FAR 28 - Equity 2 - Dividends/Splits/RE/Book Value Flashcards Preview

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Flashcards in FAR 28 - Equity 2 - Dividends/Splits/RE/Book Value Deck (57):
1

Instead of the usual cash dividend, Evie Corp. declared and distributed a property dividend from its overstocked merchandise.

The excess of the merchandise's carrying amount over its market value should be
A. Ignored.
B. Reported as a separately disclosed reduction of retained earnings.
C. Reported as an extraordinary loss, net of income taxes.
D. Reported as a reduction in income before extraordinary items.

D. When the carrying value and market value of an asset distributed as a property dividend are different, the resulting gain or loss on disposal is recognized as ordinary income, just as the gain or loss from disposal is recognized for any other reason.

Had the asset been sold first, and the cash proceeds distributed in lieu of the property dividend, the same gain or loss would have resulted. The disposal loss or gain is recognized in income from continuing operations.

2

A corporation issuing stock should charge retained earnings for the market value of the shares issued in a(an)
A. Employee stock bonus.
B. Pooling of interests.
C. 10% stock dividend.
D. 2-for-1 stock split.

C. Stock dividends, like all dividends, cause a decrease (debit or charge) in retained earnings. A stock dividend is a permanent capitalization of retained earnings to contributed capital. Stock dividends are made in lieu of cash dividends. Small stock dividends (those less than 20% to 25%) are capitalized at the market value of the shares issued.

3

East Corp., a calendar-year company, had sufficient retained earnings in 2003 as a basis for dividends, but was temporarily short of cash.

East declared a dividend of $100,000 on April 1, 2003 and issued promissory notes to its stockholders in lieu of cash. The notes, which were dated April 1, 2003, had a maturity date of March 31, 2004 and an interest rate of 10%.

How should East account for the scrip dividend and related interest?
A. Debit retained earnings for $110,000 on April 1, 2003.
B. Debit retained earnings for $110,000 on March 31, 2004.
C. Debit retained earnings for $100,000 on April 1, 2003, and debit interest expense for $10,000 on March 31, 2004.
D. Debit retained earnings for $100,000 on April 1, 2003, and debit interest expense for $7,500 on December 31, 2003.

D. Retained earnings is reduced only by the amount of the dividend otherwise payable in cash, in this case $100,000. Interest on the notes is recognized as interest expense, not as a part of the dividend. 12/31/03 is three-fourths of the way into the note term. Thus, .75(.10)($100,000) or $7,500 of interest expense should be recognized on this date.

4

Mio Corp. was the sole stockholder of Plasti Corp.

On September 30, 2004, Mio declared a property dividend of Plasti's 2,000 outstanding shares of $1 par value common stock, distributable to Mio's stockholders.
On that date, the book value of Plasti's stock was $1.50 per share. Immediately after the distribution, the market value of Plasti's stock was $4.50 per share.

What amount should Mio report in its 2004 financial statements as gain on disposal of the Plasti stock?

$6,000
When a property dividend is distributed, any unrealized holding gain or loss on the property is first recognized. The distribution of the property is a disposal and thus calls for the recognition of any holding gain or loss in earnings.
The market value exceeded the carrying value of the investment in Plasti stock by $3.00 per share ($4.50 - $1.50) on the distribution date. This is the gain recognized per share of stock distributed. With 2,000 shares distributed, the total gain is $6,000 ($3.00 x 2,000).
The gain that is recognized on the distribution of the property dividend is the same as that which would have resulted had Mio first sold the Plasti stock for a $6,000 gain and then distributed the proceeds from the sale of the stock as the dividend. The net effect on shareholders' equity would be the same either way.

5

Ole Corp. declared and paid a liquidating dividend of $100,000. This distribution resulted in a decrease in Ole's:
Paid-in capital
Retained earnings

Yes, No
A liquidating dividend is a return of capital. Its source is not earnings, and, therefore, it is not retained earnings. The firm is liquidating part of its permanent capital. The usual account to debit for a liquidating dividend is additional paid-in capital.

6

When a company declares a cash dividend, retained earnings is decreased by the amount of the dividend on the date of
A. Declaration.
B. Record.
C. Payment.
D. Declaration or record, whichever is earlier.

A. A legal liability comes into existence at declaration. The firm has committed itself to paying resources to shareholders from retained earnings on that date.

7

On December 1, 2005, Nilo Corp. declared a property dividend of marketable securities to be distributed on December 31, 2005, to stockholders of record on December 15, 2005. On December 1, 2005, 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 2005 retained earnings, after all nominal accounts are closed?
A. $0
B. $18,000 increase.
C. $60,000 decrease.
D. $78,000 decrease.

C. A property dividend is recorded at fair value, in this case $78,000. That is the reduction (debit) in retained earnings recorded in the entry for the dividend. But in this entry, the gain on disposal of the securities is also recorded.

The distribution of the assets is treated as a disposal. Had the securities been sold first, and the proceeds distributed, all parties would be in the same economic position compared to the property dividend. The $18,000 gain on disposal increases income which, when closed to retained earnings, causes retained earnings to increase $18,000. The net decrease in retained earnings is $60,000 ($78,000 - $18,000).

8

At December 31, 2004 and 2005, Apex Co. had 3,000 shares of $100 par, 5% cumulative preferred stock outstanding. No dividends were in arrears as of December 31, 2003. Apex did not declare a dividend during 2004. During 2005, Apex paid a cash dividend of $10,000 on its preferred stock.

Apex should report dividends in arrears in its 2005 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. The annual preferred stock dividend is $15,000 (3,000 x $100 x 5%). Total dividends in arrears at the end of 2005 are therefore $20,000 (2 years x $15,000 - $10,000 paid). Dividends in arrears are footnoted only. They are not recognized as a liability until they are declared.

9

T/F: A liquidating dividend reduces permanent capital rather than retained earnings.

True

10

T/F: A scrip dividend is a liquidating dividend.

False.
A scrip dividend is first distributed in NP (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.

11

T/F: The interest on a scrip dividend for which a partial cash payment was made at the time the scrip was issued is based on the period from the date the partial cash payment was made to the date the remaining cash is paid.

True

12

T/F: A liquidating dividend is a return of capital, rather than a return on capital.

True

13

T/F: The payment of a cash dividend has no effect on current liabilities.

False.
The typical entries for a cash dividend is:
dr. Retained earnings xxx
cr. Dividends Payable xxx

14

T/F: The interest on a scrip dividend for which no cash was paid at the time the scrip was issued is based on the period from declaration date to the date cash is paid.

True

15

T/F: Cash dividends reduce retained earnings at payment.

True

16

T/F: Dividends in arrears are recognized as liabilities at the end of the year for which dividends were not declared.

False.
Dividends in arrears are unpaid dividends for a particular year on cumulative preferred stock. Dividends are not required to be paid, but are said to accumulate if unpaid. No liability is declared until there has been a dividend declaration. They are disclosed in the footnotes.

17

Wood Co. owns 2,000 shares of Arlo, Inc.'s 20,000 shares of $100 par, 6% cumulative, non-participating preferred stock and 1,000 shares (2%) of Arlo's common stock.

During 2005, Arlo declared and paid dividends of $240,000 on preferred stock. No dividends had been declared or paid during 2004. In addition, Wood received a 5% common stock dividend from Arlo when the quoted market price of Arlo's common stock was $10 per share.

What amount should Wood report as dividend income in its 2005 income statement?

$24,000
The annual preferred dividend commitment is $120,000 (20,000 x $100 x .06).

The amount paid in 2005 ($240,000) covers both 2005, and 2004 (dividends in arrears). Wood owns 10% of Arlo's preferred stock and, therefore, received $24,000. This amount is recognized as revenue in 2005.

Dividends in arrears are not recognized until received. The stock dividend is not treated as revenue, but rather reduces the cost per unit of Wood's investment in Arlo's common stock.

18

At what percentage is a stock dividend considered "large"?

When it exceeds 20-25%.

19

T/F: Large stock dividends are capitalized at par value. Retained earnings is reduced by the par value of the shares issued, and common stock is increased by the par value of stock issued. There is no effect on additional paid-in capital because the entire decrease in retained earnings is recorded in common stock. A large stock dividend permanently capitalizes the par value of the issued shares into common stock.

True

20

How would the declaration of a 15% stock dividend by a corporation affect each of the following?
Retained earnings
Total stockholders' equity

Decrease, no effect
Retained earnings are debited in a stock dividend, and common stock and possibly additional paid-in capital are credited. Therefore, retained earnings are reduced, but total owners' equity is unchanged, because all accounts affected by the stock dividend are owners' equity accounts.

21

On May 18, 2004, Sol Corp.'s board of directors declared a 10% stock dividend.

The market price of Sol's 3,000 outstanding shares of $2 par value common stock was $9 per share on that date. The stock dividend was distributed on July 21, 2004, when the stock's market price was $10 per share.

What amount should Sol credit to additional paid-in capital for this stock dividend?

This question is difficult, because authoritative sources and textbooks disagree as to the market value that should be used to value stock dividends. Small stock dividends (less than 25%) are measured at the market value of the stock issued. But the market value can be measured at declaration or at issuance.

The answer listed as correct uses the market value on the declaration date. The journal entry to record the dividend assuming the declaration and distribution occurred in the same fiscal period:

dr. Retained earnings .10(3,000)($9) 2,700
cr. Common stock .10(3,000)($2) 600
cr. Additional paid-in capital 2,100

22

Ray Corp. declared a 5% stock dividend on its 10,000 issued and outstanding shares of $2 par value common stock, which had a fair value of $5 per share before the stock dividend was declared. This stock dividend was distributed 60 days after the declaration date.

By what amount did Ray's current liabilities increase as a result of the stock dividend declaration?

$0
The declaration of a stock dividend does not cause a liability to be reported. The dividend is not an asset. Stock dividends can be revoked, and the distribution of the dividend does not cause a decrease in the firm's assets or an increase in debt.

The shares distributed are in proportion to each investor's existing holdings. No investor's percentage ownership has changed. Each share is now a smaller percentage of the firm, and each investor has more of them. The investor is not receiving anything of definite value from the firm.

Only if the stock price does not fall in proportion to the dividend do the investor's holdings increase in value.

23

T/F: Small stock dividends are capitalized at market value, which exceeds par in this case. Retained earnings is reduced by the market value of the shares issued, common stock is increased by the par value of stock issued, and additional paid-in capital is increased by the difference between market value and par value times the number of shares issued.

True

24

A company whose stock is trading at $10 per share has 1,000 shares of $1 par common stock outstanding when the board of directors declares a 30% common stock dividend. Which of the following adjustments should be made when recording the stock dividend?
A. Treasury stock is debited for $300.
B. Additional paid-in capital is credited for $2,700.
C. Retained earnings is debited for $300.
D. Common stock is debited for $3,000.

C. This is a large stock dividend (> 25%); therefore retained earnings is debited for par value. The amount is the par value of the shares distributed in the dividend, or 1,000(.30)($1) = $300. The credit is to common stock for the shares issued.

25

T/F: A scrip dividend is not a true dividend.

False.
A scrip dividend is first distributed in NP (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.

26

T/F: A stock dividend reduces retained earnings.

True

27

T/F: The net effect on OE of a 100% stock dividend is the same as for a 2-for-1 split.

True

28

T/F: The individual component balances in OE are the same after a 100% stock dividend and a 2-for-1 split.

False.
100% 2-for-1
None None Effect on total OE
Decrease None Effect on RE
None Cut in 1/2 Effect on par value
Double Double Effect on shares outstanding
Increase None Effect on contributed capital
Increase None Effect on CS account

29

T/F: A 2-for-1 stock split is recorded at cost.

False.
A stock split is not recorded, it reduces the par value of the stock while increasing the number of shares outstanding.

30

T/F: A 2-for-1 stock split is recorded at market value.

False.
A stock split is not recorded, it reduces the par value of the stock while increasing the number of shares outstanding.

31

T/F: Dividends in arrears are disclosed in a footnote even if the dividends are not declared as of the balance sheet.

True.

32

T/F: 1,000 shares of 6%, $100 par cumulative preferred stock have been outstanding several years. 10,000 shares of $30 par common stock have been outstanding all year. No dividends are in arrears. The preferred stock is participating to a maximum additional 4%. Total dividends declared for the year are $28,000. Common stock receives $21,000.

True.

33

T/F: 1,000 shares of 6%, $100 par cumulative preferred stock have been outstanding several years. 10,000 shares of $30 par common stock have been outstanding all year. Two years of dividends are in arrears. The preferred stock is fully participating. Total dividends declared for the year are $40,000. Common stock receives $19,000.

False.
Common stock receives $16,050

34

If the preferred stock is noncumulative and the current year dividends are not paid, will they accumulate for the following year?

No, if dividends are not paid in the current year, noncumulative preferred stock does not accumulate the dividends to be paid in the future.

35

T/F: When the full amount of preferred stock dividend is not paid on cumulative preferred stock for any given year, the unpaid dividends are in arrears and must be paid before any other dividend.

True

36

T/F: When preferred stock is participating, the stock may receive dividends in addition to the annual current dividend requirement. When preferred participates, common receives a matching amount. Preferred stock may be fully or partially participating.

True

37

T/F: Dividends in arrears on preferred stock are a liability only if the dividends are declared.

True

38

A company issued rights to its existing shareholders without consideration. The rights allowed the recipients to purchase unissued common stock for an amount in excess of par value.

When the rights are issued, which of the following accounts will be increased?
Common stock
Additional paid-in capital

No, No
There is no effect on OE when rights are issued to existing stockholders pursuant to a future stock issuance. No journal entry is needed, because no transaction has yet taken place.

39

A retained earnings appropriation can be used to
A. Absorb a fire loss when a company is self-insured.
B. Provide for a contingent loss that is probable and reasonable.
C. Smooth periodic income.
D. Restrict earnings available for dividends.

D. The purpose of appropriations is to restrict dividends and communicate that restriction to users of the financial statements. It is merely a partitioning of retained earnings into two parts: (1) available for dividends, and (2) unavailable.

A firm need not record an appropriation in order to restrict dividends. However, it helps alert stockholders to the possibility that dividends may be curtailed, and informs them of the reason for that curtailment.

40

At December 31, 2004, Eagle Corp. reported $1.75m of appropriated retained earnings for the construction of a new office building, which was completed in 2005 at a total cost of $1.5mn.

In 2005, Eagle appropriated $1.2mn of retained earnings for the construction of a new plant. Also, $2mn cash was restricted for the retirement of bonds due in 2006.

In its 2005 balance sheet, Eagle should report what amount of appropriated retained earnings?

$1.2M
The first appropriation of $1.75mn was removed (returned to unappropriated retained earnings) when the office building was completed. Appropriations no longer needed are returned to unappropriated status. Therefore, only the new appropriation is needed at the end of 2005.

The amount of unrestricted cash is reported separately and does not affect the appropriation amount. An appropriation of retained earnings is primarily a device for communicating the intention of management to restrict dividends, so that cash will be conserved for the specified purpose. The actual restriction of cash makes that amount of cash unavailable for normal operating use. Restricted cash is an investment account. It is not part of the cash account.

41

Cricket Corp. issued, without consideration, rights allowing stockholders to subscribe for additional shares at an amount greater than par value, but less than both market and book values.

When the rights are exercised, how are the following accounts affected?
Retained earnings
Additional paid-in capital

Not affected, Increased
The exercise is treated as would be any issuance of stock. The exercise price determines the total proceeds, the common stock account is credited for the total par of stock issued, and additional paid-in capital is credited for the remainder. The exercise price exceeds par value, so additional paid-in capital is increased. Retained earnings are unaffected.

42

T/F: Retained earnings appropriations are voluntary, and retained earnings restrictions are imposed by parties external to the firm.

True.

43

T/F: When an appropriation of retained earnings is closed, total retained earnings is reduced.

False.
The RE would increase at the closing of an appropriation as the un-appropriated RE would increase.

44

T/F: When an appropriation of retained earnings is made, total retained earnings is reduced.

False.
An appropriation of RE declared amounts reserved for a specific purpose or objective. This entry doesn't reduce total RE, but rather just separates the amounts out within RE.

45

T/F: A scrip dividend would not be disclosed in the retained earnings statement.

False.
it would be.

46

T/F: Retained earnings is debited when an appropriation is created.

True

47

T/F: Retained earnings appropriated is credited when an appropriation is created.

True

48

T/F: Dividends can be reduced only through a retained earnings restriction or appropriation.

False

49

T/F: The main purpose of a retained earnings appropriation is to communicate the intent of management to make a portion of retained earnings off-limits for dividends.

True

50

Grid Corp. acquired some of its own common shares at a price greater than both their par value and original issue price, but less than their book value. Grid uses the cost method of accounting for treasury stock.

What is the impact of this acquisition on total stockholders' equity and the book value per common share?
Total stockholders' equity
Book value per share

Decrease, Increase
The purchase of treasury stock at any price decreases total owners' equity under the cost method because treasury stock is a contra OE account. When the purchase price per share is less than book value per share, then the denominator decreases by a greater percentage than does the numerator, and book value per share increases.

For example, assume for simplicity that there is only common stock outstanding. Total owners' equity and number of shares before the treasury stock purchase is $40,000 and 4,000, respectively. Book value per share then is $10. The firm purchases 200 shares of treasury stock for $8 (less than book value). The new book value per share is:

($40,000 - $1,600)/(3,800) = $10.11. Book value per share has increased.

51

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. Assets and liabilities are revalued to market or fair value to provide a fresh-start valuation.

Usually, there are overvalued assets that have contributed to the operating losses and resulting retained-earnings deficit. The write-downs of overvalued assets further increase the retained-earnings deficit, but allow a new beginning for the firm. The contributed capital of the firm is reduced, permanently recording the losses, and retained earnings are increased to a zero balance.

52

T/F: Book value per share is computed for preferred stock.

False.
It is computed for common stock.

53

T/F: The adjustment pursuant to a quasi-reorganization would be disclosed in the retained earnings statement.

True

54

T/F: If a corporation liquidated, each common share would likely be paid an amount equal to book value per share.

False.
The liquidation preference of preferred stock is the amount payable on liquidation of the company and must be paid before the CS receives any assets.

55

T/F: The weighted average number of common shares outstanding is used as the denominator of book value per share.

False

56

T/F: A quasi-reorganization increases retained earnings.

True

57

T/F: The par value of preferred stock is always used in the calculation of book value per share.

False.
It is not used if it is different from the liquidation preference.

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