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CHAPTER 15

LECTURE NOTES
STOCKHOLDERS EQUITY
Table of Contents
Page

Overview of stockholders equity

Examples of stock transactions


Accounting for donations of assets to a corporation by a government
Accounting for treasury stock
Cost method of accounting for treasury stock
Preferred stock
Redeemable preferred stock
Accounting for dividends
Cash dividends
Allocation of cash dividends between preferred and common
Liquidating cash dividends
Property dividends
Small stock dividends
Large stock dividends
Stock splits
Reverse stock splits
International financial reporting standards
Appendix A: Financial statement analysis
Appendix B: Par value method of accounting for treasury stock
Appendix C: Retained earnings appropriations
Appendix D: Fully and partially participating preferred stock
Quiz

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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
Common stock, par value(legal capital)
Additional paid in capital
Retained earnings
Total
Less treasury stock at cost
Total stockholders' equity

Case II

20,000
20,000
80,000
80,000
50,000
(82,000)
$
150,000
18,000
( 132,000)
-0$
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
2

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.
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 treasury
shares.

Financial statement effects of stock transactionsamounts are assumed:


Assets

Liabilities

Stockholders equity

+cash $5,000

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

-cash $2,000

-treasury stock(cost)
3

$2,000

Assets

Liabilities

+cash $2,500

Stockholders equity
+treasury stock(cost)
$2,000
+additional paid-in capital
500
(Treasury stock was sold for
more 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.

Corporation issues unissued


common stock-Initial public
offering (IPO)

Investors acquire
common stock

Common stock
Cash or other assets

Common stock

Cash

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

Examples of stock transactions:


1.

On January 7, 2010, Baker Company issued 1,000 shares of 6% cumulative $100 par value
preferred 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 X 1,000 shares)
4

5,000

ADDITIONAL PAID IN CAPITAL-COMMON


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

500
2,000

CASH
3.

2,500

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

COMMON STOCK SUBSCRIBED

600
500

COMMON STOCK

500
5

4.

On November 30, 2010, Baker issued 1,000 shares of its common stock to an attorney in
exchange for legal services rendered. The market value of the stock was $10 per share on
November 30. The attorneys 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

Ashe Corp. was organized on January 1,


2010, with authorized capital of 100,000
shares of $20 par value common stock.
During 2010, Ashe had the following
transactions affecting stockholders equity:
January 10:

Issued 25,000 shares at $22


a share.
March 25:
Issued 1,000 shares for legal
services when the fair value
was $24 per share.
September 30: Issued 5,000 shares for a tract
of land when the fair value was
$26 a share.

CASH(25,000 SHARES X $22)


550,000
COMMON STOCK
(25,000 SHARES X $20)
500,000
ADDITIONAL PAID IN CAPITAL
50,000
--------------------------------------------------------------------------GENERAL EXPENSES (1,000 SHARES
X $24)
24,000
COMMON STOCK
20,000
ADDITONAL PAID IN CAPITAL 4,000
---------------------------------------------------------------------------

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: A

A.
B.
C.
D.

$84,000
$80,000
$54,000
$50,000

1/10: $22 $20 = $2 X 25,000 shares = $50,000


3/25: $24 $20 = $4 X 1,000 shares =
4,000
9/30: $26 $20 = $6 X 5,000 shares = 30,000

$84,000
======
DEMONSTRATION OF CONCEPTS: STOCK SUBSCRIPTIONS
On February 1, 2010, authorized common
stock was sold on a subscription basis at a
price in excess of par value, and 20% of the
subscription price was collected. On May 1,
2010, the remaining 80% of the subscription
price was collected. Additional paid-in capital
would increase on

A.
B.
C.
D.

February 1, 2010
No
No
Yes
Yes

May 1, 2010
Yes
No
No
Yes

2/1/10(AMOUNTS ASSUMED):
CASH
STOCK SUBSCRIPTIONS
RECEIVABLE
COMMON STOCK
SUBSCRIBED (PAR VALUE)
ADDITIONAL PAID IN CAPITAL
5/1/10:
CASH

80
10
90
80

STOCK SUBSCRIPTIONS
RECEIVABLE

80

COMMON STOCK SUBSCRIBED


COMMON STOCK (PAR VALUE)

ANSWER: C

20

10
10

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

5.

Bakers 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.

RETAINED EARNINGS

20,000

DIVIDENDS PAYABLE

20,000

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

DIVIDENDS PAYABLE

20,000
7

CASH

Assets

20,000

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

- $20,000 cash
6.

Liabilities

Stockholders equity
+$XXXX revenues

+XXXX
(payables)

-$XXXX expenses

+ $20,000
(dividends payable)

- $20,000 retained earnings


(declaration of cash dividends)

- $20,000
(dividends payable)

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, 101,100


shares 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
$100,000
balance

Common stock

Additional paid in capital-preferred

$500,000
500

$500

$5,000

5,000
$505,500 balance
balance
8

$4,500

Retained earnings
$20,000

Additional paid in capital-common

$100,000

$2,000

$300,000
400
5,000
$303,400 balance

$ 80,000 balance
Accounting 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

500,000
Donated 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.
Assets

Liabilities

- Cash $2,000

Assets

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

Liabilities

+Cash $2,500

Stockholders equity
+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 undervaluedthe
intended result is to create more demand for the common stock and increase its market value;
To increase earnings per shareEPS is determined by dividing net income by outstanding
common shares, and treasury stock has the effect of decreasing outstanding shares;
9

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

The acquisition of treasury stock increases a companys debt / equity ratio.


Assets

Liabilities

Stockholders equity

Before the
acquisition of
treasury stock

$100

$40

$60

Acquisition of
treasury stock

( 10)

After the
acquisition of
treasury stock

$90

(10)

$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 of
treasury stock
Cash is borrowed

Assets

Liabilities

Stockholders equity

$100

$40

$60

10

Acquisition of
treasury stock
with cash borrowed

( 10)

After the
acquisition of
treasury stock

$100

10

(10)

$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
10

There are two methods of accounting for treasury stockthe 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.
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 accounts 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)
CASH

18,000
18,000

On February 20, 2010, Tiger reacquired another 500 shares of its common stock for $20 per share.
2/20/10:
11

TREASURY STOCK(500 shares X $20)

10,000

CASH

10,000

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
Balance

$14,400 (800 shares from block 1


at a cost of $18 per share)

$13,600

GENERAL LEDGER

SUBSIDIARY LEDGER

Additional Paid in Capital


$360,000
2,400

Additional Paid in Capital from Treasury Stock


$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)


12

transactions)
Cash dividends
(financing
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


RETAINED EARNINGS

2,400
700

TREASURY STOCK

13,600
Treasury Stock

Block 1: 200 shares


@ $18 = $3,600
Block 2: 500 shares
@ $20 = $10,000
Balance:

$13,600 (sold the 200 shares from block 1


and the 500 shares from block 2)

$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


$360,000
2,400
$2,400
$360,000 balance

APIC EXCESS OVER PAR


$360,000

APIC FROM TREASURY STOCK


$2,400
$2,400

RETAINED EARNINGS
$700
$100,000
$ 99,300 Balance
13

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, Newt
issued 3,000 of these shares at $25 per share. Newt uses the
cost method to account for its treasury stock transactions.
What accounts and amounts should Newt credit in 2010 to
record the issuance of the 3,000 shares?
Treasury
stock
A. $54,000
B. $54,000
C.
D.

Additional
paid-in
capital

Retained
earnings

Cash(3,000 shares X $25)


75,000
Treasury stock
3,000 shares X $18)
54,000
Additional paid-in
capital-treasury stock
21,000

Common
stock

$21,000
$21,000
$72,000
$51,000

$21,000

$3,000
$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 common
Average 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


14

(1,500 shares X $9)

13,500

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

7,000

TREASURY STOCK
28,000
The 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:
TREASURY STOCK

30,000

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

RETAINED EARNINGS

410,000

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 shares40,000 shares X $5
par value equals $200,000; and
15

The $30,000 cost of treasury stock is deducted as contra equity from the total of
stockholders equity.

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 liabilities
Debt/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 have
a more difficult time borrowing money at reasonable interest rates.
Redeemable preferred stock:
Pure
Debt

Pure
Equity
Redeemable preferred subject to mandatory redemption

Interest expense
must be paid

Dividends are
discretionary

Principal due at a
specific date

No due dates
for returning
the amount
invested

Senior securities

Residual
interest
16

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.
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%

$200,000

$200,000

100%

ISSUED $100,000
OF REDEEMABLE
PREFERRED
INSTEAD OF DEBT $100,000

$300,000

33.3%

Case 1:
ISSUED $100,000
OF DEBT
Case 2:

$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 emphasizedthe 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 sheetassuming the redemption date is after one year from the balance sheet date:
Current liabilities

$ 15,000

Long-term liabilities:
Bonds payable

$ 25,000
17

Redeemable preferred stock


Total liabilities
Stockholders equity:
Common stock
Additional paid in capital
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity

10,000
$ 50,000
$ 15,000
20,000
30,000
$ 65,000
$
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

Dividends declared

$ 50,000

Dividend expense
Net income

(50,000)
$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 phasefor 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.
18

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.
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 share
Dividend yield

=
Market price per share
Cash dividends declared on common

Payout 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 corporations 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:

Credit balance in the retained earnings account;

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

+
19

Stockholders equity

+Dividends payable
-Cash

-Retained earnings(declaration)

-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
Additional paid in capital
Retained earnings

$200,000
360,000
100,000
$660,000
Treasury 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
The stock price
will increase $.50
per share on 12/20

1/2
After 1/2, the stock
will sell ex-dividend.
The market price will
decrease $.50 per share.

1/15
The cash
dividend is
paid.

12/20/10-declaration date:
RETAINED EARNINGS

19,500

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

19,500

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:
DIVIDENDS PAYABLE

19,500
20

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
Before
dividend

$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.


1/15/11-payment date:
DIVIDENDS PAYABLE ($19,500 + 500)

20,000
21

CASH

20,000

The actual total amount of a cash dividend to be paid


is determined on the date of

A.
B.
C.
D.

Record.
Declaration.
Declaration or date of record, whichever is earlier.
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
Convertible preferred stock
Additional paid in capital-preferred

120,000
100,000
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
Additional paid in capital-preferred
Common stock
Additional paid in capital-common

100,000
20,000
10,000
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
22

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 years
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.

A.
B.

Regular dividend to preferred:


$5 per share X 10,000 shares

Preferred

Common

$50,000

$ 0

Remainder to common
Total

100,000
$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
A.

Arrearage to preferred:
2008 and 2009 dividend
23

Common

$5 X 10,000 shares X 2
B.

Regular dividend to preferred for 2010

C.

Remainder to common
Total

$100,000
50,000

0
0

__

350,000

$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
Additional paid in capital
Retained earnings

$200,000
150,000
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 Wilsons 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.
24

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

50,000

ADDITIONAL PAID IN CAPITAL(Return of capital)

30,000

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

80,000

1/02/11-record date: No entry


1/16/11-payment date:
DIVIDENDS PAYABLE

80,000

CASH

80,000

DEMONSTRATION OF CONCEPTS: LIQUIDATING DIVIDEND


14. On January 5, 2010, Sardi Minerals Corp.
declared a cash dividend of $600,000 to
stockholders of record on January 21, 2010,
and payable on February 11, 2010. The
dividend is permissible under the laws of
Sardis state of incorporation. The following
data pertain to 2009:
Net income for year ended 12/31/09
Additional paid in capital, 12/31/09
Retained earnings, 12/31/09

$190,000
675,000
425,000

The $600,000 dividend includes a liquidating


dividend of
A.
B.
C.
D.

Retained earnings
Additional paid in capital
Dividends payable

425,000
175,000
600,000

Additional paid in capital


1/5/10
12/31/09 balance $675,000
Dividend
$175,000
1/5/10 balance $500,000
(liquidating portion)

$0
$175,000
$410,000
$485,000

Retained earnings
1/5/10
Dividend
$425,000

Key point: The 12/31/09 balance in retained


earnings includes 2009 net income of $190,000.

12/31/09 balance $425,000


1/5/10 balance $0
Answer: B

25

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
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.
12/20/10-declaration date:
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


(report the gain as other income on the 2010 income statement)
Investment in Violet Stock
12/20/10
Bal. $100,000
20,000
Bal. $120,000

20,000

Gain on Appreciation of Securities


12/20/10
$20,000

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.

1/12/11-payment date:
26

PROPERTY DIVIDENDS PAYABLE

120,000

INVESTMENT IN VIOLET STOCK

120,000

Retained earnings
12/20/10:
$120,000

$20,000 gain (part of the income for 2010;


closed to retained earnings on 12/31/10)

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
Tell Corp. purchased in 2010 for $180,000. On
December 15, 2010, Bain declared a property
dividend of all of its Tell Corp. shares on the basis
of one share of Tell for every 10 shares of Bain
common stock held by its stockholders. The
property dividend was distributed on January 15,
2011. On the declaration date, the aggregate
market price of the Tell shares held by Bain was
$300,000. The entry to record the declaration of
the dividend would include a debit to retained
earnings (or property dividends declared) of
A.
$0
B.
$120,000
C.
$180,000
D.
$300,000

12/15/10-declaration date:
Retained earnings
Property dividends
payable

300,000

Investment in Tell Corp.


Gain on appreciation
of securities

120,000

300,000

120,000

Answer: D

Investment in Tell Corp.


2010: $180,000

27

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
their stockholders a dividend without disbursing assets? The answerdeclare 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 dividend
is 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,
28

300,000 shares issued


Additional paid in capital
Retained earnings
Total stockholders' equity

$ 600,000
900,000
500,000
$ 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 USGs common stock on the declaration date was
$6 per share.
6/10/10-declaration date:
RETAINED EARNINGS ($6 per share X 30,000 shares)
(300,000 shares X 10% = 30,000 shares)

180,000

COMMON STOCK DIVIDEND DISTRIBUTABLE


($2 par value X 30,000 shares)

60,000

ADDITIONAL PAID IN CAPITAL

120,000

Common stock dividend distributable is a temporary legal capital account. It will be eliminated on
the 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
29

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
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 on
Issued shares Outstanding shares
30

o Common stock (issued shares)


o Treasury stock
o Outstanding shares

5,500 shares*
( 550 shares)
4,950 shares

5,450 shares**
( 500 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.
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
Additional paid in capital
Retained earnings

$ 600,000
900,000
500,000

Total stockholders' equity

$ 2,000,000
31

=========
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 USGs common stock on the declaration date was
$6 per share.
6/10/10-declaration date:
RETAINED EARNINGS ($2 par value X 150,000 shares)
(300,000 shares X 50% = 150,000 shares)

300,000

COMMON STOCK DIVIDEND DISTRIBUTABLE

300,000

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.
7/10/10-distribution date:
COMMON STOCK DIVIDEND DISTRIBUTABLE
COMMON STOCK

300,000
300,000

COMPARISON OF A SMALL AND LARGE STOCK DIVIDEND


Size of stock dividend
10%
50%
Stockholders' equity of USG Company:
32

Common stock, par $2, 800,000 shares


authorized,

(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

(b) $900,000

1,020,000
>
900,000

Retained earnings

(a) $500,000 less 180,000

(b) $500,000 less 300,000

320,000

Total stockholders' equity

Common stock
$600,000
+
(a)60,000/
(b)300,000

Additional paid in capital


$900,000
+
(a)120,000

-------------

200,000
--------------

$2,000,000
========

$2,000,000
========

Retained earnings
$500,000
(a)180,000 /
(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; and
o Total stockholders equity does not change

Stock splits:
33

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 to


investors

$ 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


Retained earnings

460,000
400,000

Total
Less treasury stock, 1,000 shares at cost

$980,000
(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 Companys 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.

34

What is the effect of the split on the Medium Companys 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 number
of issued shares increased from 40,000 to 120,000)

$120,000

Additional paid in capital

460,000

Retained earnings

400,000

Total

$980,000

Less treasury stock, 3,000 shares at cost

(100,000)

Total stockholders' equity

$880,000
======

How would the declaration and subsequent


issuance of a 10% stock dividend by the issuer
affect each of the following when the market
value of the shares exceeds the par value of the
stock?

A.
B.
C.
D.

Common
stock
No effect
No effect
Increase
Increase

Additional paid-in
capital
No effect
Increase
No effect
Increase

How would the declaration of a 15% stock


dividend by a corporation affect each of the
following?

A.
B.
C.
D.

Retained
earnings
No effect
No effect
Decrease
Decrease

Total stockholders equity


No effect
Decrease
No effect
Decrease

Answer: C

Answer: D
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.

35

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

Retained earnings

400,000

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 Companys stockholders equity?
Common stock, par $12, 125,000 shares authorized,
10,000 shares issued (par increased from $3 to $12 and the number
of issued shares decreased from 40,000 to 10,000 )
Additional paid in capital
Retained earnings
Total
Less treasury stock, 250 shares at cost
Total stockholders' equity

$120,000
460,000
400,000
$980,000
(100,000)
$880,000
======

36

Lets compare a 3 for 1 stock split with a 200% stock dividend for the same company. From the investors
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
split

200% stock
dividend

Common stock, 500,000 shares


authorized, 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

Total

-----------$980,000

160,000
------------$980,000

Less treasury stock, 3,000 shares at cost


(note that treasury shares increased by 2,000)

(100,000)

(100,000)

$880,000
=======

$880,000
=======

Total stockholders equity

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

Legal capital for the large stock dividend will always be larger;
Additional paid in capital will remain unchanged;
Retained earnings will always be larger for the stock split; and
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.
37

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

10,000

Share capital-ordinary (par value)


Share premium-ordinary
To record the issuance of common stock.
Cash

2,000
8,000
10,000

Share capital-preference (par value)


Share premium-preference
To record the issuance of preferred stock.

2,000
8,000

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

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.

38

Financial statement analysis


Appendix 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 appreciationstock price increases over the amount paid.

It is very unlikely for an investment to provide both large cash dividends (as a percentage of the stocks 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 income
Return on stockholders equity = -------------------------------------------Average stockholders equity (beginning and ending equity
divided by 2)
Return on common equity

Net income less preferred dividends


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

Note that return on stockholders equity and return on common equity are the same if there is no
preferred stock.
39

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


EQUITY

Selected information for Irvington Company is as


follows:
December 31,
2009
2010
Preferred stock, 8% par
$100
$125,000 $125,000
Common stock
300,000
400,000
Retained earnings
75,000
185,000
Dividends declared on
preferred stock
10,000
10,000
Net income
60,000
120,000
Irvingtons return on common stockholders equity,
rounded, for 2010 is
A.
B.

17%
19%

C.
D.

$120,000 10,000
Return on common equity =
($375,000 +$585,000)/2
=

$110,000
$480,000

23%
===

23%
25%

Return on stockholders equity:


Using the information above, what was Irvingtons return on stockholders equity for 2010?
$120,000
Return on stockholders equity (ROSE)

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

=
=

$120,000
---------------------------------------------$605,000
19.8%
=====

40

Analysis of retained earnings at December 31, 2010:

Balance at January 1, 2010


Add net income for 2010
Deduct dividends declared during 2010
Balance at December 31, 2010

$ 75,000
120,000
(10,000)
$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 EQUITY
BOOK 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 Corporations stockholders equity at December


31, 2010, consisted of the following:

TOTAL STOCKHOLDERS' EQUITY


LESS PREFERRED EQUITY:

41

$3,900,000

8% cumulative preferred stock, $50 par;


liquidating value $55 per share; authorized,
issued, and outstanding 20,000 shares
$1,000,000

LIQUIDATION VALUE-20,000
SHARES X $55

(1,100,000)

Common stock, $25 par; 200,000 shares


authorized; 100,000 shares issued and
outstanding

DIVIDENDS IN ARREARS
20,000 SHARES X $4 PER
SHARE DIVIDEND

EQUITY LEFT FOR COMMON

$2,720,000

Retained earnings

2,500,000
400,000

Dividends on the preferred stock have been paid


through 2009 but have not been declared for 2010.
At December 31, 2010, Dixs book value (equity) per
share was
A.
B.
C.
D.

80,000)

COMMON SHARES OUTSTANDING

100,000

BOOK VALUE PER SHARE

$27.20

$25.00
$27.20
$28.20
$29.00

Appendix B
Par 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

RETAINED EARNINGS

4,000

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.

42

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?
2/3/10:
TREASURY STOCK

5,000

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)
TREASURY STOCK

3,000
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:
43

TREASURY STOCK ($5 X 2,000 shares)

10,000

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

16,000

RETAINED EARNINGS

4,000

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

ADDITIONAL PAID IN CAPITAL

304,000

RETAINED EARNINGS

406,000

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 shares38,000 shares X $5 par
value equals $190,000.

44

Appendix C
Retained 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
for Future Loss
Balance restricted
(1) $500,000
(4)
$500,000

Retained Earnings
$2,500,000
(1) $500,000
(2) $100,000
(4) 500,000
$2,400,000 balance

45

Lawsuit loss
(3) $450,000
report on
income statement

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

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)
(3)ESTIMATED LAWSUIT LIABILITY
(Report on 12/31/10 balance sheet)
(4)RETAINED EARNINGS APPROPRIATED FOR FUTURE LOSS
RETAINED EARNINGS

450,000
450,000
500,000
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
companys 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 D
Fully 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

B. Current years dividend to preferred and


common based on 5% of total par value
46

$ 0

of each issue:
Preferred: $1,000,000 X .05

50,000

Common: $2,000,000 X .05

100,000

C. Participating dividend to preferred and


common based upon the total par value
of each stock to the total par value of
both preferred and common:
Preferred:
$1,000,000 / $3,000,000 X $600,000*

200,000

Common:
$2,000,000 / $3,000,000 X $600,000
Total

_______

400,000
_______

$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.

A. Arrearage to preferred
B.

Preferred

Common

$ 50,000

$ 0

Current years dividend to


preferred and common based
upon 5% of total par of each
issue:
Preferred: $1,000,000 X .05

50,000
47

C.
D.

Common: $2,000,000 X .05

100,000

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

60,000

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


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

Total

360,000
---------$520,000
=======

Take Home Quiz 1


Spring 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
dont 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?


48

A.
B.
C.
D.
2.

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

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.
B.
C.
D.
E.

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, Garths
A.
B.
C.
D.

5.

reduction of additional paid in capitalexcess over par value.


expense of the period.
intangible asset that is amortized over its estimated useful life.
Either B or C is acceptable.
Either A or B is acceptable.

legal capital increased $5,000.


contributed capital increased $20,000.
A and B.
Neither A nor B.

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?

A.
B.

Retained
earnings

Additional paid in
capital from treasury stock

Decrease
No effect

Decrease
Decrease
49

C.
D.
6.

Decrease
No effect

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
capital
A.
B.
C.
D.

7.

No effect
No effect

No effect
No effect
Decrease
Decrease

Total stockholders
____equity______
No effect
Decrease
No effect
Decrease

Munn Corps records included the following stockholders equity accounts at December 31, 2010:
Preferred stock, par value $15, 30,000 shares authorized
Common stock, par value $5, 100,000 shares authorized
Additional paid-in capitalpreferred
Additional paid-in capitalcommon
Treasury stock, 9,000 common shares, at cost

$255,000
300,000
15,000
50,000
72,000

The number of outstanding shares for each class of stock at December 31, 2010 is
Common stock
70,000
61,000
51,000
51,000
61,000

A.
B.
C.
D.
E.
8.

Which of the following statements is correct?


A.

Printing and engraving costs associated with issuing common stock should be reported as an
expense.
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.
A and B.
Neither A nor B.

B.
C.
D.
9.

Preferred stock
17,000
18,000
17,000
18,000
17,000

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

January 5:
April 6:
July 28:
December 31:

Issued 75,000 shares @ $10 per share;


Issued 25,000 shares @ $12 per share;
Reacquired 10,000 shares @ $11 per share; and
Reissued 10,000 shares @ $18 per share.
50

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

$450,000.
$520,000.
$370,000.
$570,000.

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

Common stock, $1 par value


Common stock subscribed
Preferred stock, $50 par value(the preferred stock must be redeemed
on December 31, 2014)
Additional paid in capital-common
Donated capital
Retained earnings
Treasury stock, 7,200 shares at cost
Common stock subscriptions receivable

$1,680,000
200,000
2,400,000
6,800,000
100,000
2,600,000
180,000
600,000

What is Hillers total stockholders equity at December 31, 2010?


A.
B.
C.
D.

$13,000,000.
$11,200,000.
$10,600,000.
$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:

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.
B.
C.
D.

$6,000.
$3,000.
$9,000.
$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?
51

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.
C. A and B.
D. Neither A nor B.
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 state
in which Taft is incorporated. The following information was taken from Tafts financial statements:

Net income for 2010


Additional paid in capital at December 31, 2010
Retained earnings at December 31, 2009

$ 90,000
475,000
450,000

In the journal entry to record the declaration of the cash dividend on January 2, 2011,
A.
B.
C.
D.

Retained earnings should be debited for $450,000.


Additional paid in capital should be debited for $175,000.
A and B.
Neither A nor B.

14. Grimm Company owned 32,000 shares of common stock in Baha Inc. On December 31, 2010,
Grimms 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.
B.
C.
D.

Retained earnings should be debited for $560,000.


Investment in Baha should be debited for $160,000.
A and B.
Neither A nor B.

15. Refer to the previous question. As a result of the property dividend, what was the increase in Grimms
income before income taxes for the year ended December 31, 2010?
A.
B.
C.
D.

$400,000.
$160,000.
$420,000.
$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
52

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. Blounts 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.
B.
C.
D.

Miscellaneous expense should be debited for $45,000.


Additional paid in capital in excess of par value should be credited for $30,000.
A and B.
Neither A nor B.

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


A.
B.
C.
D.
E.

Increases contributed capital.


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

Credit to Common Stock Dividend Payable.


Credit to Additional Paid in Capital.
Debit to Retained Earnings.
Credit to Common Stock Dividend Distributable.
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?

A.
B.
C.
D.

Cash dividends
to common

Market value
of common

Numerator
Not used
Numerator
Denominator

Denominator
Numerator
Not used
Numerator

Net income
less preferred dividends
Not used
Denominator
Denominator
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.
B.
C.
D.
E.

Remained unchanged at $5.


Increased to $10.
Increased by $25.
Increased to $25.
None of the above.

53

21. On June 30, 2010, when Wangs 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
Additional paid in capital
Retained earnings
Treasury stock at cost (5,000 shares)

600,000
1,400,000
4,200,000
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.
B.
C.
D.

$3,600,000.
$3,650,000.
$3,560,000.
$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.
B.
C.
D.

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

Retained earnings should be debited for $210,000.


Additional paid in capital excess over par should be credited for $137,500.
A and B.
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 companys debt to equity ratio after the company acquired its own common stock?
A.
B.
C.
D.

183%.
276%.
367%.
122%.

54

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

Common stock, $1 par value


Additional paid in capital excess over par
Retained earnings

$ 800,000
4,000,000
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.
B.
C.
D.

Additional paid in capital excess over par value should be debited for $30,000.
Retained earnings should be debited for $20,000.
A and B.
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 Bensons 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.
B.
C.
D.

$10,000.
$500.
$9,500.
$3,000.

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

Common stock, $1 par value


Common stock dividend distributable
Preferred stock, $50 par value, cumulative
Additional paid in capital-preferred
Additional paid in capital-common
Retained earnings
Accumulated other comprehensive income
Unearned revenue
Dividends payable

$7,680,000
200,000
2,400,000
100,000
700,000
2,100,000
120,000
250,000
180,000

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


A.
B.
C.
D.
E.

$13,300,000.
$13,430,000.
$13,550,000.
$13,180,000.
$12,980,000.

55

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

In the current liability section of the balance sheet.


As a deduction from net income on the income statement.
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.
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 Ables common stock is greater than its par value. What
component of stockholders equity would always be smaller?
A.
B.
C.
D.

The amount reported for additional paid in capital for the 50% stock dividend.
The amount reported for common stock for the 10% stock dividend.
A and B.
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?

A.
B.
C.
D.

Cash dividends
to common

Market value
of common

Numerator
Not used
Numerator
Denominator

Denominator
Numerator
Not used
Numerator

Net income
less preferred dividends
Not used
Denominator
Denominator
Not used

31. A corporation declared a cash dividend, a portion of which was liquidating. How would the
dividend affect each of the following?
Additional
Paid in Capital
A.
B.
C.
D.

Decrease
Decrease
No effect
No effect

Retained Earnings
No effect
Decrease
Decrease
No effect

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 Hubs 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.
56

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.
B.
C.
D.
E.
F.

The amount reported for additional paid in capital for the stock dividend.
The amount reported for retained earnings for the stock dividend.
The amount reported for common stock for the stock split.
The amount reported for additional paid in capital for the stock split.
B and C are correct.
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, Motts board of directors declared a cash
dividend of $120,000. Of this amount, how much will Motts common stockholders receive?
A.
B.
C.
D.

$84,000.
$108,000.
$96,000.
$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 Motts common stockholders receive?
A.
B.
C.
D.

36.

$55,200.
$64,800.
$96,000.
$46,800.

If the preferred is participating in distributions in excess of 8% on the common stock and a cash
dividend of $140,000 is declared on December 31, 2010, what amount will Motts common
stockholders receive?
A.
B.
C.
D.

$60,800.
$76,800.
$79,200.
$72,900.
57

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
Common stock
Additional paid in capital-common
Retained earnings
Net income
37.

$187,500
50,000
400,000
112,500
90,000

187,500
60,000
540,000
277,500
180,000

There were no dividends in arrears either at December 31, 2009 or 2010. What is Dashs return on
common stockholders equity for 2010?
A.
B.
C.
D.

38.

18.18%.
19.83%.
22.92%.
25%.

What is Dashs return on stockholders equity for 2010?


A.
B.
C.
D.
39.

18.18%.
19.83%.
22.92%.
25%.
Assuming there were no dividends in arrears at December 31, 2010, what is Dashs 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.
B.
C.
D.

$14.625.
$17.75.
$10.00.
$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 Lizards common stock is $3 per share, and the average issue price of the
common stock is $12 per share. Lizard uses the par value method of accounting for treasury
stock. In the journal entry to record the acquisition of Lizards common stock,
58

A.
B.
C.
D.

41.

On February 3, 2010, Giraffe Inc. acquired 1,000 shares of its own common stock at $18 per
share. The par value of Giraffes 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 Giraffes common stock,
A.
B.
C.
D.

42.

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

Treasury stock should be debited for $3,000.


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

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.
B.
C.
D.

Common stock should be credited for $2,400.


Additional paid in capital in excess of par should be credited for $14,400.
A and B.
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.
B.
C.
D.

44.

Which of the following statements is correct?


A.
B.
C.
D.

45.

Cash dividends are accounted for under the entity viewpoint.


Share premium-ordinary is similar to additional paid in capital under U.S. GAAP.
A and B.
Neither A nor B.

The amount reported for reserves on the statement of financial position can include
A.
B.
C.
D.

46.

Share capital-common stock.


Common stock.
Share capital-ordinary.
Capital stock-ordinary.

Gains and losses from the sale of treasury stock.


Unrealized gains and losses from revaluing capital assets.
A and B.
Neither A nor B.

The amount reported for retained earnings on the statement of financial position includes
59

A.
B.
C.
D.
47.

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

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:
48.

Which of the following statements is correct?


A.
B.
C.
D.

49.

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

Which of the following statements is correct?


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.

50.

Which of the following statements is correct?


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

60

Accountancy 432/532
Quiz I Answers
Spring 2015
Name: Aoran Kan

Seat #: 26

1.

22.

43. C

2.

23. A

44. B

3.

24.

45. B

4.

25.

46. C

5.

26.

47. D

6.

27. A

48. C

7.

28.

49. D

8.

29.

50. C

9.

30.

10. B

31.

11. B

32.

12. C

33.

13. C

34. A

14. A

35.

B
61

15. D

36.

16. C

37.

17. E

38.

18. A

39. A

19. A

40.

20. D

41.

21. A

42.

62

57

58

59

60

61

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