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Flashcards in Equity Deck (64)

What is owners equity?

The owners' equity (OE) accounts represent the residual interest in the net assets of an entity that remain after deducting its liabilities.


What are the two main OE categories?

Earned and contributed


What is Par?

the minimum legal issue price for capital stock in most states and appears on the stock certificate.


What happens when a stock has no par value?

The firm may designate a stated value which serves the same function as par value except that it does not appear on the certificate.
The firm may not use a par value at all, in which case the stock is referred to as no par stock.


How is no par stock categorized?

If the stock is no-par stock, then the entire issuance proceeds is credited to the capital stock account and there is no additional paid-in capital account (contributed capital in excess of par).


What is the legal capital?

The legal capital or minimum capital of a corporation is usually the par value of the stock or the stated value of the stock issued


What are the rights for Preferred Stockholders?

Nonvoting, dividend preference, cumulative preferred stock and participating preferred stock, dividends in arrears, liquidation preference


What is an authorized share?

the total number of shares that can be issued


what is the number of stock shares issued?

The number of shares ever issued by the firm but not retired


What is the number of stock shares outstanding?

The number of shares currently held by stockholders


What is the common stock equation?

# Issued shares = # Outstanding shares + # Treasury shares


What information is required for the sale of stock on a subscription basis?

Specifying the share price;
Number of shares;
And the payment dates.


When is stock issued when sold on a subscription basis?

once the full amount is received


What type of account is common stock subscribed?

Owners Equity


What is convertible preferred stock?

It allows the preferred shareholder to convert the preferred shares to common shares. The journal entry for issuance of convertible preferred stock does not allocate any of the proceeds to the conversion feature


What happens when a company calls and redeems preferred stock?

Any debit difference is recorded in retained earnings;
Any credit difference is recorded in a contributed capital account.
Any dividends in arrears must be paid when the shares are acquired (retained earnings is debited).
No gain or loss is recognized for these events because the transactions are between the firm and its owners.


What happens when preferred stock is converted?

When convertible preferred stock is converted into common stock, the preferred stock accounts are transferred to the common stock accounts. Again, there is no gain or loss.


What methods are available to account for treasury stock?

Cost Method which records the treasury stock account at the cost of shares reacquired;
Par Value Method which records the treasury stock account at the par value of shares reacquired.

- Owners' equity is reduced by the same amount, regardless of which method is used, but the balances of certain OE accounts are different under the two methods.


Explain the cost method for accounting for treasury stock.

At purchase, treasury stock is debited for cost. The contributed capital in excess of par account that was credited when the stock was issued is not affected. Reissuances credit the treasury stock account at cost, and the difference between the purchase price and reissue price is recorded in contributed capital from treasury stock.


Explain the par method for accounting for treasury stock.

At purchase, the treasury stock account is debited for par value, and the contributed capital in excess of par account that was credited when the stock was issued is debited for the original amount recorded. Reissuances are treated as a regular issuance of stock except that treasury stock is credited, rather than common stock


When treasury shares are purchased at a cost greater than par but less than original issue price, what is the relative impact of the cost and the par value methods on additional paid-in capital and retained earnings?

a. Cost Method -- Under the cost method, when treasury stock is purchased for an amount less than original price, the treasury stock account is debited. This is a contra OE account. Additional paid-in capital and retained earnings are unaffected.
b. Par Value Method -- Under the par value method, the treasury stock account is debited for par value, and additional paid-in capital is debited for the amount in proportion to the original issue price. Because less was paid for the treasury stock than was received on original issuance, retained earnings is unaffected. Rather, additional paid-in capital from treasury stock is credited for the difference, but not by as much as the debit to the original issuance additional paid-in capital account.


What happens to increase the contributed capital from treasury stock account?

Cost method = Reissue at a price exceeding cost
Par Value = Purchase at a price less than original issue price


What happens to decrease the contributed capital from treasury stock account?

cost method - reissue at a price less than cost
par value method - purchase at a price exceeding original issue price


What happens when a firm retires shares?

Retired shares are placed back into the authorized but unissued category.

If the purchase price is less than the original issue price, then contributed capital from stock retirement is credited.

If the purchase price is greater than the original issue price, then contributed capital from stock retirement is debited until exhausted, and retained earnings is debited for the remainder, if any.


When is a liability recorded for dividends?

A liability is recognized for these liabilities on the date of declaration


What is a declaration date for dividends?

declaration date is the date the board of directors formally declares the dividend. This is the most important date in terms of the effect on the firm's resources and therefore its balance sheet. At this date, the firm recognizes a liability and a reduction in retained earnings


What is the date of record for dividends?

the date of record is simply a cut-off date. The shareholders of record on this date will be the recipients of the dividend payments


What is the payment date for dividends?

the payment date is the date the dividends are actually distributed to the shareholders.


What are dividends in arrears?

Unpaid dividends for a particular year on cumulative preferred stock. Dividends are not required to be paid but are said to accumulate if unpaid


Do dividends in arrears create a liability?

no liability is recognized for dividends in arrears until there has been a dividend declaration.


What happens with other property is distributed as a dividend?

In this type of dividend, the distribution of earnings will take the form of a non-cash distribution. In other words, a non-cash asset will be distributed to the shareholders. The most common type of asset distributed in a property dividend is an investment in securities of other firms.

The related liability and the gain or loss on disposal of the asset will be recognized on the date of declaration. The dividend is recorded at the market value at declaration date.


What is a scrip dividend?

A scrip dividend is first distributed in note payable (scrip) form because the firm does not have the cash at the date of declaration to pay the dividend but wants to assure the shareholders that the dividend is forthcoming


is interest paid on a scrip dividend?

Yes, it is paid on the note until cash is paid


What happens when a partial payment is made on a scrip dividend?

If a partial payment is made after declaration (to shareholders of record), then the interest expense is computed from the date of that partial payment to the date the final payment is made. The principal amount on which interest is computed is the amount of the final payment.


What is a liquidating dividend?

A liquidating dividend is a return of capital, rather than a return on capital. It is a return of contributed capital -- an amount invested by the shareholder


Does a liquidating dividend affect the contributed capital account?

The liquidating portion of a dividend reduces a contributed capital account, rather than retained earnings, and must be disclosed as a liquidating dividend.


What is a stock dividend?

A stock dividend is a distribution by a firm of its stock to its shareholders in proportion to their existing holdings. The shareholder does not pay for these shares. Stock dividends do not involve a future transfer of assets or a future provision of services


Do stock dividends create a liability?

no liability is recorded. Each investor simply holds more shares, but each share is worth proportionately less than before the dividend


What do stock dividends do?

Increase the number of shares issued and outstanding

Decrease earnings per share

reduce the market price of the stock and demand for cash dividends


How do you account for a small stock dividend (% less than 25%)

Capitalize at market price
Market price is used on the assumption that the market price of the stock will not change given the small size of the dividend


How do you account for a large stock dividend (% more than 25%)

Capitalize at par value

In this case, the assumption cannot be made that the market price of the stock will remain unchanged because of the large dilution in the number of shares outstanding.
Thus, only the par value of shares issued is permanently capitalized. Subsequent changes in market price do not affect the accounting


Do stock dividends change OE?

Neither type of stock dividend causes a change in total OE, but retained earnings is reduced and contributed capital is increased


What happens with a 2 for 1 stock dividend?

A 2-for-1 split halves the par value and doubles the number of shares. The reason firms split their shares is to reduce the market price and make the shares available to a larger number of shareholders

No change in OE


What effect on other accounts does 100% stock dividend have

Effect on total OE None
Effect on retained earnings Decrease
Effect on par value None
Effect on shares outstanding Double
Effect on contributed capital Increase
Effect on common stock account Increase


What effect on other accounts does a 2 for 1 stock split have

stock split
Effect on total OE None
Effect on retained earnings None
Effect on par value Cut in half
Effect on shares outstanding Double
Effect on contributed capital None
Effect on common stock account None


Do treasury shares receive stock dividends?



In what order are dividends allocated when the preferred stock does not participate?

1. Preferred: Any dividends in arrears (only if preferred stock is cumulative);
2. Preferred: Current period dividend;
3. Common: Remainder.


In what order are dividends allocated when the preferred stock is fully participating?

1. After any dividends in arrears are allocated, the remaining dividends are allocated based on the total par value of the preferred and common stock outstanding.
2. If total dividends are not sufficient to provide common with a matching amount equal to the preferred percentage times total par value of common, then there is no participation and common receives all the dividends after the current year preferred dividend requirement and any dividends in arrears are allocated.


In what order are dividends allocated when the preferred stock is partially participating?

a. Preferred: Any dividends in arrears;
b. Preferred: Current period dividend;
c. Common: Matching amount: preferred percentage x total par of common outstanding;
d. Preferred: Additional percentage;
e. Common: Remainder.


What is a stock right?

Gives the holder the option to purchase a certain number of shares of the issuing firm at a specified price during a specified time period.
Stock rights are often used to convey preemptive rights.
The existing shareholders are given rights (via a stock warrant) to purchase their pro rata number of shares to keep their current percentage in the firm.


What happens with a stock right when the rights are first issued?

No journal entry is made. No resources have been transferred


What happens with stock rights when they are exercised?

The usual entry to record the issuance of stock is made. The issue price is the exercise price as specified in the stock warrant, not the market price on the date of exercise.


What happens with stock rights when they lapse?

No entry is made if the shareholder does not exercise the rights.


What happens when stock rights are issued to outside parties for services?

At issuance of rights: Record an expense and owners' equity account equal to the difference between the market price and exercise price, times the number of shares under option.

At exercise of rights: Record the stock issuance at the exercise price and remove the OE account credited at issuance of the rights.


What is unappropriated retained earnings?

This portion of retained earnings is available for dividend declaration. In other words, the future use of this amount of retained earnings has not been determined.


What are appropriated retained earnings?

This amount of retained earnings has been declared off-limits for dividends so that funds may be conserved for a specific purpose or objective

This is often used for financial planning, legal requirement, contractual obligation,


What is a restriction on retained earnings?

A constraint placed on a certain portion of retained earnings by an external party.


What is the book value per share ratio equal to?

common stockholders equity per share of outstanding common stock at the end of a period


what is common stockholders equity?

Common stockholders' equity is total OE after preferred dividend claims are removed.


Equation for Book value per share oustanding

= Common stockholders' equity/ending common shares of common stock outstanding


Equation for common stock holders equity

= Total OE - liquidation preference of preferred stock- preferred stock dividends in arrears


What is quasi-reorganization?

An alternative to bankruptcy in some cases, quasi-reorganization allows a firm a fresh start and new, more conservative asset values.


What are the requirements for a Quasi reorganization?

1. Approval -- Shareholder and creditor approval.
2. Balance Becomes Zero -- The retained earnings balance must be zero immediately after the quasi-reorganization.
3. No Negative Balance After -- No contributed capital account can have a negative balance after the quasi-reorganization.
4. Assets Down to Market -- Assets must be written down to market value (asset write-ups are possible but would be rare).
5. Dated Years After -- Retained earnings must be dated for a period of 3 - 10 years after the quasi-reorganization to indicate that the balance reflects income earned after the quasi-reorganization.


What are the accounting steps for a quasi reorganization?

1. Write assets down to market value, further reducing retained earnings (increasing the deficit).
2. Reduce contributed capital to absorb the retained earnings deficit.
3. Change Value/Number Shares -- If needed, change par value or the number of shares of common stock to absorb the remaining deficit.