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Flashcards in Stockholders' Equity Deck (127):
1

Rudd Corp. had 700,000 shares of common stock authorized and 300,000 shares outstanding at December 31, 2004. The following events occurred during 2005:

  • January 31 Declared 10% stock dividend
  • June 30 Purchased 100,000 shares
  • August 1 Reissued 50,000 shares
  • November 30 Declared 2-for-1 stock split

At December 31, 2005, how many shares of common stock did Rudd have outstanding?

  1. 560,000
  2. 600,000
  3. 630,000
  4. 660,000

560,000

Stock dividends and splits increase the number of shares outstanding on the date of distribution by the percentage effect implied by the dividend (10%) or split (100% or multiply by 2). The number of shares outstanding at 12/31/92 = [300,000(1.10) - 100,000 + 50,000]2 = 560,000.

Treasury shares reduce the number of shares outstanding, and reissuance increases the number of shares outstanding. The total number of shares outstanding just before the split (280,000) is doubled in a 2-for-1 split.

2

At December 31, 2005, Salo Corp.'s balance sheet accounts increased by the following amounts compared with those at the end of the prior year:

  • Assets $178,000
  • Liabilities $54,000
  • Capital stock $120,000
  • Additional paid-in capital $12,000

The only charge to retained earnings during 2005 was for a dividend payment of $26,000. Net income for 2005 amounted to

  1. $34,000
  2. $26,000
  3. $18,000
  4. $8,000

$18,000

The change in total owners' equity for the year is $124,000, which equals the difference between the increase in assets and liabilities for the year ($178,000 - $54,000).

Contributed capital increased $132,000 ($120,000 + $12,000). The firm paid dividends of $26,000. Thus:

$132,000 + net income - $26,000 = $124,000 
net income = $124,000 - $132,000 + $26,000 
= $18,000

3

Kamy Corp. is in liquidation under Chapter 7 of the Federal Bankruptcy Code. The bankruptcy trustee has established a new set of books for the bankruptcy estate. After assuming custody of the estate, the trustee discovered an unrecorded invoice of $1,000 for machinery repairs performed before the bankruptcy filing. 
In addition, a truck with a carrying amount of $20,000 was sold for $12,000 cash. This truck was bought and paid for in the year before the bankruptcy.

What amount should be debited to estate equity as a result of these transactions?

  1. $0
  2. $1,000
  3. $8,000
  4. $9,000

$9,000

The debit to estate equity is the additional expense and loss that had not been previously recorded.

This amount is $9,000 ($1,000 repair cost + $8,000 loss on the truck). The $8,000 loss is the difference between the $20,000 carrying amount and the $12,000 proceeds.

4

Which of the following errors could result in an overstatement of both current assets and stockholders' equity?

  1. An understatement of accrued sales expenses.
  2. Noncurrent note receivable principal is misclassified as a current asset.
  3. Annual depreciation on manufacturing machinery is understated.
  4. Holiday pay expense for administrative employees is misclassified as manufacturing overhead.

Holiday pay expense for administrative employees is misclassified as manufacturing overhead.

This error reduces expenses because part of the holiday pay will be held back in ending inventory, which is a current asset. Thus, net income, and therefore OE are overstated, as well as ending inventory, which is a current asset.

5

Nest Co. issued 100,000 shares of common stock. Of these, 5,000 were held as treasury stock at December 31, 2004. During 2005, transactions involving Nest's common stock were as follows:

  • May 3- 1,000 shares of treasury stock were sold.
  • August 6- 10,000 shares of previously unissued stock were sold.
  • November 18- A 2-for-1 stock split took effect.

Laws in Nest's state of incorporation protect treasury stock from dilution. At December 31, 2005, how many shares of Nest's common stock were issued and outstanding?

  • Shares Issued
  • Shares Outstanding

  • Shares Issued - 220,000
  • Shares Outstanding - 212,000

Treasury shares are considered issued, but not outstanding. At December 31, 2005:

Number of shares issued = [100,000 (beginning) + 10,000 (new issuance)]2 = 220,000.

Number of shares outstanding = 
[95,000 (beginning) + 1,000 TS reissuance + 10,000 (new issuance)]2 = 212,000.

6

Jones Co. had 50,000 shares of $5 par value common stock outstanding at January 1. On August 1, Jones declared a 5% stock dividend followed by a two-for-one stock split on September 1. What amount should Jones report as common shares outstanding at December 31?

  1. 105,000
  2. 100,000
  3. 52,500
  4. 50,000

105,000

A 5% stock dividend increases outstanding shares by 5%, and a 2-for-1 split doubles outstanding shares. The number of outstanding shares at year-end therefore is 105,000 = 50,000(1.05)(2). Each subsequent dividend or split compounds the previous change.

7

An entity authorized 500,000 shares of common stock. At January 1, year 2, the entity had 110,000 shares of common stock issued and 100,000 shares of common stock outstanding. The entity had the following transactions in year 2:

  • March 1 Issued 15,000 shares of common stock
  • June 1 Resold 2,500 shares of treasury stock
  • September 1 Completed a 2-for-1 common stock split

What is the total number of shares of common stock that the entity has outstanding at the end of year 2?

  1. 117,500
  2. 230,000
  3. 235,000
  4. 250,000

235,000

The number of shares outstanding at the end of year 2 = (100,000 + 15,000 + 2,500)2 = 235,000. The beginning outstanding shares of 100,000 is augmented by the issuance of previously unissued stock, and by the reissuance of treasury stock. Stock splits are applied retroactively to all changes in outstanding shares occurring before the split. The split is a nonsubstantive change in shares. Each share after the split is worth half of one share before the split.

8

When collectability is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed should be recorded as

  1. No par common stock.
  2. Additional paid-in capital when the subscription is recorded
  3. Additional paid-in capital when the subscription is collected
  4. Additional paid-in capital when the common stock is issued

Additional paid-in capital when the subscription is recorded

This is one of the few examples of a recognized executory contract. Given that collectability is not an issue, the recording of a stock subscription is essentially the same as the entry for issuing stock for cash, except that a receivable stands in place of cash, and common stock subscribed stands in place of common stock.

Common stock subscribed is an owners' equity account that is replaced by common stock upon issuance. Any additional paid-in capital is recorded when the contract is signed or recorded, just as if cash were received at that point.

9

On July 1, 2005, Cove Corp., a closely-held corporation, issued 6% bonds with a maturity value of $60,000, together with 1,000 shares of its $5 par value common stock, for a combined cash amount of $110,000.

The market value of Cove's stock cannot be ascertained. If the bonds were issued separately, they would have sold for $40,000 on an 8% yield to maturity basis.

What amount should Cove report for additional paid-in capital on the issuance of the stock?

  1. $75,000
  2. $65,000
  3. $55,000
  4. $45,000

$65,000

The amount of the proceeds allocated to the stock is $70,000 ($110,000 - $40,000). When only one of the two securities has a known market value, that value is allocated to that security and the remaining proceeds are allocated to the security without a known market value.

The total par value of 1,000 shares of $5 par stock is $5,000. Therefore, $65,000 ($70,000 - $5,000) is recorded in additional paid-in capital on common stock.

10

On March 1, 2005, Rya Corp. issued 1,000 shares of its $20 par value common stock and 2,000 shares of its $20 par value convertible preferred stock for a total of $80,000. 
At this date, Rya's common stock was selling for $36 per share, and the convertible preferred stock was selling for $27 per share.

What amount of the proceeds should be allocated to Rya's convertible preferred stock?

  1. $60,000
  2. $54,000
  3. $48,000
  4. $44,000

$48,000

The total proceeds are allocated to the two securities based on relative market values.

  • Market value of common: 1,000 ($36) =$36,000
  • Market value of preferred: 2,000 ($27) =54,000
  • Total market value $90,000

11

On September 1, 2004, Hyde Corp., a newly formed company, had the following stock issued and outstanding:

  • Common stock, no par, $1 stated value, 5,000 shares originally issued at $15 per share.
  • Preferred stock, $10 par value, 1,500 shares originally issued for $25 per share.

Hyde's September 1, 2004 statement of stockholders' equity should report

  • Common stock    
  • Additional Preferred stock    
  • Paid-in capital  

  • Common stock - $5,000
  • Additional Preferred stock $15,000   
  • Paid-in capital - $92,500
  • Common stock: 5,000($1) = $5,000 (only par is recorded in common stock
  • Preferred stock: 1,500($10) = $15,000 (only par is recorded in preferred stock
  • Additional paid-in capital: 
  • Common: 5,000($15 - $1) = $70,000 
  • Preferred: 1,500($25 - $10) = 22,500 

Total additional paid-in capital $92,500

12

On April 1, 2004, Hyde Corp., a newly formed company, had the following stock issued and outstanding:

  • Common stock, no par, $1 stated value, 20,000 shares originally issued for $30 per share.
  • Preferred stock, $10 par value, 6,000 shares originally issued for $50 per share.

Hyde's April 1, 2004 statement of stockholders' equity should report

  • Common stock
  • Preferred stock
  • Additional paid-in capital 

  • Common stock - $20,000
  • Preferred stock - $60,000
  • Additional paid-in capital - $820,000

​Common stock: 20,000($1) = $20,000. Only par value is credited to common stock.

Preferred stock: 6,000($10) = $60,000. Only par value is credited to preferred stock.

Additional paid-in capital (the amount received on issuance in excess of par): 

  • Common: 20,000($30 - $1) = $580,000 
  • Preferred: 6,000($50 - $10) = 240,000 
  • Total $820,000

13

500 shares of 6%, $100 par convertible preferred stock were issued at $103 per share. Each share is convertible into 20 shares of $5 par common stock. The journal entry to record conversion includes which of the following?

  1. Dr. preferred stock $51,500.
  2. Dr. retained earnings $1,500
  3. Cr. paid in capital in excess of par, common $1,500.
  4. Cr. common stock $51,500

Cr. paid in capital in excess of par, common $1,500.

The contributed capital accounts for the preferred are closed and the total amount is transferred to the common stock accounts resulting from issuance upon conversion. The total par value of common stock is first credited to the common stock account. If there is a credit remainder, it is recorded in paid in capital in excess of par, common. If there is a debit remainder, retained earnings is debited. In this case, there is no remainder. The journal entry is:

  • DR:Preferred stock 500($100) $50,000
  • DR:PIC-preferred 500($103 - $100) $1,500
    • CR: Common stock 500(20) ($5)50,000
    • CR: PIC-common $1,500

14

Cross Corp. had outstanding 2,000 shares of 11% preferred stock, $50 par. On August 8, 1992, Cross redeemed and retired 25% of these shares for $22,500. On that date, Cross' additional paid-in capital from preferred stock totaled $30,000.

To record this transaction, Cross should debit (credit) its capital accounts as follows:

  • Preferred stock
  • Additional paid-in capital
  • Retained earnings 

  • Preferred stock $25,000
  • Additional paid-in capital ($2,500)
  • Retained earnings - none

The journal entry for retirement:

  • Preferred stock 2,000(.25)($50) $25,000
  • Additional paid-in capital, preferred stock $30,000(.25) $7,500
    • Additional paid-in capital from retirement of preferred stock $10,000
    • Cash $22,500

The additional paid-in capital from retirement of preferred stock is the net difference between the other amounts in the entry.

When preferred stock is retired, the par value of the stock retired is removed from the preferred stock account, and the pro-rata share of the additional paid-in capital from original issuance is removed. If the total of these two amounts exceeds the amount paid to redeem and retire the stock, as is the case here, additional paid-in capital from retirement of preferred stock is credited. The net effect on additional paid-in capital is an increase of $2,500 ($10,000 - $7,500).

Retained earnings is unaffected.

15

When preferred stock is called and retired, which account or aggregate category of accounts can be increased?

  • Total Owners' Equity   
  • Retained Earnings

  • Total Owners' Equity - NO
  • Retained Earnings - NO

When a firm retires preferred stock, cash is paid to the shareholders reducing total owners' equity. Retained earnings can never be increased when shares are retired, redeemed, or converted into another class of stock.

16

The acquisition of treasury stock will cause the number of shares outstanding to decrease if the treasury stock is accounted for by the

  • Cost method
  • Par value method  

  • Cost method - YES
  • Par value method - YES

17

On December 31, 2004, Pack Corp.'s Board of Directors canceled 50,000 shares of $2.50 par value common stock held in treasury at an average cost of $13 per share. Before recording the cancellation of the treasury stock, Pack had the following balances in its stockholders' equity accounts:

  • Common stock $540,000
  • Additional paid-in capita $l,750,000
  • Retained earnings $900,000
  • Treasury stock, at cost $650,000

In its balance sheet at December 31, 2004, Pack should report common stock outstanding of

  1. $0
  2. $250,000
  3. $415,000
  4. $540,000

$415,000

When treasury stock is cancelled (retired), the common stock account is reduced by the par value of the common stock cancelled. The ending common stock account balance is $415,000 = $540,000 - 50,000($2.50).

18

Cyan Corp. issued 20,000 shares of $5 par common stock at $10 per share.

On December 31, 2005, Cyan's retained earnings were $300,000. In March 2006, Cyan reacquired 5,000 shares of its common stock at $20 per share. In June 2006, Cyan sold 1,000 of these shares to its corporate officers for $25 per share. Cyan uses the cost method to record treasury stock. Net income for the year ended December 31, 2006 was $60,000.

At December 31, 2006, what amount should Cyan report as retained earnings?

  1. $360,000
  2. $365,000
  3. $375,000
  4. $380,000

$360,000

The treasury stock transactions had no effect on retained earnings because the stock was reissued at a price in excess of its purchase price. This transaction increases additional paid-in capital from treasury stock transactions. Retained earnings cannot be increased as a result of treasury stock transactions. Purchases of treasury stock under the cost method do not affect retained earnings.

Thus, the ending retained earnings balance is:
$360,000 = $300,000 beginning balance + $60,000 earnings for 2006.

19

In 2003, Fogg, Inc. issued $10 par value common stock for $25 per share. No other common stock transactions occurred until March 31, 2005, 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?

  1. 2005 net income is decreased.
  2. 2005 net income is increased.
  3. Additional paid-in capital is decreased
  4. Retained earnings is increased

Additional paid-in capital is decreased

Additional paid-in capital is reduced when stock is retired because the additional paid-in capital from treasury stock transactions is closed.

The other three alternative answers cause income to change or retained earnings to increase. Retained earnings can never be increased through transactions with owners, nor can income be affected by such transactions.

20

Porter Co. began its business last year and issued 10,000 shares of common stock at $3 per share. The par value of the stock was $1 per share.

During January of the current year, Porter bought back 500 shares at $6 per share, which were reported by Porter as treasury stock. The treasury stock shares were reissued later in the current year at $10 per share. Porter used the cost method to account for its equity transactions.

What amount should Porter report as paid-in capital related to its treasury stock transactions on its balance sheet for the current year?

  1. $1,500
  2. $2,000
  3. $4,500
  4. $20,000

$2,000

When treasury stock is reissued at a price exceeding its cost, the cost method records the increase in paid-in capital related to treasury stock. This account is an owners' equity account - treasury stock transactions do not affect earnings. The increase for this situation is 500($10 - $6) = $2,000.

The full entry for reissuance is:

  • dr. Cash $5,000;
    • cr. Treasury stock $3,000;
    • cr. Paid-in capital from treasury stock $2,000.

21

If a corporation sells some of its treasury stock at a price that exceeds its cost, this excess should be

  1. Reported as a gain in the income statement.
  2. Treated as a reduction in the carrying amount of remaining treasury stock.
  3. Credited to additional paid-in capital
  4. Credited to retained earnings

Credited to additional paid-in capital

Under both the par and cost methods, sale of treasury stock at a price in excess of cost increases an additional paid-in capital account.

Effectively, the firm has obtained additional resources from the issuance of the stock a second time. Income is never increased or decreased by treasury stock transactions because such transactions are between the firm and its owners. A firm cannot profit from its owners.

22

Lem Co., which accounts for treasury stock under the par value method, acquired 100 shares of its $6 par value common stock for $10 per share. The shares had originally been issued by Lem for $7 per share. By what amount would Lem's additional paid-in capital from common stock decrease as a result of the acquisition?

  1. $0
  2. $100
  3. $300
  4. $400

$100

When the common stock was originally issued, the contributed capital for the common stock was $100 (($7 - $6) x 100 shares). The $100 of contributed capital should be debited when the stock is repurchased for treasury. Once the balance of the contributed capital for common stock is reduced to zero, you would debit retained earnings.

Original issue

  • Cash $700
  •     Common Stock $600
  •     APIC - CS $100

Purchase of Treasury

  • Treasury Stock$600
  • APIC - Common$100
  • Retained Earnings$300
  •     Cash$1,000

23

When preparing a draft of its 2005 balance sheet, Mont, Inc. reported net assets totaling $875,000. Included in the asset section of the balance sheet were the following:

  • Treasury stock of Mont, Inc. at cost, which approximates market value on December 31 $24,000
  • Idle machinery $11,200
  • Cash surrender value of life insurance on corporate executives $13,700
  • Allowance for decline in market value of noncurrent equity investments $8,400

At what amount should Mont's net assets be reported in the December 31, 2005 balance sheet?

  1. $851,000
  2. $850,100
  3. $842,600
  4. $834,500

$851,000

  • Preadjusted asset total $875,000
  • Less Mont stock ($24,000)
  • Corrected total assets $851,000

A firm's treasury stock is not an asset of that firm. A firm cannot own its own stock. The other items listed are appropriately included in assets.

24

On December 1, 2004, Line Corp. received a donation of 2,000 shares of its $5 par value common stock from a stockholder. On that date, the stock's market value was $35 per share. The stock was originally issued for $25 per share.

By what amount would this donation cause total stockholders' equity to decrease?

  1. $70,000
  2. $50,000
  3. $20,000
  4. $0

$0

The shares are considered donated treasury shares. Treasury stock and a gain or revenue account are increased by the market value of the stock received in donation (FAS 116). The increase in the treasury stock account decreases the owners' equity, but the gain or revenue increases the owners' equity by the same amount. Therefore, there is no net effect on the owners' equity.

25

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?

  • Net common stock
  • Additional paid-in capital
  • Retained earnings

  • Net common stock - DECREASE
  • Additional paid-in capital- DECREASE
  • Retained earnings- DECREASE

Under the par value method, when treasury stock is purchased and retired at a price exceeding the original issue price, the following entry is made. No additional paid-in capital from treasury stock transactions exists.

Therefore, retained earnings is debited. Common stock par Additional paid-in capital original issue price - par Retained earnings acquisition price - original issuance price Cash acquisition price. Thus, all three accounts listed in the question are decreased.

26

Pott Co. owned shares in Rose Co. On December 1, 2005, Pott declared and distributed a property dividend of Rose shares when their fair value exceeded the carrying amount.

As a consequence of the dividend declaration and distribution, the accounting effects would be

  • Property dividends recorded at
  • Retained earnings  

  • Property dividends recorded at - FAIR VALUE
  • Retained earnings - DECREASED

A property dividend is recorded at fair value. This means that retained earnings is reduced by fair value upon recording the transaction. The asset distributed is reduced at its carrying value.

In this case, fair value exceeds carrying value, causing a gain to be recorded. This gain causes income, and therefore, retained earnings are to be increased. The net effect on retained earnings, without considering tax effects, is a reduction in the amount of the carrying value of the asset distributed.

27

When a company declares a cash dividend, retained earnings is decreased by the amount of the dividend on the date of

  1. Declaration.
  2. Record.
  3. Payment.
  4. Declaration or record, whichever is earlier.

Declaration.

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

28

On January 2, 2004, Lake Mining Co.'s Board of Directors declared a cash dividend of $400,000 to stockholders of record on January 18, 2004, payable on February 10, 2004. The dividend is permissible under law in Lake's state of incorporation. 
Selected data from Lake's December 31, 2003 balance sheet are as follows:

  • Accumulated depletion $100,000
  • Capital stock $500,000
  • Additional paid-in capital $150,000
  • Retained earnings $300,000

The $400,000 dividend includes a liquidating dividend of

  1. $0
  2. $100,000
  3. $150,000
  4. $300,000

$100,000

A liquidating dividend is paid from contributed capital, rather than from earned capital (retained earnings). It is assumed that retained earnings is used first when dividends are paid.

Thus, $400,000 - $300,000 or $100,000 of the dividend is liquidating. The fact that accumulated depletion is also $100,000 justifies the amount of the liquidating dividend. Depletion is a reduction in earnings, but it represents the recognition in expense of an investment that will not be replaced (a depletable resource is never replaced). Thus, there is no capital maintenance requirement as there would be in the case of equipment, for example, which must be replaced.

Therefore, dividends in excess of earnings, to the extent of accumulated depletion, are permissible.

29

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)

  1. Accrued liability of $15,000.
  2. Disclosure of $15,000.
  3. Accrued liability of $20,000.
  4. Disclosure of $20,000.

Disclosure of $20,000.

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.

30

A property dividend should be recorded in retained earnings at the property's

  1. Market value at date of declaration.
  2. Market value at date of issuance (payment).
  3. Book value at date of declaration.
  4. Book value at date of issuance (payment).

Market value at date of declaration.

The date of declaration is the date on which the firm has made the commitment to pay the dividend. The market value on this date is the value that was considered when the board made the decision to distribute a property dividend and thus is the appropriate measure of the sacrifice to the firm.

31

n June 27, 2004, Brite Co. distributed to its common stockholders 100,000 outstanding common shares of its investment in Quik, Inc., an unrelated party. The carrying amount on Brite's books of Quik's $1 par common stock was $2 per share. Immediately after the distribution, the market price of Quik's stock was $2.50 per share. 
In its income statement for the year ended June 30, 2004, what amount should Brite report as gain before income taxes on disposal of the stock?

  1. $250,000
  2. $200,000
  3. $50,000
  4. $0

$50,000

The gain or loss on disposal of the asset distributed in a property dividend is the same gain or loss that would be recognized had the asset been sold at the time of the dividend.

The gain or loss is the difference between fair value and book value or $.50 per share of Quik stock for a total gain of $50,000 (100,000 x $.50). The difference is a gain because fair value exceeds book value.

32

A corporation issuing stock should charge retained earnings for the market value of the shares issued in a(an)

  1. Employee stock bonus.
  2. Pooling of interests.
  3. 10% stock dividend.
  4. 2-for-1 stock split

10% stock dividend.

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.

33

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

  1. Ignored.
  2. Reported as a separately disclosed reduction of retained earnings.
  3. Reported as a decrease in other comprehensive income.
  4. Reported as a reduction in income from continuing operations.

Reported as a reduction in income from continuing operations.

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 in income from continuing operations, 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.

34

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?

  1. A.  $1,000
  2. B.  $2,000
  3. C.  $3,000
  4. D.  $6,000

$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.

35

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?

  1. $0
  2. $18,000 increase.
  3. $60,000 decrease.
  4. $78,000 decrease.

$60,000 decrease.

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).

36

Bal Corp. declared a $25,000 cash dividend on May 8, 2005, to stockholders of record on May 23, 2005, payable on June 3, 2005. As a result of this cash dividend, working capital

  1. Was not affected.
  2. Decreased on June 3.
  3. Decreased on May 23.
  4. Decreased on May 8.

Decreased on May 8.

It is at declaration that a dividend has its effect on the value of the firm and on working capital. Retained earnings are decreased (or a holding account called Dividends, which is closed to retained earnings, may be recorded), and dividends payable are increased. Dividends payable are a current liability, causing working capital to decrease.

Working capital equals current assets, less current liabilities. The payment of a dividend does not affect working capital, because both cash and the dividend payable are reduced. Both current assets and current liabilities are reduced by the same amount.

37

Godart Co. issued $4.5mn notes payable as a scrip dividend that matured in five years. At maturity, each shareholder of Godart's 3mn shares will receive payment of the note principal, plus interest. The annual interest rate was 10%.

What amount should be paid to the stockholders at the end of the fifth year?

  1. $450,000
  2. $2.25m
  3. $4.5mn
  4. $6.75mn

$6.75mn

Instead of paying $4.5mn in dividends at declaration, the firm decided to issue notes due in five years, calling for the principal amount ($4.5mn), plus five years of simple interest to be paid. The note does not call for compounding.

Therefore, the amount due at maturity is $4.5mn + (5 years)(.10)($4.5mn) = $6.75.

38

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 

  • Paid-in capital - YES
  • Retained earnings - 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.

39

In 2005, Elm Corp. bought 10,000 shares of Oil Corp. at a cost of $20,000. On January 15, 2006, Elm declared a property dividend of the Oil stock to shareholders of record on February 1, 2006, payable on February 15, 2006. During 2006, the Oil stock had the following market values:

  • January 15 $25,000
  • February 1 $26,000
  • February 15 $24,000

The net effect of the foregoing transactions on retained earnings during 2006 should be a reduction of

  1. $20,000
  2. $24,000
  3. $25,000
  4. $26,000

$20,000

The property dividend is recorded at market value, with a debit of $25,000 to retained earnings at declaration. A gain of $5,000 on the securities is recognized as a gain on disposal (as if it were sold). The net effect is a decrease in retained earnings of $20,000.

40

How would the declaration of a 15% stock dividend by a corporation affect each of the following?

  • Retained earnings
  • Total stockholders' equity

  • Retained earnings - DECREASE
  • Total stockholders' equity - 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.

41

Long Co. had 100,000 shares of common stock issued and outstanding at January 1, 2006. During 2006, Long took the following actions:

  • March 15 - Declared a 2-for-1 stock split, when the fair value of the stock was $80 per share.
  • December 15 - Declared a $.50 per share cash dividend.

In Long's statement of stockholders' equity for 2006, what amount should Long report as dividends?

  1. $50,000
  2. $100,000
  3. $850,000
  4. $950,000

$100,000

Total shares receiving a dividend equal 200,000, which is twice the number of shares at the beginning of the year.

The stock split doubled the number of shares outstanding. Therefore, the total cash dividend is $.50(200,000) = $100,000. This amount will appear in the statement of stockholders' equity as dividends declared.

42

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?

  1. $2,100
  2. $2,400
  3. $2,700
  4. $3,000

$2,100

Small stock dividends (less than 25%) are measured at the market value of the stock issued, with the stock price at date of declaration used as the measurement date. The journal entry to record the dividend assuming the declaration and distribution occurred in the same fiscal period is:

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

43

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?

  1. $0
  2. $500
  3. $1,000
  4. $2,500

$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.

44

In September 2000, Cal Corp. made a dividend distribution of one right for each of its 240,000 shares of outstanding common stock.

Each right was exercisable for the purchase of one-hundredth of a share of Cal's $50 variable-rate preferred stock at an exercise price of $80 per share. On March 20, 2005, none of the rights had been exercised, and Cal redeemed them by paying each stockholder $0.10 per right.

As a result of this redemption, Cal's stockholders' equity was reduced by

  1. $240
  2. $4,800
  3. $24,000
  4. $72,000

$24,000

None of the rights was exercised. The net effect on stockholders' equity is the $24,000 of cash paid to the shareholders: 240,000($.10).

45

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. $1.2mn
  2. $1.45mn
  3. $2.95mn
  4. $3.2mn

$1.2mn

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.

46

A retained earnings appropriation can be used to

  1. Absorb a fire loss when a company is self-insured.
  2. Provide for a contingent loss that is probable and reasonable.
  3. Smooth periodic income.
  4. Restrict earnings available for dividends.

Restrict earnings available for dividends.

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.

47

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

  • Retained earnings - NOT AFFECTED
  • Additional paid-in capital - 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.

48

Zinc Co.'s adjusted trial balance at December 31, 2005 includes the following account balances:

  • Common stock, $3 par $600,000
  • Additional paid-in capital $800,000
  • Treasury stock, at cost $50,000
  • Net unrealized loss on non-current marketable equity securities $20,000
  • Retained earnings: appropriated for uninsured earthquake losses $150,000
  • Retained earnings: unappropriated $200,000

What amount should Zinc report as total stockholders' equity in its December 31, 2005 balance sheet?

  1. $1.68mn
  2. $1.72mn
  3. $1.78mn
  4. $1.82mn

$1.68mn

Each item listed belongs in owners' equity. The treasury stock and net unrealized loss are negative items (debits), but the rest are positive items (credits).

Therefore, total owners' equity is $1.68mn = $600,000 + $800,000 - $50,000 - $20,000 + $150,000 + $200,000.

49

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 

  • Common stock - NO
  • Additional paid-in capital - 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.

50

On November 2, 2003, Finsbury, Inc. issued warrants to its stockholders, giving them the right to purchase additional $20 par value common shares at a price of $30.

The stockholders exercised all warrants on March 1, 2004. The shares had market prices of $33, $35, and $40 on November 2, 2003, December 31, 2003, and March 1, 2004, respectively.

What were the effects of the warrants on Finsbury's additional paid-in capital and net income?

  • Additional paid-in capital
  • Net income 

  • Additional paid-in capital - INCREASED IN 2004
  • Net income - NO EFFECT

51

Boe Corp.'s stockholders' equity at December 31, 2004 was as follows:

  • 6% non-cumulative preferred stock, $100 par (liquidation value $105 per share) $100,000
  • Common stock, $10 par $300,000
  • Retained earnings $95,000

At December 31, 2004, Boe's book value per common share was

  1. $13.17
  2. $13.00
  3. $12.97
  4. $12.80

$13.00

Book value per share of common stock is common stockholders' equity per share of common stock. The portion of owners' equity allocated to preferred stock for this ratio is measured as the liquidation value per share. Therefore, the book value per share equals the net assets of the corporation per share that would be distributed to common shareholders on liquidation of the company, if the market value equaled book value for all assets and liabilities. The preferred shareholders would be paid the liquidation value per share first.

This firm has 1,000 shares of preferred stock outstanding: $100,000/$100 par; and 30,000 shares of common stock ($300,000/$10 par). It also has total owners' equity of $495,000 ($100,000 + $300,000 + $95,000).

For this firm, book value per share is $13.00 = [$495,000 - 1,000($105)]/30,000. Had there been dividends in arrears, they would also be subtracted from total owners' equity in the numerator. However, the preferred stock is non-cumulative, so there could be no dividends in arrears.

52

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

  • Total stockholders' equity - DECREASE
  • Book value per share - 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.

53

Hoyt Corp.'s current balance sheet reports the following stockholders' equity:

  • 5% cumulative preferred stock, par value $100 per share; 2,500 shares issued and outstanding $250,000
  • Common stock, par value $3.50 per share; 100,000 shares issued and outstanding $350,000
  • Additional paid-in capital in excess of par value of common stock $125,000
  • Retained earnings $300,000

Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, the preferred stockholders would receive par value plus a premium of $50,000. The book value of common stock is

  1. $7.75
  2. $7.50
  3. $7.25
  4. $7.00

$7.00

Book value per share of common stock is the portion of owners' equity that would remain for common shareholders after the preferred claim was paid, divided by the number of common shares outstanding.

The preferred dividend claim includes the liquidation preference ($50,000 premium above par, plus par value) and the $25,000 dividends in arrears. All preferred stock dividends in arrears must be paid on liquidation before common shareholders receive any cash.

Total owners' equity is $1.025mn, the sum of the four items taken from the owners' equity section of the balance sheet ($250,000 + $350,000 + $125,000 + $300,000).

Book value per share of common stock = $7.00 = ($1.025 - $250,000 - $50,000 premium - $25,000 dividends in arrears)/100,000.

54

The stockholders' equity section of Brown Co.'s December 31, 2005 balance sheet consisted of the following:

  • Common stock, $30 par, 10,000 shares authorized and outstanding $300,000
  • Additional paid-in capital $150,000
  • Retained earnings (deficit) ($210,000)

On January 2, 2006, Brown put into effect a stockholder-approved quasi-reorganization by reducing the par value of the stock to $5 and eliminating the deficit against additional paid-in capital. Immediately after the quasi-reorganization, what amount should Brown report as additional paid-in capital?

  1. $(60,000)
  2. $150,000
  3. $190,000
  4. $400,000

$190,000

Reducing the par value to $5 creates $250,000 of additional paid-in capital: ($30 - $5)10,000 shares = $250,000. The common stock account is now $50,000: ($5)10,000.

Additional paid-in capital now stands at $400,000 ($150,000 + $250,000).

After absorbing the deficit in retained earnings, $190,000 remains in additional paid-in capital: ($400,000 - $210,000). Retained earnings are now zero.

55

When a company goes through a quasi-reorganization, its balance sheet carrying amounts are stated at:

  1. Original cost.
  2. Original book value.
  3. Replacement value.
  4. Fair value.

Fair value.

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.

56

On January 5, year 2, Sardi Minerals Corp. declared a cash dividend of $600,000 to stockholders of record on January 21, year 2, and payable on February 11, year 2.  The dividend is permissible under the laws of Sardi’s state of incorporation.  The following data pertain to year 1:

  • Net income for year ended 12/31/Y1 $190,000
  • Additional paid-in capital, 12/31/Y1 $675,000
  • Retained earnings, 12/31/Y1 $425,000

The $600,000 dividend includes a liquidating dividend of

  1. $0
  2. $175,000
  3. $410,000
  4. $485,000

$175,000

Any dividend which exceeds the balance of retained earnings is considered a liquidating dividend. In this case, the cash dividend exceeds 12/31/Y1 retained earnings by $175,000 ($600,000 − $425,000). The $175,000 represents the liquidating portion of the dividend.

57

The following information pertains to Ali Corp. as of and for the year ended December 31, year 1:

  • Liabilities $60,000
  • Stockholders’ equity $500,000
  • Shares of common stock issued and outstanding $10,000
  • Net income $30,000

During year 1, Ali’s officers exercised stock options for 1,000 shares of stock at an option price of $8 per share. What was the effect of exercising the stock options?

  1. Debt-to-equity ratio decreased to 12%.
  2. Earnings per share increased by $0.33.
  3. Asset turnover increased to 5.4%.
  4. No ratios were affected.

Debt-to-equity ratio decreased to 12%.

First, the debt-to-equity ratio is calculated as follows:

  • Debt to equity =Total liabilities / Common stockholder’s equity

The figures given in the problem reflect the account balances after the exercise of the stock options. Thus, Ali’s debt-to-equity ratio after the exercise is

  • $60,000 / $500,000= 12%

When the options were exercised, total stockholders’ equity would have increased by the amount of the option price as follows:

  • Common stock increased by par value × 1,000 shares
  • Paid-in capital increased by (option price-par) × 1,000 shares

Note that the information given is incomplete as to whether compensation was recorded under the stock option plan.  However, even if compensation were recorded the entries are made only to accounts that impact stockholders’ equity, and the net effect is no change. Thus, the only change is an increase resulting from the exercise of the options.  Since common stockholders’ equity increased, the denominator of the debt-to-equity ratio also increased.  As the denominator becomes larger and the numerator remains constant, the quotient becomes smaller. Therefore, the debt-to-equity ratio must have decreased to its current level of 12%.

58

The par value method of accounting for treasury stock differs from the cost method in that

  1. Any gain is recognized upon repurchase of stock but a loss is treated as an adjustment to retained earnings.
  2. No gains or losses are recognized on the sale of treasury stock using the par value method.
  3. It reverses the original entry to issue the common stock with any difference being shown as an ordinary gain or loss and does not recognize any gain or loss on a subsequent resale of the stock.
  4. It records treasury stock at par and any difference between carrying value and purchase price adjusted through paid-in capital and/or retained earnings.

It records treasury stock at par and any difference between carrying value and purchase price adjusted through paid-in capital and/or retained earnings.

At acquisition, the par value method records treasury stock at par and reduces additional paid-in capital for the original amount recorded when the stock was issued. Any difference between the purchase price and the total of these accounts is either debited to Retained earnings (cost > capital accounts) or credited to paid-in capital from treasury stock (cost < capital accounts). Subsequent sales of the treasury stock are treated as new issuances of common stock. The cost method records acquisitions of treasury stock at the cost of the shares and recognizes gains/losses on subsequent sales of the stock.

59

Seco Corp. was incorporated on January 2, year 1.  The following information pertains to Seco’s common stock transactions:

  • Year 1  
  • January 2Number of shares authorized 80,000
  • February 1Number of shares issued 60,000
  • July 1Number of shares reacquired but not canceled 5,000
  • December 1 - 2-for-1 stock split 

At December 31, year 1, the number of shares of Seco’s common stock outstanding is

  1. 150,000
  2. 120,000
  3. 115,000
  4. 110,000

110,000

Before the stock split, 60,000 shares of common stock were issued, of which 5,000 shares were reacquired. Any time stock is reacquired, it is no longer considered to be outstanding. Therefore, there were 55,000 (60,000 − 5,000) shares outstanding before the 2-for-1 stock split and 110,000 (55,000 × 2) shares outstanding after the stock split.

60

Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year.  Net income was $2,000,000. What was Jen’s basic earnings per share?

  1. $9.00
  2. $9.09
  3. $10.00
  4. $11.11

$9.00

The formula for basic earnings per share is (net income minus preferred dividends) divided by the weighted-average common shares outstanding.  Although no dividends were declared during the year, the preferred dividend must be subtracted because the preferred stock is cumulative.  The preferred dividend of $200,000 (10% × $2,000,000 par) must be subtracted in determining the numerator for basic earnings per share.  Accordingly, this answer is correct because basic EPS is ($2,000,000 net income − $200,000 preferred dividends) ÷ 200,000 weighted-average common shares outstanding = $9.00 per share.

61

In determining earnings per share, interest expense, net of applicable income taxes, on convertible debt which is dilutive should be

  1. Added back to net income for basic earnings per share, and ignored for diluted earnings per share.
  2. Added back to net income for diluted earnings per share.
  3. Deducted from net income for basic earnings per share and ignored for diluted earnings per share.
  4. Deducted from net income for both basic earnings per share and diluted earnings per share.

Added back to net income for diluted earnings per share.

If the convertible debt is dilutive, then the debt is treated as common stock by the "if converted" method. Interest expense is added back to net income for diluted earnings per share.

62

When collectibility is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed should be recorded as

  1. Additional paid-in capital when the subscription is received.
  2. Additional paid-in capital when the subscription is collected.
  3. Additional paid-in capital when the common stock is issued.
  4. Part of common stock, no par.

Additional paid-in capital when the subscription is received.

the excess is recorded as additional paid-in capital when the subscription is received.  Upon receipt of the subscription, the entry is

  • Subscriptions receivable(subscription price)
    •  Common stock subscribed (stated value)
    •  Additional paid-in capital (excess)

Upon issuance of stock and collection of the receivable, it is

  • Cash( subscription price)
    •  Subscriptions receivable (subscription price)
  • Common stock subscribed (stated value)
    •  Common stock (stated value)

63

When treasury stock is purchased for more than its par value, treasury stock is debited for the purchase price under which of the following methods?

  • Cost method
  • Par value method

  • Cost method - YES
  • Par value method - NO

When treasury stock is purchased for more than its par value, treasury stock is debited for the purchase price (cost) under the cost method. When the par value method is used, the entry is typically more complex. Treasury stock is debited for its par value. The excess of the purchase price over par may be allocated between additional paid-in capital and retained earnings. The charge to additional paid-in capital should be the sum of (1) total paid-in capital resulting from previous treasury stock transactions of the same issue, and (2) the pro rata portion of other additional paid-in capital relating to the same issue. The rest of the excess is then charged to retained earnings. An acceptable alternative is to charge the entire excess to retained earnings. Conversely, an excess of par over purchase price is credited to additional paid-in capital.

64

For a company that has only common stock outstanding, total shareholders’ equity divided by the number of shares outstanding represents the

  1. Return on equity.
  2. Stated value per share.
  3. Book value per share.
  4. Price-earnings ratio.

Book value per share.

Book value per common share is defined as total common equity less the portion allocable to preferred stock, if any, divided by the number of common shares. It is a measure of the amount of common stockholders’ equity in each share of stock.

65

The Amlin Corporation was incorporated on January 1, year 1, with the following authorized capitalization:

  • 20,000 shares of common stock, no par value, stated value $40 per share.
  • 5,000 shares of 5% cumulative preferred stock, par value $10 per share.

During year 1 Amlin issued 12,000 shares of common stock for a total of $600,000 and 3,000 shares of preferred stock at $16 per share.  In addition, on December 20, year 1, subscriptions for 1,000 shares of preferred stock were taken at a purchase price of $17. These subscribed shares were paid for on January 2, year 2. What should Amlin report as total contributed capital on its December 31, year 1 balance sheet?

  1. $520,000
  2. $648,000
  3. $665,000
  4. $850,000

$665,000

 

Total contributed capital is total legal capital plus other paid-in amounts. Thus, the $600,000 received for common and the $48,000 received for preferred are part of contributed capital. Also, when the 1,000 shares of preferred were subscribed for $17 in December, the following entry was made:

  • Stock subscriptions receivable $17,000
    • Preferred stock subscribed $10,000
    • Paid-in preferred $7,000

Both the preferred stock subscribed and the paid-in capital on preferred are considered contributed capital. Thus, the contributed capital consists of

  • Common $600,000
  • Preferred $48,000
  • Preferred subscribed $17,000
  • = $665,000

66

Earnings per share data must be reported on the face of the income statement for

  • Income from continuing operations
  • Discontinued operations

  • Income from continuing operations - YES
  • Discontinued operations - NO

Earnings per share data shall be shown on the face of the income statement. Earnings per share amounts must be presented for

  1. income from continuing operations, and
  2. net income.

Earnings per share date on discontinued operations must be shown either on the face of the income statement or in the footnotes.

67

On May 18, year 1, 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, year 1, when the stock’s market price was $10 per share. What amount should Sol credit to additional paid-in capital for this stock dividend?

  1. $2,100
  2. $2,400
  3. $2,700
  4. $3,000

$2,100

The issuance of a stock dividend less than 20-25% (a “small” stock dividend) requires that the fair value of the stock (on the date of declaration) be transferred from retained earnings, and a dividend greater than 20-25% (a “large” stock dividend) requires that the par value of the stock be transferred from retained earnings.  Thus, a 10% stock dividend is considered to be a “small” stock dividend and should be transferred from retained earnings at the FV on the date of declaration as follows:

  • Retained earnings2,700 (300 × $9) 
  •       Common stock 600 (300 × $2)
  •       APIC 2,100 (excess)

Thus, Sol should credit $2,100 to additional paid-in capital.

68

On January 1, year 1, Rodriguez Corp. granted stock options to corporate executives for the purchase of 10,000 shares of the company’s $20 par value common stock at 70% of the market price on the exercise date, December 30, year 1. On January 1, year 1, no market price or estimate could be made for the value of the options.  All stock options were exercised on December 30, year 1.  The quoted market prices of Rodriguez Corp.’s $20 par value common stock were as follows:

  • January 1, year 1 $50 per share
  • December 30, year 1 $60 per share

As a result of the exercise of the stock options and the issuance of the common stock, Rodriguez should recognize compensation expense in year 1 of

  1. $180,000
  2. $200,000
  3. $500,000
  4. $600,000

$180,000

When there is no observable market price of the option or estimate of the value of the option, the intrinsic value is measured at the end of each reporting period.  The intrinsic value of the option is net of any amounts that the employee must pay. The employees must pay 70% of the value of the stock on the exercise date.  Therefore, the employees will pay 70% × $60 = $42 per share. On the exercise date, the compensation expense recognized is $60 − $42 = $18 × 10,000 options = $180,000.

69

Stent Co. had total assets of $760,000, capital stock of $150,000, and retained earnings of $215,000. What was Stent’s debt-to-equity ratio?

  1. 2.63
  2. 1.08
  3. 0.52
  4. 0.48

1.08

The debt-to-equity ratio is equal to total liabilities divided by total owners’ equity. Total owners’ equity is common stock plus retained earnings, or $365,000 ($150,000 + $215,000). Since assets equal liabilities plus owners’ equity, liabilities are equal to $395,000 ($760,000 − $365,000). The debt-to-equity ratio is equal to 1.08 ($395,000/$365,000).

70

A clearly identified appropriation of retained earnings for reasonably possible loss contingencies should be

  1. Charged with all losses related to that contingency.
  2. Transferred to income as losses are realized.
  3. Classified in the liability section of the balance sheet.
  4. Shown within the stockholders’ equity section of the balance sheet.

Shown within the stockholders’ equity section of the balance sheet.

An amount that is clearly identified as an appropriation of retained earnings should be shown within the stockholders’ equity section of the balance sheet.

71

During year 1 Bradley Corporation issued for $110 per share, 5,000 shares of $100 par value convertible preferred stock.  One share of preferred stock can be converted into three shares of Bradley’s $25 par value common stock at the option of the preferred shareholder.  On December 31, year 2 all of the preferred stock was converted into common stock.  The market value of the common stock at the conversion date was $40 per share. What amount should be credited to the common stock account on December 31, year 2?

  1. $375,000
  2. $500,000
  3. $550,000
  4. $600,000

$375,000

All 5,000 shares of the convertible preferred stock were converted to common stock at the rate of 3 to 1 (making 15,000 common shares issued).  The common stock account is credited for the par value of these shares:  15,000 × $25 or $375,000. Although not necessary, the journal entry to record the conversion can be prepared

  • Preferred stock $500,000 (5,000 × $100)
  • Paid-in capital—PS $50,000 (5,000 × $10)
    • Common stock 375,000 (15,000 × $25)
    • Paid-in capital—CS 175,000 (plug)

The $40 market value of the common stock is ignored.  Gains (losses) are not recognized on the conversion of preferred stock. The book value method is used and the paid-in capital, common stock account is credited for the amount necessary to balance the entry.

72

A company issued rights to its existing shareholders to purchase for par unissued shares of common stock with a par value of $10 per share.  When the market value of the common stock was $12 per share, the rights were exercised.  Common stock should be credited at $10 per share and

  1. Appropriation for stock retirement credited at $2 per share.
  2. No credit made to additional paid-in capital or retained earnings.
  3. Additional paid-in capital credited at $2 per share.
  4. Retained earnings credited at $2 per share.

No credit made to additional paid-in capital or retained earnings.

the stock rights entitle the holder to purchase stock at par value ($10), not market price ($12).  Since only a memorandum entry was required when the rights were originally issued, the entry to record the exercise of the rights is

  • Cash 10 
    • Common stock 10

73

How is earnings per share used in the calculation of the following? 

  • Dividend per share payout ratio
  • Price-earnings ratio

Denominator for BOTH.

Dividends per share payout ratio =

  • Dividends per share / Earnings per share

Price earnings ratio =

  • Market price share / Earnings per share

74

Elaine Corporation was organized on January 1, year 1, with an authorization of 1,000,000 shares of common stock with a par value of $5 per share.  During year 1, the corporation had the following capital transactions:

  • January 4—issued 200,000 shares @ $5 per share.
  • April 8—issued 100,000 shares @ $7 per share.
  • June 9—issued 30,000 shares @ $10 per share.
  • July 29—purchased 50,000 shares @ $4 per share.
  • December 31—sold 50,000 shares held in treasury @ $8 per share.

Elaine used the cost method to record the purchase and reissuance of the treasury shares. What should be the balance in the account “capital in excess of par value” as of December 31, year 1?

  1. $400,000
  2. $450,000
  3. $500,000
  4. $550,000

$550,000

The change in the account resulting from each transaction described should be identified

  • Effect
  • January 4- Shares issued at par $0
  • April 8- Shares issued at $2 above par (100,000 × $2)  $200,000
  • June 9- Shares issued at $5 above par (30,000 × $5)  $150,000
  • July 29- Purchased treasury shares $0
  • December 31- Sold at $4 above cost (50,000 × $4)  $200,000
  • Change in“capital in excess of par”$550,000

Since Elaine uses the cost method, there is no effect on “capital in excess of par” when the shares are purchased, but the account is increased when the treasury shares are reissued above cost.  Remember: “capital in excess of par value” includes APIC from all sources.

75

Kent, Inc. has been forced into bankruptcy and has begun to liquidate.  Unsecured claims will be paid at the rate of 40 cents on the dollar. Apex Co. holds a noninterest-bearing note receivable from Kent in the amount of $100,000, collateralized by machinery with a liquidation value of $25,000.  The total amount to be realized by Apex on this note receivable is

  1. $25,000
  2. $40,000
  3. $55,000
  4. $65,000

$55,000

Bankruptcy law requires that the claims of secured creditors be satisfied before any unsecured claims are paid.  Apex is a secured creditor in the amount of $25,000 (the liquidation value of the collateral). The remainder of Apex’s claim ($100,000 − $25,000 = $75,000) is an unsecured claim because it is not secured by any collateral.  Unsecured claims are paid at the rate of 40 cents on the dollar.  Therefore, Apex will receive a total of $55,000 on this note:  $25,000 received in full as a secured creditor, and $30,000 received as an unsecured creditor ($75,000 × .40).

76

How would the declaration of a 10% stock dividend by a corporation affect each of the following on its books?

  • Retained earnings (RE)
  • Total stockholders' equity (SE)

  • Retained earnings (RE) - Decreased
  • Total stockholders' equity (SE) - No Effect

Regardless of the size of a stock dividend, RE is decreased and other SE accounts are increased. Since the dividend described in this question is small (< 20-25% of the outstanding shares), the journal entry would be

  • Retained earnings(FV) 
    • Common stock dividend distributable (par value)
    • Additional paid-in capital (plug)

Accordingly, RE will decrease and, since all affected accounts are elements of SE, total SE will not change. Note that the entry for a large stock dividend would be

  • Retained earnings(par) 
    • Common stock dividend distributable (par)

77

At December 31, year 1, the Merlin Company had 50,000 shares of common stock issued and outstanding.  On April 1, year 2, an additional 10,000 shares of common stock were issued.  Merlin’s net income for the year ended December 31, year 2, was $172,500.  During year 2, Merlin declared and paid $100,000 cash dividends on its nonconvertible preferred stock.  The basic earnings per common share, rounded to the nearest penny, for the year ended December 31, year 2, should be

  1. $1.26
  2. $1.32
  3. $3.00
  4. $3.14

$1.26

The formula for EPS is

  • EPS = (Net income − Applicable preferred dividends)  /  (Weighted-average number of common shares outstanding)

The $172,500 must be reduced by the $100,000 dividend to the preferred stockholders.  The 50,000 shares outstanding at the beginning of the year must be adjusted to reflect the 10,000 shares that were outstanding for 9 months, resulting in a total weighted-average of 57,500 shares outstanding.  The final computation is the $72,500 of adjusted earnings divided by 57,500 shares, resulting in $1.26 of EPS.

78

During the current year, Comma Co. had outstanding:  25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible.  The bonds were originally issued at par, and each bond was convertible into thirty shares of common stock.  During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%. What amount was Comma’s basic earnings per share for the current year?

  1. $3.38
  2. $7.36
  3. $7.55
  4. $8.00

$7.36

Basic earnings per share is calculated by dividing earnings available to common shareholders by the weighted-average number of common shares outstanding.  In this case, earnings available to common shareholders is equal to net income ($200,000) minus preferred dividends $16,000 (8,000 × $20 × 10%).  Therefore, this answer is correct because basic earnings per share is equal to $7.36 [($200,000 − $16,000) ÷ $25,000].

79

The following is the stockholders’ equity section of Harbor Co.’s balance sheet at December 31:

  • Common stock $10 par, 100,000 shares authorized, 50,000 shares issued of which 5,000 have been reacquired, and are held in treasury $450,000
  • Additional paid-in capital common stock $1,100,000
  • Retained earnings $800,000
  • Subtotal $2,350,000
  • Less treasury stock ($150,000)
  • Total stockholders’ equity $2,200,000

Harbor has insignificant amounts of convertible securities, stock warrants, and stock options.  What is the book value per share of Harbor’s common stock?

  1. $31
  2. $44
  3. $46
  4. $49

$49

The book value per share is calculated as the total owners’ equity divided by the number of common shares outstanding, or $49 ($2,200,000/45,000 shares outstanding). The number of shares outstanding is 45,000 because the treasury shares are not outstanding shares.

80

The following information pertains to Ceil Co., a company whose common stock trades in a public market:

  • Shares outstanding at 1/1 $100,000
  • Stock dividend at 3/31 $24,000
  • Stock issuance at 6/30 $5,000

What is the weighted-average number of shares Ceil should use to calculate its basic earnings per share for the year ended December 31?

  1. 120,500
  2. 123,000
  3. 126,500
  4. 129,000

$126,500

  • Shares outstanding at 1/1 100,000 shares × 12/12   100,000
  • Stock dividend at 3/31 24,000 shares × 12/12    24,000
  • Stock issued on 6/30 5,000 shares × 6/12     2,500
  • Total weighted-average common shares outstanding    126,500

NOTE: The stock dividend is treated as if the shares were outstanding for the entire year.  The stock issued during the year is weighted by the number of months outstanding.

81

Timp, Inc. had the following common stock balances and transactions during year 2:

  • 1/1/Y2 Common stock outstanding 39,000
  • 2/1/Y2 Issued a common stock dividend 3,000
  • 7/1/Y2 Issued common stock for cash 8,000
  • 12/31/Y2 Common stock outstanding 50,000

What was Timp’s year 2 weighted-average shares outstanding?

  1. 40,000
  2. 44,250
  3. 44,500
  4. 46,000

46,000

The 3,000 shares issued as a result of a stock dividend are weighted at 12/12 instead of 11/12 because for EPS purposes stock dividends are treated as if they occurred at the beginning of the year.

82

A company wishes to raise funds by issuing either bonds or cumulative preferred stock. How will the annual interest or dividend affect total liabilities each year?

  1. Interest is a current liability each year (until paid).
  2. Cumulative preferred dividends are a current liability each year (until paid).
  3. Both interest and cumulative preferred dividends are current liabilities each year (until paid).
  4. Interest and cumulative preferred dividends in arrears are current liabilities each year (until paid).

Interest is a current liability each year (until paid).

When bonds are issued, any interest that has not been paid will be accrued and accounted for as a current liability. In addition, cumulative preferred dividends are not considered liabilities until declared by the board of directors.

83

On September 30, year 1, Grey Company issued 3,000 shares of its $10 par common stock in connection with a stock dividend.  No entry was made on the stock dividend declaration date.  The market value per share immediately after issuance was $15.  Grey’s stockholders’ equity accounts immediately before issuance of the stock dividend shares were as follows:

  • Common stock $10 par; 20,000 shares authorized outstanding $200,000
  • Additional paid-in capital $300,000
  • Retained earnings $350,000

What should be the retained earnings balance immediately after the stock dividend?

  1. $305,000
  2. $320,000
  3. $327,500
  4. $350,000

$305,000

The stock dividend is a 15% dividend (3,000/20,000).  A stock dividend of less than 20-25% is recorded (on the date of declaration) at the FV of the shares to be issued.  This amount is charged to Retained earnings and credited to the Stock dividend distributable and Paid-in capital accounts. The FV of the stock on the date of declaration is not indicated in the problem; however, the FV immediately after issuance of the stock dividend is $15.  This is the best choice based on the information available.  Therefore, Retained earnings would be charged for $45,000 (3,000 × $15).  The retained earnings balance would then be $305,000 ($350,000 − $45,000).

84

How would the declaration and subsequent issuance of a 10% stock dividend by the issuer affect each of the following when the market value of the shares exceeds the par value of the stock?

  • Common stock
  • Additional paid-in capital

  • Common stock - Increase
  • Additional paid-in capital - Increase
  • Retained earnings (fair market value) 
    • Common stock (par value)
    • Additional paid-in capital (excess)

85

On January 1, year 2, Karva Company granted James Dean, the president, an option to purchase 1,000 shares of Karva’s $30 par value common stock at $40 per share.  The option becomes exercisable on January 1, year 4, after Dean has completed 2 years of service. Assume that the fair value at the grant date of Karva’s options with similar terms and conditions is $15. As a result of the option granted to Dean, Karva should recognize compensation expense in year 2 of

  1. $0
  2. $5,000
  3. $7,500
  4. $15,000

$7,500

The options are measured at the fair value grant date of ($15 × 1,000 options)/2 years service period = $7,500 compensation expense in year 2.

86

In accounting for stock-based compensation, what interest rate is used to discount both the exercise price of the option and the future dividend stream?

  1. The firm’s known incremental borrowing rate.
  2. The current market rate that firms in that particular industry use to discount cash flows.
  3. The risk-free interest rate.
  4. Any rate that firms can justify as being reasonable.

The risk-free interest rate.

Share-based payments classified as equity 
If an option-pricing model (such as Black-Scholes model) is used, the options pricing model should consider the following variables:

  • Current price of the underlying stock
  • Exercise price of the option
  • Expected life of the option
  • Expected volatility of the underlying stock
  • Expected dividends on the stock
  • Risk-free interest rate during the expected option term

The resulting fair value shall be applied to the number of options expected to vest (based on the grant date estimate) or the total number of options issued.

87

In year 1, Orlando, Inc. issued for $105 per share, 8,000 shares of $100 par value convertible preferred stock.  One share of preferred stock can be converted into three shares of Orlando’s $25 par value common stock at the option of the preferred shareholder.  In August year 2 all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $30 per share. What total amount should be credited to additional paid-in capital (APIC) as a result of the issuance of the preferred stock and its subsequent conversion into common stock?

  1. $80,000
  2. $120,000
  3. $200,000
  4. $240,000

$240,000

The solutions approach is to prepare the journal entry to reflect the conversion as illustrated below.  The convertible preferred stock was originally issued for $840,000 ($105 × 8,000 shares) at a par value of $800,000 ($100 × 8,000 shares), and APIC on preferred stock of $40,000. The entry to record the conversion at the carrying value of the convertible preferred is to reverse the original entry by debiting preferred stock for $800,000 and APIC on preferred for $40,000.  Since 24,000 shares of $25 par common are issued (8,000 shares × 3 = 24,000 shares), there is a credit of $600,000 to common stock. The remaining credit of $240,000 is to APIC on common.

  • Preferred stock800,000 
  • APIC on preferred40,000 
  •       Common stock 600,000
  •       Paid-in capital—CS 240,000

88

In September year 1, Cal Corp. made a dividend distribution of one right for each of its 240,000 shares of outstanding common stock. Each right was exercisable for the purchase of 1/100 of a share of Cal’s $50 variable rate preferred stock at an exercise price of $80 per share.  On March 20, year 3, none of the rights had been exercised, and Cal redeemed them by paying each stockholder $0.10 per right.  As a result of this redemption, Cal’s stockholders’ equity was reduced by

  1. $240
  2. $4,800
  3. $24,000
  4. $72,000

$24,000

The only time an entry related to the issuance and exercise of stock rights, which affects the equity accounts of a corporation, is recorded is on the date of exercise. At the date of issuance, only a memorandum entry is recorded, and on the date the rights lapse, no entry is recorded. The redemption of the rights issued to the shareholders should be treated like a dividend. Accordingly, retained earnings will be decreased by the amount paid to the shareholders ($.10 × 240,000 rights = $24,000).

89

In what circumstances is compensation expense immediately recognized for an employee share-based payment?

  1. In all circumstances.
  2. In circumstances when the options are exercisable within 2 years for services rendered over the next 2 years.
  3. In circumstances when options are granted for prior service, and the options are immediately exercisable.
  4. In no circumstances is compensation expense immediately recognized.

In circumstances when options are granted for prior service, and the options are immediately exercisable.

If the stock options are for past services, as indicated when the options are immediately exercisable by the holders, compensation cost must be fully expensed at the grant date.

90

Under IFRS, the method used when preferred shares are converted into ordinary shares is

  1. Market value method.
  2. Book value method.
  3. Fair value method.
  4. Cost plus differential method.

Book value method.

Preferred shares that are convertible into ordinary shares are recorded in the preferred share account.  Later, if the shares are converted, the book value method is used to account for the conversion of preferred stock into common stock.

91

How would a stock split affect each of the following?

  • Assets
  • Total stockholders' equity
  • Additional paid-in capital

  • Assets - No Effect
  • Total stockholders' equity - No Effect
  • Additional paid-in capital - No Effect

Stock splits do not decrease the property of the corporation nor do they increase the property of the recipient. The only effects of a stock split are on the number of shares outstanding and on the par value of the stock. The assets, total stockholders’ equity, and the additional paid-in capital accounts of the company are not affected.

92

Sydney Corporation granted 1,000 stock options to its employees on January 1, year 1, for services performed during year 1 and year 2.  At the date of the grant, the fair value of the stock options is $6,000. The options are exercisable on January 1, year 3, and expire on June 30, year 3.  On July 1, year 3, it was determined that none of the options were exercised.  On December 31, year 3, Sydney Corporation should

  1. Restate its financial statements for year 1 and year 2 and reduce compensation expense for each year.
  2. Make a prior period adjustment to retained earnings for compensation expense recognized in year 1 and year 2.
  3. Record $6,000 of compensation expense in year 3.
  4. Not adjust or reverse compensation expense.

Not adjust or reverse compensation expense.

If an employee renders the requisite service and the share option expires or is unexercised, previously recognized compensation cost is not reversed.

93

Ten thousand (10,000) shares of common stock with a par value of $20 per share were initially issued at $25 per share. Subsequently, two thousand (2,000) of these shares were purchased as treasury stock at $30 per share. Assuming that the par value method of accounting for treasury stock transactions is used, what is the effect of the purchase of the treasury stock on each of the following?

  • Additional paid-in capital
  • Retained earnings

  • Additional paid-in capital - Decrease
  • Retained earnings - Decrease

Under the par method, the acquisition cost of treasury shares is compared with the amount received at the time of their original issue. The amount originally received in excess of the par value is first charged to additional paid-in capital relating to the original issue, and the remainder to retained earnings. The journal entry would be

  • Treasury stock (2,000 × $20) $40,000
  • Additional paid-in capital (2,000 × $5) $10,000
  • Retained earnings (forced) $10,000
  •       Cash (2,000 × $30) $60,000

94

A company declared a cash dividend on its common stock in December year 1, payable in January year 2.  Retained earnings would

  1. Increase on the date of declaration.
  2. Not be affected on the date of declaration.
  3. Not be affected on the date of payment.
  4. Decrease on the date of payment.

Not be affected on the date of payment.

In this question, the dividend is declared in December of year 1 and is paid in January of year 2. The appropriate journal entries are

  • 12/Y1 Retained earnings xx   
    • Dividends payable xx
  • 1/Y2 Dividends payable xx 
    • Cash xx

Since the entry made on the declaration date reduces retained earnings for the dividend, the entry on the payment date does not affect the retained earnings balance.

95

Which of the following is issued to shareholders by a corporation as evidence of the ownership of rights to acquire its unissued or treasury stock?

  1. Stock options.
  2. Stock warrants.
  3. Stock dividends.
  4. Stock subscriptions.

Stock warrants.

stock warrants are issued to existing shareholders so that they can purchase additional shares of stock in order to maintain their ownership percentage.

Stock Rights
Generally, before additional stock is offered to the public, stock rights are issued to existing shareholders to prevent involuntary dilution of their voting rights (e.g., the preemptive privilege).  The stock rights, evidenced by warrants, indicate the number and price at which the shares may be purchased.  At issuance, the issuer makes only a memorandum entry.  Upon exercise, the following entry is made:

  • Cash(proceeds) 
    • Common stock  (par)
    • Paid-in capital  (plug)

Information relating to stock rights outstanding must be disclosed. Detachable stock rights issued with preferred stock are treated like those on bonds.

96

Effective April 27, year 2, the stockholders of Bennett Corporation approved a two-for-one split of the company’s common stock, and an increase in authorized common shares from 100,000 shares (par value $20 per share) to 200,000 shares (par value $10 per share). Bennett’s stockholders’ equity accounts immediately before issuance of the stock split shares were as follows:

  • Common stock, par value $20; 100,000 shares authorized; 50,000 shares outstanding   $1,000,000
  • Additional paid-in capital (premium of $3 per share on issuance of common stock)   $150,000
  • Retained earnings $1,350,000

What should be the balances in Bennett’s additional paid-in capital and retained earnings accounts immediately after the stock split is effected?

  • Additional paid-in capital
  • Retained earnings

  • Additional paid-in capital $150,000
  • Retained earnings $1,350,000

A stock split results in a decrease in par value per share and an increase in the number of shares outstanding. The total par value of shares outstanding remains unchanged, as do the balances of additional paid-in capital and retained earnings. No journal entries are recorded for a stock split.

97

Murphy Co. had 200,000 shares outstanding of $10 par common stock on March 30 of the current year. Murphy reacquired 30,000 of those shares at a cost of $15 per share, and recorded the transaction using the cost method on April 15.  Murphy reissued the 30,000 shares at $20 per share, and recognized a $50,000 gain on its income statement on May 20.  Which of the following statements is correct?

  1. Murphy’s comprehensive income for the current year is correctly stated.
  2. Murphy’s net income for the current year is overstated.
  3. Murphy’s net income for the current year is understated.
  4. Murphy should have recognized a $50,000 loss on its income statement for the current year.

Murphy’s net income for the current year is overstated.

it is not appropriate to recognize gains or losses on treasury stock transactions. Therefore, the company’s net income is overstated by $50,000.

98

A company with a simple capital structure for purposes of computing earnings per share would include which of the following in the computation of basic earnings per share?

  1. Dividends on nonconvertible cumulative preferred stock.
  2. Dividends on common stock.
  3. Potentially dilutive securities.
  4. Number of shares of nonconvertible cumulative preferred stock.

Dividends on nonconvertible cumulative preferred stock.

A corporation’s capital structure is considered "simple" if it consists only of common stock or does not include potentially dilutive securities that could dilute earnings per common share upon conversion or exercise. The computation of earnings per share is net income (adjusted as described below) divided by the weighted-average number of shares outstanding during the period. Net income is decreased by both dividends on cumulative preferred stock and declared dividends on noncumulative preferred stock. The rationale for this treatment is that both types of dividends are not available to common stockholders.

99

Godart Co. issued $4,500,000 notes payable as a scrip dividend that matured in five years.  At maturity, each shareholder of Godart’s three million shares will receive payment of the note principal plus interest.  The annual interest rate was 10%.  What amount should be paid to the stockholders at the end of the fifth year?

  1. $450,000
  2. $2,250,000
  3. $4,500,000
  4. $6,750,000

$6,750,000

The amount paid to stockholders should be $4,500,000 plus the interest earned during each of the five years. Using simple interest, the interest can be calculated as $4,500,000 × 10% = $450,000 each year × 5 years = $2,250,000 interest. The total amount due to the stockholders for the scrip dividend is $4,500,000 + $2,250,000 interest = $6,750,000.

100

Of the 125,000 shares of common stock issued by Vey Corp., 25,000 shares were held as treasury stock at December 31, year 1. During year 2, transactions involving Vey’s common stock were as follows:

  • January 1 through October 31 — 13,000 treasury shares were distributed to officers as part of a stock compensation plan.
  • November 1—A 3-for-1 stock split took effect.
  • December 1—Vey purchased 5,000 of its own shares to discourage an unfriendly takeover. These shares were not retired.

At December 31, year 2, how many shares of Vey’s common stock were issued and outstanding?

  • Shares issued
  • Shares outstanding

  • Shares issued - $375,000
  • Shares outstanding - $334,000

The purchase or issuance of treasury stock has no effect on shares issued. Stock splits must be accounted for using the number of shares outstanding at the time of the split. In this case the shares issued at 12/31/Y2 are 375,000 (125,000 × 3). For shares outstanding (OS), there were 100,000 shares OS at 12/31/Y1 (125,000 − 25,000). There were 113,000 shares OS after the issuance of the 13,000 shares of treasury stock (100,000 + 13,000). After the 3-for-1 stock split, there were 339,000 shares OS (113,000 × 3). The purchase of treasury shares at December 1 reduced the number of shares OS to 334,000 (339,000 − 5,000). As there were no other stock transactions after December 1, there were 334,000 shares OS at December 31, year 2.

101

When a property dividend is declared and the book value of the property exceeds its market value, the dividend is recorded at the

  1. Market value of the property at the date of distribution.
  2. Market value of the property at the date of declaration.
  3. Book value of the property at the date of declaration.
  4. Book value of the property at the date of distribution if it still exceeds the market value of the property at the date of declaration.

Market value of the property at the date of declaration.

A transfer of a nonmonetary asset to a stockholder or to another entity in a nonreciprocal transfer should be recorded at the fair market value of the asset transferred. The declaration date is the date that a dividend becomes a liability of the corporation and thus is the date to measure and record the dividend.

102

Earl was engaged by Farm Corp. to perform consulting services.  Earl’s compensation for these services consisted of 1,000 shares of Farm’s $10 par value common stock, to be issued to Earl on completion of Earl’s services.  On the execution date of Earl’s employment contract, Farm’s stock had a market value of $40 per share. Six months later, when Earl’s services were completed and the stock issued, the stock’s market value was $50 per share. Farm’s management estimated that Earl’s services were worth $100,000 in cost savings to the company.  As a result of this transaction, additional paid-in capital should increase by

  1. $100,000
  2. $90,000
  3. $40,000
  4. $30,000

$30,000

When stock is issued for personal services performed by employees or outsiders, the transaction should be valued at the FMV of the stock or the FMV of the services, whichever is more clearly determinable.  The market value of the shares as of the date of the contract for such services, rather than at the date of issuance of the shares, should be the basis for valuation.  The contract is viewed in an accounting sense as a stock subscription.  Therefore, on the date of the contract, the following journal entry should be made by Farm Corp.:

  • Compensation expense $40,000
    • Common stock $10,000
    • Additional paid-in capital $30,000

103

On May 1, year 1, Rhud Corp. declared and issued a 10% common stock dividend.  Prior to this dividend, Rhud had 100,000 shares of $1 par value common stock issued and outstanding.  The fair value of Rhud’s common stock was $30 per share on May 1, year 1.  As a result of this stock dividend, Rhud’s total stockholders’ equity

  1. Increased by $300,000.
  2. Decreased by $300,000.
  3. Decreased by $10,000.
  4. Did not change.

Did not change.

A stock dividend has no effect on total stockholders’ equity. No assets are transferred to stockholders as in the case of a cash or property dividend.  Stockholders merely receive more shares of stock.  The journal entry to record a small stock dividend (less than 20-25%) transfers an amount equal to the fair value of the stock to be issued from retained earnings to paid-in capital.  Therefore, one part of stockholders’ equity decreases while another part increases. The journal entry below summarizes the net effect of the entries to record a stock dividend.

  • Retained earnings (10,000 × $30) $300,000 
    • Common stock (10,000 × $1) $10,000
    • Paid-in capital $290,000

104

Heritage Corporation issues convertible bonds for $600,000.  At the date of issuance, it is determined that the fair value of the bonds is $580,000.  Heritage prepares its financial statements in accordance with IFRS.  How should the issuance of the bonds be recognized?

  1. As a bond liability for $600,000.
  2. As a bond liability for $580,000 and other comprehensive income of $20,000.
  3. As a bond liability for $580,000 and an equity component of $20,000.
  4. As a bond liability for $600,000 and a contra liability of $20,000.

As a bond liability for $580,000 and an equity component of $20,000.

IFRS provides that financial instruments with characteristics of both debt and equity are compound instruments and must be separated into its respective components. The liability is valued at the fair value at the date of issuance and the residual value is assigned to the equity component. Therefore, the bond should be recorded at its fair value of $580,000, and an equity component should be recorded for $20,000.

105

On December 31, year 1, Case, Inc. had 300,000 shares of common stock issued and outstanding. Case issued a 10% stock dividend on July 1, year 2. On October 1, year 2, Case purchased 24,000 shares of its common stock for treasury, and recorded the purchase by the cost method. What is the number of shares that should be used in computing basic earnings per share for the year ended December 31, year 2?

  1. 306,000
  2. 309,000
  3. 324,000
  4. 330,000

324,000

For EPS purposes, shares of stock issued as a result of stock dividends or splits should be considered outstanding for the entire period in which they were issued.  Therefore, both the original 300,000 shares and the additional 30,000 shares (10% × 300,000) are treated as outstanding for the entire year.  The 10/1/Y2 purchase of 24,000 treasury shares results in a weighted-average deduction of 6,000 shares (3/12 × 24,000) because the shares were not outstanding for only 3 months during year 2.  Therefore, the number of shares for EPS computations is 324,000.

  • Outstanding 12/31/Y1 $300,000
  • Stock dividend (10% × 300,000) $30,000
  • 10/1 purchase (3/12 × 24,000) ($6,000)
  • = $324,000

106

Jones Co. had 50,000 shares of $5 par value common stock outstanding at January 1. On August 1, Jones declared a 5% stock dividend followed by a two-for-one stock split on September 1. What amount should Jones report as common shares outstanding at December 31?

  1. $105,000
  2. $100,000
  3. $52,500
  4. $50,000

$105,000

The calculation of common shares outstanding is as follows: 50,000 + (50,000 × 0.05) = 52,500 × 2 = 105,000.

107

Treasury stock was acquired for cash at more than its par value, and then subsequently sold for cash at more than its acquisition price. Assuming that the cost method of accounting for treasury stock transactions is used, what is the effect on additional paid-in capital from treasury stock transactions?

  • Purchase of treasury stock
  • Sale of treasury stock

  • Purchase of treasury stock - No effect
  • Sale of treasury stock - increase

 

When treasury stock is acquired using the cost method, a stockholders’ equity account is debited for the cost of the treasury stock.

  • Treasury stockxxx 
    • Cash xxx

When the treasury stock is subsequently sold for cash at more than its acquisition price, additional paid-in capital is credited for the gain.

  • Cash xx 
    • Treasury stock xxx
    • APIC treasury stock xxx

108

Compensatory stock options were granted to executives on January 1, year 1, for services to be rendered during year 1, year 2, and year 3. The options are accounted for under ASC Topic 718. The fair value of the option was measured at the grant-date fair value using the observable market price of an option with similar terms. The fair value of the options was in excess of the amount the executives must pay for the stock. The stock options were exercised on December 30, year 3. Compensation expense should be recognized in the income statement in which of the following years?

  • Year 1
  • Year 2
  • Year 3

  • Year 1 - YES
  • Year 2 - YES
  • Year 3 - YES

Per ASC Topic 718, compensation expense resulting from compensatory stock option plans is typically determined at the grant date, and then allocated to the periods in which the employees perform the services.

109

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?

  1. $0
  2. $1,500,000
  3. $4,500,000
  4. $7,500,000

$0

The stock dividend involves transferring an equal amount from retained earnings to invested capital. In this case, the dividend is a large stock dividend resulting in a transfer at par value. Total equity does not change.

110

A corporation declared a dividend, a portion of which was liquidating. How would this declaration affect each of the following?

  • Additional paid-in capital 
  • Retained earnings

  • Additional paid-in capital - Decrease
  • Retained earnings - Decrease

A liquidating dividend represents a return of capital to stockholders because the dividend declared exceeds the corporation’s retained earnings. When a corporation declares a liquidating dividend, the following journal entry is made:

  • Retained earnings(balance) 
  • Additional paid-in capital(plug) 
    • Dividends payable  (dividend amount)

Therefore, declaration of a liquidating dividend will decrease both APIC and retained earnings.

111

On January 1, year 2, Pall Corp. granted stock options to key employees for the purchase of 40,000 shares of the company’s common stock at $25 per share. The options are intended to compensate employees for the next 2 years.  The options are exercisable within a 4-year period beginning January 1, year 3, by grantees still in the employment of the company.  The market price of Pall’s common stock was $25 per share at the date of grant. The value of each option under the Black-Scholes model was $8.00.  No stock options were terminated during the year.  What amount should Pall charge to compensation expense for the year ended December 31, year 2?

  1. $320,000
  2. $160,000
  3. $ 80,000
  4. $0

$160,000

Employee compensation expense as the result of a stock option plan is calculated as the value of each option at the date of grant times the number of option shares.

  • Option shares × Value of each option = Total compensation expense
  • 40,000 × $8.00 = $320,000

112

If a corporation sells some of its treasury stock at a price that exceeds its cost, this excess should be

  1. Reported as a gain in the income statement.
  2. Treated as a reduction in the carrying amount of remaining treasury stock.
  3. Credited to additional paid-in capital.
  4. Credited to retained earnings.

Credited to additional paid-in capital.

If the cost method is used to account for treasury stock, the sale of treasury stock above cost is recorded as follows:

  • Cash = Selling price
    • Treasury stock = Cost 
    • APIC—TS = Excess

The excess of selling price over cost is credited to an additional paid-in capital account.

113

On January 2, year 3, Morey Corp. granted Dean, its president, 20,000 stock appreciation rights for past services.  Those rights are exercisable immediately and expire on January 1, year 4. On exercise, Dean is entitled to receive cash for the excess of the stock’s market price on the exercise date over the market price on the grant date.  Dean did not exercise any of the rights during year 3.  The market price of Morey’s stock was $30 on January 2, year 3, and $45 on December 31, year 3.  Morey should recognize compensation expense under the stock appreciation rights plan for year 3 of

  1. $0
  2. $100,000
  3. $300,000
  4. $600,000

$300,000

The 20,000 stock appreciation rights (SAR) each entitle the holder to receive cash equal to the excess of the market price of the stock on the exercise date over the market price on the grant date ($30). Since these SAR are payment for past services and are exercisable immediately, there is no required service period.  Therefore, the expense computed at 12/31/Y3 does not have to be allocated to more than one period.  At 12/31/Y3, compensation expense is measured based on the excess of the 12/31/Y3 market price ($45) over the predetermined price ($30), resulting in compensation expense of $300,000 [20,000 ($45 − $30)]. Note that if Dean was required to work 3 years before the SAR could be exercised, the expense would be allocated over the 3 years of required service ($300,000 × 1/3 = $100,000).

114

On July 1, year 1, Alto Corp. split its common stock 5-for-1 when the market value was $100 per share. Prior to the split, Alto had 10,000 shares of $10 par value common stock issued and outstanding. After the split, the par value of the stock

  1. Remained at $10.
  2. Was reduced to $8.
  3. Was reduced to $5.
  4. Was reduced to $2.

Was reduced to $2.

A stock split results in an increase or decrease in the number of shares outstanding and a corresponding decrease or increase in the par value per share. A 5-for-1 split in this case would increase the shares outstanding to 50,000 and decrease the par value per share to $2 ($10/5). Total par value is not affected by a stock split (10,000 × $10 before split; 50,000 × $2 after split).

115

Treasury stock was acquired for cash at more than its par value, and then subsequently sold for cash at more than its acquisition price. Assuming that the cost method of accounting for treasury stock transactions is used, what is the effect of the subsequent sale of the treasury stock on each of the following?

  • Additional paid-in capital
  • Retained earnings

  • Additional paid-in capital - Increase
  • Retained earnings - No Effect

R/E is only effected via the Par value method for treasury stock.

When treasury stock is acquired by an entity using the cost method, the treasury stock account is debited for the acquisition price (cost).

  • Treasury stock (cost) 
    • Cash (cost)

Note that the price paid for treasury stock in relation to its par/stated value does not affect the accounting under the cost method as it does under the par value method. When the shares are later resold for an amount greater than cost, the excess increases the Additional paid-in capital account.

  • Cash (proceeds) 
    • Treasury stock (cost)
    • APIC-treasury stock (excess)

116

For purposes of computing the weighted-average number of shares outstanding during the year, a midyear event that must be treated as occurring at the beginning of the year is the

  1. Declaration and payment of stock dividend.
  2. Purchase of treasury stock.
  3. Sale of additional common stock.
  4. Issuance of stock warrants.

Declaration and payment of stock dividend.

A stock dividend is considered to have occurred on the first day of the year when computing the weighted-average number of shares outstanding.

117

On February 1, Year 1, Kew Corp., a newly formed company, had the following stock issued and outstanding:

  • Common stock, no par, $1 stated value, 10,000 shares originally issued for $15 per share.
  • Preferred stock, $10 par value, 3,000 shares originally issued for $25 per share.

Kew’s February 1, Year 1, statement of stockholders’ equity should report

  • Common stock
  • Preferred stock
  • Additional paid-in capital

  • Common stock $10,000
  • Preferred stock $30,000
  • Additional paid-in capital $185,000

Common stock and preferred stock are reported at par or stated value, and any excess invested above par or stated value is recorded as additional paid-in capital. In this case, common stock is recorded at stated value (10,000 × $1 = $10,000), and preferred stock is recorded at par value (3,000 × $10 = $30,000). Additional paid-in capital from common stock is $140,000 [10,000 × ($15 − $1)], and additional paid-in capital from preferred stock is $45,000 [3,000 × ($25 − $10)], so additional paid-in capital is $185,000 ($140,000 + $45,000).

118

The following information was abstracted from the accounts of the Oar Corporation at December 31, Year 2:

  • Total income since incorporation $840,000
  • Total cash dividends paid $260,000
  • Proceeds from sale of donated stock (FV on date of donation was ($30,000) $90,000
  • Total value of stock dividends distributed $60,000
  • Excess of proceeds over cost of treasury stock sold $140,000

The donated stock was classified as a trading security. What should be the current balance of retained earnings?

  1. $520,000
  2. $580,000
  3. $610,000
  4. $670,000

$520,000

Retained earnings is increased by income and decreased by dividends. Donated assets are recorded at FV upon receipt and recognized as revenue in the period of donation. Trading securities are measured at fair value at the end of the year, and the unrealized is included in net income.

  • Retained earnings=Income−Cash dividends−Stock dividends
  • $520,000=$840,000−$260,000−$60,000

The excess of proceeds over cost of treasury stock sold would be credited to paid-in capital.

119

The purchase of treasury stock

  1. Decreases common stock authorized.
  2. Decreases common stock issued.
  3. Decreases common stock outstanding.
  4. Has no effect on common stock outstanding.

Decreases common stock outstanding.

Only the common stock outstanding will be decreased by the amount of treasury stock purchased. When a company reacquires its own stock, the purchase does not reduce the number of shares issued or authorized, but does reduce the number of shares outstanding and the total stockholders’ equity.

120

Munn Corp.’s records included the following stockholders’ equity accounts:

  • Preferred stock, par value $15, authorized 20,000 shares $255,000
  • Additional paid-in capital, preferred stock $15,000
  • Common stock, no par, $5 stated value, 10,000 shares authorized $300,000

In Munn’s statement of stockholders’ equity, the number of issued and outstanding shares for each class of stock is

  • Common stock
  • Preferred stock

  • Common stock - $60,000
  • Preferred stock - $17,000

The balances in the common stock and preferred stock accounts equal the total par or stated value of the shares issued. Therefore, when the account balance is divided by the par or stated value per share, the result is the number of shares issued.

  • Preferred stock ($225,000 ÷ $15), 17,000 shares issued
  • Common stock ($300,000 ÷ $ 5), 60,000 shares issued

121

Tyson Corp. purchased trading securities in March 1, year 1, for $200,000.  Tyson uses a December 31 year-end.  The following information pertains to a property dividend of the trading securities purchased in March.

  • Fair value
  • Declaration date—December 20, year 1$300,000
  • Record date—January 10, year 2  310,000
  • Distribution date—January 28, year 2  305,000

How much gain should Tyson recognize in year 1 as a result of this property dividend?

  1. $0
  2. $100,000
  3. $105,000
  4. $110,000

$100,000

A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners. A transfer of a nonmonetary asset to a stockholder or to another entity in a nonreciprocal transfer should be recorded at the fair value of the asset transferred, and a gain (loss) should be recognized on the disposition of the asset. The fair value of the property on the declaration date less the carrying value of the property equals the gain (loss). Because the trading securities were purchased in the current year, they have not yet been adjusted to fair value. Therefore, the carrying value at the date of declaration is $200,000, and the amount of gain to be recognized is $300,000 − $200,000 = $100,000.

122

A company issued rights to its existing shareholders to purchase for $15 per share, 5,000 unissued shares of common stock with a par value of $10 per share.  Common stock will be credited at

  1. $15 per share when the rights are exercised.
  2. $15 per share when the rights are issued.
  3. $10 per share when the rights are exercised.
  4. $10 per share when the rights are issued.

$10 per share when the rights are exercised.

At issuance, the issuer makes only a memorandum entry indicating the number and price at which the shares may be purchased.  Upon exercise, the company receives the cash and makes the following entry:

  • Cash (proceeds) 
  •       Common stock (par value)
  •       APIC (plug)

123

Faucet Company has 2,500,000 shares of common stock outstanding on December 31, year 1.  An additional 500,000 shares of common stock were issued on April 1, year 2, and 250,000 more on July 1, year 2. On October 1, year 2, Faucet issued 5,000, $1,000 face value, 7% convertible bonds.  Each bond is convertible into 40 shares of common stock.  No bonds were converted into common stock in year 2. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively, for the year ended December 31, year 2?

  1. 2,875,000 and 2,975,000.
  2. 2,875,000 and 3,075,000.
  3. 3,000,000 and 3,050,000.
  4. 3,000,000 and 3,200,000.

3,000,000 and 3,050,000.

For DEPS the bonds would be considered converted. Since there were 5,000 bonds, each convertible into 40 shares of stock, this results in an additional 50,000 equivalent shares (5,000 × 40 × 3/12 yr.). Thus, there would be 3,000,000 shares outstanding for BEPS and 3,050,000 shares outstanding for DEPS.

124

As of December 15, year 3, Aviator had dividends in arrears of $200,000 on its cumulative preferred stock.  Dividends for year 3 of $100,000 have not yet been declared. The board of directors plans to declare cash dividends on its preferred and common stock on January 16, year 4.  Aviator paid an annual bonus to its CEO based on the company’s annual profits.  The bonus for year 3 was $50,000, and it will be paid on February 10, year 4.  What amount should Aviator report as current liabilities on its balance sheet at December 31, year 3?

  1. $50,000
  2. $150,000
  3. $200,000
  4. $350,000

$50,000

The bonus ($50,000) is the only liability at year-end. The dividends are not a liability until they are declared.

125

Newton Corporation was organized on January 1, year 1.  On that date it issued 200,000 shares of its $10 par value common stock at $15 per share (400,000 shares were authorized).  During the period January 1, year 1, through December 31, year 4, Newton reported net income of $750,000 and paid cash dividends of $380,000. On January 5, year 4, Newton purchased 12,000 shares of its common stock at $12 per share.  On December 31, year 4, 8,000 treasury shares were sold at $8 per share.  Newton used the cost method of accounting for treasury shares.  What is the total stockholders’ equity of Newton as of December 31, year 4?

  1. $3,290,000
  2. $3,306,000
  3. $3,338,000
  4. $3,370,000

$3,290,000

The effect of each transaction on stockholders’ equity would be

  • Effect 
  • 1/1/Y1200,000 shares issued for $15 $3,000,000
  • Y1-Y4Net income $750,000
  • Y1-Y4Dividends ($380,000)
  • 1/5/Y4Purchased 12,000 treasury shares at $12 ($144,000)
  • 12/31/Y4 Sell treasury shares at $8 
  •        Decrease in treasury stock account $96,000
  •        Decrease in additional paid-in capital   ($32,000)
  • 12/31/Y4 Stockholders’ equity $3,290,000

Thus, total stockholders’ equity is $3,290,000.

126

The stockholders of Meadow Corp. approved a stock-option plan that grants the company's top three executives options to purchase a maximum of 1,000 shares each of Meadow's $2 par common stock for $19 per share. The options were granted on January 1 when the fair value of the stock was $20 per share. Meadow determined that the fair value of the compensation is $300,000 and the vesting period is three years. What amount of compensation expense from the options should Meadow record in the year the options were granted?

  1. $20,000
  2. $60,000
  3. $100,000
  4. $300,000

$100,000

compensation expense for employee stock options allocates the fair value of the compensation (as determined by an option pricing model) over the vesting period ($300,000/3 = $100,000).

127

Ashe Corp. was organized on January 1, Year 1, with authorized capital of 100,000 shares of $20 par value common stock. During Year 1 Ashe had the following transactions affecting stockholders’ equity:

  • January 10 Issued 25,000 shares at $22 a share.
  • March 25 Issued 1,000 shares for legal services when the fair value was $24 a share.
  • September 30 Issued 5,000 shares for a tract of land when the fair value was $26 a share.

What amount should Ashe report for additional paid-in capital at December 31, Year 1?

  1. $84,000
  2. $80,000
  3. $54,000
  4. $50,000

$84,000

All three transaction increase additional paid-in capital (APIC) because they involve the issuance of common stock for an amount above par value. The January 10 transaction increases APIC by $50,000 [25,000 × ($22 − $20)]. The March 25 transaction increases APIC by $4,000 [1,000 × ($24 − $20)] because the transaction is valued at the FV of the services or the FV of the stock, whichever is more clearly determinable. Similarly, the September 30 transaction increases APIC by $30,000 [5,000 × ($26 − $20)]. Therefore, Ashe should report APIC of $84,000 ($50,000 + $4,000 + $30,000) at 12/31/Y1.