432 chapter 15 notes 2015

CHAPTER 15

LECTURE NOTESSTOCKHOLDERS’ EQUITY

Table of Contents

Page

Overview of stockholders’ equity 2

Examples of stock transactions 4 Accounting for donations of assets to a corporation by a government 9 Accounting for treasury stock 9 Cost method of accounting for treasury stock 11 Preferred stock 16 Redeemable preferred stock 16 Accounting for dividends 18 Cash dividends 19 Allocation of cash dividends between preferred and common 22 Liquidating cash dividends 24 Property dividends 25 Small stock dividends 27 Large stock dividends 30 Stock splits 33 Reverse stock splits 34 International financial reporting standards 37 Appendix A: Financial statement analysis 38 Appendix B: Par value method of accounting for treasury stock 41 Appendix C: Retained earnings appropriations 44 Appendix D: Fully and partially participating preferred stock 45 Quiz 47

Overview of stockholders' equity for a corporation:

Assets are financed by creditors and by owners. This is what the equation “assets equal liabilities plus stockholders’ equity” is telling us. Assets minus liabilities equals stockholders' equity (net assets). Stockholders' equity is the residual interest in a corporation. It is the amount left after liabilities are paid.

Assets = Liabilities + Stockholders’ equity

Assets – Liabilities = Stockholders’ equity(residual interest)(net assets)

Stockholders' equity is reported on the balance sheet according to source. The sources of stockholders’ equity are:

Contributed capital:

Common and preferred stock is valued at par value or stated value.* Additional paid-in-capital is the amount recorded in stock transactions that is

above par value or stated value. Par value or stated value is the amount of a corporation's legal capital.

In many states, it is illegal for total stockholders' equity to be less than legal capital as a result of discretionary actions by the board of directors or management of the company. In both cases below, total stockholders’ equity is lower than the legal capital of $20,000. Case I demonstrates that all of the treasury stock should not have been acquired because it reduced total stockholders' equity below legal capital. The acquisition of treasury stock is the result of a discretionary action by the company. Case II shows a deficit in retained earnings that causes stockholders' equity to be less than legal capital. It is not illegal for losses to cause total stockholders' equity to be less than legal capital.

Case I Case II

Common stock, par value(legal capital) $ 20,000 20,000Additional paid in capital 80,000 80,000Retained earnings 50,000 (82,000) Total $ 150,000 18,000Less treasury stock at cost ( 132,000) -0- Total stockholders' equity $ 18,000 18,000

====== ======* Stated value is found in states that do not require par value. The difference between par value and stated value is that par value per share is determined when the stock is authorized whereas stated value is determined after the stock is issued. When stated value is used, the common stock is said to be “no par stock with a stated value of $X.” For example, a corporation can issue no par common stock with a stated value of $5 per share. All proceeds above $5 per share are credited to additional paid in capital.

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Retained earnings:

Total net income minus total net losses since the corporation started; Less total dividends declared on both common and preferred stock since the

corporation started.

Accumulated other comprehensive income:

Unrealized gains and losses on available-for-sale securities-covered in 432/532. Prior service cost amendments and actuarial gains and losses related to defined

benefit pension plans-covered in 432/532. Translation adjustments from translating foreign subsidiaries-covered in

433/633. Gains(losses) on the effective portion of cash flow hedges-covered in 433/633.

Other item reported in the stockholders' equity section:

Treasury stock (contra equity).

Stock terminology:

Authorized stock--the number of shares of preferred and common stock that the state of incorporation has authorized to be issued. The number of shares authorized (common and preferred) is disclosed in the stockholders’ equity section of the balance sheet.

Issued stock--the number of shares of preferred and common stock that have been fully paid for. Stock can be issued for cash, other assets, or for services provided to the corporation.

Outstanding stock--the number of shares of preferred and common stock that are (1) fully paid for and (2) have not been reacquired as treasury stock. Treasury stock is issued stock that is no longer outstanding stock. Outstanding shares equals issued shares less treasuryshares.

Financial statement effects of stock transactions—amounts are assumed:


+cash $5,000 +common stock(par) $1,000+additional paid-in capital, 4,000(Stock was issued for morethan its par value)

-cash $2,000 -treasury stock(cost) $2,000

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+cash $2,500 +treasury stock(cost) $2,000+additional paid-in capital 500(Treasury stock was sold formore than its cost)

Transactions involving stock issuances are between the corporation and investors who acquired unissued stock. Once the stock has been issued, investors can sell the stock to other investors, but the corporation does not receive the cash or other assets. Cash received from issuing stock and cash paid to acquire treasury stock are reported as financing activities on the statement of cash flows.

Common stock

Cash or other assets

Common stock Cash

Examples of stock transactions:

1. On January 7, 2010, Baker Company issued 1,000 shares of 6% cumulative $100 par valuepreferred stock for $105 per share and 100,000 shares of $5 par value common stock for $8 per share. According to Baker's corporate charter, the company has 10,000 shares of preferred stock authorized and 1,000,000 shares of common stock authorized.

1/7/10:

CASH 905,000

PREFERRED STOCK($100 par X 1,000 shares) 100,000

COMMON STOCK($5 par X 100,000 shares) 500,000

ADDITIONAL PAID IN CAPITAL-PREFERRED 5,000($5 X 1,000 shares)

ADDITIONAL PAID IN CAPITAL-COMMON 300,000($3 X 100,000 shares)

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Corporation issues unissued common stock-Initial public offering (IPO)

Investors acquire common stock

Investors acquire common stock from other investors in the secondary market.

Additional paid in capital-preferred and additional paid in capital-common are control accounts for all of the transactions involving the different kinds of additional paid in capital. For example, one type of specific additional paid in capital is from issuance of stock above par or stated value. There are many other types of additional paid in capital as you will see as we progress through the chapter.

2. On January 8, 2010, Baker paid various items that related to the issuance of its preferred and common stock. These stock issue costs amounted to $2,500, of which $500 related to the preferred stock.

1/8/10:

ADDITIONAL PAID IN CAPITAL-PREFERRED 500

ADDITIONAL PAID IN CAPITAL-COMMON 2,000

CASH 2,500

3. On October 10, 2010, Baker contracted to issue 100 shares of its common stock to Art Bell for $9 per share. This is an example of a subscription contract. According to the terms of the contract, Art paid $3 per share on October 10 and the remaining $6 per share on November 10.

10/10/10:

CASH 300

COMMON STOCK SUBSCRIPTIONS RECEIVABLE(REPORTED AS A NEGATIVE ITEM IN STOCKHOLDERS' EQUITY) 600

COMMON STOCK SUBSCRIBED ($5 par X 100 shares) 500

ADDITIONAL PAID IN CAPITAL-COMMON($4 X 100 shares) 400

11/10/10:

CASH 600

COMMON STOCK SUBSCRIPTIONS RECEIVABLE 600

COMMON STOCK SUBSCRIBED 500

COMMON STOCK 500

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4. On November 30, 2010, Baker issued 1,000 shares of its common stock to an attorney inexchange for legal services rendered. The market value of the stock was $10 per share on November 30. The attorney’s invoice showed an amount due of $9,995.

11/30/10:

ADMINISTRATIVE EXPENSES 10,000

COMMON STOCK ($5 par X 1,000 shares) 5,000

ADDITIONAL PAID IN CAPITAL-COMMON 5,000

Legal and accounting costs incurred to start a corporation are referred to as organization costs. Organization costs are expensed immediately in the year the costs are incurred. Organization costs are not deemed to be an asset because they fail the “probable future benefit” test for an asset. Note that common stock was issued for services rendered. When common stock is issued for services and for noncash assets (i.e. land, equipment, etc.), the rule is to value the assets or services received at the fair value of the common stock issued if the fair value is reliable. If the fair value of the common stock is not reliable, then the services or noncash assets received should be valued at their fair values (i.e. the invoice price for services, the selling price of the equipment, and the appraisal value of the land). A common stock price is reliable if the common stock is publicly traded.

DEMONSTRATION OF CONCEPTS: COMMON STOCK ISSUED IN CASH AND NONCASH TRANSACTIONS

CASH(25,000 SHARES X $22) 550,000 Ashe Corp. was organized on January 1, COMMON STOCK 2010, with authorized capital of 100,000 (25,000 SHARES X $20) 500,000 shares of $20 par value common stock. ADDITIONAL PAID IN CAPITAL 50,000 During 2010, Ashe had the following transactions affecting stockholders’ equity: ---------------------------------------------------------------------------

January 10: Issued 25,000 shares at $22 GENERAL EXPENSES (1,000 SHARESa share. X $24) 24,000

March 25: Issued 1,000 shares for legal COMMON STOCK 20,000 services when the fair value ADDITONAL PAID IN CAPITAL 4,000 was $24 per share.

September 30: Issued 5,000 shares for a tract ---------------------------------------------------------------------------of land when the fair value was$26 a share. LAND (5,000 SHARES X $26) 130,000

COMMON STOCK 100,000 What amount should Ashe report for additional ADDITIONAL PAID IN CAPITAL 30,000 paid-in capital at December 31, 2010?

ANSWER: AA. $84,000B. $80,000 1/10: $22 – $20 = $2 X 25,000 shares = $50,000C. $54,000 3/25: $24 – $20 = $4 X 1,000 shares = 4,000D. $50,000 9/30: $26 – $20 = $6 X 5,000 shares = 30,000

$84,000======

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DEMONSTRATION OF CONCEPTS: STOCK SUBSCRIPTIONS

On February 1, 2010, authorized common 2/1/10(AMOUNTS ASSUMED):stock was sold on a subscription basis at a price in excess of par value, and 20% of the CASH 20subscription price was collected. On May 1, STOCK SUBSCRIPTIONS 2010, the remaining 80% of the subscription RECEIVABLE 80price was collected. Additional paid-in capital COMMON STOCK would increase on SUBSCRIBED (PAR VALUE) 10

ADDITIONAL PAID IN CAPITAL 90 February 1, 2010 May 1, 2010 5/1/10:A. No Yes CASH 80B. No No STOCK SUBSCRIPTIONSC. Yes No RECEIVABLE 80D. Yes Yes

COMMON STOCK SUBSCRIBED 10ANSWER: C COMMON STOCK (PAR VALUE) 10

Do exercises 15-2, 15-3, 15-6 (items 1 and 2), and concepts for analysis(CA) 15-2 at this time.

5. Baker’s net income for 2010 was $100,000, and dividends of $20,000 were declared and paid. The next two entries are closing entries that would be made to (1) close revenues and expenses to income summary and (2) close income summary to retained earnings.

REVENUES(each revenue is closed) XXXX

EXPENSES (each expense account is closed) XXXX

INCOME SUMMARY 100,000

INCOME SUMMARY 100,000

RETAINED EARNINGS 100,000

The entry below is recorded on the date dividends are declared. As you will see later in this chapter, dividends are first declared and then paid a few weeks after declaration.


DIVIDENDS PAYABLE 20,000

The entry below is recorded on the date that cash dividends are paid.


CASH 20,000

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+$XXXX +$XXXX revenues(accounts receivable)-$XXXX +XXXX -$XXXX expenses(cash/other assets/contra (payables) assets)

+ $20,000 - $20,000 retained earnings(dividends payable) (declaration of cash dividends)

- $20,000 cash - $20,000(dividends payable)

6. Using the information provided for Baker Company, prepare the stockholders’ equity section of its balance sheet on December 31, 2010. Contributed capital:

6% cumulative preferred stock, par $100, 10,000 shares authorized, 1,000 shares issued $100,000

Common stock, par $5, 1,000,000 shares authorized, 101,100shares issued 505,500

Additional paid-in capital-preferred 4,500

Additional paid-in capital-common 303,400

Total contributed capital $913,400

Retained earnings 80,000

Total stockholders' equity $993,400

=======

Preferred stock Common stock Additional paid in capital-preferred

$100,000 $500,000 $500 $5,000 balance 500 5,000

$505,500 balance $4,500

balance

Retained earnings Additional paid in capital-common

$20,000 $100,000 $2,000 $300,000

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400 $ 80,000 balance 5,000

$303,400 balanceAccounting for donations of assets to a corporation by a government:

Governments often donate assets to corporations as inducements to locate their businesses within the boundaries of the governments. The donation of assets by a government to a corporation may be reported by the corporation as donated capital, as opposed to revenue. For example, if the City of DeKalb donated land with a fair value of $500,000 to Dotson Company as an inducement to locate its plant in DeKalb, Dotson should record the donation in the following manner:

Land 500,000Donated Capital (report with additional paid in capital) 500,000

Treasury stock:

Treasury stock is issued stock that is reacquired by the corporation and

formally retired; or held temporarily, and reissued for cash or other assets

Treasury stock is issued stock that is no longer outstanding.

The financial statement effects of acquiring treasury stock are (1) a decrease in assets and (2) a decrease in stockholders’ equity. The effects of reissuing treasury stock are the opposite, namely, (1) an increase in assets and (2) an increase in stockholders’ equity. The amounts are assumed below.


- Cash $2,000 -Treasury stock, cost $2,000(contra equity)


+Cash $2,500 +Treasury stock, cost $2,000(contra equity)+Additional paid in capital-treasury stock 500

Treasury stock is reacquired for a number of reasons:

To indicate to the marketplace that the company believes its common stock is undervalued—the intended result is to create more demand for the common stock and increase its market value;

To increase earnings per share—EPS is determined by dividing net income by outstanding common shares, and treasury stock has the effect of decreasing outstanding shares;

To give investors capital gains instead of dividend income—long-term capital gains are taxed preferentially while cash dividends are not.

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The acquisition of treasury stock increases a company’s debt / equity ratio.


Before the acquisition oftreasury stock $100 = $40 + $60

Acquisition oftreasury stock ( 10) (10)

After theacquisition oftreasury stock $90 = $40 + $50

The debt/equity ratio before the acquisition of the treasury stock was 66.7% ($40 / $60). After the acquisition of the treasury stock, the debt/equity ratio was 80% ($40/$50). The increase in the debt/equity ratio is more pronounced if the company borrows cash to acquire its common stock.


Before the acquisition oftreasury stock $100 = $40 + $60

Cash is borrowed 10 10

Acquisition oftreasury stockwith cash borrowed ( 10) (10)

After theacquisition oftreasury stock $100 = $50 + $50

The debt/equity ratio before the acquisition of the treasury stock was 66.7% ($40 / $60). After the borrowing of cash and the acquisition of the treasury stock, the debt/equity ratio was 100% ($50/$50).

Methods of accounting for treasury stock

There are two methods of accounting for treasury stock—the par value and the cost methods. Of the two methods, the cost method is used much more frequently than the par value method due to it being easier to apply. The par value method is covered in Appendix B.

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Example of the cost method of accounting for treasury stock:

Tiger Corporation had the following stockholder equity accounts on January 31, 2010:

Common stock, par $5, 100,000 shares authorized, 40,000 shares issued and outstanding $200,000

Additional Paid in Capital 360,000

Retained Earnings 100,000

Total Stockholders' Equity $660,000======

When the cost method of accounting for treasury stock is used, the account “TREASURY STOCK” is debited for the entire acquisition cost of the common stock reacquired. When treasury stock is reissued, the cost method has rules for each of the following situations:

Treasury stock is issued for more than its cost. The excess of the amount received over the cost of the treasury stock should be credited to “ADDITIONAL PAID IN CAPITAL FROM TREASURY STOCK.” The excess should never be credited to retained earnings.

Treasury stock is issued for less than its cost. The excess of the cost of the treasury stock over the amount received should be debited to “ADDITIONAL PAID IN CAPITAL FROM TREASURY STOCK.” If this account’s credit balance is not sufficient to absorb the excess, then the amount should be debited to “RETAINED EARNINGS.”

Both of the above rules will be demonstrated in the transactions which follow.

On February 3, 2010, Tiger reacquired 1,000 shares of its own common stock at $18 per share.

2/3/10:

TREASURY STOCK(1,000 shares X $18) 18,000

CASH 18,000

On February 20, 2010, Tiger reacquired another 500 shares of its common stock for $20 per share.

2/20/10:

TREASURY STOCK(500 shares X $20) 10,000

CASH 10,000

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On July 11, 2010, Tiger reissued 800 of its treasury shares at $21 per share. Tiger uses the FIFO method for determining the cost of the treasury stock reissued. Note that this transaction illustrates the reissuance of treasury stock for more than its cost--$21 proceeds per share less $18 cost per share.

7/11/10:

CASH(800 shares X $21) 16,800

TREASURY STOCK(800 shares X $18) 14,400

ADDITIONAL PAID IN CAPITAL FROM TREASURY STOCK 2,400

Treasury Stock Block 1: $18,000

Block 2: $10,000 $14,400 (800 shares from block 1 at a cost of $18 per share)

Balance $13,600

GENERAL LEDGER SUBSIDIARY LEDGER

Additional Paid in Capital Additional Paid in Capital from Treasury Stock$360,000

2,400 $2,400

Why is the excess of the issue price over the cost of treasury stock accounted for as an increase in additional paid in capital as opposed to being reported as a gain on the income statement? The Securities and Exchange Commission has a rule that states that the increase in assets that results from issuing treasury stock for more than its cost should be reported as an increase in additional paid in capital. This rule has become part of Generally Accepted Accounting Principles (GAAP) for treasury stock. The reasoning behind the rule is that a company cannot earn income from its own stock transactions. Acquiring and issuing treasury stock are both financing transactions. Consequently, the excess of the issue price over the cost of treasury stock is not reported on the income statement.

Retained Earnings

Net loss (operating Net income (operating transactions) transactions)

Cash dividends(financing

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transactions)On September 12, 2010, Tiger issued the remaining 700 shares at $15 per share. Note that this transaction demonstrates the issuance of treasury stock for less than its cost--$18 per share (Block I) and $20 per share (Block 2) less $15 proceeds per share from issuance.

CASH (700 shares X $15) 10,500

ADDITIONAL PAID IN CAPITAL FROM TREASURY STOCK 2,400

RETAINED EARNINGS 700

TREASURY STOCK 13,600

Treasury Stock

Block 1: 200 shares@ $18 = $3,600

Block 2: 500 shares@ $20 = $10,000 $13,600 (sold the 200 shares from block 1

and the 500 shares from block 2)Balance: $0

When treasury stock is issued for less than its cost, the excess should first be debited to any additional paid in capital from previous treasury stock transactions. If any excess remains after step 1, the remaining excess should be debited to retained earnings. Do not debit the remaining excess to additional paid in capital from sources other than treasury stock. The debit to retained earnings does not represent a loss. The debit to retained earnings represents a financing transaction, similar to a cash dividend.

GENERAL LEDGER SUBSIDIARY LEDGER

ADDITIONAL PAID IN CAPITAL APIC EXCESS OVER PAR $360,000 $360,000 2,400

$2,400 $360,000 balance

APIC FROM TREASURY STOCK RETAINED EARNINGS $2,400

$700 $100,000 $2,400

$ 99,300 Balance

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Demonstration of concepts: Issuance of treasury stock above cost

In 2009, Newt Corp. acquired 6,000 shares of its own$1 par value common stock at $18 per share. In 2010, Newtissued 3,000 of these shares at $25 per share. Newt uses thecost method to account for its treasury stock transactions. What accounts and amounts should Newt credit in 2010 torecord the issuance of the 3,000 shares?

Cash(3,000 shares X $25) 75,000Additional Treasury stock

Treasury paid-in Retained Common 3,000 shares X $18) 54,000 stock capital earnings stock Additional paid-in

capital-treasury stock 21,000A. $54,000 $21,000B. $54,000 $21,000C. $72,000 $3,000D. $51,000 $21,000 $3,000 Answer: B

Do exercises 15-6 (item 3), 15-7, 15-10, and problem 15-5 at this time.

Besides issuing its treasury stock, a company may also decide to formally retire its treasury stock.

Assume that Tiger decided to formally retire all 1,500 shares of its treasury stock instead of issuing the shares. On July 11, 2010, all 1,500 shares were formally retired. The retirement of the common stock requires that the average issue price (AIP) of the common shares be removed from stockholders' equity. The average issue price is $14 per share.

The average issue price is computed in the following manner:

Common stock + additional paid in capital from commonAverage issue price =

Number of common shares issued

$200,000 + $360,000=

40,000 shares

= $14 per share==========

7/11/10:

COMMON STOCK(1,500 shares X $5) 7,500

ADDITIONAL PAID IN CAPITAL-EXCESS OVER PAR(1,500 shares X $9) 13,500

RETAINED EARNINGS($28,000 cost less $21,000) 7,000

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TREASURY STOCK 28,000The reasoning behind the retirement entry is this: On average, investors gave $14 per share to the corporation when they originally acquired the common stock. The company gave them $7,000 more than the amount that was originally invested to acquire the treasury stock and then retire it. This excess of $7,000 represents something like a cash dividend. This is the reason that $7,000 is debited to retained earnings.

Reporting treasury stock on the balance sheet under the cost method:

ASSUME A CORPORATION ACQUIRED 2,000 SHARES OF ITS OWN COMMON STOCK AT A COST OF $30,000. THE PAR OF THE COMMON STOCK IS $5 PER SHARE.

JOURNAL ENTRY TO RECORD THE ACQUISITION OF THE TREASURY STOCK:


CASH 30,000

BALANCE SHEET

STOCKHOLDERS’ EQUITY:

COMMON STOCK, PAR $5, 100,000 SHARES AUTHORIZED, 40,000 SHARES ISSUED $200,000

ADDITIONAL PAID IN CAPITAL 320,000


TOTAL $930,000

LESS TREASURY STOCK AT COST(2,000 SHARES) ( 30,000)

TOTAL STOCKHOLDERS' EQUITY $900,000 =========

Note the following points:

There are 40,000 common shares issued and 38,000 common shares outstanding; Common stock is extended using issued shares not outstanding shares—40,000 shares X $5

par value equals $200,000; and The $30,000 cost of treasury stock is deducted as contra equity from the total of

stockholders’ equity.

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Preferred stock:

Preferred stock is preferred (1) as to dividends and (2) as to assets upon corporate liquidation. In exchange for the dividend privilege, preferred stock does not vote. Preferred dividends will be covered later in this chapter.

One of the most widely used financial ratios is the debt to equity ratio. The ratio is usually calculated by dividing total debt by total stockholders' equity. Analysts look at the debt/equity ratio to assess the riskiness of the company. The higher the debt/equity ratio, the riskier the company. Interest and principal of debt must be repaid, and the inability to pay interest and principal on time will cause the corporation to declare bankruptcy.

Total liabilitiesDebt/equity ratio =

Stockholders’ equity

The debt/equity ratio discloses the dollar amount of debt per dollar of equity; more risk is associated with companies which have high debt/equity ratios. More risk means that the corporation will havea more difficult time borrowing money at reasonable interest rates.

Redeemable preferred stock:

Pure PureDebt Equity

Redeemable preferred subject to mandatory redemption

Interest expense Dividends aremust be paid discretionary

Principal due at a No due datesspecific date for returning

the amountinvested

Senior securities Residualinterest

Redeemable preferred stock that is subject to mandatory redemption is a hybrid security. Preferred stock that is subject to mandatory redemption has both debt and equity characteristics. The accounting issue is whether to report redeemable preferred stock as debt or as stockholders’ equity.

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Before the FASB addressed the issue of how to report redeemable preferred stock, companies that issued redeemable preferred stock wanted to report the redeemable preferred stock in stockholders’ equity so that the debt/equity ratio would decrease. Stockholders’

Debt Equity Debt/equity ratio

BALANCES: $100,000 $200,000 50%

Case 1:

ISSUED $100,000OF DEBT $200,000 $200,000 100%

Case 2:

ISSUED $100,000OF REDEEMABLEPREFERREDINSTEAD OF DEBT $100,000 $300,000 33.3%

$200,000 $200,000 100%======= ======= ====

Should redeemable preferred stock be reported as debt or as stockholders’ equity? The answer depends on which characteristic of the redeemable preferred stock is emphasized—the equity characteristic or the debt characteristic.

The Financial Accounting Standards Board has addressed this issue and requires that preferred stock that is subject to mandatory redemption be reported as a liability. The FASB emphasized the debt characteristic over the equity characteristic. If the date for redemption is within one year of the balance sheet, the redeemable preferred stock would be reported as a current liability. If the date for redemption is longer than one year from the balance sheet date, the redeemable preferred stock would be reported as a long-term liability.

Partial balance sheet—assuming the redemption date is after one year from the balance sheet date:

Current liabilities $ 15,000Long-term liabilities:Bonds payable $ 25,000Redeemable preferred stock 10,000 Total liabilities $ 50,000 Stockholders’ equity:Common stock $ 15,000Additional paid in capital 20,000

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Retained earnings 30,000 Total stockholders’ equity $ 65,000 Total liabilities and stockholders’ equity $ 115,000

=======Accounting for dividends:

Dividends are a distribution of income as opposed to a determinant of income. Items that determine income are expenses, which means that dividends are not expenses. This is the proprietary view of the corporation; that is, the corporation and its owners are not separate and distinct from one another.

Proprietary view Entity view

Net Income $330,000 Dividend expense (50,000)

Dividends declared $ 50,000 Net income $280,000

Net Income

$280,000 ======= =======

Unlike interest expense, dividends do not accrue with the passage of time. A formal, legal action must be taken by the board of directors in order to pay a dividend. This formal action is referred to as the dividend declaration.

From the investor's viewpoint, there are 2 ways of increasing wealth from stock ownership. First, the shares may appreciate in value, and if this occurs, the investor may choose to sell the shares for a capital gain. Dividends are a second way of increasing wealth. Companies that are in their growth phase usually do not pay cash dividends. This is why investors should not purchase stock in companies that are in industries which are in their growth phase—for example, companies that are currently in the “social media” industry. Many of these companies are not currently profitable, but are projected to be profitable in the next 2-3 years. Mature companies usually pay cash dividends. Once a company decides to pay cash dividends, investors expect the company to continue paying cash dividends and to increase the cash dividends. For example, Proctor & Gamble has paid a cash dividend every year since 1896 and has increased the amount of the cash dividend every year since 1956.

Other dividend issues:

Dividends are subjected to double taxation. Corporate income is taxed at the corporate level and then at the investor level when distributed in the form of dividends.

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Investors like companies that consistently increase their dividends. The term “dividend push” refers to these companies. Investors generally believe that an increasing dividend is more important than a larger but stagnant dividend.

Investors should be suspicious of companies which have dividend yields that are higher than the industry average. Usually, the high dividend yield is the result of a falling stock price, which usually signals a decrease in the dividend.

Microsoft declared its first cash dividend in January, 2003. Investors generally were not pleased with this action because it demonstrated Microsoft was becoming a mature company, and that the large growth in stock price was over. This has proven to be correct. There are two ratios for investors who are interested in acquiring stocks of companies that pay cash dividends. These two ratios are (1) the dividend yield and (2) the payout ratio.

Cash dividend per shareDividend yield =

Market price per share

Cash dividends declared on commonPayout ratio =

Net income minus preferred dividends

The dividend yield indicates the current return on investment if an investor were to acquire the common stock. For example, the dividend yield would be 7% if a company declared a $3.50 per share cash dividend on its common stock when the market value per share was $50 ( $3.50 / $50 = 7%). The payout ratio indicates the percentage of a corporation’s net income that is distributed in the form of dividends. Dividend yields and payout ratios should be analyzed for trends and benchmarked against the same ratios of other companies in the same industry.

Prerequisites for a cash dividend:

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21

Credit balance in the retained earnings account;

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Sufficient cash available for the dividend; and

Formal action by the board of directors in the form of a dividend declaration.

Financial statement effects of a cash dividend: total stockholders’ equity and assets both decrease.

Assets = Liabilities + Stockholders equity

+Dividends payable -Retained earnings(declaration)

-Cash -Dividends payable(payment)

Cash dividends:Stockholders' equity for Taft Inc. before the declaration of a cash dividend:

Common stock, par $5, 100,000 shares authorized,40,000 shares issued $200,000Additional paid in capital 360,000Retained earnings 100,000

$660,000Treasury stock, 1,000 shares at cost ( 18,000) Total stockholders' equity $642,000

=======Cash dividends are declared only on outstanding shares. In the case of Taft Inc., the cash dividend would be declared on 39,000 shares of common stock (40,000 issued shares minus 1,000 shares of treasury stock).

The board of directors of Taft declared a quarterly $.50 dividend per share on December 20, 2010, payable on January 15, 2011, to stockholders' of record on January 2, 2011.

Declaration Record Payment Date Date Date

I-----------------------X-------------------------------X-------------------------------------X--------I

12/20 1/2 1/15The stock price After 1/2, the stock The cash will increase $.50 will sell ex-dividend. dividend is per share on 12/20 The market price will paid.

decrease $.50 per share.

12/20/10-declaration date:


DIVIDENDS PAYABLE 19,500(39,000 outstanding shares X $.50 per share)

1/2/11-record date: No entry is made. A list is compiled of the stockholders who are to receive the cash dividend.

1/15/11-payment date:


CASH 19,500

Financial statement effects of a cash dividend:

Declaration of a cash dividend decreases retained earnings and total stockholders' equity and increases current liabilities. On the declaration date, the current ratio (current assets/current liabilities) and working capital (current assets minus current liabilities) decrease because current liabilities increase. Payment of a cash dividend decreases current liabilities and decreases cash. Payment of the cash dividends has no effect on working capital, but payment increases the current ratio if it is larger than 1 before payment. Assume a $50,000 cash dividend was declared by ABC Inc.

ABC had the following current assets and current liabilities before the dividend:Current assets divided by current liabilities = Current Ratio

Beforedividend $400,000 / 200,000 2 to 1

Declaration $400,000 / 250,000 1.6 to 1 (decrease in ratio)

Payment $350,000 / 200,000 1.75 to 1 (increase in ratio)

In case 1, assume that Taft issued the 1,000 shares of treasury stock on December 30, 2010. How would this affect the cash dividend? When the number of outstanding common shares increases or decreases between the declaration date and the record date, the amount of the cash dividend has to be adjusted either upward, as in the case of Taft, or downward to reflect the actual amount of the cash dividend to be paid.

12/30/10:

RETAINED EARNINGS (1,000 shares X $.50) 500

DIVIDENDS PAYABLE 500

1/2/11-record date: No entry.


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DIVIDENDS PAYABLE ($19,500 + 500) 20,000

CASH 20,000

The actual total amount of a cash dividend to be paidis determined on the date of

A. Record.B. Declaration.C. Declaration or date of record, whichever is earlier.D. Payment. Answer: A

Allocation of a cash dividend between preferred and common stock:

Keys Company had 10,000 shares of 5%, $100 par value cumulative preferred stock outstanding on December 31, 2010. Keys also had 1,000,000 shares of $2 par value common stock outstanding on the same date.

Preferred stock can contain many different features to make it attractive to investors.

For example, preferred stock can be convertible into common. If preferred stock is convertible, the preferred stock price per share will tend to move in tandem with the price of the common stock.

When convertible preferred stock is issued, the journal entry looks as follows (amounts are assumed):

Cash 120,000Convertible preferred stock 100,000Additional paid in capital-preferred 20,000

When convertible preferred stock is converted into common, the journal entry looks as follows, assuming all of the preferred was converted into common stock with a par value of $10,000:

Convertible preferred stock 100,000Additional paid in capital-preferred 20,000

Common stock 10,000Additional paid in capital-common 110,000

Another feature that makes preferred stock attractive is the cumulative feature. When preferred stock is cumulative, it means that any cash dividends passed on the preferred stock become an arrearage that will

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be paid in the future when cash dividends are declared. In the case of Keys Company, the dividend per share of preferred stock is $5, and the total dividend applicable to the preferred is $50,000 each year. If dividends are not declared in a year, the $50,000 preferred dividend becomes an arrearage that will be paid in the future when dividends are declared.

Dividend arrearages related to cumulative preferred stock are not reported as liabilities on the balance sheet. Dividends are not a liability until they have been declared. Arrearages are disclosed in the notes.

Common stock cannot receive any cash dividends until the arrearage, as well as the current year’s preferred dividend, have been declared.

Compute the amount of dividends that should be allocated to preferred and common in each of the situations below.

Case I:

Keys declared a $150,000 cash dividend on December 31, 2010. There were no dividends in arrears on the preferred stock.

Preferred Common

A. Regular dividend to preferred: $5 per share X 10,000 shares $50,000 $ 0

B. Remainder to common 100,000

Total $50,000 $100,000====== =======

Case II:

Keys declared a $500,000 cash dividend on December 31, 2010. No dividends were declared in 2008 and 2009. Dividends in arrears are disclosed only in the notes to the financial statements.

Preferred Common

A. Arrearage to preferred: 2008 and 2009 dividend $5 X 10,000 shares X 2 $100,000 $ 0

B. Regular dividend to preferred for 2010 50,000 0

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C. Remainder to common __ 350,000

Total $150,000 $350,000======= =======

Do exercises 15-17 and 15-21(parts a and b only) at this time.

Liquidating cash dividends:

A liquidating cash dividend is a return of invested capital (additional paid in capital), which means that part of the stockholders’ investment is returned. A liquidating dividend results in a reduction of additional paid in capital.

Stockholders' equity of Wilson Inc.:

Common stock, par $5, 100,000 shares authorized, 40,000 shares issued $200,000Additional paid in capital 150,000Retained earnings 50,000

Total stockholders' equity $400,000=======

The board of directors of Wilson declared a $2 per share dividend on December 15, 2010, payable on January 16, 2011, to stockholders' of record on January 2, 2011. The dividend is permissible under the laws of Wilson’s state of incorporation. Note that liquidating dividends may not be legal distributions because they result in a decrease in contributed capital. This is why legal counsel of the corporation has to research the laws of the state of incorporation to find out if the liquidating portion of the dividend is permissible.

12/15/10-declaration date: RETAINED EARNINGS (Return on capital) 50,000

ADDITIONAL PAID IN CAPITAL(Return of capital) 30,000

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DIVIDENDS PAYABLE ($2 X 40,000 shares = $80,000) 80,000

1/02/11-record date: No entry



CASH 80,000

DEMONSTRATION OF CONCEPTS: LIQUIDATING DIVIDEND

14. On January 5, 2010, Sardi Minerals Corp.declared a cash dividend of $600,000 to Retained earnings 425,000stockholders of record on January 21, 2010, Additional paid in capital 175,000and payable on February 11, 2010. The Dividends payable 600,000dividend is permissible under the laws of Sardi’s state of incorporation. The followingdata pertain to 2009:

Net income for year ended 12/31/09 $190,000 Additional paid in capitalAdditional paid in capital, 12/31/09 675,000Retained earnings, 12/31/09 425,000

1/5/10 12/31/09 balance $675,000The $600,000 dividend includes a liquidating Dividenddividend of $175,000 1/5/10 balance $500,000

(liquidating portion)A. $0B. $175,000 Retained earningsC. $410,000 D. $485,000 1/5/10 12/31/09 balance $425,000

Dividend $425,000 1/5/10 balance $0

Key point: The 12/31/09 balance in retainedearnings includes 2009 net income of $190,000. Answer: B

Do exercise 15-12 at this time.

Property dividends:

On December 20, 2010, the board of directors of Rose Company declared a property dividend of 1 share of Violet Company stock for every 10 shares of Rose stock outstanding. On the declaration date, Rose owned 20,000 shares of Violet, for which it originally paid $100,000($5 per share). There were 200,000

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shares of Rose stock outstanding on December 20, 2010. The fair value of the Violet stock on the declaration date was $6 per share. The dividend was paid on January 12, 2011.


RETAINED EARNINGS (20,000 shares X $6) 120,000

PROPERTY DIVIDENDS PAYABLE 120,000

200,000 outstanding shares of Rose divided by 10 equals 20,000 shares of Violet that will be distributed. Note that this is exactly the number of shares of Violet that are owned by Rose. If the ratio was 1 share of Violet for every 20 shares of Rose stock outstanding, then only 10,000 shares of Violet would be distributed. This will have an effect on the amount of the gain or loss reported because gains and losses are reported only on the shares that are distributed in the property dividend.

INVESTMENT IN VIOLET STOCK 20,000

GAIN ON APPRECIATION OF SECURITIES 20,000(report the gain as “other income” on the 2010 income statement)

Investment in Violet Stock Gain on Appreciation of Securities 12/20/10 12/20/10 Bal. $100,000

20,000 $20,000 Bal. $120,000

A gain(loss) is recognized on a property dividend because the earnings process has been completed on the asset(s) distributed. A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners. According to generally accepted accounting principles, the transfer should be recorded at the fair value of the asset transferred, and a gain or loss should be recognized on the asset transferred.


PROPERTY DIVIDENDS PAYABLE 120,000

INVESTMENT IN VIOLET STOCK 120,000

Retained earnings

12/20/10: $20,000 gain (part of the income for 2010;$120,000 closed to retained earnings on 12/31/10)

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The net effect of every property dividend is to decrease retained earnings for the book value of the property distributed. The book value of the violet common stock is its cost of $100,000.

DEMONSTRATION OF CONCEPTS: PROPERTY DIVIDENDS

Bain Corp. owned 20,000 common shares of 12/15/10-declaration date:Tell Corp. purchased in 2010 for $180,000. OnDecember 15, 2010, Bain declared a property Retained earnings 300,000dividend of all of its Tell Corp. shares on the basis Property dividendsof one share of Tell for every 10 shares of Bain payable 300,000common stock held by its stockholders. Theproperty dividend was distributed on January 15,2011. On the declaration date, the aggregate Investment in Tell Corp. 120,000market price of the Tell shares held by Bain was Gain on appreciation$300,000. The entry to record the declaration of of securities 120,000the dividend would include a debit to retainedearnings (or property dividends declared) of A. $0B. $120,000C. $180,000D. $300,000 Answer: D

Investment in Tell Corp.

2010: $180,000

12/15/10 120,000

12/15/10 $300,000

Small stock dividends:

Small stock dividends are declared by growth companies. In growth companies, retained earnings is growing due to the successes of the company. However, growth companies do not have excess cash to distribute to stockholders because the cash is needed to grow. Therefore, how can growth companies give

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their stockholders a dividend without disbursing assets? The answer—declare a small stock dividend. A small stock dividend is defined as one that is less than 20 to 25% of the shares outstanding at the date of declaration. A small stock dividend is assumed to have a negligible effect on the market price of the stock.

Assumed market price of common before 10% stock dividend $27.50

Assumed market price after 10% stock dividend: $27.50/1.1 shares $25.00

A stock dividend does not result in a wealth transfer. The fair value of 1 share of common before the stock dividend was $27.50, while the fair value of 1.1 shares after the 10% stock dividendis also $27.50 ($25 X 1.1 = $27.50). A common stockholder who owns 100 common shares before the stock dividend worth $27.50 per share ($27.50 X 100 shares = $2,750) will have 110 shares of common stock worth $25 per share after the stock dividend (110 shares X $25 = $2,750).

Even though stock dividends do not result in wealth transfers, the accounting for small stock dividends gives the impression that there is a wealth transfer. What is the basis for this accounting?

In most situations of small stock dividends, the market price of the common stock does not decrease proportionately in the short run. In the example, if the stock price stayed at $27.50 after the stock dividend was distributed, investors would have 1.1 shares X $27.50, or $30.25 of market value after the stock dividend. The result is that investors, in the short run, view small stock dividends as an increase in their wealth. Investors view small stock dividends as good news. This results in more demand for the common stock of the company that declares a small stock dividend, and this increased demand increases the stock price in the short run. Accordingly, investors believe that their wealth has increased because they have more shares and the aggregate market value of their shares has increased. The accounting for small stock dividends is based upon this investor reaction to small stock dividends.

Stockholders' equity of USG Company prior to a stock dividend:

Common stock, par $2, 800,000 shares authorized, 300,000 shares issued $ 600,000Additional paid in capital 900,000Retained earnings 500,000 Total stockholders' equity $ 2,000,000

=========On June 10, 2010, USG Company declared a 10% stock dividend, distributable on July 10, to stockholders of record on June 30. The market value of USG’s common stock on the declaration date was $6 per share.


RETAINED EARNINGS ($6 per share X 30,000 shares) 180,000(300,000 shares X 10% = 30,000 shares)

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COMMON STOCK DIVIDEND DISTRIBUTABLE($2 par value X 30,000 shares) 60,000


Common stock dividend distributable is a temporary legal capital account. It will be eliminated onthe date the stock dividend is distributed.

6/30/10-record date: no entry. A list is compiled of who gets the stock dividend.

7/10/10-distribution date:

COMMON STOCK DIVIDEND DISTRIBUTABLE 60,000

COMMON STOCK 60,000

Financial statement effects of a small stock dividend, one that is less than 20-25% of outstanding shares at the date of declaration:

The amounts below are from the USG case:

Assets = Liabilities + Stockholders equity

-$180,000 Retained earnings

+$ 60,000 Common stock+$120,000 APIC

Retained earnings decreases(fair value of stock distributed) but contributed capital increases; therefore, total stockholders' equity remains the same. Accountants refer to this effect of a stock dividend as a permanent capitalization of retained earnings.

Par value remains unchanged, but the number of shares issued and outstanding increases.

There is no effect on assets.

How would the existence of treasury stock affect a stock dividend? Normally, dividends are not declared on treasury stock. This is true for cash and property dividends. However, stock dividends are

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an exception to this rule, since assets are not distributed in a stock dividend. Whether or not stock dividends are declared on treasury stock is a matter for the law of the state of incorporation. For solving problems, you can tell if a stock dividend is declared on treasury stock by the way the problem is worded. If the problem states that the stock dividend is based on outstanding shares, the number of shares distributed in the stock dividend is determined without regard to the treasury shares. However, if the problem states that the stock dividend is based on issued shares, the number of shares distributed in the stock dividend includes shares that are added to the treasury shares owned by the corporation.

A company declared a 10% stock dividend when it had the following:

o 5,000 shares of common stock issued;o 500 shares of treasury stock.

If the company declared a 10% stock dividend, this is how the dividend would affect common stock issued, treasury stock, and outstanding shares if the stock dividend was based on issued shares (5,000) and outstanding shares (4,500):

Stock dividend based onIssued shares Outstanding shares

o Common stock (issued shares) 5,500 shares* 5,450 shares**o Treasury stock ( 550 shares) ( 500 shares)o Outstanding shares 4,950 shares 4,950 shares

*5,000 issued shares X 10% = 500 shares, of which 50 are added to the treasury shares;**4,500 outstanding shares X 10% = 450 shares, of which 0 shares are added to the treasury shares.

Large stock dividends:

A large stock dividend is defined as one that is more than 25% of the outstanding shares at the date of declaration.

A large stock dividend is assumed to have a material effect on the market price of the common stock. Large stock dividends are really stock splits, not stock dividends. This is why the accounting for large stock dividends is different from the accounting for small stock dividends. Large stock dividends are declared with the intention of materially decreasing the per share price of the common. Because the per share price will decrease significantly as a result of a large stock dividend, investors do not believe that large stock dividends result in an increase in their wealth.

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Assumed market price before 50% stock dividend $30 per share

Assumed market price after 50% stock dividend: $30/1.5 shares $20 per share

Due to the significant decrease in the market value of the stock after a large stock dividend, investors do not believe that their wealth increased. An investor who owns 100 shares of common stock worth $30 per share (100 shares X $30 = $3,000) will have 150 shares worth $20 after the stock dividend ($150 shares $ 20 = $3,000). In the short run, the market price of the common stock will decrease, and this decrease leads to the investor perception that large stock dividends do not transfer wealth. The accounting for a large stock dividend is based upon this investor reaction.

Stockholders' equity of USG Company prior to a stock dividend:

Common stock, par $2, 800,000 shares authorized, 300,000 shares issued $ 600,000Additional paid in capital 900,000Retained earnings 500,000

Total stockholders' equity $ 2,000,000=========

On June 10, 2010, USG Company declared a 50% stock dividend, distributable on July 10, to stockholders of record on June 30. The market value of USG’s common stock on the declaration date was $6 per share.


RETAINED EARNINGS ($2 par value X 150,000 shares) 300,000(300,000 shares X 50% = 150,000 shares)


Note that only the par value of the shares to be distributed is recorded. Since par value per share is usually very small, the amount of retained earnings that is permanently capitalized into contributed capital will also be very small (i.e. immaterial). Do not use the market value of common stock to determine the value of a large stock dividend because investors do not perceive a large stock dividend to be a wealth transfer.

6/30/10-record date: no entry. A list is compiled of who gets the stock dividend.

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7/10/10-distribution date:


COMMON STOCK 300,000

COMPARISON OF A SMALL AND LARGE STOCK DIVIDEND

Size of stock dividend10% 50%

Stockholders' equity of USG Company:

Common stock, par $2, 800,000 sharesauthorized,

(a) 330,000 shares issued X $2 par value $660,000 <

(b) 450,000 shares issued X $2 par value $900,000

Additional paid in capital

(a) $900,000 + 120,000 1,020,000 >

(b) $900,000 900,000

Retained earnings

(a) $500,000 less 180,000 320,000

(b) $500,000 less 300,000 200,000------------- --------------

Total stockholders' equity $2,000,000 $2,000,000 ======== ========

Common stock Additional paid in capital Retained earnings

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$600,000 $900,000 $500,000 + + (a)60,000/ (a)120,000 (a)180,000 / (b)300,000 (b)300,000

When comparing large and small stock dividends for the same company, note that

o Legal capital for the large stock dividend will always be larger;o Additional paid in capital for the small stock dividend will always be larger; ando Total stockholders’ equity does not change

Stock splits:

What is the reason for a stock split? Companies split their common stock so that the market value decreases to what most investors think is affordable. For example, investors may think that a stock price of $150 per share is too expensive, even though the company is sound financially and has an excellent future. Therefore, investors may decide not to purchase the stock solely because of its high price. Note that the upside for the market value of the common stock is restricted if investors behave in this fashion. If the company splits its shares 3 for 1, the market price should decrease from $150 per share to approximately $50 per share. At this price, investors will view the stock as more affordable and acquire it, all other things being equal. According to studies done in finance, the most popular price range for common stock is between $30 and $70 per share. Microsoft split its stock 2 for 1 in 2003 when its common stock was selling for $45 per share. The split reduced the common stock price to $22.50 per share. What Microsoft did was very unusual.

Market price of common $150 share

Desired market price to make stock more attractive toinvestors $ 50 share

Action: have a 3 for 1 stock split.

The stockholders' equity for Medium Company is presented below at June 30, 2010:

Common stock, par $3, 500,000 shares authorized, 40,000 shares issued $120,000

Additional paid in capital 460,000Retained earnings 400,000

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Total $980,000Less treasury stock, 1,000 shares at cost (100,000)

Total stockholders’ equity $880,000=======

On July 1, 2010, Medium Company declared a 3 for 1 stock split.

Before we look at the effects of Medium Company’s stock split, note the following points:

a stock split does not result in any journal entries; there is no effect on any of the total dollar amounts reported in stockholders’ equity for contributed

capital and retained earnings; the only effects of a stock split are (1) a proportionate decrease in the par value per share

and (2) a proportionate increase in the number of shares authorized, issued, and outstanding; treasury shares are always increased proportionately as a result of a stock split.

What is the effect of the split on the Medium Company’s stockholders’ equity section disclosed on the previous page?

Common stock, par $1, 1,500,000 shares authorized,120,000 shares issued (par decreased from $3 to $1 and the numberof issued shares increased from 40,000 to 120,000) $120,000

Additional paid in capital 460,000


Total $980,000

Less treasury stock, 3,000 shares at cost (100,000)

Total stockholders' equity $880,000 ======

How would the declaration and subsequent How would the declaration of a 15% stockissuance of a 10% stock dividend by the issuer dividend by a corporation affect each of theaffect each of the following when the market following?value of the shares exceeds the par value of thestock? Retained Total stock-

earnings holders’ equityCommon Additional paid-in A. No effect No effect stock capital B. No effect Decrease

A. No effect No effect C. Decrease No effectB. No effect Increase D. Decrease DecreaseC. Increase No effectD. Increase Increase

Answer: CAnswer: D

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Reverse stock splits:

Reverse stock splits have become much more popular in recent times as the stock market has lowered the common stock prices of many companies below $1 per share. For companies whose shares are publicly traded, market values for common stock that are below $1 per share will lead to delisting if the common stock continues to trade below $1. The objective of a reverse stock split is to increase the price of the common stock per share so that the common stock is not delisted. Palm Inc. had a reverse stock split in 2002 that increased its stock price from below a dollar to $12.43 per share. The reverse split was 1 for 20. Blockbuster wanted to have a reverse split in 2009, but the proposal did not garner enough stockholder votes to get done.

The stockholders' equity for Medium Company is presented below at June 30, 2010:

Common stock, par $3, 500,000 shares authorized, 40,000 shares issued $120,000

Additional paid in capital 460,000


Total $980,000

Less treasury stock, 1,000 shares at cost (100,000)

Total stockholders’ equity $880,000=======

On July 1, 2010, Medium Company declared a 1 for 4 stock split because its shares are being traded on the NASDAQ at $.80 per share, and the exchange has threatened to delist the company if the market value remains below $1.

What is the effect of the split on the Medium Company’s stockholders’ equity?

Common stock, par $12, 125,000 shares authorized,10,000 shares issued (par increased from $3 to $12 and the numberof issued shares decreased from 40,000 to 10,000 ) $120,000 Additional paid in capital 460,000Retained earnings 400,000

Total $980,000Less treasury stock, 250 shares at cost (100,000)

Total stockholders' equity $880,000 ======

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Let’s compare a 3 for 1 stock split with a 200% stock dividend for the same company. From the investor’s standpoint, a 200% stock dividend has the same effect as a 3 for 1 split. In both cases, if an investor owns 100 common shares before the split or stock dividend, the investor will have 300 shares after the split / stock dividend. However, there are significant differences between the split and the stock dividend on the company that declares the split or the stock dividend.

3 for 1 200% stock split dividend

Common stock, 500,000 sharesauthorized, 120,000 shares issued

Split: $1 par value X 120,000 shares $120,000 <

Dividend: $3 par value X 120,000 shares $360,000

Additional paid in capital 460,000 = 460,000

Retained earnings

Split: no effect on retained earnings 400,000 >

Stock dividend: $400,000 less 240,000 160,000------------ -------------

Total $980,000 $980,000

Less treasury stock, 3,000 shares at cost(note that treasury shares increased by 2,000) (100,000) (100,000)

Total stockholders’ equity $880,000 $880,000======= =======

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When comparing a large stock dividend with a stock split for the same company, note that

o Legal capital for the large stock dividend will always be larger;o Additional paid in capital will remain unchanged;o Retained earnings will always be larger for the stock split; ando Total stockholders’ equity does not change.

Do exercises 15-13 and 15-14, problem 15-8, and CA 15-4 and 15-6 at this time.

International financial reporting standards related to stockholders’ equity:

Terminology issues:

Companies that prepare their financial statements in accordance with IFRS use different descriptions for common and preferred stock and for additional paid in capital. These different descriptions are shown in the entries below (amounts are assumed);

Cash 10,000Share capital-ordinary (par value) 2,000Share premium-ordinary 8,000

To record the issuance of common stock.

Cash 10,000Share capital-preference (par value) 2,000Share premium-preference 8,000

To record the issuance of preferred stock.

Stockholders’ equity is replaced by the term equity. Equity consists of share capital, share premium, retained earnings, reserves (accumulated other comprehensive income), and treasury shares.

IFRS companies report reserves in equity. These reserves contain many of the items that U.S. GAAP reports in accumulated other comprehensive income as well as unrealized gains and losses from revaluing capital assets. U.S. GAAP does not permit unrealized gains on capital assets to be reported.

Both IFRS and U.S. GAAP report retained earnings. It is not unusual for companies using IFRS to report their reserves along with retained earnings. For example, companies using IFRS might report the following in equity:

Retained earnings and reserves $200,000

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The accounting for the declaration and payment of dividends and the acquisition and reissuance treasury stock is essentially the same under IFRS as it is under U.S. GAAP, although there is a minor difference between IFRS and U.S. GAAP in the accounting for the retirement of treasury stock.

Financial statement analysisAppendix A

The following ratios provide useful information when evaluating whether you should acquire, hold, or sell the common stock of a corporation:

Return on stockholders’ equity (ROSE) and Return on common stockholders’ equity (ROCE);

Investors acquire common stock for one or both of the following reasons:

Cash dividends and/or Capital appreciation—stock price increases over the amount paid.

It is very unlikely for an investment to provide both large cash dividends (as a percentage of the stock’s cost) and large capital appreciation. Usually, one of the two cash flows is emphasized over the other. For example, if an investor acquires common stock in a growth corporation, the expectation would be for no cash dividends and for large capital appreciation. Note the word “expectation.” Investments carry risk, and there is certainly no guarantee that there will be capital appreciation. However, before an investor acquires common stock, the investor should do some basic financial statement analysis on the companies being considered for investment.

Net incomeReturn on stockholders’ equity = --------------------------------------------

Average stockholders’ equity (beginning and ending equity divided by 2)

Net income less preferred dividendsReturn on common equity = -------------------------------------------

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Average common equity (beginning + ending common equity divided by 2); common equity is equal to total stockholders’ equityminus preferred equity.

Note that return on stockholders’ equity and return on common equity are the same if there is no preferred stock.

DEMONSTRATION OF CONCEPTS: RETURN ON COMMON EQUITY (ROCE) AND RETURN ON STOCKHOLDERS’ EQUITY

Selected information for Irvington Company is asfollows:

December 31, 2009 2010 $120,000 – 10,000

Preferred stock, 8% par Return on common equity =$100 $125,000 $125,000 ($375,000 +$585,000)/2Common stock 300,000 400,000Retained earnings 75,000 185,000 = $110,000Dividends declared onpreferred stock 10,000 10,000 $480,000Net income 60,000 120,000Irvington’s return on common stockholders’ equity, = 23%rounded, for 2010 is ===

A. 17% C. 23%B. 19% D. 25%

Return on stockholders’ equity:

Using the information above, what was Irvington’s return on stockholders’ equity for 2010?

$120,000Return on stockholders’ equity (ROSE) = ---------------------------------------

($500,000 + $710,000) / 2

$120,000= ----------------------------------------------

$605,000

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= 19.8%=====

Analysis of retained earnings at December 31, 2010:

Balance at January 1, 2010 $ 75,000 Add net income for 2010 120,000 Deduct dividends declared during 2010 (10,000) Balance at December 31, 2010 $185,000

=======

Book value per share:

Common equity (total stockholders’ equity less preferred equity*)Book value per share = --------------------------------------------------------------

Outstanding common shares

*Preferred equity includes (1) any dividends in arrears if the preferred stock is cumulative and (2) the liquidation value of the preferred shares.

Book value per share of common stock:

BOOK VALUE IS THE AMOUNT PER SHARE THAT COMMON WOULD BE PAID AFTER THE CORPORATION

SELLS ALL OF ITS ASSETS FOR THEIR BOOK VALUES; PAYS ALL OF ITS LIABILITIES AT THEIR BOOK VALUES; AND PAYS PREFERRED STOCKHOLDERS ANY DIVIDENDS IN ARREARS ALONG WITH THE LIQUIDATION

VALUE OR THE PAR VALUE OF THE PREFERRED STOCK. USE THE LIQUIDATION VALUE PER SHARE IF IT IS PROVIDED IN THE QUESTION.

COMPUTATION OF BOOK VALUE FOR COMMON STOCK:

STOCKHOLDERS’ EQUITY MINUS PRFERRED EQUITYBOOK VALUE PER COMMON SHARE =

NUMBER OF OUTSTANDING COMMON SHARES

DEMONSTRATION OF CONCEPTS: BOOK VALUE PER SHARE

PRFERRED STOCK HAS A LIQUIDATION VALUE AND DIVIDENDS ARE IN ARREARS

Dix Corporation’s stockholders’ equity at December TOTAL STOCKHOLDERS' EQUITY $3,900,00031, 2010, consisted of the following:

LESS PREFERRED EQUITY:

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8% cumulative preferred stock, $50 par;liquidating value $55 per share; authorized, LIQUIDATION VALUE-20,000 issued, and outstanding 20,000 shares $1,000,000 SHARES X $55 (1,100,000)

Common stock, $25 par; 200,000 shares DIVIDENDS IN ARREARSauthorized; 100,000 shares issued and 20,000 SHARES X $4 PER outstanding 2,500,000 SHARE DIVIDEND ( 80,000)

Retained earnings 400,000 EQUITY LEFT FOR COMMON $2,720,000

Dividends on the preferred stock have been paid COMMON SHARES OUTSTANDING 100,000through 2009 but have not been declared for 2010.At December 31, 2010, Dix’s book value (equity) per BOOK VALUE PER SHARE $27.20share was

A. $25.00B. $27.20C. $28.20D. $29.00

Appendix BPar value method of accounting for treasury stock

The par value method of accounting for treasury stock transactions assumes that a corporation is reacquiring its own common stock for the purpose of constructive retirement. The entries for the par value method are shown below using some of the same data that we used to demonstrate the cost method.

On February 3, 2010, Tiger reacquired 1,000 shares of its own common stock at $18 per share.

2/3/10:

TREASURY STOCK (1,000 SHARES X $5 PAR VALUE PER SHARE) 5,000

ADDITIONAL PAID IN CAPITAL-EXCESS OVER PAR (1,000 SHARES X $9) 9,000


CASH 18,000

Note, when the par value method is used, the cost of acquiring the treasury stock is compared with the average issue price of the common stock. The price paid was $18 per share, while the average issue price was $14 per share (this is the same amount that was calculated for the retirement of treasury stock under the cost method on page 14 of these notes). The excess of the cost over the average issue price is charged or debited to retained earnings under the assumption that this is similar to a dividend distribution.

Assume that Tiger reacquired the 1,000 shares on 2/3/10 for $12 per share instead of $18 per share. How would the entry to record the acquisition of treasury stock be different?

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2/3/10:


ADDITIONAL PAID IN CAPITAL-EXCESS OVER PAR 9,000

CASH 12,000

ADDITONAL PAID IN CAPITAL-TREASURY STOCK 2,000

Note, when treasury stock is reacquired and the cost is less than the average issue price, the excess of the average issue price over cost is credited to “additional paid in capital-treasury stock.” This account is similar to the account that is credited under the cost method when treasury stock is reissued for an amount greater than its cost.

On March 15, 2010, Tiger reissued 400 of the 1,000 shares and received $19 per share. Note that the entry below is not affected by how much Tiger paid for the treasury stock--$18 per share or $12 per share.

3/15/10:

CASH (400 SHARES X $19) 7,600

TREASURY STOCK (400 SHARES X $5 PAR VALUE) 2,000

ADDITIONAL PAID IN CAPITAL-EXCESS OVER PAR 5,600

Assume that Tiger retired the remaining 600 shares of treasury stock on March 31, 2010.

3/31/10:

COMMON STOCK (600 SHARES X $5 PAR VALUE) 3,000


Reporting treasury stock on the balance sheet under the par value method:

ASSUME A CORPORATION ACQUIRED 2,000 SHARES OF ITS OWN COMMON STOCK AT A COST OF $30,000. THE PAR OF THE COMMON STOCK IS $5 PER SHARE.

JOURNAL ENTRY TO RECORD THE ACQUISITION OF THE TREASURY STOCK, ASSUMING THE AVERAGE ISSUE PRICE OF THE COMMON IS $13 PER SHARE:

TREASURY STOCK ($5 X 2,000 shares) 10,000

ADDITIONAL PAID IN CAPITAL ($8 X 2,000 shares) 16,000


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CASH 30,000

BALANCE SHEET

STOCKHOLDERS’ EQUITY:

COMMON STOCK, PAR $5, 100,000 SHARES AUTHORIZED,40,000 SHARES ISSUED, 38,000 SHARES OUTSTANDING $190,000



TOTAL $900,000 =========

Note the following points:

There are 40,000 common shares issued and 38,000 common shares outstanding; Common stock is extended using outstanding shares not issued shares—38,000 shares X $5 par

value equals $190,000.

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Appendix CRetained earnings appropriations

Appropriations of retained earnings:What is the financial statement effect of a retained earnings appropriation? An appropriation of retained earnings restricts the dividend paying ability of the corporation. Dividends are declared from unappropriated retained earnings. Appropriations are either discretionary or nondiscretionary. Discretionary means that the board of directors of the company voluntarily restricts its retained earnings, while nondiscretionary means that the board of directors is required by contract to appropriate retained earnings. For example, retained earnings may be appropriated due to a debt covenant. The appropriation example below is an example of a discretionary appropriation.

Retained Earnings Appropriated Retained Earnings Lawsuit loss for Future Loss $2,500,000

Balance restricted (1) $500,000 (3) $450,000 (1) $500,000 (2) $100,000 report on

(4) income statement $500,000 (4) 500,000

$2,400,000 balance

On July 10, 2010, the board of directors of Spade Company appropriated $500,000 for a reasonably possible loss due to pending litigation. The unappropriated retained earnings on July 10 amounted to $2,500,000.

(1)RETAINED EARNINGS 500,000(1)RETAINED EARNINGS APPROPRIATED FOR FUTURE LOSS 500,000

On September 5, 2010, the board of directors declared a cash dividend of $100,000.

(2)RETAINED EARNINGS 100,000

(2)DIVIDENDS PAYABLE 100,000

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On December 31, 2010, Spade's legal council determined that it was probable that Spade would lose the lawsuit, and a reasonable estimate of loss was $450,000.

(3)LAWSUIT LOSS(Report on 2010 income statement) 450,000(3)ESTIMATED LAWSUIT LIABILITY 450,000

(Report on 12/31/10 balance sheet)(4)RETAINED EARNINGS APPROPRIATED FOR FUTURE LOSS 500,000


The estimated loss from lawsuit is reported on the income statement. The loss cannot be charged to the appropriated retained earnings account. After the lawsuit has been settled, the appropriation account is closed and the amount of the appropriation is credited to retained earnings. This is item (4) in the “T” accounts. You will not see appropriations of retained earnings disclosed in the annual report. You will have to read the company’s 10-K filing with the SEC to determine if there are any appropriations. The amount reported for retained earnings on the balance sheet includes both appropriated and unappropriated amounts.

Appendix DFully and Partially Participating Preferred Stock

Keys Company had 10,000 shares of 5%, $100 par value cumulative preferred stock outstanding on December 31, 2010. Keys also had 1,000,000 shares of $2 par value common stock outstanding on the same date. Compute the amount of dividends that should be allocated to preferred and common stock in each situation described below.

Case I:

Keys declared an $800,000 cash dividend on December 31, 2010. No dividends were declared in 2009. The preferred stock is fully participating.

Preferred Common

A. Arrearage to preferred $ 50,000 $ 0

B. Current year’s dividend to preferred andcommon based on 5% of total par valueof each issue:

Preferred: $1,000,000 X .05 50,000

Common: $2,000,000 X .05 100,000

C. Participating dividend to preferred andcommon based upon the total par valueof each stock to the total par value ofboth preferred and common:

Preferred:

$1,000,000 / $3,000,000 X $600,000* 200,000

Common:

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$2,000,000 / $3,000,000 X $600,000 400,000 _______ _______

Total $300,000 $500,000 ======== =======

The amount of the participating dividend is $800,000 minus $200,000, or $600,000.

Case II:

An $800,000 cash dividend was declared, and preferred dividends were not paid in 2009. The preferred is participating in distributions in excess of 8% on the common stock.

Preferred Common

A. Arrearage to preferred $ 50,000 $ 0

B. Current year’s dividend topreferred and common based upon 5% of total par of eachissue:

Preferred: $1,000,000 X .05 50,000

Common: $2,000,000 X .05 100,000

C. Additional 3% to common:$2,000,000 X .03 60,000

D. Participating dividend of$800,000 minus 260,000, or$540,000.

Preferred: 1/3rd X $540,000 180,000

Common: 2/3rd X $540,000 360,000 ----------- ----------

Total $280,000 $520,000 ======= =======

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Take Home Quiz 1Spring 2015

Instructions for all quizzes:

Type the answer to each question. Handwritten answers will be graded, but the grade will not be entered in the grade book until typed answers are submitted.

For multiple choice questions, the letter of the best answer should be chosen. For journal entry answers, credits should be indented and account titles should be typed in their entirety—

don’t abbreviate. For example, the account “additional paid in capital excess over par” should be typed as opposed to typing APIC excess over par.

1. Which of the following statements is correct?

A. When treasury stock is acquired for more than the par value of the common stock, additional paid in capital from treasury stock should be decreased for the excess of cost over par value if the cost method is used in accounting for treasury stock.

B. The acquisition of treasury stock has no effect on earnings per share. C. A and B. D. Neither A nor B.

2. The amount reported for retained earnings represents

A. the amount of cash that may be distributed as dividends.B. the cumulative net income earned since the corporation started less the cumulative dividends

declared since the corporation started.C. the residual interest of the common stockholders in the corporation.D. B and C are correct.E. A, B, and C are correct.

3. Attorneys’ fees related to starting a corporation should be accounted for as a(an)

A. reduction of additional paid in capital—excess over par value.B. expense of the period.C. intangible asset that is amortized over its estimated useful life.D. Either B or C is acceptable.E. Either A or B is acceptable.

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4. Garth Company issued 1,000 shares of its $5 par value common stock for $20 per share on October 1, 2010. As a result of this transaction, Garth’s

A. legal capital increased $5,000.B. contributed capital increased $20,000.C. A and B.D. Neither A nor B.

5. At its date of incorporation, Watts Inc. issued 100,000 shares of its $10 par value common stock at$11 per share. During the current year, Watts reacquired 20,000 shares of its common stock at a price of$15 per share and accounted for them by the cost method. Subsequently, these shares were reissued at$13 per share. There have been no other issuances or acquisitions of its own common stock. What effect does the reissuance of the common stock have on the following accounts?

Retained Additional paid inearnings capital from treasury stock

A. Decrease DecreaseB. No effect DecreaseC. Decrease No effectD. No effect No effect

6. Ten thousand shares of $10 par value common stock were issued initially at $12 per share. Subsequently, one thousand of these shares were reacquired as treasury stock at $13 per share. The cost method of accounting for treasury stock is used. What is the effect of the acquisition of treasury stock on each of the following?

Contributed Total stockholders’ capital ____equity______

A. No effect No effectB. No effect DecreaseC. Decrease No effectD. Decrease Decrease

7. Munn Corp’s records included the following stockholders’ equity accounts at December 31, 2010:

Preferred stock, par value $15, 30,000 shares authorized $255,000Common stock, par value $5, 100,000 shares authorized 300,000Additional paid-in capital—preferred 15,000Additional paid-in capital—common 50,000Treasury stock, 9,000 common shares, at cost 72,000 The number of outstanding shares for each class of stock at December 31, 2010 is

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Common stock Preferred stockA. 70,000 17,000B. 61,000 18,000C. 51,000 17,000D. 51,000 18,000E. 61,000 17,000


A. Printing and engraving costs associated with issuing common stock should be reported as an expense.

B. It is not illegal for total stockholders’ equity to be lower than legal capital as a result of net operating losses sustained by the company.

C. A and B.D. Neither A nor B.

9. Steele Co. was organized on January 1, 2010, with an authorization of 400,000 shares of common stockwith a par value of $6 per share. During 2010, the company had the following common stock transactions:

January 5: Issued 75,000 shares @ $10 per share; April 6: Issued 25,000 shares @ $12 per share; July 28: Reacquired 10,000 shares @ $11 per share; and December 31: Reissued 10,000 shares @ $18 per share.

Steele uses the cost method of accounting for treasury stock. What is the amount that should be reported as additional paid in capital on Steele’s December 31, 2010 balance sheet?

A. $450,000.B. $520,000.C. $370,000.D. $570,000.

10. Presented below is information related to Hiller Corporation at December 31, 2010:

Common stock, $1 par value $1,680,000 Common stock subscribed 200,000 Preferred stock, $50 par value(the preferred stock must be redeemed

on December 31, 2014) 2,400,000 Additional paid in capital-common 6,800,000 Donated capital 100,000 Retained earnings 2,600,000 Treasury stock, 7,200 shares at cost 180,000 Common stock subscriptions receivable 600,000

What is Hiller’s total stockholders’ equity at December 31, 2010?

A. $13,000,000.B. $11,200,000.C. $10,600,000.D. $10,400,000.

11. Maddox was organized on January 2, 2010 with 100,000 authorized shares of $10 par value common stock. During 2010, Maddox had the following common stock transactions:

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January 5, issued 75,000 shares at $14 per share; July 27, reacquired 5,000 shares at $11 per share; November 25, reissued 3,000 shares of treasury stock at $13 per share. December 10, reissued 2,000 shares of treasury stock at $9.50 per share.

Maddox uses the cost method of accounting for treasury stock. What is the balance in the account“additional paid in capital from treasury stock” at December 31, 2010?

A. $6,000.B. $3,000.C. $9,000.D. $8,000.

12. Wilson Co. had 150,000 common shares issued on September 10, 2010. On this date, the company owned 5,000 of its own common shares. On September 11, 2010, the Board of Directors of Wilson declared a quarterly cash dividend of $1.00 per share, payable on September 30, 2010 to stockholders of record on September 20, 2010. On September 15, 2010, Wilson reacquired an additional 2,000 of its common shares for $75 per share. Which of the following statements is correct?

A. In the journal entry to record the declaration of the cash dividend on September 11, retained earnings should be debited for $145,000.

B. In the journal entry to record the payment of the cash dividend on September 30, cash dividends payable should be debited for $143,000.


13. Taft Inc. declared a $625,000 cash dividend on January 2, 2011, payable on January 20, 2011, to stockholders of record on January 12, 2011. The dividend is permissible under the laws of the statein which Taft is incorporated. The following information was taken from Taft’s financial statements:

Net income for 2010 $ 90,000 Additional paid in capital at December 31, 2010 475,000 Retained earnings at December 31, 2009 450,000

In the journal entry to record the declaration of the cash dividend on January 2, 2011,

A. Retained earnings should be debited for $450,000.B. Additional paid in capital should be debited for $175,000.C. A and B.D. Neither A nor B.

14. Grimm Company owned 32,000 shares of common stock in Baha Inc. On December 31, 2010, Grimm’s Board of Directors voted to distribute one share of Baha for every 4 shares of Grimm common stock outstanding. On the declaration date, there were 112,000 common shares of Grimm outstanding. The dividend was payable on January 25, 2011 to stockholders of record January 15, 2011. The cost of the Baha Inc. shares was $15 per share, while the fair value was $20 per share on December 31, 2010. On the declaration date of the property dividend, which of the following statements is correct?

A. Retained earnings should be debited for $560,000.B. Investment in Baha should be debited for $160,000.C. A and B.

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D. Neither A nor B.

15. Refer to the previous question. As a result of the property dividend, what was the increase in Grimm’s income before income taxes for the year ended December 31, 2010?

A. $400,000.B. $160,000.C. $420,000.D. $140,000.

16. Blount Inc. started operations in 2003. The company has 1,000,000 shares of authorized common stock with a par value of $2 per share. In 2010, the company hired a local architect to draw plans for a new office building. The architect sent a bill for $45,000 to Blount on December 20, 2010. Instead of paying the bill with cash, Blount gave the architect 7,500 shares of its unissued common stock. Blount’s common

stock is not traded on a stock exchange; however, the common stock had a fair value of $9 per share in October, 2008, which was the last time common stock was issued by Blount. In the journal entry to record the issuance of the 7,500 shares of common stock on December 20, 2010,

A. Miscellaneous expense should be debited for $45,000.B. Additional paid in capital in excess of par value should be credited for $30,000.C. A and B.D. Neither A nor B.

17. The declaration and issuance of a 40% stock dividend

A. Increases contributed capital.B. Decreases retained earnings but has no effect on total stockholders’ equity.C. Has no effect on additional paid in capital.D. A and B are correct.E. A, B, and C are correct.

18. At the declaration date of a 10% stock dividend in which the market value of the common stock exceeds its par value, the journal entry to record the stock dividend would not include a

A. Credit to Common Stock Dividend Payable.B. Credit to Additional Paid in Capital.C. Debit to Retained Earnings.D. Credit to Common Stock Dividend Distributable.E. Two of the above are correct.

19. How are the following used in the calculation of the dividend yield when the company has preferred stock upon which dividends were declared this year?

Cash dividends Market value Net income to common of common less preferred dividends

A. Numerator Denominator Not usedB. Not used Numerator Denominator

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C. Numerator Not used DenominatorD. Denominator Numerator Not used

20. On July 1, 2010, Elbert Inc. declared a 1 for 5 stock split when the market value of its common stock was $2 per share. Immediately before the split, the company had 10,000 shares of $5 par value common stock issued and outstanding. As a result of the reverse stock split, par value per share

A. Remained unchanged at $5.B. Increased to $10.C. Increased by $25.D. Increased to $25.E. None of the above.

21. On June 30, 2010, when Wang’s Co.’s common stock was selling for $35 per share, its capital accounts were as follows:

Common stock, par value $10, 200,000 shares authorized, 60,000 shares issued $ 600,000Additional paid in capital 1,400,000Retained earnings 4,200,000Treasury stock at cost (5,000 shares) 310,000

On July 1, 2010, a 100% stock dividend was declared on issued shares. The dividend was distributed on July 15. What is the balance in retained earnings after recording the declaration of the stock dividend?

A. $3,600,000.B. $3,650,000.C. $3,560,000.D. $2,100,000.

22. Refer to the previous question. Assume the stock dividend was 10% of the outstanding shares instead of 100% of the issued shares. What is the total amount of contributed capital after recording the declaration of the stock dividend?

A. $2,210,000.B. $1,537,500.C. $2,192,500.D. $1,610,000.

23. Refer to the previous question. Assume the stock dividend was 10% of the issued shares instead of 10% of the outstanding shares. On the declaration date, in the journal entry to record the stock dividend,

A. Retained earnings should be debited for $210,000.B. Additional paid in capital excess over par should be credited for $137,500.C. A and B.D. Neither A nor B.

24. Miller Inc. reported assets of $3,500,000 and liabilities of $2,000,000 as of June 30, 2010. On July 1, 2010, the company borrowed $750,000 and used the entire amount to acquire its own common stock. What is the company’s debt to equity ratio after the company acquired its own common stock?

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A. 183%.B. 276%.C. 367%.D. 122%.

25. Presented below is information related to Hiller Corporation at December 31, 2010:

Common stock, $1 par value $ 800,000 Additional paid in capital excess over par 4,000,000 Retained earnings 2,000,000

On January 2, 2011, Hiller acquired 5,000 shares of treasury stock for $50,000 and accounted for the shares using the cost method. On January 4, 2011, the company retired the shares. In the journal entry to retire the treasury shares,

A. Additional paid in capital excess over par value should be debited for $30,000.B. Retained earnings should be debited for $20,000.C. A and B.D. Neither A nor B.

26. Benson Corp. entered into a stock subscription contract to sell 500 shares of its unissued common stock to Mary Young for $20 per share. Ms. Young paid Benson $6 per share on June 30, 2010 and agreed to pay the remainder one month later. The par value of Benson’s common stock is $1 per share.Assume a balance sheet was prepared on June 30, 2010. As a result of the subscription contract, total stockholders’ equity on the June 30, 2010 balance increased by what amount?

A. $10,000.B. $500.C. $9,500.D. $3,000.

27. Presented below is information related to Putnam Corporation at December 31, 2010:

Common stock, $1 par value $7,680,000 Common stock dividend distributable 200,000 Preferred stock, $50 par value, cumulative 2,400,000 Additional paid in capital-preferred 100,000 Additional paid in capital-common 700,000 Retained earnings 2,100,000 Accumulated other comprehensive income 120,000 Unearned revenue 250,000 Dividends payable 180,000

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What is total stockholders’ equity of Putnam at 12/31/10?

A. $13,300,000.B. $13,430,000.C. $13,550,000.D. $13,180,000.E. $12,980,000.

28. How should cumulative preferred dividends in arrears be disclosed in the financial statements of a corporation?

A. In the current liability section of the balance sheet.B. As a deduction from net income on the income statement.C. In the current liability section of the balance sheet for the amount expected to be paid in the

next 12 months, and in the long-term liability section for the amount expected to be paid after 12 months from the balance sheet date.

D. In the notes to the financial statements.

29. Compare the stockholder equity effects of a 50% stock dividend with those of a 10% stock dividend for Able Inc. when the market value of Able’s common stock is greater than its par value. What component of stockholders’ equity would always be smaller?

A. The amount reported for additional paid in capital for the 50% stock dividend.B. The amount reported for common stock for the 10% stock dividend.C. A and B.D. Neither A nor B.

30. How are the following used in the calculation of the dividend payout ratio when the company has cumulative preferred stock outstanding?

Cash dividends Market value Net income to common of common less preferred dividends

A. Numerator Denominator Not usedB. Not used Numerator DenominatorC. Numerator Not used DenominatorD. Denominator Numerator Not used

31. A corporation declared a cash dividend, a portion of which was liquidating. How would the dividend affect each of the following?

AdditionalPaid in Capital Retained Earnings

A. Decrease No effectB. Decrease DecreaseC. No effect DecreaseD. No effect No effect

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32. Compare the stockholder equity effects of a 3 for 2 stock split with the stockholder equity effects of a 10% stock dividend for Hub Co. when the market value of Hub’s common stock is greater than its par value. What component of stockholders’ equity would always be larger?

A. The amount reported for additional paid in capital for the stock dividend.B. The amount reported for retained earnings for the stock split.C. The amount reported for common stock for the stock split.D. A and B are correct.E. A, B, and C are correct.

33. Compare the stockholder equity effects of a 3 for 2 stock split with the stockholder equity effects of a 50% stock dividend for Lori Co. What component of stockholders’ equity would always be smaller?

A. The amount reported for additional paid in capital for the stock dividend.B. The amount reported for retained earnings for the stock dividend.C. The amount reported for common stock for the stock split.D. The amount reported for additional paid in capital for the stock split.E. B and C are correct.F. B, C, and D are correct.

34. At December 31, 2010, Mott Co. had outstanding 20,000 shares of 6% cumulative nonparticipating preferred stock with a $10 par value and 100,000 shares of $3 par value common stock. Preferred and common cash dividends were declared and paid every year through 2007. Mott did not declare any cash dividends in 2008 or 2009. On December 31, 2010, Mott’s board of directors declared a cash dividend of $120,000. Of this amount, how much will Mott’s common stockholders receive?

A. $84,000.B. $108,000.C. $96,000.D. $36,000.

Use the following information to answer questions 35 and 36 (See Appendix D to answer these questions).

At December 31, 2010, Mott Co. had outstanding 20,000 shares of 6% cumulative preferred stock with a $10 par value and 100,000 shares of $3 par value common stock. Dividends have been declared every year except for 2009.

35. If the preferred stock is fully participating and a cash dividend of $120,000 is declared on December 31, 2010, what amount will Mott’s common stockholders receive?

A. $55,200.B. $64,800.C. $96,000.D. $46,800.

36. If the preferred is participating in distributions in excess of 8% on the common stock and a cashdividend of $140,000 is declared on December 31, 2010, what amount will Mott’s common stockholders receive?

A. $60,800.

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B. $76,800.C. $79,200.D. $72,900.

Use the following information to answer questions 37 through 39 (See Appendix A to answer these questions).

Information for Dash Company is as follows: December 31, 2009 2010

Preferred stock, cumulative, 8% par $187,500 187,500Common stock 50,000 60,000Additional paid in capital-common 400,000 540,000Retained earnings 112,500 277,500Net income 90,000 180,000

37. There were no dividends in arrears either at December 31, 2009 or 2010. What is Dash’s return on common stockholders’ equity for 2010?

A. 18.18%.B. 19.83%.C. 22.92%.D. 25%.

38. What is Dash’s return on stockholders’ equity for 2010?

A. 18.18%.B. 19.83%.C. 22.92%.D. 25%.

39. Assuming there were no dividends in arrears at December 31, 2010, what is Dash’s book value per share at December 31, 2010 if the par value of the common stock is $1 per share? The liquidation value of the preferred stock is equal to its par value.

A. $14.625.B. $17.75.C. $10.00.D. $14.265.

See Appendix B to answer questions 40 through 42.

40. On February 3, 2010, Lizard Inc. acquired 1,000 shares of its own common stock at $18 per share. The par value of Lizard’s common stock is $3 per share, and the average issue price of the common stock is

58

$12 per share. Lizard uses the par value method of accounting for treasury stock. In the journal entry to record the acquisition of Lizard’s common stock,

A. Additional paid in capital excess over par should be debited for $9,000.B. Retained earnings should be debited for $6,000.C. A and B.D. Neither A nor B.

41. On February 3, 2010, Giraffe Inc. acquired 1,000 shares of its own common stock at $18 per share. The par value of Giraffe’s common stock is $3 per share, and the average issue price of the common stock is $20 per share. Giraffe uses the par value method of accounting for treasury stock. In the journal entry to record the acquisition of Giraffe’s common stock,

A. Treasury stock should be debited for $3,000.B. Additional paid in capital from treasury stock should be credited for $2,000.C. A and B.D. Neither A nor B.

42. Refer to the previous question. After holding the 1,000 shares of treasury stock for two months, Giraffe sold 800 shares for $21 per share. In the entry to record the sale of the treasury stock,

A. Common stock should be credited for $2,400.B. Additional paid in capital in excess of par should be credited for $14,400.C. A and B.D. Neither A nor B.

For questions 43-47, assume international financial reporting standards are used:

43. Common stock is reported on the statement of financial position as

A. Share capital-common stock.B. Common stock.C. Share capital-ordinary.D. Capital stock-ordinary.


A. Cash dividends are accounted for under the entity viewpoint.B. Share premium-ordinary is similar to additional paid in capital under U.S. GAAP.C. A and B.D. Neither A nor B.

45. The amount reported for “reserves” on the statement of financial position can include

A. Gains and losses from the sale of treasury stock.B. Unrealized gains and losses from revaluing capital assets.C. A and B.D. Neither A nor B.

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46. The amount reported for retained earnings on the statement of financial position includes

A. Total net income earned less total dividends declared since the corporation began business. B. Reserves for items such as currency translation adjustments and pensions.C. A and B.D. Neither A nor B.

47. Major differences between IFRS and U.S. GAAP exist in the accounting for

A. The purchase and sale of treasury stock.B. The declaration and payment of cash dividends.C. A and B.D. Neither A nor B.

See Appendix C to answer questions 48-50:


A. Appropriating retained earnings decreases the dividend paying ability of the corporation.B. Retained earnings may be appropriated for potential loss contingencies.C. A and B.D. Neither A nor B.


A. Appropriations of retained earnings are disclosed in stockholders’ equity on the balance sheet.B. Appropriating retained earnings as a result of a debt covenant requirement is an example of a

discretionary appropriation.C. A and B.D. Neither A nor B.


A. If retained earnings is appropriated for a potential loss from a lawsuit, the actual loss can be charged directly to the appropriation when the lawsuit is settled.

B. The amount reported for retained earnings on the balance sheet includes both the amount that is appropriated as well as the amount that is unappropriated.


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Accountancy 432/532Quiz I Answers

Spring 2015

Name: Aoran Kan Seat #: 26

1. D 22. C 43. C

2. B 23. A 44. B

3. B 24. C 45. B

4. C 25. B 46. C

5. C 26. D 47. D

6. B 27. A 48. C

7. C 28. D 49. D

8. B 29. C 50. C

9. B 30. C

10. B 31. B

11. B 32. E

12. C 33. B

13. C 34. A

14. A 35. B

15. D 36. C

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16. C 37. C

17. E 38. B

18. A 39. A

19. A 40. C

20. D 41. C

21. A 42. D

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432 chapter 15 notes 2015

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