chapter 11 • stockholders’ equity 11-53
CHAPTER 11
Stockholders’ Equity
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Identify the components of the Stockholders’ Equity category 1 10 Easy
of the balance sheet and the accounts found in each 2 10 Mod
component.
2. Show that you understand the characteristics of common
and preferred stock and the differences between the classes
of stock.
3. Determine the financial statement impact when stock is 3 10 Mod
issued for cash or other consideration. 4 20 Mod
4. Describe the financial statement impact of stock treated as 5 15 Mod
treasury stock. 6 15 Mod
5. Compute the amount of cash dividends when a firm has 7 10 Mod
issued both preferred and common stock. 8 15 Mod
6. Show that you understand the difference between cash 9 15 Mod
and stock dividends and the effect of stock dividends.
7. Determine the difference between stock dividends and stock 10 15 Diff
splits. 11 15 Diff
8. Show that you understand the statement of stockholders’ 12 10 Easy
equity and comprehensive income. 13 15 Diff
9. Understand how investors use ratios to evaluate stockholders’ 14 5 Mod
equity.
10. Explain the effects that transactions involving stockholders’ 15 5 Mod
equity have on the statement of cash flows. 16 5 Mod
17 5 Mod
18 5 Easy
11. Describe the important differences between the sole 19 15 Mod
proprietorship and partnership forms of organization 20 10 Mod
versus the corporate form (Appendix).
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Identify the components of the Stockholders’ Equity category 1 20 Mod
of the balance sheet and the accounts found in each 12* 15 Mod
component. 14* 15 Diff
2. Show that you understand the characteristics of common 2 15 Mod
and preferred stock and the differences between the classes
of stock.
3. Determine the financial statement impact when stock is 13* 20 Mod
issued for cash or other consideration.
4. Describe the financial statement impact of stock treated as 12* 15 Mod
treasury stock. 13* 20 Mod
14* 15 Mod
5. Compute the amount of cash dividends when a firm has 3 20 Mod
issued both preferred and common stock.
6. Show that you understand the difference between cash 4 15 Diff
and stock dividends and the effect of stock dividends.
7. Determine the difference between stock dividends and stock 5 20 Mod
splits. 13* 20 Mod
8. Show that you understand the statement of stockholders’ 6 20 Mod
equity and comprehensive income. 7 10 Mod
9. Understand how investors use ratios to evaluate stockholders’
equity.
10. Explain the effects that transactions involving stockholders’ 8 15 Diff
equity have on the statement of cash flows.
11. Describe the important differences between the sole 9 15 Mod
proprietorship and partnership forms of organization 10 20 Mod
versus the corporate form (Appendix). 11 10 Mod
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Identify the components of the Stockholders’ Equity category 1* 15 Mod
of the balance sheet and the accounts found in each 3* 10 Mod
component.
2. Show that you understand the characteristics of common 3* 10 Mod
and preferred stock and the differences between the classes 4 10 Mod
of stock.
3. Determine the financial statement impact when stock is
issued for cash or other consideration.
4. Describe the financial statement impact of stock treated as
treasury stock.
5. Compute the amount of cash dividends when a firm has 6 15 Mod
issued both preferred and common stock.
6. Show that you understand the difference between cash
and stock dividends and the effect of stock dividends.
7. Determine the difference between stock dividends and stock
splits.
8. Show that you understand the statement of stockholders’ 1* 15 Mod
equity and comprehensive income.
9. Understand how investors use ratios to evaluate stockholders’ 5 15 Mod
equity.
10. Explain the effects that transactions involving stockholders’ 2 15 Mod
equity have on the statement of cash flows.
11. Describe the important differences between the sole
proprietorship and partnership forms of organization
versus the corporate form (Appendix).
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
questions
1. The two major components of stockholders’ equity are contributed capital and retained earnings. Accounts in contributed capital include the Common Stock and Preferred Stock accounts and the Additional Paid-in Capital accounts. The primary
account in the retained earnings component is the Retained Earnings account.
2. The number of shares authorized is the total number that the corporation can issue, as indicated in the corporate charter. Shares issued are shares that have been distributed to stockholders. Shares outstanding is the number of shares in the stockholders’ hands as of the balance sheet date. The difference between shares issued and shares outstanding is normally the result of treasury stock.
3. Firms designate the par value of the stock for legal reasons. Par value is not an indication of the selling price or market value of the stock.
4. The balance of the Retained Earnings account is not equal to the firm’s net income. The account indicates the amount of income for all previous years that has been earned but has not been paid out as dividends to the stockholders.
5. Preferred stock normally must be paid a dividend before a dividend may be paid to common stock. However, even if the preferred stock is cumulative, preferred stockholders do not have a right to dividends in arrears until the time the dividend is declared.
6. Preferred stock is generally a lower risk stock that provides a stable return but does not provide for the potentially high return of a common stock. The advantages of preferred stock are the safety and stability it provides.
7. Common shareholders are considered residual shareholders because the amount of book value of preferred shareholders is subtracted from total stockholders’ equity before the common book value is determined. Common shareholders also have a right to the earnings after preferred dividends are distributed.
8. The asset should be recorded at the fair market value of the consideration given (the stock) or the fair market value of the consideration received (the asset), whichever is more readily determinable. Fair market value may be determined by reference to sales of the stock on the stock exchange or, in some cases, by an appraisal of the asset.
9. Treasury stock is stock that has been issued and then repurchased by a corporation. There are a variety of uses of treasury stock, including use in employee benefit plans, prevention of an unwanted takeover, and reduction in the number of shares of stock to improve financial ratios. Treasury Stock is a contra equity account and is shown as a reduction of stockholders’ equity.
10. Gains or losses on treasury stock are not recorded on the income statement. Rather, the amounts are shown as additions or deductions of stockholders’ equity. Additions appear in the Paid-in Capital—Treasury Stock account. Deductions reduce that account or the Retained Earnings account if the Paid-in Capital account is not present. No income statement amounts are recorded to prevent manipulation of income by firms who would buy and sell their own stock in order to show a “profit.”
11. Firms do not pay out all of their income as dividends because there are other alternative uses of the income. Management’s objective should be to maximize the wealth of the stockholders. Sometimes that can be achieved by paying dividends; other times it can be achieved by retaining the income and reinvesting it in alternatives that will produce a satisfactory return.
12. A stock dividend occurs when a company issues shares of stock to its existing stockholders instead of paying cash as a dividend. Stock dividends should be recorded as a reduction of Retained Earnings and an increase in Stock Dividend Distributable. Therefore, stock dividends do not affect total stockholders’ equity. Normally, retained earnings is reduced by the market value of the stock distributed.
13. It is better to receive a stock dividend when the company is using earnings to expand and reinvest in the business. A cash dividend is preferred by investors who need the cash to meet current needs, like senior citizens.
14. Stock dividends do not reduce the par value per share of the stock. Stock splits do reduce the par value per share. Splits do not require any journal entry but should be noted in the notes that accompany the balance sheet.
15. Book value per share is calculated as the total net assets of the corporation divided by the number of shares of common stock. It is a measure of the rights of the common stockholders to the assets of the firm in the event of liquidation. It does not mean that the common stockholders will receive a dividend equal to the book value per share.
16. The market value per share of the stock is related to the income of the corporation, but many other factors also influence the market value. General economic factors such as inflation, factors related to the particular industry, tax consequences, and the mood of current and potential investors all have an impact on the market value of the stock.
17. The statement of stockholders’ equity explains all reasons for the difference between the beginning and ending balances of each of the accounts in the stockholders’ equity category. The retained earnings statement details the changes in only one component of stockholders’ equity—retained earnings.
18. The advantages of organizing as a corporation include limited liability and the increased ability to raise funds from a wider group of unrelated investors. Companies choose not to incorporate because it costs to file papers with the state and to issue stock, and corporations must file annual reports, open to public inspection.
19. Partners could share income equally, as a percentage of investment (capital balance), or as a proportion based on the amount of hours each partner works. The partners can share income based on any method that is reasonable, provided that the method has been agreed upon, in writing, by the partners.
exercises
LO 1 / EXERCISE 11-1 STOCKHOLDERS’ EQUITY ACCOUNTS1. Yes, Preferred Stock, Increase
2. Yes, Additional Paid-in Capital, Increase
3. Not recorded until declared
4. Cash Dividends Payable is recorded as a liability, Decrease Retained Earnings
5. Yes, Stock Dividend Distributable, No change in total stockholders’ equity
6. Yes, Treasury Stock, Decrease
7. Yes, Additional Paid-in Capital—Treasury Stock, Increase
8. Yes, Retained Earnings, Increase
LO 1 / EXERCISE 11-2 SOLVE FOR UNKNOWNS1. Total par value = $10 × 10,000 = $100,000
Additional Paid-in Capital = $350,000 – $100,000 = $250,000
Total Stockholders’ Equity = $350,000 + $100,000 (Retained Earnings) – $10,000 (Treasury Stock) = $440,000
2. Number of shares of Treasury Stock = number of shares issued – number
outstanding = 10,000 – 9,200 = 800 shares
Cost per share = $10,000/800 shares = $12.50
LO 3 / EXERCISE 11-3 STOCK ISSUANCE1. a. The effect on the accounting equation of the issuance of common stock for cash is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Cash 75,000* Common
Stock 25,000**
Additional
Paid-in
Capital 50,000***
* $15 ´ 5,000 = $75,000
** $5 ´ 5,000 = $25,000
*** $10 ´ 5,000 = $50,000
b. The effect on the accounting equation of issuing common stock for a building is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Building 175,000 Common
Stock 35,000*
Additional
Paid-in
Capital 140,000
*$5 ´ 7,000 = $35,000
c. The effect on the accounting equation of issuing common stock to acquire a patent is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Patent 50,000* Common
Stock 10,000**
Additional
Paid-in
Capital 40,000
*$25 ´ 2,000 = $50,000
** $5 ´ 2,000 = $10,000
EXERCISE 11-3 (Concluded)
2. Common Stock, $5 par value: 14,000 shares issued and
outstanding $ 70,000
Additional Paid-in Capital ($50,000 + $140,000 + $40,000) 230,000
Total Contributed Capital $300,000
LO 3 / EXERCISE 11-4 STOCK ISSUANCES1. a. There is no effect on the accounting equation.
b. The effect on the accounting equation of the issuance of common stock on March 10, 2007, is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Cash 175,000* Common
Stock 50,000**
Additional
Paid-in
Capital—
Common 125,000
*$35 ´ 5,000 = $175,000
**$10 ´ 5,000 = $50,000
c. The effect on the accounting equation of the March 18, 2007, issuance of preferred stock is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Cash 12,000* Preferred
Stock 10,000**
Additional
Paid-in
Capital—
Preferred 2,000
*$120 ´ 100 = $12,000
**$100 ´ 100 = $10,000
EXERCISE 11-4 (Concluded)
d. The effect on the accounting equation of the April 12, 2007, issuance of common stock is as follows:
Balance Sheet income Statement
Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses
Cash 450,000* Common
Stock 100,000**
Additional
Paid-in
Capital—
Common 350,000
*$45 ´ 10,000 = $450,000
**$10 ´ 10,000 = $100,000
2. 8% Preferred stock, $100 par value, 5,000 shares authorized,
100 shares issued and outstanding $ 10,000
Common stock, $10 par value, 2,000,000 shares authorized,
15,000 shares issued and outstanding 150,000
Additional paid-in capital—preferred stock 2,000
Additional paid-in capital—common stock 475,000