, with the sale of any merchandise being incidental to their operations. In contrast, merchandising companies get their revenue from the sale of merchandise or goods. They may get some revenue from the sale of services, but this is incidental to their operations. The differences between service companies and merchandising companies are reflected in the financial statements. On the Balance Sheet, there is a minor difference: The merchandising company has inventory, and the service company does 107 108 Accounting Demystified not. The bigger difference is on the Income Statement. The basic Income Statement used by service companies (also called the single-step Income Statement) is shown in Figure 17-1. This type of Income Statement is called a single-step income statement because there is only one subtraction necessary to arrive at net income. Merchandising companies add at least one more step to the Income Statement. Since merchandising companies earn their revenue from the sale of products, the Income Statement needs to reflect both the money received from the sale of the goods and the cost of the goods that were sold. This interim step adds a subtotal called gross profit. Gross profit is the difference between revenue and the cost of goods sold (see Figure 17-2). FIGURE 17-1 Jeffry Haber Company Income Statement For the Year Ended December 31, 2002 Revenues: Sales Interest income $2,500,000 24,000 Total revenue $2,524,000 Expenses: Salaries Professional fees Payroll taxes Rent Utilities Office supplies Office expense $1,875,000 240,000 187,500 110,000 23,000 15,000 12,000 Total expenses $2,462,500 Net income $61,500 109 Merchandising Companies FIGURE 17-2 Jeffry Haber Company Income Statement For the Year Ended December 31, 2002 Sales Cost of goods sold Gross profit $2,500,000 1,650,000 $850,000 There are a lot more expenses to be accounted for on the Income Statement than those shown in Figure 17-2. The next section is called operating expenses, and it is broken down into selling expenses and general and administrative expenses (see Figure 17-3). Selling expenses are those expenses that are related to the selling of the merchandise. These include salaries of sales personnel, rent, utilities, repair and maintenance and other occupancy expenses, the cost of shipping the merchandise to customers, and other expenses that can be directly related to the sales function. General and administrative expenses are those expenses that are related to the management of the company. These often include salaries for the executive, legal, human resources, and accounting departments; the related payroll taxes on those salaries; occupancy costs for the administrative offices; and general fees and costs paid by the company. Often a company gets interest on its bank account (grouped with ‘‘other income’’) or pays interest on outstanding borrowings (grouped with ‘‘other expense’’). These are usually grouped together after the operating income line. If the company has very few ‘‘other income’’ and ‘‘other expense’’ 110 Accounting Demystified FIGURE 17-3 Jeffry Haber Company Income Statement For the Year Ended December 31, 2002 Sales Cost of goods sold Gross profit $2,500,000 1,650,000 $850,000 Operating expenses: Selling expenses: Salaries Payroll taxes Rent Repair and maintenance Real estate taxes Freight out 125,000 34,000 12,000 10,000 8,000 6,500 Total selling expenses 195,500 General and administrative expenses: Salaries Payroll taxes Rent Repair and maintenance Real extate taxes Subscriptions Professional fees 365,000 42,000 24,000 10,000 7,000 2,500 2,000 Total general and administrative expenses 452,500 Operating income $202,000 items, it can group these items in one category (usually called ‘‘other income and other expense’’), as shown in Figure 17-4. If there are numerous items, there should be a separate section for each category, as shown in Figure 17-5. When you add other income to operating income and sub- 111 Merchandising Companies FIGURE 17-4 Other income and expense: Interest income Interest expense 23,000 2,000 Total other income and expense 21,000 FIGURE 17-5 Other income: Interest Dividends Gain on sale of asset 23,000 15,000 12,500 Total other income 50,500 Other expense: Interest Loss on sale of asset 2,000 1,500 Total other expense 3,500 Total other income and expense 47,000 tract other expense from it, you get a figure called income before taxes. Subtracting income taxes yields the final line of the Income Statement, net income. Figure 17-6 shows the entire multistep Income Statement. Perpetual Inventory System If things were in fact this simple, it would not be so bad, but they can get more complicated. The multistep Income Statement illustrated is perfect, as long as the company uses a perpetual inventory system. In the perpetual inventory system, Cost of goods sold is recorded each time a sale is made (hence