The University of Chicago Financial Accounting 30000

Booth School of Business

Adobe Systems, Inc.

Stock splits, dividends, and stock repurchases

Adobe Systems Inc. (Adobe) is a California-headquartered multinational software company

focused on digital media and digital marketing. Adobe was founded in December 1982
by John Warnock and Charles Geschke to develop and sell the PostScript page description
language. Adobe had its IPO in August 1986 at a split-adjusted share price of $0.17; and, as
of February 2013, Adobe’s market capitalization was about $20.70 billion. The price of its
stock was increasing since IPO and the company had six stock-splits with the first one in
March 1987. The most recent two-for-one stock split happened in May 2005. After this stock
split, the company also ceased paying cash dividends. Instead it intended to utilize the cash
used to pay dividends for its ongoing stock repurchase (buyback) programs.

Answer the following questions using excerpts from the Adobe’s Consolidated Statement of
Financial Position, Consolidated Statement of Income, Consolidated Statement of Cash
Flows, and Consolidated Statement of Stockholders' Equity from its 10-K for fiscal year
ending December 31, 2006.

1. Why do you think Adobe splits its shares? What is the effect of stock splits on
Shareholders' Equity, return on equity (defined as Net Income/Stockholders’ Equity),
and return on assets (defined as Net Income/Total Assets)?

2. Why do you think Adobe engages in stock repurchases?

3. Please, answer the following questions regarding fiscal year ending December 1,
2006.

a. How many shares did Adobe buy back in fiscal year 2006?

b. What was the average price Adobe paid to buy back these shares?

c. How many shares did Adobe re-issue from the treasury under its employee
compensation plans in fiscal year 2006?
 d. What was the average amount per share Adobe received from its employees on
shares re-issued under its employee plans in fiscal year 2006?1

e. How does the amount you calculated in part (d) compare with the average price
Adobe paid to buy back its shares in fiscal year 2006? What explains the
difference?

4. Does Adobe account for its stock buybacks as “Treasury Stock” or as “Retirement of
Shares” in 2006? Explain its accounting treatment of stock buybacks.

5. What are the effects of Adobe's stock buybacks on Total Assets, return on equity
(defined as Net Income/Stockholders’ Equity), and leverage (defined as Total
Liabilities/Total Stockholders’ Equity)?

                                                            
1
 Basic journal entries for employee stock options are as follows. First, recognize stock option
compensation expense on a straight-line basis over vesting period. Suppose the firm grants 30 thousand of
employee stock options at an exercise price of $20. Assume that options vest over three years and the total fair
value of these options at the grant date is $300 thousands. In each of the three years, the firm will recognize
compensation expense:

(in $ thousands)
DR Compensation expense (+E, -SE) $100 = $300/3
CR Paid-in-capital (Stock-based compensation) (+SE) $100

Under US GAAP, the value of options (fair value), is measured only once, at the grant date. Further,
suppose that the price rises above $20 after the vesting period (i.e., after the three years) and all 30 thousand of
options are exercised on the same day. The entry to record the exercise of employee stock options (assuming $1
par value of stock) if the firm issues new shares:

(in $ thousands)
DR Cash (+A) $600 = $20 x 30 thousand shares
DR Paid-in-capital (Stock-based compensation) (- SE) $300
CR Common stock (par) (+SE) $30 = $1 x 30 thousand shares
CR Paid-in-capital in excess of par (+SE) $870

Under current U.S. tax law, firms are allowed a tax deduction for the intrinsic value of the options, i.e.,
for the difference between the share price and the option exercise price in the exercise year. This tax deduction
represents tax benefit which is a part of cash from financing.