F7 - Equity, EPS, and Cash Flows

Question 1

M1 - Stockholders’ Equity: Part 1

Dividends in “arrears”

Answer 1

(undeclared dividends on cumulative preferred stock) should be reported in the footnotes.

Since they are not declared, no journal entry is made.

Neither liabilities nor equity are affected.

Question 2

M1 - Stockholders’ Equity: Part 1

Dividends are not reported as a liability until the dividends are declared.

Question 3

M1 - Stockholders’ Equity: Part 1

Book value per share

Answer 3

BV per common share = = Common SE’s equity / Common shares outstanding

Question 4

M1 - Stockholders’ Equity: Part 1

Common stock that contains an unconditional redemption feature

Answer 4

should be reported on the issuer’s books as a liability on the date of issuance because there is an obligation of a cash outflow in the future that the company has no ability to prevent.

Question 5

M1 - Stockholders’ Equity: Part 1

Cumulative preferred stock dividends

Answer 5

are paid on par value (not sales price) of preferred stock and have a “preference” over common stock dividends until all past preferred stock dividends are paid.

Question 6

M1 - Stockholders’ Equity: Part 1

When the purpose of the appropriation has been achieved

Answer 6

it should be restored to unappropriated retained earnings.

Question 7

M1 - Stockholders’ Equity: Part 1

A “retained earnings appropriation” can be used to:

Answer 7

to restrict earnings available for dividends.

A retained earnings appropriation debits (reduces) “unappropriated retained earnings” and sets up (credits) “appropriated retained earnings.” It does not affect the Income Statement.

Question 8

M1 - Stockholders’ Equity: Part 1

There is no requirement to appropriate retained earnings for any purpose.

Answer 8

Retained earnings may be set aside for future purposes by classifying a portion as “appropriated”.

Note: “Losses” on treasury stock would reduce paid in capital in excess of par.

Question 9

M1 - Stockholders’ Equity: Part 1

Gains and losses on treasury stock transactions are NEVER recorded on the Income Statement.

Answer 9

• Gains are recorded by increasing APIC-Treasury stock.
• Losses are recorded by first eliminating any balance in APIC-Treasury stock and then decreasing R/E.

Question 10

M1 - Stockholders’ Equity: Part 1

Gains and losses on the purchase and resale of treasury stock are reflected in:

Answer 10

Paid-in capital and retained earnings
- Gains on treasury stock transactions increase paid-in capital, while losses on treasury stock transactions decrease existing paid-in capital from treasury stock transactions to zero and then decrease retained earnings.

Common stock and income statement accounts are never used.

Question 11

M1 - Stockholders’ Equity: Part 1

The sale of treasury stock at less than cost will result in a net increase in stockholder’s equity.

Answer 11

• The original cost of the treasury stock is credited; any APIC-treasury stock is debited; and any excess over the APIC would reduce R/E.
• However, the net impact to stockholders’ equity would still be positive as long as cash is received from the sale of the treasury stock.

Question 12

M1 - Stockholders’ Equity: Part 1

The acquisition of treasury stock at a price less than their book value will:

Answer 12

1. Decrease stockholders’ equity in total. All treasury stock transactions decrease total equity.
   
   2. Increase book value per share. Book value per share is based on the number of outstanding common shares, which is reduced by the acquisition of treasury stock (the denominator is reduced). The numerator (book value) is also reduced by the cost to purchase the shares, but the overall effect on the ratio is an increase in book value per share.

Question 13

M1 - Stockholders’ Equity: Part 1

Corporations are not permitted to report income statement gains and losses from treasury stock transactions.

Answer 13

• Instead, treasury stock “gains and losses” are reported as direct adjustments to stockholders’ equity.
• Gains are recorded by crediting APIC-TS, while losses are recorded by first reducing any existing APIC-TS to $0, and then debiting any additional loss to R/E.

Question 14

M1 - Stockholders’ Equity: Part 1

There is no gain or loss on the purchase and/or sale of treasury stock.

Answer 14

Any “difference” goes to paid-in capital, or if there is not enough paid-in capital to absorb a loss, the loss would be (subtracted) from “retained earnings”.

Question 15

M2 - Stockholders’ Equity: Part 2

When collectibility is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed..

Answer 15

should be recorded as additional paid-in capital (APIC) when the subscription is received.

Question 16

M2 - Stockholders’ Equity: Part 2

When stock rights are “issued” without consideration, no entry (only disclosure) is made by either the “issuer” or the “recipient”.

Answer 16

At the time the rights are “exercised” (and the corporation receives a cash inflow), APIC would be credited if the purchase price of the stock exceeded the par value (which is usually the case).
- Retained earnings is not affected because this is a “capital” transaction, not an “operations” transaction.

Question 17

M2 - Stockholders’ Equity: Part 2

No entry is made when the rights are issued since no consideration is given.

CS or APIC does not increase

Answer 17

If the rights are exercised and stock is issued, then common stock and APIC increase.

Question 18

M2 - Stockholders’ Equity: Part 2

liquidating dividend

Answer 18

The dividend is a liquidating dividend to the extent that the dividend exceeded retained earnings.

Question 19

M2 - Stockholders’ Equity: Part 2

property dividend

Answer 19

should be recorded in retained earnings at the property’s market value at date of declaration.

Question 20

M2 - Stockholders’ Equity: Part 2

Working capital

Answer 20

is decreased on the declaration date, per the rule that the liability for a cash dividend is incurred and recorded on the declaration date.

RULE:
A liability for a cash dividend is incurred and recorded on the declaration date.

Question 21

M2 - Stockholders’ Equity: Part 2

A property dividend is recorded at the fair value of the property to be distributed.

Answer 21

The property has to be adjusted to fair value with the adjustment affecting earnings (Net income) for the period.

APIC is not affected

Question 22

M2 - Stockholders’ Equity: Part 2

liquidating dividend

Answer 22

A “liquidating dividend” is a return of capital (which decreases APIC) and not a distribution of earnings (which decreases retained earnings).

Question 23

M2 - Stockholders’ Equity: Part 2

Property dividends

Answer 23

are recorded at “FV”.

Question 24

M2 - Stockholders’ Equity: Part 2

Retained earnings

Answer 24

are “decreased” when property dividends are “declared”.

Question 25

M2 - Stockholders’ Equity: Part 2

liquidating dividend

Answer 25

is one in which the company is returning a portion of capital originally contributed to the company in excess of retained earnings.

A (pure) “liquidating dividend” implies there is no “retained earnings” left to decrease.

Question 26

M2 - Stockholders’ Equity: Part 2

The difference between book value and fair market value of the property dividend..

Answer 26

should be recorded as gain/loss on disposal of asset.

Question 27

M2 - Stockholders’ Equity: Part 2

Stock dividends and stock splits are NOT considered income to the recipient.

Answer 27

Therefore, investors do NOT record stock dividends at fair market value.
- They simply reallocate the investment account balance (under either method – cost or equity) over more shares so that value per share decreases.

Question 28

M2 - Stockholders’ Equity: Part 2

stock dividend (less than 20-25% of stock outstanding)

Answer 28

is treated by transferring the FMV of the stock dividend at declaration date from retained earnings to capital stock and paid-in capital.

There is no effect on total shareholders’ equity because all transfers take place within shareholder’s equity.

Question 29

M2 - Stockholders’ Equity: Part 2

Stock split

Answer 29

A “stock split” increases the number of shares.
- Only the number of shares changes.
- The capital stock and retained earnings do not change.

It is NOT considered a capital or asset distribution.

Question 30

M2 - Stockholders’ Equity: Part 2

Common and preferred stock are recorded at the number of shares issued times stated or par value.

Question 31

M3 - Stock Compesation

Compensation cost for restricted share plans is determined using the following formula:

Answer 31

Total compensation cost = Market price of the share on date of grant x Number of restricted shares awarded

Total compensation cost is allocated to compensation expense on a straight-line basis over the time period in which the employee must provide service.

Question 32

M3 - Stock Compesation

Stock options outstanding are reduced at the exercise date.

Question 33

M3 - Stock Compesation

Per SFAS 123 (ASC 718-20), equity instruments issued for employee services..

Answer 33

are to be valued at the date of the grant.

Question 34

M3 - Stock Compesation

Compensation expense for stock options

Answer 34

is derived based on fair value and is allocated over the service period, which represents the period from the grant date to the vesting date.

Question 35

M3 - Stock Compesation

service period of the stock options

Answer 35

this is the tiem between the grant date and the exercise (vesting) date.

Question 36

M3 - Stock Compesation

Compensation expense relative to stock options is recognized regardless of whether the option is exercised.

Question 37

M4 - Earnings per share

Income available to common shareholders is determined by

Answer 37

deducting dividends declared in the period on non-cumulative preferred stock (regardless of whether they have been paid) and dividends accumulated in the period on cumulative preferred stock (regardless of whether they have been declared).

Question 38

M4 - Earnings per share

Earnings per share for income from continuing operations and for net income

Answer 38

must be presented on the face of a public company’s income statement.

Question 39

M4 - Earnings per share

EPS disclosures are required for:

Answer 39

all companies with publicly traded common stock or potential common stock including:
- stock options
- stock warrants
- convertible securities
- “contingent stock” agreement

• Also required by companies that have made a filing or are in the process of filing with a regulatory agency (e.g., the SEC) in preparation for a public sale of common stock.

Question 40

M4 - Earnings per share

When computing basic earnings per share

Answer 40

convertible securities are ignored for purposes of computing the weighted average of common shares outstanding.

Question 41

M4 - Earnings per share

All public entities must present earnings per share on the face of the income statement.

Answer 41

• In a simple capital structure, basic EPS for income from continuing operations and net income are presented.
• In a complex capital structure, basic and diluted EPS must be presented for income from continuing operations and net income.

Question 42

M4 - Earnings per share

If the entity reports a discontinued operation

Answer 42

the entity presents the basic and diluted (if applicable) per share amounts for those items either on the face of the income statement or in the notes to the financial statement.
- Basic and diluted per share amounts for income from continuing operations and for net income should be presented on the face of the income statement (or statement of income and comprehensive income if the entity is using the one-statement approach) with equal prominence.

Question 43

M4 - Earnings per share

To calculate earnings per share

Answer 43

Net income - Preferred Dividends / weighted average number of common shares outstanding.

Question 44

M4 - Earnings per share

When a company has cumulative preferred stock,

Answer 44

the preferred dividends from net income to derive income available to common shareholders are equal to the dividends accumulated in the period, regardless of whether the have been declared.

Question 45

M4 - Earnings per share

In computing the weighted-average number of shares outstanding for earnings per share (EPS) determination,

Answer 45

a stock dividend (or a stock split) to the same class of shareholders must be retroactively recognized and treated as if it had occurred at the beginning of the year.
- In addition, EPS for all prior periods presented must be adjusted as though the shares had been outstanding for the entire period presented.

Question 46

M4 - Earnings per share

Stock dividends and stock splits require restatement of the shares outstanding before the stock dividend or stock split.

Answer 46

Thus, the stock dividend would be treated as if it had occurred at the beginning of the fiscal year.

Question 47

M4 - Earnings per share

When a stock splits (or reverse splits),

Answer 47

there is no change to equity as a result of the transaction.

Question 48

M4 - Earnings per share

Convertible securities are recognized when

Answer 48

computing diluted EPS only if the conversion is dilutive.

Recognized ONLY if they are dilutive

Question 49

M4 - Earnings per share

Dilutive stock options

Answer 49

would be used in the calculation of diluted EPS.

Question 50

M4 - Earnings per share

A dilutive security will produce

Answer 50

an EPS number below Basic EPS.

Question 51

M4 - Earnings per share

Compute the dilutive effect of options:

Answer 51

Number of shares - ( Number of shares x Exercise price / Average market price ) = Additional shares outstanding

Question 52

M4 - Earnings per share

The treasury stock method

Answer 52

presumes that option proceeds can be used to reacquire shares on the open market and that any option requirement will be satisfied by the issuance of new shares to be held in the treasury.

Treasury shares themselves do not have an impact on the calculation.

Question 53

M4 - Earnings per share

In determining EPS, interest expense, net of applicable taxes, on convertible debt that is dilutive should be:

Answer 53

Added back to net income for diluted earnings per share, and ignored for basic earnings per share.
- Interest expense (net of income tax) on debt considered would be added back to the numerator for diluted EPS if the effects are dilutive.

Question 54

M4 - Earnings per share

Contingent shares (that are dilutive)

Answer 54

are included in the calculation of Basic EPS if (and as of the date) all conditions for issuance are met.

Stock options do NOT enter into the calculation of Basic EPS.

Question 55

M5 - Statement of Cash Flows

When the direct method of preparing a statement of cash flows is used, an enterprise should provide a reconciliation of net income to net cash flows from?

Answer 55

Operating activity
- If the direct method is used to present cash flows from operating activities, the indirect method must also be presented in the footnotes.
- The indirect method starts with net income and makes adjustments to it generating cash flows from operating activities that would agree to the same amount calculated using the direct method.

Question 56

M5 - Statement of Cash Flows

A reconciliation of ending retained earnings to net cash flow from operations is not disclosed on the statement of cash flows either on the direct or indirect method, nor is it shown in a separate schedule.

Answer 56

Instead, the reconciliation is from “net income” to “net cash from operations”.
The following are required disclosures of a statement of cash flosws under the direct method under U.S. GAAP:
- the major classes of gross cash receipts and gross cash payments.
- the amount of income taxes paid
- a reconciliatino of net income to net cash flow from operations

Question 57

M5 - Statement of Cash Flows

Amortization of bond discount

Answer 57

is an income-related item; thus, it is almost automatically an operating activity, not a financing activity.

Amortization of bond discount is NOT a financing activity at all and certainly not a financing cash inflow.

Question 57

M5 - Statement of Cash Flows

When the indirect method is used,

Answer 57

a supplemental disclosure of cash paid for interest and income taxes is required.

Question 58

M5 - Statement of Cash Flows

When the indirect method is used, adjustments are made to net income to derive cash flows from operations.

Answer 58

Gains are subtracted from net income and losses are added.

In terms of current assets and current liabilities:
- decreases in current assets and increases in current liabilities are added back to net income.
- increases in current assets and decreases in current liabilities are subtracted from net income.

The change in value of land has NO impact on cash flows from o

Question 59

M5 - Statement of Cash Flows

Start with cash flows from operating activities and subtract depreciation and impairment expenses.

Answer 59

Dividends paid are not included because dividends reduce retained earnings, not net income, and are included in cash flows from financing activities.

Question 60

M5 - Statement of Cash Flows

Purchases = COGS + change in inventory

Question 61

M5 - Statement of Cash Flows

Cash paid = purchases - Change in AP

Answer 61

if AP decreases, it means more cash was paid

Question 62

M5 - Statement of Cash Flows

In a statement of cash flows using the indirect method,

Answer 62

gain from the sale of used equipment for cash should be reported in operating activities as a deduction from income.

Question 63

M5 - Statement of Cash Flows

In a statement of cash flows,

Answer 63

if used equipment is sold at a gain, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment plus the gain (or, the proceeds from the sale).

Question 64

M5 - Statement of Cash Flows

On a statement of cash flows, cash flows from investing activities would be decreased by?

Answer 64

Purchase of long-term investments.

The purchase of long-term investments would be reported in the investing activities section as an outflow of cash.

Question 65

M5 - Statement of Cash Flows

Cash flow from investing?

Answer 65

Sale of property, plant and equipment

Question 66

M5 - Statement of Cash Flows

Investing activities consider the cash effects of transaction affecting long-term assets.

Question 67

M5 - Statement of Cash Flows

**Conversion of debt to equity **should be disclosed as supplemental information in the statement of cash flows.

Cash flow per share should not be disclosed.

Question 68

M5 - Statement of Cash Flows

Financing activities reflect cash flows from non-current liabilities and equity activities.

Question 69

M5 - Statement of Cash Flows

Conversion of preferred stock into common stock is a noncash financing disclosure.

Question 70

M5 - Statement of Cash Flows

Financing activities cover transactions involving long-term liabilities and equity.

Question 71

M6 - Financial Statements of Employee Benefit Plan

What are two required financial statements of a defined contribution retirement plan?

Answer 71

The only two statements required for a defined contribution plan are:
- Statement of net assets available for benefits of the plan
- Statement of changes in net assets available for benefits.

Question 72

M6 - Financial Statements of Employee Benefit Plan

Footnote disclosures in the financial statements for pensions do NOT require inclusion of:

Answer 72

• The differences in executive and non-executive plans.

Question 73

M6 - Financial Statements of Employee Benefit Plan

What is the financial statement required of BOTH defined benefit pension plans and defined contribution pension plans?

Answer 73

Statement of Changes in Net Assets Available for Benefits

Question 74

M6 - Financial Statements of Employee Benefit Plan

Statement of Changes in Net Assets Available for Benefits

Answer 74

• shows the causes of the changes of a pension plan’s assets, which would include increases such as investment income as well as decreases such as benefits paid to beneficiaries.

Question 75

M6 - Financial Statements of Employee Benefit Plan

Statement of Changes in Accumulated Plan Benefits

Answer 75

• shows the causes of the changes in the present value of benefits to be paid to beneficiaries, which would include factors such as the effect of plan amendments and changes in actuarial assumptions as well as benefits paid to beneficiaries.

Question 76

M6 - Financial Statements of Employee Benefit Plan

In the financial statements of employee benefit pension plans and trusts,

Answer 76

the plan investments must be reported at fair value.

Question 77

M6 - Financial Statements of Employee Benefit Plan

The Statement of Changes in Accumulated Plan Benefits shows

Answer 77

the impact of every factor that caused a change in a plan’s actuarial present value of plan benefits, including changes in:
- actuarial assumptions,
- the effect of plan amendments, and
- the amount of benefits paid to beneficiaries.

However, the appreciation of a plan’s assets would have no effect on the plan’s actuarial present value of plan benefits and would thus not be included on the Statement of Changes in Accumulated Plan Benefits.

Question 78

M6 - Financial Statements of Employee Benefit Plan

The Statement of Changes in Net Assets Available for Benefits shows

Answer 78

• the appreciation in the fair value of investments,
• any other investment income,
• investment expenses,
• contributions,
• benefits paid, and
• administrative expenses to arrive at the net increase or decrease in net assets available for benefits during the period.

The change in actuarial present value of accumulated plan benefits is shown on the Statement of Changes in Accumulated Plan Benefits.