Equity Flashcards
(24 cards)
The following condensed balance sheet is presented for the partnership of Alfa and Beda, who share profits and losses in the ratio of 60:40, respectively:
Cash $ 45,000
Other assets 625,000
Beda, loan 30,000
$700,000
Accounts payable $120,000
Alfa, capital 348,000
Beda, capital 232,000
$700,000
Alfa and Beda decide to liquidate the partnership. If the other assets are sold for $500,000, what amount of the available cash should be distributed to Alfa?
A. $255,000
B. $273,000
C. $327,000
D. $348,000
B. $273,000
The liquidation process begins with selling the noncash assets and allocating any gain or loss on the sale to the partners based on their profit ratios. After the partnership’s debts are satisfied, the remaining cash is distributed to the partners based on their updated capital accounts. If a partner owes money to the partnership (eg, a loan) and does not repay it, the unpaid balance reduces the cash distributed to that partner.
In this scenario, no mention is made of Beda repaying the loan. Therefore, one can assume it was not repaid, and the amount of the loan will reduce the cash distributed to Beda. Alfa will receive $273,000 as calculated below.
Step 1 Sell noncash assets $500,000 − $625,000 = ($125,000) loss
Step 2 Allocate loss to partners Alfa: ($125,000) × 60% = ($75,000)
Beda: ($125,000) × 40% = ($50,000)
Step 3 Pay liabilities ($45,000 beginning cash + $500,000) − $120,000 = $425,000 remaining cash
Step 4 Distribute cash based on capital accounts Alfa capital: ($348,000 − $75,000) = $273,000
Beda capital: ($232,000 − $50,000) = $182,000 − $30,000 loan = $152,000
Check figure: ($273,000 + $152,000) = $425,000
In Year 1, Fogg, Inc. issued $10 par value common stock for $25 per share. No other common stock transactions occurred until March 31, Year 2, when Fogg acquired some of the issued shares for $20 per share and retired them. Which of the following statements correctly states an effect of this acquisition and retirement?
A. Year 2 net income is decreased.
B. Year 2 net income is increased.
C. Additional paid-in capital is decreased.
D. Retained earnings is increased.
C. Additional paid-in capital is decreased.
Treasury stock (T/S) is repurchased company stock that is usually held for future reissuance. However, a company may buy back its stock with the intention of permanently retiring the shares. When retiring shares, the entry made essentially reverses the original entry at issuance. Any amounts initially credited to common stock and APIC-common stock are removed (ie, debited) from the books.
However, an issue arises when the cash paid to reacquire the stock to be retired does not equal the amount received when the shares were originally issued.
If the stock to be retired is reacquired for less than the original issue price, the difference is recorded as a credit (ie, increase) to APIC-retired stock.
If reacquired for more, the difference is first recorded as a debit (ie, reduction) to any existing APIC-retired stock, with the remaining amount, if any, debited to retained earnings.
In this situation, Fogg, Inc. reacquired the stock at $20 per share, $5 less than the original issuance of $25. Although APIC-retired stock is increased $5 per share, the original $15 ($25 − $10 par) per share APIC-common stock is removed (ie, decreased). The result is a net decrease in APIC of $10 per share.
Baker Co. issued 100,000 shares of common stock in the current year. On October 1, Baker repurchased 20,000 shares of its common stock on the open market for $50 per share. At that date, the stock’s par value was $1, and the average issue price was $40 per share. Baker uses the cost method for treasury stock transactions. On December 1, Baker reissued the stock for $60 per share. What amount should Baker report as treasury stock gain at December 31?
A. $0
B. $200,000
C. $400,000
D. $980,000
A. $0
Treasury stock (T/S) is company stock that is repurchased but not retired. Because a company is not allowed to report owning its stock as an investment (ie, asset), T/S is recorded as a contra account (ie, debit balance) to stockholders’ equity on the balance sheet.
There are two methods used to account for T/S transactions: cost and par value. In this question, the cost method is used. However, whichever method is followed, all transactions involving T/S generally affect only stockholders’ equity accounts (never income statement accounts). No gain or loss is recognized on any T/S transaction (Choices B, C, and D). In this scenario, when Baker Co reissued (ie, resold) the T/S at a price greater than its cost, APIC-T/S is credited.
Things to remember:
All transactions involving treasury stock generally affect only stockholders’ equity accounts (never income statement accounts). No gain or loss is recognized in the income statement from the purchase, reissue, or retirement of treasury stock.
ASP Corporation was organized on January 2, Year 3, with 100,000 authorized shares of $10 par value common stock. During Year 3 ASP had the following capital transactions:
January 5—issued 75,000 shares at $14 per share.
December 27—purchased 5,000 shares at $11 per share.
ASP used the par value method to record the purchase of the treasury shares. What would be the balance in the paid-in capital from treasury stock account at December 31, Year 3?
A. $0
B. $5,000
C. $15,000
D. $20,000
C. $15,000
A reacquisition of common stock (C/S) removes any APIC (referred to as APIC-common stock) associated with the original issuance. The other stockholders’ accounts affected depend on the difference between the repurchase price and the original stock issuance price (ie, total par value and the APIC-common stock).
If the repurchase price is less than the original issuance price, a credit to APIC-treasury stock is required (Choice A).
If the repurchase price is greater, additional debits to APIC-treasury stock (from any previous T/S transactions) and/or retained earnings are required.
In this scenario, the stock transactions include C/S issued for more ($14) than par value ($10), which creates APIC-common stock. The T/S repurchase is at a price ($11) less than the original issuance price ($14). This transaction creates APIC-treasury stock of $15,000.
In the Adel-Brick partnership, Adel and Brick had a capital ratio of 3:1 and a profit and loss ratio of 2:1, respectively. The bonus method was used to record Colter’s admittance as a new partner. What ratio would be used to allocate, to Adel and Brick, the excess of Colter’s contribution over the amount credited to Colter’s capital account?
A. Adel and Brick’s new relative capital ratio.
B. Adel and Brick’s new relative profit and loss ratio.
C. Adel and Brick’s old capital ratio.
D. Adel and Brick’s old profit and loss ratio.
D. Adel and Brick’s old profit and loss ratio.
At December 31, Year 1, Eagle Corp. reported $1,750,000 of appropriated retained earnings for the construction of a new office building, which was completed in Year 2 at a total cost of $1,500,000. In Year 2, Eagle appropriated $1,200,000 of retained earnings for the construction of a new plant. Also, $2,000,000 of cash was restricted for the retirement of bonds due in Year 3. In its Year 2 balance sheet, Eagle should report what amount of appropriated retained earnings?
A. $1,200,000
B. $1,450,000
C. $2,950,000
D. $3,200,000
A. $1,200,000
Retained earnings (RE) are earnings accumulated since inception of the company that have not been paid out to shareholders in the form of a dividend. Generally, RE are assumed to be available for the payment of dividends. Occasionally, a company may want to set aside (restrict) some of the earnings for specific business situations (eg, certain contingent liabilities, future construction) rather than dividends.
Restricting RE is done through an appropriation (ie, a reserve). A journal entryreclassifies unappropriated RE to appropriated RE. When the reserve is no longer needed, the original entry is reversed. Appropriating RE is not used for actual transactions incurred (eg, debt payments, fire loss), which are recorded in the financial records.
In this case, restricted cash of $2,000,000 for the actual debt payments is reported as a current asset (decrease cash and increase restricted cash) (Choice D). Upon completion of the building in Year 2, the $1,750,000 appropriation was reversed. Therefore, as of 12/31/YR 2, only the $1,200,000 appropriation for the new plant remains in appropriated RE.
On October 1, Year 3, Sheyer Corp. declared a scrip dividend of $600,000 and issued promissory notes to its stockholders in lieu of cash. The corporation has sufficient retained earnings. The notes, which were dated October 1, Year 3, had a maturity date of September 30, Year 4 and a 5% interest rate. What is the effect of this scrip dividend on Sheyer’s Year 3 retained earnings after all nominal accounts are closed?
A. $0
B. $600,000 decrease.
C. $607,500 decrease.
D. $630,000 decrease.
C. $607,500 decrease.
Dividends are a distribution of a company’s accumulated earnings to its stockholders and are charged to retained earnings. A company that is experiencing temporary cash flow problems may still want to issue a dividend. When this occurs, the company can choose to issue a scrip dividend (assuming adequate retained earnings). Although scrip dividends can be structured in various forms, a promissory note is common.
On the declaration date, retained earnings and notes payable are recorded for a dividend ($600,000), indicating that the company will pay its stockholders at a future date when funds become available (Choice A). As compensation for waiting to receive the dividend, the note is usually interest-bearing. On the payment date, stockholders receive the dividend ($600,000) plus the total interest accrued ($30,000 = $600,000 × 5% × 12/12) on the note.
However, interest expense is recorded as incurred (ie, matching principle). For Year 3, the interest expense is from October to December, or $7,500 ($600,000 × 5% × 3/12) (Choice D). The expense, a nominal or temporary account, is closed (transferred) to retained earnings at year end (Choice B). Therefore, the total effect on retained earnings in Year 3 is a decrease of $607,500. The additional interest of $22,500 ($600,000 × 5% × 9/12) will be recognized in Year 4
Ole Corp. declared and paid a liquidating dividend of $100,000 when retained earnings had a balance of $60,000. This distribution resulted in a decrease to Ole’s
APIC RE
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Yes Yes
On December 1, Year 1, Nilo Corp. declared a property dividend of trading marketable securities to be distributed on December 31, Year 1, to stockholders of record on December 15, Year 1. On December 1, Year 1, the marketable securities had a carrying amount of $60,000 and a fair value of $78,000. What is the effect of this property dividend on Nilo’s Year 1 retained earnings after all nominal accounts are closed?
A. $0.
B. $18,000 increase.
C. $60,000 decrease.
D. $78,000 decrease.
C. $60,000 decrease.
Dividends are distributions to shareholders of accumulated earnings (retained earnings). When any type of dividend is declared, retained earnings are decreased. Instead of giving a cash or stock dividend, a company may choose to distribute one of its assets (ie, real estate, marketable securities). This type of distribution, a property dividend, is considered a nonreciprocal transfer to the shareholders.
GAAP requires nonreciprocal transfers of property to be recorded at the asset’s fair value (FV) and any gain/loss recognized as if the asset was sold. To achieve this, recording a property dividend requires a two-step process:
Adjust the asset to its FV near (or at) the time of distribution (normally date of declaration). If the FV differs from the net carrying value (ie, net book value), a gain or loss is recognized.
Record the liability (dividends payable) and reduce retained earnings for the property’s FV.
In this scenario, the FV of the securities on date of declaration is used to value the dividend, resulting in a gain of $18,000 ($78,000 − $60,000). The gain, a nominal or temporary account, is closed (transferred) to retained earnings at year end. Therefore, the net effect on retained earnings is a decrease of $60,000 ($78,000 decrease for the FV – $18,000 increase for the transferred gain) (Choices B and D).
Note: Carefully read the question requirements. Often on the exam, the “net” effect of transactions will be asked.
(Choice A) A $0 change in retained earnings assumes that neither the declaration of the property dividend nor the gain on the revaluation of the securities to FV impact retained earnings.
On incorporation, Dee Inc. issued common stock at a price in excess of its par value. No other stock transactions occurred except treasury stock was acquired for an amount exceeding this issue price. If Dee uses the par value method of accounting for treasury stock appropriate for retired stock, what is the effect of the acquisition on the following?
APIC Net CS RE
A. No effect Decrease No effect
B. Decrease Decrease Decrease
C. Decrease No effect Decrease
D. No effect Decrease Decrease
B. Decrease Decrease Decrease
The par value method is used to record treasury stock (T/S) transactions when a company’s initial intent is to hold repurchased shares indefinitely. Under this method, T/S is always recorded at the stock’s par value. T/S is a contra equity account (ie, debit balance) that is reported under the par value method as a deduction to common stock (C/S), not total stockholders’ equity.
A reacquisition of C/S removes any APIC-C/S associated with the original issuance. Which other stockholders’ accounts are affected depends on the difference between the repurchase price and the original stock issuance price (ie, total par value and the APIC-C/S).
If the repurchase price is less than the original issuance price, a credit to APIC-T/S is required.
If the repurchase price is greater, additional debits to APIC-T/S (from any previous T/S transactions) and/or retained earnings are required.
In this scenario, the reacquisition price is greater than the original issue price. Therefore, after the original AIPC-C/S is removed, additional debits would be required to APIC-T/S and/or retained earnings. Because no transactions occurred that would have created APIC-T/S, the debit will be charged to (ie, decrease) retained earnings.
The overall result is a decrease to net C/S (ie, C/S less treasury stock), to existing APIC-C/S, and to retained earnings.
Note: If the assumption is made that the shares were immediately retired, the answer would be the same. The only difference would be that C/S instead of T/S is debited.
The partnership of Golay and Tyler had the following items during Year 3:
Cash withdrawals from partnership by Golay $20,000
Bonus paid to Golay 50,000
Salary allowance paid to Tyler 75,000
Partnership net income before any payments to the partners was $400,000. The partnership agreement states the annual allocation of net profits or losses is 60% to Golay and 40% to Tyler. What amount of net income should be allocated to Golay?
A. $215,000
B. $223,000
C. $240,000
D. $260,000
A. $215,000
In accordance with the partnership agreement, each partner is entitled to a portion of the partnership’s net income/loss and to special allocations and allowances (eg, bonuses, salary allowances). The allocations and allowances are distributed equitably with consideration for the time each partner has devoted to the partnership. The partners may also be rewarded for their capital investment.
The special allocations and allowances paid to partners are considered expenses of the partnership, and therefore are deducted first in the allocation of net income/loss and recorded in the capital accounts at year end.
The deductions reduce the net income/loss available to be divided among the partners.
Any remainder is split according to the partners’ profit/loss ratios.
A withdrawal by a partner represents a return of investment and does not impact the allocation of net income/loss. Instead, it reduces the partner’s capital.
In this scenario, start the allocation with the bonus and the salary allowance. The remaining net income is allocated according to the partners’ profit ratios. Golay’s share of the net income is $215,000, as shown below.
Pugh Co. reported the following in its statement of stockholders’ equity on January 1, Year 2:
Common stock, $5 par value, authorized 200,000 shares, issued 100,000 shares $500,000
Additional paid-in capital 1,500,000
Retained earnings 516,000
$2,516,000
Less treasury stock, at cost, 5,000 shares (40,000)
Total stockholders’ equity $2,476,000
The following events occurred in Year 2:
May 1 - 1,000 shares of treasury stock were sold for $10,000.
July 9 - 10,000 shares of previously unissued common stock were sold for $12 per share.
October 1 - The distribution of a 2-for-1 stock split resulted in the common stock’s per share par value being halved.
Pugh accounts for treasury stock under the cost method. Laws in the state of Pugh’s incorporation protect shares held in treasury from dilution when stock dividends or stock splits are declared. In Pugh’s December 31, Year 2, statement of stockholders’ equity, the par value of the issued common stock should be
A. $275,000
B. $291,000
C. $518,000
D. $550,000
D. $550,000
Stock splitsincrease the number of common stock shares issued without changing the total par value (in dollars) of the stock. This is accomplished by proportionally reducing the par value per share. One reason a company may issue a stock split is to increase the marketability of its stock (ie, reduce price to increase sales).
When a stock split is declared, the existing stock certificates, at the original (or current) par value per share, are exchanged for new shares at the reduced par value. Because the total par value of the stock does not change (ie, more shares but at a reduced par value), no formal journal entry is required.
In this scenario, the treasury stock reduces Pugh’s outstanding shares (ie held by stockholders); however, it has no effect on the number of shares issued. Only when treasury stock is retired will the issued shares decrease. The split reduces the par value per share to $2.50, resulting in the total par value remaining at $550,000.
Anchor Co. owns 40% of Main Co.’s common stock outstanding and 75% of Main’s noncumulative preferred stock outstanding. Anchor exercises significant influence over Main’s operations. During the current period, Main declared dividends of $200,000 on its common stock and $100,000 on its noncumulative preferred stock. What amount of dividend income should Anchor report on its income statement for the current period related to its investment in Main?
A. $75,000
B. $80,000
C. $120,000
D. $225,000
A. $75,000
The equity method is used when an investor has the ability to exercise significant influence (ie, between 20% and 50% voting stock ownership) over the operating and financial policies of the investee. Under the equity method, an investor owning common stock recognizes the pro rata share of the investee’s net income in earnings, but dividends received are a reduction to the investment account.
More than 20% ownership of preferred stock cannot give an investor significant influence because it is nonvoting stock. But if the investor has influence due to other causes (eg, major customer or supplier), the equity method may be used for the preferred stock. If used for preferred stock, the income reported is equal to the allocated dividends (ie, treated like less than 20% ownership). For noncumulative preferred stock, the amount equals declared dividends; for cumulative preferred stock, it is the annual dividend (declared or undeclared).
In this scenario, Anchor Co. owns 40% of the common stock of Main Co., so it will use the equity method. Anchor recognizes $80,000 (40% × $200,000) of Main’s dividends to common stockholders as a reduction to the investment, not dividend income (Choice B). Whether or not the equity method is used for the preferred stock, Anchor recognizes the $75,000 (75% × $100,000) dividends as income.
On May 18, Year 2, Sol Corp.’s board of directors declared a 10% stock dividend. On the same date, the market price of Sol’s 3,000 outstanding shares of $2 par value common stock was $9 per share. The stock dividend was distributed on July 21, Year 2, when the stock’s market price was $10 per share. What amount should Sol credit to additional paid-in capital for this stock dividend?
A. $2,100
B. $2,400
C. $2,700
D. $3,000
A. $2,100
Stock dividends are a pro rata issuance of additional shares to existing stockholders. That issuance represents a transfer of capital from retained earnings to contributed capital accounts (eg, common stock, additional paid-in capital). Therefore, total stockholders’ equity is unchanged. There are numerous reasons to issue stock dividends, such as a lack of cash funds.
If the dividend is less than 20-25% of the outstanding shares, it is considered a small stock dividend and is recorded at fair value (FV) on the date of declaration. Since common stock is recorded at par value, any excess FV is recorded as additional paid-in capital. Sol’s dividend of 300 (3,000 × 10%) shares has an excess FV (ie, market value) over par value of $7 ($9 − $2), resulting in a credit to additional paid-in capital of $2,100 (300 × $7). The journal entry would be:
On January 1, Year 1, Company X, a closely held corporation, issued 5% bonds with a maturity value of $90,000 together with 1,500 shares of its $3 par value common stock for a combined cash amount of $121,800. The FV of Company X’s stock is uncertain. If the bonds had been issued separately, they would have sold at 102. What amount should Company X report for APIC upon issuing the stock?
A. $34,500
B. $31,800
C. $30,000
D. $25,500
D. $25,500
To increase the demand and marketability of bonds, common stock may be issued with the bonds. When common stock is issued with bonds, the sales proceeds must be allocated between the bonds and stock based on relative FVs if the FVs of both securities are known.
The incremental method is used when the FV of only one security is known; proportions can be used only when the FV of all securities is known. The known amount is allocated first, and the remainder of the proceeds is assigned to the other security.
In this scenario, only the FV of the bond is known; therefore, the bond will be recorded at its FV (Face value + Premium) with the remaining proceeds assigned to the common stock equity, as shown below:
Total proceeds $121,800
Less: allocation to bonds ($90,000 × 1.02) 91,800
Remainder assigned to total equity of common stock 30,000
Less: par value of common stock ($3.00 × 1,500 shares) 4,500
APIC $25,500
A corporation declared a 10% stock dividend on 15,000 shares outstanding of $5 par common stock when the fair value was $10 per share. Which change in the corporation’s stockholders’ equity accounts is correct?
A. Retained earnings is decreased by $15,000.
B. Additional paid-in capital is increased by $15,000.
C. Common stock is decreased by $7,500.
D. Common stock is increased by $15,000.
B. Additional paid-in capital is increased by $15,000.
Stock dividends are pro rata issuances of additional stock to existing stockholders that result in a transfer (reclassification) from retained earnings to contributed capital accounts. A stock dividend less than 20–25% of the outstanding shares is considered a small stock dividend and recorded at fair value; a large stock dividend (ie, greater than 20–25%) is recorded at par value.
The dividends are treated differently because fair value is not considered a realistic estimate of stock value after the issuance of a large stock dividend since a large dividend will reduce the selling price of the shares. When recording a small stock dividend, retained earnings is decreased (ie, debited) for fair value and the contributed capital accounts (eg, common stock, APIC) are increased (ie, credited). The common stock is always increased by its par or stated value.
Here, the corporation issued a small stock dividend (ie, 10%) which is 1,500 shares (15,000 × 10%). The shares are recorded at fair value ($10) which results in a $15,000 decrease to retained earnings as shown below.
The following condensed balance sheet is presented for the partnership of Alfa and Beda, who share profits and losses in the ratio of 60:40, respectively:
Cash $45,000
Other assets 625,000
Beda, loan 30,000
$700,000
Accounts payable $120,000
Alfa, capital 348,000
Beda, capital 232,000
$700,000
The assets and liabilities are fairly valued on the balance sheet. Alfa and Beda decide to admit Capp as a new partner with a 20% interest. No goodwill or bonus is to be recorded. What amount should Capp contribute in cash or other assets?
A. $110,000
B. $116,000
C. $140,000
D. $145,000
D. $145,000
When an existing partnership (P/S) admits a new partner, the purchase price paid (ie, contributions received) does not always equal the book value (BV) of the capital account purchased. Accounting for the admission depends on which of three methods is used: bonus, exact, or goodwill.
When the exact method is used, no goodwill or bonus is recorded. Therefore, the old partners’ capital accounts do not change; however, their percent of ownership decreases. The new partner must contribute an amount that will achieve the desired initial capital ownership (ie, 20%) based on the new value of the total P/S capital. Once that amount is determined, the new partner’s capital account is equal to the fair value (FV) of the assets contributed.
Here, the old partners’ capital equals $580,000, which now represents an 80% ownership after the admittance of the new partner. The new partner will be required to contribute $145,000 in cash or other assets as calculated below.
Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30% stock dividend. The market value was $50 per share, the par value was $10, and the average issue price was $30 per share. By what amount will Universe decrease stockholders’ equity for the dividend?
A. $0
B. $1,500,000
C. $4,500,000
D. $7,500,000
A. $0
Stock dividends are transfers of capital from retained earnings to contributed capital accounts (eg, common stock, additional paid-in capital). The number of shares outstanding is increased, but there is no monetary effect on any component of stockholders’ equity; therefore, total stockholders’ equity is unchanged.
Large stock dividends (ie, greater than 20–25% of the outstanding shares) are recorded at par value whereas small stock dividends (ie, less than 20–25%) are recorded at fair value. The reason for the different treatment is that the fair value of the stock is not deemed to be a realistic estimate after a large stock dividend occurs since a large dividend will normally cause a reduction in the selling price of the shares.
Because Universe Co. issued a 30% stock dividend, the dividend is recorded at par value or $1,500,000 (500,000 × 30% × $10). Retained earnings are decreased and common stock is increased by $1,500,000, resulting in $0 change to stockholders’ equity.
(Choice B) A decrease of $1,500,000 ignores the offsetting increase to additional paid-in capital.
(Choices C and D) Both choices fail to consider the offsetting increase to additional paid-in capital. Choice C uses the average issue price, and Choice D uses market price to value the stock dividend.
Things to remember:
Stock dividends represent a reclassification of capital and are recorded by decreasing retained earnings and increasing contributed capital accounts (eg, common stock, additional paid-in capital). Large stock dividends (ie, greater than 20–25% of the outstanding shares) are recorded at par value. There is no effect on total stockholders’ equity.
Cross Corp. had 2,000 outstanding shares of 11% preferred stock, $50 par. On August 8, Year 3, Cross redeemed and retired 25% of these shares for $22,500. On that date, Cross’s additional paid-in capital from preferred stock totaled $30,000. To record this transaction, Cross should debit (credit) its capital accounts as follows:
PS APIC RE
A. $25,000 $7,500 ($10,000)
B. $25,000 —($2,500)
C. $25,000 ($2,500) —
D. $22,500 ——
C. $25,000 ($2,500) —
Treasury stock (T/S) is repurchased company stock that is normally held for future reissuance. However, a company may buy back its stock with the intention of permanently retiring the shares. When shares are repurchased and retired, the entry essentially reverses the original entry at issuance. The amounts initially credited to preferred stock and APIC-preferred stock (if any) are removed (ie, debited) from the books.
An issue arises when the cash paid to reacquire and retire the stock does not equal the amount received when the shares were originally issued.
If reacquired for less than the original issue price, the difference is recorded as credit (ie, increase) to APIC-retired stock.
If reacquired for more, the difference is first recorded as a debit (ie, reduction) to any APIC existing from previous stock retirements, then from retained earnings, if needed.
In this case, Cross Corp. repurchased and retired 500 shares ( 2,000×25%
2,000
×
25
%
at a cost less than the original issue price. This will require a credit to APIC-retired stock for the difference. Although the original APIC-preferred stock is removed with a debit of $7,500, the required credit to APIC-retired stock is $10,000, resulting in a net increase of $2,500.
When a company goes through a quasi-reorganization, its balance sheet carrying amounts are stated at:
A. Original cost.
B. Original book value.
C. Replacement value.
D. Fair value.
D. Fair value.
A corporation with a large deficit balance (ie, debit) in retained earnings may face legal proceedings (eg, bankruptcy) or be forced to legally reorganize as a new entity. In rare situations, GAAP does permit such a corporation, as means for a fresh start, to eliminate the deficit balance and restate its balance sheet to fair value in a quasi-reorganization,
A quasi-reorganization should not result in a write-up of net assets (eg equity) and retained earnings must be zeroed out. Once the quasi-reorganization receives shareholder approval, readjustments are made.
Assets and liabilities are generally revalued to fair value, if required. Using fair value makes accounting information more relevant to the users.
The deficit in retained earnings is eliminated.
Paid-in capital (par value and/or APIC) is adjusted, but not below zero.
Ole Corp. declared and paid a liquidating dividend of $100,000. This distribution resulted in a decrease in Ole’s
APIC RE
A. Yes Yes
B. Yes No
C. No Yes
D. No No
B. Yes No
Dividends are distributions of a company’s accumulated profits (ie, retained earnings). Declared dividends may not reduce retained earnings below zero (ie, create a deficit). When a company’s declared dividend exceeds its retained earnings balance, the excess is considered a liquidating dividend or return of capital. On occasion, the declared dividend may be entirely liquidating in nature, as in this case.
To record a liquidating dividend, the excess dividend over the current retained earnings balance is charged (debited) to additional paid-in capital. Therefore, if Ole Corp. declared and paid a liquidating dividend of $100,000, the entire amount would have been debited to additional paid-in capital. Retained earnings are only decreased by the normal portion of the dividend (ie, the amount that reduces retained earnings to zero), not the liquidating dividend portion (Choices A, C, and D).
Things to remember:
Declared dividends may not reduce retained earnings below zero. A liquidating dividend is any amount of a dividend that is in excess of current retained earnings balance. As a result, a liquidating dividend is recorded with a decrease to additional paid-in capital rather than retained earnings.
At December 31, Year 2 and Year 3, Apex Co. had 3,000 shares of $100 par, 5% cumulative preferred stock outstanding. No dividends were in arrears as of December 31, Year 1. Apex did not declare a dividend during Year 2. During Year 3, Apex paid a cash dividend of $10,000 on its preferred stock. Apex should report dividends in arrears in its Year 3 financial statements as a (an)
A. Accrued liability of $15,000.
B. Disclosure of $15,000.
C. Accrued liability of $20,000.
D. Disclosure of $20,000.
D. Disclosure of $20,000.
Dividends are distributions to shareholders of accumulated earnings (retained earnings). A dividend must be declared to be paid. On the date of declaration, a liability (ie, dividends payable) is incurred and remains on the books until the date of payment.
If preferred stock is cumulative, any undeclared annual dividend not paid in the previous year(s) accumulates (ie, dividends in arrears) and is paid in the future when declared. Because dividends in arrears represent undeclared dividends, they are not a liability and therefore not accrued. However, they are disclosed in the notes to financial statements (Choices A and C).
Apex Co.’s preferred shareholders have a 5% dividend preference, meaning they are entitled to an annual dividend of $15,000 (3,000 shares × 5%).
Because the stock is cumulative, the preferred shareholders are owed Year 2 and Year 3’s undeclared dividends of $30,000 (15,000 shares × 2).
Because a $10,000 dividend was paid in Year 3, the remaining dividends in arrears are $20,000 ($30,000 − $10,000). Accordingly, $20,000 is disclosed in the notes to the financial statements (Choice B).
Eagle and Falk are partners with capital balances of $45,000 and $25,000, respectively. They agree to admit Robb as a partner. After the assets of the partnership are revalued, Robb will have a 25% interest in capital and profits, for an investment of $30,000. What amount, if any, should be recorded as goodwill to the original partners?
A. $0
B. $5,000
C. $7,500
D. $20,000
D. $20,000
When an existing partnership admits a new partner, the purchase price paid (ie, contributions received) does not always equal the book value (BV) of the capital account purchased. Accounting for the admission depends on which of three methods is used: bonus, exact, or goodwill.
The goodwill method is based on the total value of the partnership implied by the new partner’s contribution. If the existing partners’ capital accounts do not equal their pro rata share of the implied partnership value, goodwill is recorded for the difference. The old partners’ capital balances are increased by the goodwill according to their old profit ratios (Choice A).
In this scenario, Robb is admitted as a 25% partner for a $30,000 contribution. This implies the partnership’s BV is $120,000. The resulting goodwill is $20,000, as show below.
Kern and Pate are partners with capital balances of $60,000 and $20,000, respectively. Profits and losses are divided in the ratio of 60:40. Kern and Pate decided to form a new partnership with Grant, who invested land valued at $15,000 for a 20% capital interest in the new partnership. Grant’s cost of the land was $12,000. The partnership elected to use the bonus method to record the admission of Grant into the partnership. Grant’s capital account should be credited for
A. $12,000
B. $15,000
C. $16,000
D. $19,000
D. $19,000
When an existing partnership (P/S) admits a new partner, the purchase price (ie, contributions received) does not always equal the book value (BV) of the capital account purchased. If the bonus method is used to account for the admission, a reallocation of the capital balances of both the new and old partners is required.
The reallocation is based on the difference between the BV of the capital account acquired and the fair value (FV) of the contribution. If the contribution is more than the capital’s BV, a bonus is paid to the old partners, if less, then a bonus is paid to the new partner. The existing partners’ old profit and loss ratio is used to allocate any bonus.
In this scenario, the $15,000 FV of Grant’s contribution is less than the $19,000 BV of capital acquired. A $4,000 bonus is paid to the new partner, calculated as follows:
