Chapter 7 Section 1: Stockholder's Equity

Question 1

What are the five major components of stockholder’s equity?

Answer 1

1. Capital stock
2. APIC
3. Retained earnings (deficit)
4. AOCI
5. Treasury stock

Question 2

Define legal capital

Answer 2

The amount of capital that must be retained by the corporation for the protection of creditos
Par value of preferred and common stock
Commonly referred to as capital stock

Question 3

Define common stock

Answer 3

The basic ownership interest in a corporation
Ultimate risk of loss and benefit of success
Not guaranteed dividends or assets
Have the right to vote and share in earnings

Question 4

How do you calculate book value per common share?

Answer 4

Common shareholders’ equity/common shares outstanding

Question 5

How do you calculate common shareholders’ equity

Answer 5

Total shareholders’ equity
- Preferred stock outstanding
- Cumulative preferred dividends in arrears
= Common shareholders’ equity

Question 6

Define preferred stock

Answer 6

Can include a preference related to dividends or liquidation

No right to vote

Question 7

Define cumulative and non-cumulative preferred stock

Answer 7

Cumulative provides that all preferred dividends not paid in a year accumulate and must be paid the next time they declare dividends before common shareholders get anything
Non-cumulative means that if you don’t get dividends one year you don’t get then at all

Question 8

Define participating and non-participating preferred stock

Answer 8

Participating means you share with common shareholders in dividends in excess of a specific amount. Fully participating means you get to participate in excess dividends without limit.
Non-participating means you get the dividends according to your ownership, but nothing more.

Question 9

Define convertible preferred stock

Answer 9

May be exchanged for common stock at the investor’s choice

COMPLEX

Question 10

Define callable (redeemable) preferred stock

Answer 10

May be called (repurchased) at a specified price by the issuing company

Question 11

Define and classify mandatorily redeemable preferred stock

Answer 11

The stock must be bought back by the company on the maturity date
Liability usually

Question 12

Define retained earnings

Answer 12

Accumulated earnings during the life of the company that have not been paid out as dividends

Question 13

What is the purpose of appropriated retained earnings?

Answer 13

To tell the shareholders that some of the R/E isn’t available to pay dividends because it’s been restricted for legal or contractual reasons

Question 14

Define quasi-reorganization

Answer 14

An accounting adjustment that allows the company to eliminate a deficit in retained earnings and get a fresh start.

Question 15

How do you do a quasi-reorganization?

Answer 15

1. Revalue assets to current fair values and liabilities to present values
2. Bring retained earnings to zero (by reducing par value of stock because if stated capital goes down, earned capital goes up)
   When you do the journal entry, bring retained earnings to zero, not above that. Excess goes to APIC

Question 16

Does AOCI go into retained earnings?

Answer 16

No - it’s not included in income, so it doesn’t go to R/E

Question 17

What balance does treasury stock have, and what does it do?

Answer 17

Debit balance, reduces stockholders’ equity

Question 18

What are the two ways to account for treasury stock?

Which is used more?

Answer 18

Cost and Par

Cost is used more

Question 19

Explain the cost method

Answer 19

Treasury shares are recorded at their reacquisition price
Gain or loss is determined when they’re resold or retired
Original issue price and BV don’t matter at all
APIC - T/S (or R/E) is used for the difference between reissue and reacquisition price

Question 20

Explain the par value method

Answer 20

Record treasury shares at par value
APIC - C/S is used for the original issue price attributable to the reaquired shares
APIC - T/S is used for the difference between repurchase and original selling price

Question 21

What happens when stock is donated?

Answer 21

A company’s own stock is donated back from a shareholder

No change in total SHE, but the number of shares outstanding decreases, so BV/sh increases

Question 22

Define a stock subscription

Answer 22

A contractual agreement to sell a specified number of shares at an agreed-upon price on credit. Upon full payment of the subscription, the stock is issued

Question 23

Define stock rights

Answer 23

The opportunity to buy additional shares at a price below market value on the date the rights are granted
Issuance of the rights is a memo entry only

Question 24

How do you account for stock issued for outside services?

Answer 24

At fair value of the stock

Question 25

What are the three dates important to dividends, and what do you do on each?

Answer 25

Declaration - make the JE and liability Record - decide who gets them. No JE Payment - JE, pay cash

Question 26

How do you do property (in-kind) dividends?

Answer 26

Restate the property to fair value on the date of declaration and recognize gain or loss in income. Record the JE at the FV or the property

Question 27

Define scrip dividends

Answer 27

A form of notes payable where a corporation commits to paying a dividend later. Used during a cash shortage CR notes payable instead of dividends payable

Question 28

Define liquidating dividends

Answer 28

Happen when dividends to shareholders exceed retained earnings. The excess is charged to APIC and then to common stock. They reduce total paid in capital

Question 29

What happens when there are stock dividends?

Answer 29

They distribute additional shares, reducing the cost basis

Question 30

Explain a small stock dividend

Question 31

Explain a large stock dividend

Answer 31

> 20-25% of shares previously outstanding are issued | Reduce R/E by the par value and increase common stock

Question 32

What happens with stock splits?

Answer 32

No journal entry It reduces the par value per share proportionally No change in total book value

Question 33

What are the ways stock issued to employees can be classified under GAAP and IFRS?

Answer 33

GAAP: compensatory and noncompensatory (if everyone is eligible for it) IFRS: compensatory

Question 34

How are compensatory stock option plans valued

Answer 34

Fair value of options issued

Question 35

Define option price

Answer 35

Also called the exercise price | Price at which the underlying stock can be purchased

Question 36

Define exercise date

Answer 36

The date by which the option holder must use it

Question 37

Define grant date

Answer 37

The date the option is issued. No JE

Question 38

Define vesting period

Answer 38

The period over which the employee has to earn the right to exercise the option

Question 39

Define service period

Answer 39

What you recognize compensation over. Usually the vesting period