Let's see how we are going to do the accounting for
these type of distributions.
Let's start with dividends and here's a small example.
We have a firm with 10,000 shares outstanding, declares and
pays $1 per share as dividends.
In terms of accounting, there is a reduction of $10,000,
which is 10,000 shares times $1 each as a dividend.
There is a $10,000 decrease in cash.
At the same time, there will be $10,000 decrease from retained earnings.
The important detail here is dividends are paid from retained earnings.
Does this make sense?
It does make sense, if you remember from the previous slides, retained earnings is
the total amount of profits earned by firms but not distributed to shareholders.
Then these profits are distributed to shareholders because normal debt,
there should be a reduction in retained earnings.
Here is an example about share repurchases.
We have a firm repurchasing 100 shares from the stock market
by paying $1,500 in total.
How do we do the accounting for this?
Notice that first of all,
we are paying $1,500, therefore there is a cash reduction of 1,500.
But at the same time, we created a very special account
under shareholders' equity and this account is called treasury stock.
Treasury stock has a negative balance because it's recorded under
shareholders' equity and it's an account used to record repurchased shares.
The question here is why have they repurchased some of these shares?
There are many reasons.
The first one is, the firm is signaling that look, we have lots of money.
We can do a lot of other things but instead, we trust our firm and
to show our trust, we're repurchasing some of our shares back.
In other words, the firm is giving confidence to the marketplace and because
of this confidence, it's possible that stock market price of shares can go up.
Second reason is repurchased shares
are not counted with an outstanding number of shares.
An outstanding number of shares is an important number that we are going to see
in the next lesson when we are calculating earnings per shares.
Basically, by repurchasing shares, firms can reduce the outstanding number of
shares and can increase earnings per share and
as I said, we are going to see an example about this soon.
The third reason is that repurchased shares can be used by firms as
a compensation to employees.
It's a big hassle in terms of legal fees, etc., to print shares.
Instead of printing shares, firms can just go ahead and either repurchase shares
from the market and distribute those to employees as a form of compensation.
