FAR 2I - Equity

Question 1

How does buying treasury stock at greater than book value affect equity and EPS?

Answer 1

Buying treasury stock at greater than book value reduces equity and the number of shares outstanding, which increases EPS due to fewer shares being available.

Question 2

What are the two methods for accounting for treasury stock?

Answer 2

Cost Method: Treasury stock is carried at cost until reissued or retired.
Par Value Method: Reacquired shares are treated as if retired, and subsequent sales are treated as if the shares were unissued.

Question 3

When is a liability for dividends payable recorded?

Answer 3

A liability for dividends payable is recorded when the board of directors declares the dividend. Prior to declaration, there is no legal obligation to pay.

Question 4

What are liquidating dividends, and how are they recorded?

Answer 4

Liquidating dividends are a return of capital, not a return on investment. They occur when dividends exceed retained earnings and are debited to other equity accounts.

Question 5

What factors are commonly considered in a partnership’s income or loss distribution agreement?

Answer 5

Salaries for partners.
Interest on capital balances.
Bonuses to managing partners.
Residual distributed by a fixed ratio.

Question 6

How are initial partnership capital accounts determined?

Answer 6

Initial partnership capital accounts are based on the net fair value invested by each partner into the partnership.

Question 7

What happens to a subscriber’s rights when stock is sold on a subscription basis?

Answer 7

The subscriber usually has all the rights and privileges of a stockholder, unless specified otherwise in the subscription contract, even before the full subscription price is paid.

Question 8

How are quasi-endowments classified in Not-for-Profit (NFP) organizations?

Answer 8

Quasi-endowments in NFPs are classified as net assets without donor restrictions because future governing boards can undo the designation.

Question 9

What are warrants, and what rights do they give the holder?

Answer 9

Warrants give the holder the right to purchase a set number of shares at a fixed price on or before the expiration date. They provide potential for future equity ownership.

Question 10

How are partnership capital balances treated during liquidation?

Answer 10

During liquidation, combine the partner’s loans to the partnership with their capital balances. After paying debts and accounting for losses, distribute any remaining cash based on the final capital account balances.

Question 11

How does the bonus-to-new-partner method work in partnerships?

Answer 11

Under the bonus-to-new-partner method, the new partner’s capital is based on their percentage ownership of the total revalued partnership capital, computed by adding the new partner’s investment.

Question 12

When issuing additional shares less than 20-25%, what amount is transferred from retained earnings?

Answer 12

When issuing additional shares less than 20-25%, transfer an amount equal to the fair value of the additional shares from retained earnings.

Question 13

How are warrants recorded?

Answer 13

Warrants are recorded when issued, typically under equity. They provide the holder the option to purchase shares at a fixed price before expiration.

Question 14

What is the difference between cost method and par value method for treasury stock?

Answer 14

Cost Method: Reacquired shares are carried at cost until sold or retired.
Par Value Method: Reacquired shares are treated as if they were retired immediately.

Question 15

How are treasury stock sales treated under the par value method?

Answer 15

Under the par value method, the reacquisition and subsequent sale are treated as separate transactions. The sale is accounted for as if the shares were newly issued.

Question 16

How are liquidating dividends accounted for?

Answer 16

Liquidating dividends are recorded by debiting equity accounts when the dividend amount exceeds retained earnings, as they represent a return of investment rather than income.

Question 17

What happens if a partnership agreement does not specify profit or loss distribution?

Answer 17

If there is no specific agreement, profits and losses are shared equally among all partners, regardless of their capital contributions.

Question 18

What are the major factors considered in determining a partnership’s profit-sharing agreement?

Answer 18

Asset investment by partners.
Time (service) investment of partners.
Experience, expertise, and education of partners.

Question 19

What is the treatment of unpaid dividends before the declaration date?

Answer 19

Before the declaration date, there is no liability for dividends payable, as the company has no legal obligation to distribute them until they are declared by the board.

Question 20

What rights do subscribers of stock on a subscription basis have?

Answer 20

Subscribers typically have all stockholder rights unless the subscription contract specifies otherwise, even before the full payment for the shares is received.

Question 21

How are quasi-endowments treated in NFPs?

Answer 21

Quasi-endowments in NFPs are classified as net assets without donor restrictions, as future governing boards can change or revoke the designation.

Question 22

What is a liquidating dividend, and when does it occur?

Answer 22

A liquidating dividend is a return of capital to investors, and it occurs when the dividend exceeds retained earnings, requiring debits to other equity accounts. No dividend income is booked

Question 23

How are treasury stock transactions treated in financial reporting?

Answer 23

Treasury stock transactions affect equity accounts like additional paid-in capital (APIC) and retained earnings. They do not result in gains or losses in the income statement.

Question 24

When must a company accrue for dividends?

Answer 24

A company must accrue for dividends only after they are declared by the board of directors, creating a legal obligation to pay.

Question 25

What is the role of a sinking fund related to treasury stock?

Answer 25

A sinking fund is not typically involved with treasury stock but is used in bond payments, where funds are set aside to ensure repayment of debt. Treasury stock is an equity transaction.

Question 26

What are dividends in arrear?

Answer 26

Unpaid dividends on cumulative preferred stock that have accumulated because the company has not paid them on their scheduled payment dates

Question 27

When to accrue for dividends in arrear?

Answer 27

When actually declared

Question 28

What is the bonus method in a partnership?

Answer 28

Adjusts partners' capital balances without recognizing goodwill. Any excess or shortfall in payments to a retiring partner or contributions by a new partner is allocated to the remaining partners based on their profit-sharing ratios

Question 29

What are dividends in arrears?

Answer 29

Any preferred dividend not paid out, so cumulative preferred stock ## Footnote Must be disclosed in total and on a per share basis

Question 30

What are liquidating dividends?

Answer 30

Non-dividend distribution made during a partial or full liquidation. Retained earnings is used up and APIC is debited which is the portion that is not taxable for shareholders

Question 31

2 Types of partnership admissions are?

Answer 31

1) Bonus method 2) Goodwill method

Question 32

How does the bonus method in a partnership admission work?

Answer 32

New partner contributes cash and identifiable assets at FV (no intangible recognition). Total partner contributions are carrying amount of existing net assets + FV of contributed new assets Any difference between assets contributed and interest granted to new partner is the bonus recognized

Question 33

How does the goodwill method in a partnership admission work?

Answer 33

Same as Bonus method, but intangible contribution (e.g. expertise) IS recognized Difference FV of partnership and interest granted is recognized as goodwill (if FV>interest received, excess goodwill goes to old partners and vice versa)

Question 34

Steps of partnership liquidation?

Answer 34

1) Sell off assets; Recognize any gain/loss in partners' capital accounts 2) Pay off liabilities 3) Any negative partner's account is either absorbed by other partners or an additional contribution is made by that partner 4) Final distribution to partners

Question 35

Accumulated other comprehensive income examples? (BS)

Answer 35

a) Unrealized holding gains/losses on available-for-sale investments b) Foreign currency translation gains/losses c) Pension plan gains/losses d) Pension prior service costs or credits ## Footnote AOCI represents the sume of unrealized ganis/losses from OCI on the income statement

Question 36

Components of statement of retained earnings?

Answer 36

a) BB RE b) + Net income of the year c) - dividends paid d) - appropreated RE for e.g. contruction e) +- Net unrealized gain/loss on AOCI f) = EB RE

Question 37

Stock dividend bookings at FV or par value?

Answer 37

a) less than 20-25% record at FV (difference between FV and par is credited as APIC) b) more than 20-25% record at par value (like a stock split, no APIC used, credit is fully in Common stock dividend distributable at par) ## Footnote Retained earnings is debited at either FV or par at date of declaration.

Question 38

Stock dividend booking at a) Date of declaration and b) disctribution?

Answer 38

a) Debit RE (FV or Par), Credit Common Stock Dividend Distributable, Credit APIC for difference (if below 20-25% and FV method is used) b) Debit Common Stock Dividend Distributable, Credit Common Stock

Question 39

When is APIC credited when treasury stock is reissued under the cost method?

Answer 39

When reissued at excess of bought back previously. A loss does not touch APIC, but Retained Earnings

Question 40

When issuing a stock dividend, at what timing is the APIC calculated? Date of declaration or distribution?

Answer 40

Date of declaration, ignore date of distribution

Question 41

What happens if a company redeems preferred stock above par value and the Additional Paid-In Capital (APIC) from preferred stock is insufficient to absorb the excess over par?

Answer 41

The shortfall is debited to Retained Earnings, reducing the company’s overall equity. ## Footnote Redeem=Retires=Buys back=repurchases

Question 41

When issuing a stock dividend, what is key to look at and what are the implications on the journal entries?

Answer 41

Above or below 20-25%. a) If above, then RE is only lowered by the par value of the issued shares and the credit entry is common stock (no APIC is recorded, no FV is used). b) if below, RE is debited by FV, common stock Par value credited, and APIC for difference credited

Question 42

What happens if a company redeems preferred stock below par value?

Answer 42

The difference between the par value and the redemption price is credited to Additional Paid-In Capital (APIC), and Retained Earnings is not affected. ## Footnote Redeem=Retires=Buys back=repurchases

Question 43

Are APIC and APIC TS 2 different FSLI?

Answer 43

Yes, so if the cost method of treasury stock is applied and treasury stock transaction resulted in a loss and there is no APIC TS balance available (although there would be APIC on common stock), then RE is debited and not APIC (TS)

Question 44

How is dividend income from preferred stock treated for an investor?

Answer 44

Dividend income from preferred stock is recognized separately from equity method earnings. It represents a fixed return based on ownership and is recorded as dividend income on the income statement.

Question 45

How should an investor account for preferred dividends when calculating share of earnings from an investee?

Answer 45

Indicators include representation on the board of directors, participation in policy-making, material intercompany transactions, interchange of managerial personnel, and technological dependency

Question 46

What are indicators of significant influence over an investee?

Answer 46

Indicators include representation on the board of directors, participation in policy-making, material intercompany transactions, interchange of managerial personnel, and technological dependency

Question 47

What does "without consideration" mean when a company issues rights to its existing shareholders, and which accounts are affected at the time of issuance?

Answer 47

💡 Without Consideration: Means the rights are issued for free to shareholders. 📈 Effect on Accounts: At the time of issuance, no accounts are increased because the company does not receive any payment. 🔄 Subsequent Action: If the rights are exercised, the company receives cash, and common stock and additional paid-in capital (APIC) are increased.

Question 48

When collectibility is reasonably assured, when should the excess of the subscription price over the stated value of no-par common stock be recorded as additional paid-in capital?

Answer 48

💼 When the subscription is recorded. Explanation: Since collectibility is reasonably assured, the company has a legal claim to the subscription amount at the time of recording, so the excess over stated value is recognized as APIC immediately.

Question 49

Is APIC attributed to Preferred Stock?

Answer 49

Yes, if issue price per stock is higher than par

Question 50

In the bonus-to-new-partner method, how is the new partner’s capital account determined?

Answer 50

💼 The new partner’s capital account is based on the new partner’s percentage of the total partnership value computed after the contribution, regardless of whether the contribution justifies the amount.

Question 51

What are the key steps in the bonus-to-new-partner method?

Answer 51

💰 Compute Total Partnership Value: Add existing capital and the new partner’s contribution. 📊 Determine New Partner’s Capital: Base it on the agreed percentage of the new total. 🔄 Adjust Capital Accounts: Allocate the bonus to either the new partner (if contribution is less) or existing partners (if contribution is more).

Question 52

When a company reissues treasury stock below cost, how do you determine whether the loss affects Additional Paid-In Capital (APIC) or Retained Earnings (RE)?

Answer 52

💼 APIC-Treasury: Use APIC from Treasury Stock first to absorb the loss if it exists. 📉 Retained Earnings: If APIC-Treasury is insufficient or non-existent, the remaining loss decreases Retained Earnings. Key Rule: APIC first, then RE when reissuing treasury stock below cost.

Question 53

Why is the par value method called that way, and how are transactions recorded when buying back and reissuing treasury stock?

Answer 53

Because the treasury stock account is recorded at par value, not at cost. 📥 Buying Back Treasury Stock: Debit Treasury Stock (at par) Debit APIC - Common Stock (if purchase price exceeds par) Debit Retained Earnings (if APIC is insufficient) Credit Cash (total purchase amount) 📤 Reissuing Treasury Stock: Debit Cash (reissue price) Credit Treasury Stock (at par) Credit APIC - Treasury Stock (if reissue price exceeds par) Key Rule: Use par value for treasury stock, with APIC adjustments for any difference.

Question 54

What is the difference between the Par Value Method and the Cost Method for treasury stock?

Answer 54

🔑 Par Value Method: Treasury stock is recorded at par value. Any difference between purchase price and par affects APIC - Common Stock or Retained Earnings. Losses: Reduce APIC first, then Retained Earnings. 💰 Cost Method: Treasury stock is recorded at purchase cost. Gains and losses on reissuance affect APIC - Treasury Stock. Losses exceeding APIC-Treasury: Reduce Retained Earnings. Key Difference: Par Value Method: Focuses on par value and APIC from common stock. Cost Method: Focuses on acquisition cost and APIC from treasury stock.

Question 55

When is APIC - Treasury Stock recorded under the Cost Method?

Answer 55

💼 APIC - Treasury Stock is recorded only when reissuing treasury shares at a price higher than their original cost. Example: 🔄 Buyback: No APIC recorded (entire cost in Treasury Stock). 📈 Reissue at a Gain: If reissue price > cost, record the difference as APIC - Treasury Stock. 📉 Reissue at a Loss: Use APIC - Treasury Stock first, then reduce Retained Earnings if APIC is insufficient. Key Rule: APIC - Treasury Stock is created during reissuance at a gain, not at buyback.

Question 56

How are losses on reissuance of treasury stock handled under the Cost Method and Par Value Method?

Answer 56

💰 Cost Method: Buying Back: Record entire cost in the Treasury Stock account (no APIC involved). Reissuing at a Loss: 📉 Reduce APIC - Treasury Stock (if available). 💼 If insufficient, reduce Retained Earnings. 🏷️ Par Value Method: Buying Back: Record at par value. Any excess over par reduces APIC - Treasury Stock. Reissuing at a Loss: 📉 Reduce APIC - Treasury Stock (if available). 💼 If insufficient, reduce Retained Earnings. Key Rule: In both methods, losses on reissuance are absorbed by APIC first, then Retained Earnings. The Cost Method only involves APIC when reissuing at a gain, not when buying back.

Question 57

What is the correct journal entry when a company retires treasury stock at a cost lower than the original issue price under the Cost Method?

Answer 57

💼 Journal Entry: Debit Common Stock (at par value) Debit APIC - Issuance (from original issue) Credit Cash (for amount paid to repurchase) Credit APIC - Retirement of Stock (for the difference between equity removed and cash paid) Key Rule: Under the Cost Method, if the retirement cost is less than the original equity recorded, the excess increases APIC - Retirement of Stock. APIC from Issuance is debited because the buyback removes both par value and previously recorded APIC.

Question 58

What is the correct journal entry when a company retires treasury stock at a cost lower than the original issue price under the Par Value Method?

Answer 58

💼 Journal Entry: Debit Common Stock (at par value) Credit APIC - Retirement of Stock (for the difference between the cash paid and par value) Credit Cash (for amount paid to repurchase) Key Rule: Under the Par Value Method, the buyback is recorded at par value. The difference between the buyback cost and par value increases APIC - Retirement of Stock. APIC from Issuance is not affected because the buyback does not reverse previously recorded APIC.