fundamental accounting principles

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Chapter 13

Accounting for Corporations

QUESTIONS

1. Organization expenses (costs) are incurred in creating a corporation. Examples include: legal fees, promoter fees, accountant fees, costs of printing stock certificates, and fees paid to obtain a state charter.

2. Organization expenses (costs) are reported as expenses when incurred—as part of operating expenses—because the amount and timing of their future benefit is difficult to determine. (Instructor note: Prior to SOP 98-5, organization costs were classified as part of intangible assets and then allocated to amortization expense.)

3. The board of directors of a corporation is responsible for directing the corporation's affairs. The directors are elected by the corporation’s stockholders.

4. The preemptive right of common stockholders is the right to maintain their relative ownership interests in the corporation by having the first opportunity to purchase their proportionate share of any additional common shares issued by the corporation.

5. The general rights of common stockholders include: (1) the right to vote in stockholders’ meetings, (2) the right to sell or otherwise dispose of stock, (3) the preemptive right, (4) the right to share proportionately in dividends, and (5) the right to share proportionately in assets remaining after the creditors are paid when, and if, the corporation is liquidated. In addition, stockholders have the general right to receive timely and useful financial reports that describe the corporation’s financial position and the results of its activities.

6. Authorized shares represent the maximum number of shares that a corporation’s charter allows it to sell. Outstanding shares are the number of issued shares that are held by stockholders. The number of authorized shares usually exceeds the number of issued shares, often by a large amount.

7. Convertible preferred stock is potentially attractive because it offers the safety of a regular return as well as the opportunity to share in the increased value of the issuer’s common stock through conversion (or potential conversion).

8. The market value per share of stock is the price at which a share of stock is bought or sold. Many factors—including expected future earnings, dividends, growth, and other company and economic factors—affect market value. Par value per share is an arbitrary value assigned by the corporation in its charter.

9. The par value is an arbitrary value placed on a share of stock when it is authorized. The call price is an amount that a corporation must pay if it exercises the option to buy back and retire a share of callable preferred stock.

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a. date of declaration the date the directors vote to pay a dividend.

b. date of record a future date specified by the directors to identify the particular shareholders that are to receive the dividend.

c. date of payment the date when shareholders receive the dividend payment.

11. Cash dividends debited against paid-in capital accounts are called liquidating dividends because they represent a return of amounts originally invested in the corporation by the stockholders. (They are a return of, not a return on, capital contributions.)

12. Declaring a stock dividend has no effect on assets, liabilities, or total equity. Also, the subsequent distribution of the stock dividend has no effect on these items. Instead, the stock dividend simply increases the number of shares outstanding and results in a transfer of equity from retained earnings to paid-in capital.

13. A stock dividend results in a distribution of additional shares to stockholders and the capitalization of retained earnings. A stock split calls in the old shares and replaces them with a different number of new shares with a new par value. Also, no entry is made to any of the equity accounts with a stock split. In spite of these technical differences, there is no practical difference in most cases between a stock split and a large stock dividend.

14. A stock dividend should not be considered income because it does not transfer any assets from the corporation to the stockholders.

15. A treasury stock purchase reduces total assets and total equity by equal amounts.

16. Treasury stock purchases affect the corporate assets and stockholders’ equity just like a cash dividend. To keep a company from dissipating its assets by paying an inordinate amount of dividends to its stockholders, state laws protect the company’s creditors by imposing limits on treasury stock purchases.

17. With a simple capital structure, earnings per share is calculated by first subtracting any declared and cumulative preferred dividends from net income, and then dividing the difference by the weighted-average number of shares of outstanding common stock. The resulting figure is called the basic earnings per share.

18. A stock option is the right to purchase common stock at a fixed price over a specified period. 19. When a corporation has no preferred stock, book value per share is calculated by dividing total stockholders’ equity by the number of common shares outstanding. The main limitation of using book value per share to value a corporation is the potential difference between recorded value and market value for assets and liabilities.

20. Best Buy has preferred stock and common stock listed on its balance sheet. As of March 3, 2007, however, Best Buy has not issued any of the preferred stock.

21. The par value for Circuit City’s common stock is $0.50 per share (as reported on its balance sheet). The company has likely set the par value to minimize the amount of legal capital the company must maintain (and that stockholders would be liable for).

22. At December 31, 2006, RadioShack had 650,000,000 shares of common stock authorized and 191,033,000 shares of common stock issued.

23. Apple received $318,000,000 from the issue of common stock, and paid $355,000,000 to repurchase common stock for the year ended September 30, 2006.

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QUICK STUDIES

Quick Study 13-1 (10 minutes) True statements: 1, 2, 5 and 6 Quick Study 13-2 (5 minutes)

a. Cash 50,000

Common Stock, $1 Par Value... 50,000 Issued par value stock for cash. (50,000 x $1)

b. Cash* 150,000

Common Stock, $1 Par Value... 50,000 Paid-In Capital in Excess of Par Value,

Common Stock... 100,000 Issued par value stock for cash. *(50,000 x $3)

Quick Study 13-3 (5 minutes)

a. Cash* 900,000

Common Stock, $5 Par Value**... 375,000 Paid-In Capital in Excess of Par Value,

Common Stock***... 525,000 Issued par value stock for cash.

*75,000 x $12 = $900,000 **75,000 x $5 = $375,000

***$900,000 - $375,000 = $525,000

b. Cash* 900,000

Common Stock, $5 Stated Value**... 375,000 Paid-In Capital in Excess of Stated Value,

Common Stock***... 525,000 Issued stated value stock for cash.

*75,000 x $12 = $900,000 **75,000 x $5 = $375,000

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a. Cash 1,560,000

Common Stock, No-Par Value... 1,560,000 Issued no-par value stock for cash. (52,000 x $30)

b. Land 1,560,000

Common Stock, No-Par Value... 1,560,000 Issued no-par value stock for land.

(a) Mar. 1 Cash 300,000

Common Stock, $5 Par Value... 187,500 Paid-In Capital in Excess of Par Value,

Common Stock... 112,500 Issued par value stock for cash.

(b) Apr. 1 Cash...90,000

Common Stock, No-Par Value... 90,000 Issued no-par value stock for cash.

(c) Apr. 6 Inventory...20,000 Machinery...130,000

Note Payable... 75,000 Common Stock, $10 Par Value... 35,000 Paid-In Capital in Excess of Par Value,

Common Stock... 40,000 Issued stock for inventory, machinery, and note.

1. Cash* 612,000

Preferred Stock, $100 Par Value**... 600,000 Paid-In Capital in Excess of Par Value,

Preferred Stock***... 12,000 Issued par value stock for cash.

*6,000 x $102 = $612,000 **6,000 x $100 = $600,000 ***$612,000 - $600,000 = $12,000

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May 15 Retained Earnings...32,000

Common Dividend Payable... 32,000 Declared cash dividend on common.

June 30 Common Dividend Payable...32,000

Cash... 32,000 Paid cash dividend to common.

Atari Company Stockholders’ Equity April 2 (after stock dividend) Common stock $5 par value, 375,000 shares

authorized, 220,000 shares issued and outstanding ... $1,100,000 Paid-in capital in excess of par value, common stock... 860,000 Total paid-in capital ... 1,960,000 Retained earnings ... 473,000 Total stockholders' equity ... $2,433,000

Supporting work

Apr. 2 Retained Earnings...360,000

Common Stock*... 100,000 Paid-In Capital in Excess of Par Value,

Common Stock**... 260,000

To record declaration and distribution of a 10% common stock dividend.

* 200,000 shares x 10% x $5 par value = $100,000 **200,000 shares x 10% x ($18 market value – $5 par value) = $260,000

Total cash dividend... $ 92,000 To preferred shareholders... 32,000* Remainder to common shareholders... $ 60,000

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May 3 Treasury Stock (3,000 shares)...45,000

Cash... 45,000 Purchased treasury stock

($45,000 / 3,000 shares = $15 per share cost).

Nov. 4 Cash...14,450

Treasury Stock... 12,750 Paid-In Capital, Treasury Stock... 1,700 Reissued treasury stock at a price

greater than its cost.

($15 per share x 850 shares = $12,750)

1. This material error should be reported on the statement of retained earnings (and/or the statement of stockholders’ equity) as a prior period adjustment to the beginning retained earnings balance. Also, if prior year’s financial numbers are reported, they should be revised to show the correct numbers.

2. This change in the expected useful life is a change in an accounting estimate—affecting current and future accounting periods. Therefore, the current year depreciation should be modified to reflect the change and the revised depreciation expense reported on the income statement as a regular part of income from continuing operations. The remaining years’ depreciation also should reflect this new estimate of useful life.

Quick Study 13-12 (10 minutes) Basic earnings per share: =

= ($840,000 - $0) / 300,000 shares = $2.80 per share

Net income - Preferred dividends

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Quick Study 13-13 (10 minutes) Basic earnings per share: =

= ($950,000 - $40,000) / 400,000 shares = $2.275 per share

Price-earnings ratio = = = 8.4

Analysis: Many analysts consider stocks with a PE less than 5 to 8 as potentially underpriced. This stock with a PE of 8.4 would exceed this criterion. (Instructor note: This is a good point at which to emphasize that PE is based on expectations—expectations can prove to be higher or lower than actual results.)

Dividend yield = = = 7.2%

Analysis: The company’s dividend yield of 7.2% indicates that it should be classified as an income stock. That is, the company annually pays out cash dividends to its shareholders in an amount that equals 7.2% of the company’s market value.

Total stockholders' equity...$1,839,500 Less equity attributable to preferred shares

Call price (20,000 shares x $25)... 500,000 Equity applicable to common shares...$1,339,500 Book value of common shares ($1,339,500/150,000 shares)...$ 8.93

Net income - Preferred dividends

Weighted-average common shares outstanding

$31.50 $3.75 Market value per share

Earnings per share

$1.62 $22.50 Annual cash dividends per share

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EXERCISES

Exercise 13-1 (15 minutes)

Characteristic Corporations

1. Owner authority and control...One vote per share

2. Ease of formation...Requires government approval 3. Transferability of ownership...Readily transferred

4. Ability to raise large amounts of capital...High ability 5. Duration of life...Unlimited 6. Owner liability...Limited

7. Legal status...Separate legal entity

8. Tax status of income...Corporate income is taxed and

its cash dividends are usually taxed at the 15% rate (some cases at a lower rate)

Exercise 13-2 (15 minutes) 1.

Feb. 20 Cash...182,700

Common Stock, No-Par Value... 182,700 Issued common stock for cash.

2.

Feb. 20 Cash...182,700

Common Stock, $12 Par Value*... 144,000 Paid-In Capital in Excess of Par Value,

Common Stock**... 38,700 Issued common stock for cash.

*12,000 shares x $12 per share = $144,000 **$182,700 - $144,000 = $38,700

3.

Feb. 20 Cash...182,700

Common Stock, $6 Stated Value*... 72,000 Paid-In Capital in Excess of Stated Value,

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1. Organization Expenses... 43,500

Common Stock, No-Par Value... 43,500 Issued stock to promoters.

2. Organization Expenses... 43,500

Common Stock, $2 Stated Value... 5,000 Paid-In Capital in Excess of Stated Value,

Common Stock... 38,500 Issued stock to promoters.

3. Cash 180,000

Common Stock**... 30,000 Issued common stock for cash.

4. Cash 168,500

Preferred Stock, $100 Par Value*... 125,000 Paid-In Capital in Excess of Par Value,

Preferred Stock**... 43,500 Issued preferred stock for cash.

Land... 75,000 Building... 120,000

Common Stock... 87,000 Issued stock for land and building.

*12,000 shares x $9 per share = $108,000 **($75,000 + $120,000) – $108,000 = $87,000

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1.

a. Retained earnings

Before dividend... $ 356,000 $8 par value of 32,000 dividend shares... (256,000) After dividend... $ 100,000 b. Total stockholders’ equity

Common stock $8 par value, 80,000 shares

authorized, 64,000 shares issued and outstanding... $ 512,000 Paid-in capital in excess of par value... 100,000 Retained earnings... 100,000 Total stockholders’ equity... $ 712,000 c. Number of outstanding shares

Outstanding shares before the dividend... 32,000 Dividend shares... 32,000 Outstanding shares after the dividend... 64,000 2.

a. Retained earnings (no change)

Before and after stock split... $ 356,000 b. Total stockholders’ equity

authorized, 64,000 shares issued and outstanding... $ 256,000 Paid-in capital in excess of par value... 100,000 Retained earnings... 356,000 Total stockholders’ equity... $ 712,000 c. Number of outstanding shares

Outstanding shares before the split... 32,000 Additional split shares (2-for-1)... 32,000 Outstanding shares after the split... 64,000 3. From a stockholder’s point of view, there is no practical difference between the stock dividend and the stock split. The number of shares will be increased equivalently under either approach, and the market value change, if any, should be approximately the same.

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Feb. 5 Retained Earnings*...480,000

Common Stock Dividend Distributable**... 240,000 Paid-In Capital in Excess of Par Value,

Common Stock***... 240,000 Declared 15% common stock dividend

Shares to be issued: 64,000 shares x 15% = 9,600 shares *9,600 shares x $50 per share = $480,000

**9,600 shares x $25 per share = $240,000 ***$480,000 - $240,000 = $240,000

Feb.28 Common Stock Dividend Distributable...240,000

Common Stock, $25 Par Value... 240,000 Distributed common stock dividend.

2.

Before After

Total stockholders’ equity... $2,796,800 $2,796,800 Issued and distributable shares...  64,000  73,600 Book value per share... $ 43.70 $ 38.00 Shares owned... x 900 x 1,035* Total book value of shares... $ 39,330 $ 39,330

* 900 shares x 115% = 1,035 shares.

3.

February 5 February 28 Market value per share... $ 50.00 $ 43.60 Shares owned... x 900 x 1,035 Total market value of shares owned... $ 45,000 $ 45,126

Note: The total market value of the investor’s holdings is approximately the same for February 5 and February 28. Assuming that the stock dividend is the only value-relevant information/event between February 5th and February 28th, these per share values highlight the lack of value distributed in a stock dividend.

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Preferred Common 2009 ($8,000 paid)

Preferred*... $ 8,000

Common remainder... _______ $ 0 Total for the year... $ 8,000 $ 0 2010 ($24,000 paid)

Preferred*... $ 10,400

Common remainder... _______ $ 13,600 Total for the year... $ 10,400 $ 13,600 2011 ($120,000 paid)

Preferred*... $ 10,400

Common remainder... _______ $109,600 Total for the year... $ 10,400 $109,600 2012 ($197,000 paid)

Preferred*... $ 10,400

Common remainder... _______ $186,600 Total for the year... $ 10,400 $186,600

2009-2012 ($349,000 paid) _______ _______

Total for four years... $ 39,200 $309,800 * The holders of the noncumulative preferred stock are entitled to no more than

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Preferred Common 2009 ($8,000 paid)

Preferred*... $ 8,000

Common remainder... _______ $ 0 Total for the year... $ 8,000 $ 0 (Note: $2,400 in preferred stock dividends in arrears.)

2010 ($24,000 paid)

Preferred arrears from 2009... $ 2,400 Preferred*... 10,400

Common remainder... _______ $ 11,200 Total for the year... $ 12,800 $ 11,200 (Note: $0 in preferred stock dividends in arrears.)

2011 ($120,000 paid)

Preferred*... $ 10,400

Common remainder... _______ $109,600 Total for the year... $ 10,400 $109,600 (Note: $0 in preferred stock dividends in arrears.)

2012 ($197,000 paid)

Preferred*... $ 10,400

Common remainder... _______ $186,600 Total for the year... $ 10,400 $186,600 (Note: $0 in preferred stock dividends in arrears.)

2009-2012 ($349,000 paid) _______ _______

Total for four years... $ 41,600 $307,400 * The holders of the cumulative preferred stock are entitled to no more than

$10,400 of dividends declared in any year (8% x $10 x 13,000 shares) plus any dividends skipped in prior years.

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1. (a)

Oct. 11 Treasury Stock (5,000 x $22)...110,000

Cash... 110,000 Purchased treasury stock.

(b)

Nov. 1 Cash (1,000 x $28)...28,000

Treasury Stock (1,000 x $22)... 22,000 Paid-In Capital, Treasury Stock... 6,000 Reissued treasury stock at a price exceeding cost.

(c)

Nov. 25 Cash (4,000 x $17)...68,000 Paid-In Capital, Treasury Stock...6,000 Retained Earnings...14,000

Treasury Stock (4,000 x $22)... 88,000 Reissued treasury stock at a price less than cost.

2. Changes to the equity section include the following

(i) The common stock account description line will change. After the treasury stock purchase, it should read:

Common stock $10 par value; 72,000 shares

authorized and issued; 5,000 shares in treasury...$720,000 The dollar balance of this account does not change with a treasury stock purchase.

(ii) The descriptions and dollar amounts for Paid-In Capital in Excess of Par Value, Common Stock will not change.

(iii) The retained earnings dollar balance will not change but its description should change to read:

Retained earnings ($110,000 restricted for treasury stock)...$864,000 (iv) After the purchase, a deduction for the cost of treasury stock is

reported immediately before the total line for stockholders’ equity as: Less cost of treasury stock...$(110,000) (v) Total stockholders’ equity will change from $1,800,000 to $1,690,000.

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Exercise 13-10 (concluded)

Revised equity section appears as follows

Common stock $10 par value; 72,000 shares authorized

and issued; 5,000 shares in treasury...$ 720,000 Paid-in capital in excess of par value, common stock... 216,000 Retained earnings, $110,000 restricted by treasury stock... 864,000 Total...1,800,000 Less cost of treasury stock... (110,000) Total stockholders’ equity...$1,690,000 Exercise 13-11 (15 minutes)

Arturo Company

Statement of Retained Earnings For Year Ended December 31, 2009

Retained earnings, December 31, 2008, as previously reported....$1,375,000

Prior period adjustment

Depreciation expense not recorded in 2007 (net of $4,500

in income taxes)... (55,500) Retained Earnings, December 31, 2008, as adjusted... 1,319,500 Plus net income... 126,000 Less dividends... (43,000) Retained earnings, December 31, 2009... $1,402,500

1. Net income...$1,375,500 Less preferred dividends... (192,500) Net income available to common stockholders...$1,183,000 2. Net income available to common stockholders...$1,183,000 Divided by weighted-average outstanding shares... 350,000 Basic earnings per share...$ 3.38

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1. Net income...$1,875,000 Less preferred dividends... (262,500) Net income available to common stockholders...$1,612,500 2. Net income available to common stockholders... $1,612,500 Divided by weighted-average outstanding shares... 250,000 Basic earnings per share...$ 6.45 Exercise 13-14 (15 minutes)

Stock Market Valueper Share Dividedby per ShareEarnings Price-EarningsRatio

1... $145.20  $12.00 = 12.1

2... 116.60  11.00 = 10.6

3... 74.10  7.80 = 9.5

4... 60.48  43.20 = 1.4

Analysis: Stocks with PE ratios less than about 5 to 8 are likely viewed as potentially undervalued by the market. Of the stocks above, an analyst would likely investigate stock #4 as possibly undervalued with a PE ratio of 1.4. Exercise 13-15 (15 minutes) Dividend yield 1. $14.00 / $229.51 = 6.1% 2. $11.00 / $110.00 = 10.0% 3. $ 5.52 / $ 60.00 = 9.2% 4. $ 1.90 / $118.75 = 1.6%

Analysis: The yield of 1.6% on stock #4 is sufficiently low that it probably would be classified as a growth stock, and not an income stock. Note that classification involves expectations (not necessarily realizations).

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Total stockholders’ equity... $ 917,500 Less equity applicable to preferred shares

Call price ($35 x 10,000)... $350,000

Cumulative dividends in arrears (none)... 0 (350,000) Equity applicable to common shares... $ 567,500 Book value of preferred stock ($350,000/10,000)... $ 35.00 Book value of common stock ($567,500/35,000)... $ 16.21 2.

Total stockholders’ equity... $ 917,500 Less equity applicable to preferred shares

Call price ($35 x 10,000)... $350,000

Cumulative dividends in arrears (3 x 6% x $300,000)... 54,000 (404,000) Equity applicable to common shares... $ 513,500 Book value of preferred stock ($404,000/10,000)... $ 40.40 Book value of common stock ($513,500/35,000)... $ 14.67

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PROBLEM SET A

Problem 13-1A (30 minutes) Part 1

a. To record sale of 10,000 ($250,000/$25 per share) shares of $25 par value common stock for $32 ($320,000/10,000 shares) per share.

b. To record issuance of 5,000 ($125,000/$25 per share) shares of $25 par value common stock to the company’s promoters for their efforts in organizing the company when the market value is $32 ($160,000/5,000 shares) per share.

c. To record acquisition of assets and liabilities by issuing 2,000 ($50,000/$25) shares of $25 par value common stock at $42 per share. d. To record sale of 3,000 ($75,000/$25 per share) shares of $25 par

value common stock for $41 ($123,000/3,000 shares) per share. Part 2

Number of outstanding shares

Issued in (a)... 10,000 Issued in (b)... 5,000 Issued in (c)... 2,000 Issued in (d)... 3,000 Total... 20,000 Part 3

Minimum legal capital = Outstanding shares x Par value per share = 20,000 x $25 = $500,000

Part 4

Total paid-in capital from common stockholders From transaction (a)... $320,000 From transaction (b)... 160,000 From transaction (c)... 84,000 From transaction (d)... 123,000 Total paid-in capital... $687,000 Part 5

Book value per common share

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Jan. 1 Treasury Stock, Common...112,500

Cash... 112,500 Purchased treasury stock (4,500 x $25).

Jan. 5 Retained Earnings...121,500

Common Dividend Payable... 121,500 Declared $3 dividend on 40,500 outstanding shares.

Feb. 28 Common Dividend Payable...121,500

Cash... 121,500 Paid cash dividend.

July 6 Cash*...48,952

Treasury Stock, Common**... 42,200 Paid-In Capital, Treasury Stock***... 6,752 Reissued treasury stock.

*(1,688 x $29) **(1,688 x $25) ***(1,688 x $4)

Aug. 22 Cash*...61,864 Paid-In Capital, Treasury Stock...6,752 Retained Earnings...1,684

Treasury Stock, Common**... 70,300 Reissued treasury stock.

*(2,812 x $22) **(2,812 x $25)

Sept. 5 Retained Earnings...135,000

Common Dividend Payable... 135,000 Declared $3 dividend on 45,000 outstanding shares.

Oct. 28 Common Dividend Payable...135,000

Dec. 31 Income Summary...388,000

Retained Earnings... 388,000 Closed Income Summary account.

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Part 2

ROCKLIN CORPORATION Statement of Retained Earnings For Year Ended December 31, 2010

Retained earnings, December 31, 2009... $ 460,000 Plus net income... 388,000 848,000 Less:Cash dividends declared... (256,500)

Treasury stock reissuances... (1,684) Retained earnings, December 31, 2010... $ 589,816

Part 3

ROCKLIN CORPORATION

Stockholders’ Equity Section of the Balance Sheet December 31, 2010

authorized, 45,000 shares issued and outstanding... $1,125,000 Paid-in capital in excess of par value, common stock.... 60,000 Retained earnings (from part 2)... 589,816 Total stockholders’ equity... $1,774,816

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Explanations for each of the journal entries

Oct. 2 Declared a cash dividend of $1.50 per share of common stock. ($63,000 / 42,000 shares)

Oct. 25 Paid the cash dividend on common stock.

Oct. 31 Declared a 10% stock dividend when the market value is $22 per share. ($42,000/$10 par = 4,200 shares = 10% of 42,000 shares; $92,400/4,200 shares = $22 per share)

Nov. 5 Distributed the common stock dividend.

Dec. 1 Executed a 2-for-1 stock split. ($10 par / $5 par = 2-for-1 ratio) Dec. 31 Closed the Income Summary account to Retained Earnings. Part 2

Oct. 2 Oct. 25 Oct. 31 Nov. 5 Dec. 1 Dec. 31

Common stock... $420,000 $420,000 $420,000 $462,000 $462,00 0 $ 462,000 Common stock dividend distributable.. . 0 0 42,000 0 0 0 Paid-in capital in excess of par... 100,000 100,000 150,400 150,400 150,400 150,400 Retained earnings... 337,000 337,000 244,600 244,600 244,60 0 474,600 Total equity... $857,000 $857,000 $857,000 $857,000 $857,00 0 $1,087,000

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Part 1

Outstanding common shares

Jan. 5 Apr. 5 July 5 Oct. 5

Beginning balance...45,000 45,000 45,000 45,000 Less treasury stock (Mar. 20)... (4,000) (4,000) (4,000)

Plus dividend shares (July 31)*...______ ______ ______ 8,200 Outstanding shares...45,000 41,000 41,000 49,200 *(20% x 41,000)

Part 2

Cash dividend amounts

Jan. 5 Apr. 5 July 5 Oct. 5

Outstanding shares... 45,000 41,000 41,000 49,200 Dividend per share... $ 0.50 $ 0.50 $ 0.50 $ 0.50 Total dividend... $22,500 $20,500 $20,500 $24,600 Part 3

Capitalization of retained earnings for small stock dividend

Number of shares... 8,200 Market value per share... x $10 Total capitalized... $ 82,000 Part 4

Cost per share of treasury stock

Total amount paid... $ 60,000 Shares purchased... 4,000 Cost per share... $ 15 Part 5

Net income

Retained earnings, beginning balance...$340,000 Less dividends: Jan. 5... (22,500)

Apr. 5... (20,500) July 5... (20,500) July 31... (82,000) Oct. 5... (24,600) Total before net income...$169,900 Plus net income... ?

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Problem 13-5A (40 minutes)

1. Market price = $183 per share (current stock exchange price given) 2. Computation of par values of stock

Preferred: Paid-in amount / Number of shares = $ 85,000 / 1,000 = $85 Common: Paid-in amount / Number of shares = $200,000 / 4,000 = $50 3. Book values with no dividends in arrears

Book value per preferred share = par value (when not callable) = $85 Common stock

Total equity... $635,000 Less equity for preferred... (85,000) Common stock equity... $550,000 Number of outstanding shares... 4,000

Book value per common share... $ 137.50 ($550,000 / 4,000 shares) 4. Book values with two years’ dividends in arrears

Preferred stock

Preferred stock par value... $ 85,000 Plus two years’ dividends in arrears*... 8,500 Preferred equity... $ 93,500 *2 years’ dividends = 2 x ($85,000 x 5%) = $8,500

Number of outstanding shares... 1,000

Book value per preferred share... $ 93.50 ($93,500 / 1,000 shares) Common stock

Total equity... $635,000 Less equity for preferred... (93,500) Common stock equity... $541,500 Number of outstanding shares... 4,000

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5. Book values with call price and two years’ dividends in arrears Preferred stock

Preferred stock call price (1,000 x $95)... $ 95,000 Plus two years’ dividends in arrears*... 8,500 Preferred equity... $103,500 *2 years’ dividends = 2 x ($85,000 x 5%) = $8,500

Book value per preferred share... $ 103.50 ($103,500 / 1,000 sh.) Common stock

Total equity... $635,000 Less equity for preferred... (103,500) Common stock equity... $531,500 Number of outstanding shares... 4,000

Book value per common share... $ 132.88 ($531,500 / 4,000 sh.) 6. Dividend allocation in total

Preferred Common Total

2 years’ dividends in arrears...$ 8,500 $ 0 $ 8,500 Current year dividends... 4,250 4,250 Remainder to common... . 12,000 12,000 Totals...$12,750 $12,000 $24,750

Dividends per share for the common stock

$12,000 / 4,000 shares = $3.00

7. Equity represents the residual interest of owners in the assets of the business after subtracting claims of creditors. With few exceptions, these assets and liabilities are reported at historical cost, not market value. Therefore, the book value of common stock does not normally match its market value. Also, the book value of common stock is based on past transactions and events, whereas the market value takes into account expected future earnings, growth, dividends, and other

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PROBLEM SET B

Problem 13-1B (30 minutes) Part 1

a. To record sale of 1,500 ($1,500/$1 per share) shares of $1 par value common stock for $40 ($60,000/1,500) per share.

b. To record issuance of 500 ($500/$1 per share) shares of $1 par value common stock to the company’s promoters for their efforts in organizing the company when the market value is $40 per share.

c. To record acquisition of assets and liabilities by issuing 400 ($400/$1 per share) shares of $1 par value common stock at $50 per share and issuing a note for $9,150.

d. To record sale of 600 shares of $1 par value common stock for $50 per share.

Part 2

Number of outstanding shares

Issued in (a)... 1,500 Issued in (b)... 500 Issued in (c)... 400 Issued in (d)... 600 Total... 3,000 Part 3

Minimum legal capital = Outstanding shares x Par value per share = 3,000 x $1 = $3,000

Part 4

Total paid-in capital from common stockholders From transaction (a)...$ 60,000 From transaction (b)... 20,000 From transaction (c)... 20,000 From transaction (d)... 30,000 Total paid-in capital...$130,000 Part 5

Book value per common share

Total stockholders’ equity (given)...$141,500 Outstanding shares (from 2)... 3,000

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Part 1

Jan. 10 Treasury Stock, Common...240,000

Cash... 240,000 Purchased treasury stock (20,000 x $12).

Mar. 2 Retained Earnings...120,000

Common Dividend Payable... 120,000 Declared $1.50 dividend on 80,000 outstanding shares.

Mar. 31 Common Dividend Payable...120,000

Nov. 11 Cash* 156,000

Treasury Stock, Common**... 144,000 Paid-In Capital, Treasury Stock***... 12,000 Reissued treasury stock.

*(12,000 x $13) **(12,000 x $12) ***(12,000 x $1)

Nov. 25 Cash*...76,000 Paid-In Capital, Treasury Stock...12,000 Retained Earnings...8,000

Treasury Stock, Common**... 96,000 Reissued treasury stock.

*(8,000 x $9.50) **(8,000 x $12)

Dec. 1 Retained Earnings...250,000

Common Dividend Payable... 250,000 Declared $2.50 dividend on 100,000 outstanding shares.

Dec. 31 Income Summary...536,000

Retained Earnings... 536,000 Closed Income Summary account.

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Problem 13-2B (Concluded) Part 2

SAN MARCO CORP.

Statement of Retained Earnings For Year Ended December 31, 2010

Retained earnings, December 31, 2009... $1,080,000 Plus: Net income... 536,000 1,616,000 Less: Cash dividends declared... (370,000)

Treasury stock reissuances... (8,000) Retained earnings, December 31, 2010... $1,238,000 Part 3

SAN MARCO CORP.

Stockholders’ Equity Section of the Balance Sheet December 31, 2010

authorized, 100,000 shares issued and outstanding.... $ 100,000 Paid in capital in excess of par value, common stock... 700,000 Retained earnings (from part 2)... 1,238,000 Total stockholders’ equity... $2,038,000

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Part 1

Explanations for each of the journal entries

Jan. 17 Declared a cash dividend of $1 per share of common stock. ($48,000 / 48,000 shares)

Feb. 5 Paid the cash dividend on common stock.

Feb. 28 Declared a 12.5% stock dividend when the market value is $21 per share. ($60,000 / $10 par = 6,000 shares = 12.5% of 48,000 shares; $126,000 / 6,000 shares = $21 per share)

Mar. 14 Distributed the common stock dividend.

Mar. 25 Executed a 2-for-1 stock split. ($10 par / $5 par = 2-for-1 ratio) Mar. 31 Closed the Income Summary account to Retained Earnings.

Part 2

Jan. 17 Feb. 5 Feb. 28 Mar. 14 Mar. 25 Mar. 31

Common stock...$ 480,000 $ 480,000 $ 480,000 $ 540,000 $ 540,000 $ 540,000 Common stock dividend distributable. 0 0 60,000 0 0 0 Paid-in capital in excess of par... 192,000 192,000 258,000 258,000 258,000 258,000 Retained earnings... 752,000 752,000 626,000 626,000 626,000 986,000 Total equity...$1,424,000 $1,424,000 $1,424,000 $1,424,000 $1,424,000 $1,784,000

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Problem 13-4B (45 minutes) Part 1

Outstanding common shares

Feb. 15 May 15 Aug. 15 Nov. 15 Beginning balance... 8,500 8,500 8,500 8,500 Less treasury stock (Mar. 2)... (500) (500) (500) Plus dividend shares (Oct. 4)*... _____ _____ _____ 1,000 Outstanding shares... 8,500 8,000 8,000 9,000 *(12.5% x 8,000)

Part 2

Cash dividend amounts

Feb. 15 May 15 Aug. 15 Nov. 15 Outstanding shares... 8,500 8,000 8,000 9,000 Dividend per share...$ 0.40 $ 0.40 $ 0.40 $ 0.40 Total dividend...$3,400 $3,200 $3,200 $3,600 Part 3

Capitalization of retained earnings for small stock dividend Number of shares...1,000 Market value per share...$ 42 Total capitalized...$ 42,000 Part 4

Cost per share of treasury stock

Total amount paid...$ 20,000 Shares purchased... 500 Cost per share...$ 40 Part 5

Net income

Retained earnings, beginning balance...$135,000 Less dividends: Feb. 15...(3,400) May 15...(3,200) Aug. 15...(3,200)

Oct. 4 (42,000)

Nov. 15... (3,600) Total before net income...$ 79,600 Plus net income... ? Retained earnings, ending balance...$147,600 Therefore, net income = $68,000

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1. Market price = $90 per share (current stock exchange price given) 2. Computation of stock par values

Preferred: Paid-in amount / Number of shares = $187,500 / 1,500 = $125 Common: Paid-in amount / Number of shares = $450,000 /18,000 = $ 25 3. Book values with no dividends in arrears

Book value per preferred share = par value (when not callable) = $125

Common stock

Total equity... $1,200,000 Less equity for preferred... (187,500) Common stock equity... $1,012,500 Number of outstanding shares... 18,000

Book value per common share... $ 56.25 ($1,012,500 / 18,000) 4. Book values with two years’ dividends in arrears

Preferred stock

Preferred stock par value... $ 187,500 Plus two years’ dividends in arrears*... 30,000 Preferred equity... $ 217,500

*2 years’ dividends = 2 x ($187,500 x 8%) = $30,000

Book value per preferred share... $ 145.00 ($217,500 / 1,500) Common stock

Total equity... $1,200,000 Less equity for preferred... (217,500) Common stock equity... $ 982,500 Number of outstanding shares... 18,000

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Problem 13-5B (Concluded)

5. Book values with call price and two years’ dividends in arrears Preferred stock

Preferred stock call price (1,500 x $140) $ 210,000 Plus two years’ dividends in arrears*... 30,000 Preferred equity... $ 240,000

*2 years’ dividends = 2 x ($187,500 x 8%) = $30,000

Book value per preferred share... $ 160.00 ($240,000 / 1,500) Common stock

Total equity... $1,200,000 Less equity for preferred... (240,000) Common stock equity... $ 960,000 Number of outstanding shares... 18,000

Book value per common share... $ 53.33 ($960,000 / 18,000) 6. Dividend allocation in total

Preferred Common Total

2 years’ dividends in arrears.... $ 30,000 $ 0 $ 30,000 Current year dividends... 15,000 — 15,000 Remainder to common... — 5,000 5,000 Totals... $ 45,000 $ 5,000 $ 50,000

Dividends per share for the common stock

$5,000 / 18,000 shares = $0.28

7. Equity represents the residual interest of owners in the assets of the business after subtracting claims of creditors. With few exceptions, these assets and liabilities are valued at historical cost, not market value. Therefore, the book value of common stock does not normally match its market value. Also, the book value of common stock is based on past transactions and events, whereas the market value takes into account expected future earnings, growth, dividends, and other industry and economic factors.

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SERIAL PROBLEM

— SP 13 Serial Problem — SP 13, Success Systems (25 minutes) 1a. Journal entry for issuance of common stock to Cicely

Cash...86,000

Common Stock... 86,000 Issuance of common stock.

1b. Journal entry for issuance of preferred stock to Uncle Marcello Cash...86,000

Preferred Stock... 86,000 Issuance of $100 par 7% preferred stock.

1c. Journal entry to record $86,000 borrowed from the bank Cash...86,000

Notes Payable... 86,000 Borrowed $86,000 on a 10-year, 7% note payable

2. Evaluation of the three proposals

a. Cicely’s investment as a common shareholder would mean that Adriana would have a second person who would be an owner. Adriana has been working on her own for about 15 months, and may not wish to have a second person who may have authority to make decisions. If Cicely and Adriana do not agree completely on policies and procedures, this may create some difficulties for Adriana. On the other hand, Cicely may have skills that could complement Adriana’s skills, and the two may make a great success.

As Cicely is an owner there is no need to repay the $86,000, nor is there any requirement that dividends be paid. If Success Systems gets into cash flow difficulties, any dividends can be postponed until a later time.

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Serial Problem (concluded)

b. Having a preferred shareholder means that Adriana’s Uncle Marcello will not have the same voting rights as Adriana. Uncle Marcello may be expecting regular dividend, however, so Adriana should be prepared to pay $6,020 ($86,000 x 7%) in dividends each year. This is not a requirement, however, even if the preferred stock is cumulative.

The preferred stock does not require repayment, and technically, Adriana would have the use of the $86,000 for as long as Uncle Marcello wishes to be a preferred shareholder.

c. The loan requires regular monthly payments, so Adriana will need to budget the $1,000 each month as a cash outflow. The loan may be riskier because it does require regular payments. Interest on the loan balance is a tax-deductible expense to Success Systems, while any dividends (whether to the common or preferred shareholders) are not a tax-deductible expense to Success Systems.

In addition, Adriana does not have an additional owner that could exert some control over her business.

3. There is no correct answer to the question of which proposal Adriana should adopt. Class discussion may indicate which proposal the class prefers.

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Reporting in Action

— BTN 13-1

1. As of March 3, 2007, the shares of common stock issued and outstanding are 480,655,000 (see balance sheet). As of February 25, 2006, the number of shares of common stock issued and outstanding is 485,098,000.

The weighted-average common shares used in calculating earnings per share are disclosed within Best Buy’s income statement. At March 3, 2007, the basic weighted-average shares were 482,100,000. At February 25, 2006, the basic weighted-average shares were 490,300,000. Therefore, for both years, the shares outstanding at year-end were slightly lower than the basic weighted-average shares outstanding during the year. (Differences between the year-end and weighted-average share amounts are likely the result of timing differences with share repurchases, issuances, and retirements.)

2. Total stockholders’ equity as of March 3, 2007... $6,201,000,000 Book value of equity applicable to common stock*... $6,201,000,000 * Given that there is only one class of stock, all the equity items listed can be considered to

represent the book value of the common stock.

3. Best Buy paid cash dividends of $174,000,000 for the year ended March 3, 2007, and $151,000,000 for the year ended February 25, 2006.

4. Best Buy’s income statement reports the following

2007 2006 2005

Basic earnings per common share... $2.86 $2.33 $2.01 Its basic earnings per common share figure has consistently grown over this 3-year period.

5. Best Buy’s consolidated balance sheet does not list any shares of treasury stock in 2007 or 2006.

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Comparative Analysis

— BTN 13-2 1. Book value per common share =

Best Buy’s book value per common share

= $6,201 / 481 = $12.89 Circuit City’s book value per common share

= $1,791 / 171 = $10.47 RadioShack’s book value per common share

= $654 / 136 = $ 4.81 2. Earnings per share =

Best Buy’s earnings per share: $1,377/ 482 = $ 2.86 Circuit City’s earnings per share: $ (8) / 170 = $(0.05) RadioShack’s earnings per share: $73 / 136 = $ 0.54 3. Dividend Yield =

Best Buy dividend yield = $0.36 / $46.35= 0.78% Circuit City dividend yield = $0.12 / $19.00= 0.63% RadioShack dividend yield = $0.25 / $16.78= 1.49%

Analysis: The low dividend yield for all three companies suggests that they are “growth stocks.”

4. Price-earnings ratio =

Best Buy price-earnings ratio: $46.35 / $2.86 = 16 Circuit City price-earnings ratio: $19.00 / $(0.05) = (380) RadioShack price-earnings ratio: $16.78 / $0.54 = 31

Interpretation: The price-earnings ratios of the companies are considerably different. In Best Buy’s case, the market appears willing to pay a multiple of 16 times its earnings. For RadioShack, that multiple is considerably greater at 31 times its earnings. Circuit City’s price-earnings ratio is difficult to interpret because Circuit City had a net loss. In the case of net losses, users commonly adjust earnings per share to the “usual, expected earnings,” often times using an average from recent periods.

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Ethics Challenge

— BTN 13-3

During the course of her duties, Brianna has learned information that others might not know. If she uses this information to trade in New World Pharmaceuticals’ stock, Brianna may be violating securities laws, so she should be careful if she buys or sells any New World stock.

It is possible that the new drug will not be as profitable as expected, and the stock might not increase as much as Brianna expects. Nevertheless, Brianna might be accused of insider trading in the future if she buys the stock.

Communicating in Practice

— BTN 13-4

There is no set solution to this activity. Solutions will vary based on the industry and the companies selected.

Taking It to the Net

— BTN 13-5

1. The balance sheet of McDonald’s shows that they have both preferred and common stock authorized, but it has only issued common stock. 2. The preferred stock has no par value. There are 165.0 million preferred

shares authorized, and none issued. The common stock has a $0.01 par value. There are 3.5 billion shares authorized and 1,660.6 million shares issued.

3. In 2006, the financing section of the statement of cash flows shows that McDonald’s paid $2,959.4 million to purchase treasury stock.

4. In 2006, the financing section of the statement of cash flows shows that McDonald’s paid common stock cash dividends of $1,216.5 million.

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Teamwork in Action

— BTN 13-6 1. The team statement should include the following:

a. When a corporation “buys back” its stock (engages in a treasury stock acquisition), the effect on financial position is a decrease in both assets (cash) and equity (treasury stock). Also, treasury stock is a contra equity account that decreases equity.

b. Reasons for “buybacks”:

 to use shares to acquire another corporation.

 to avoid a hostile takeover by an investor seeking to take control of the company.

 to reissue shares to employees as compensation.

 to maintain a strong or stable market for the stock. 2. The team should establish the acquisition entry as follows

Treasury Stock, Common... 13,400

Cash... 13,400

Reacquired 100 shares of $100 par value

common stock at a cost of $134 per share.

Each member should prepare one of the following reissue entries: a. Cash...13,400

Treasury Stock, Common... 13,400

Received $134 per share for 100 treasury

shares costing $134 per share.

b. Cash...15,000

Paid-In Capital, Treasury Stock... 1,600 Treasury Stock, Common... 13,400 Received $150 per share for 100 treasury

c. Cash...12,000 Paid-In Capital, Treasury Stock...1,400

Treasury Stock, Common... 13,400 Received $120 per share for 100 treasury

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d. Cash...12,000 Paid-In Capital, Treasury Stock...1,000 Retained Earnings...400

Treasury Stock, Common... 13,400

Received $120 per share for 100 treasury

e. Cash...12,000 Retained Earnings...1,400

Treasury Stock, Common... 13,400 Received $120 per share for 100 treasury

3. When presenting and explaining the above entries to the team, the following points should be made by the team members:

The similarities in all reissue entries a through e are:

 The net affect of the transaction is to increase assets and equity by the amount received on reissue.

 Cash (assets) is always increased by the amount received.

 Treasury Stock is always decreased by the full cost regardless of whether the reissue is at cost, above cost, or below cost.

The differences in reissue entries b through e are:

(b) Reissuing above cost creates additional Paid-In Capital.* (c) Reissuing below cost reduces existing Paid-In Capital.* (d) Reissuing below cost reduces existing Paid-In Capital,*

but after this account’s balance has been eliminated, then Retained Earnings must be reduced by the additional amount below cost. (e) Reissuing below cost reduces Retained Earnings when Paid-In

Capital* does not exist.

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Entrepreneurial Decision

— BTN 13-7 1.

Plan A Plan B Net income... $ 72,000 $ 72,000 Less preferred dividends... 0 (10,000) Net income for common stockholders... $ 72,000 $ 62,000 Group’s share of common equity... 80% 100%

Group’s share of income after any preferred

stock dividends... $ 57,600 $ 62,000 Group’s initial equity... $375,000 $375,000 Group’s return on equity... 15.4% 16.5% 2.

Plan A Plan B Net income... $ 16,800 $ 16,800 Less preferred dividends... 0 (10,000) Net income for common stockholders... $ 16,800 $ 6,800 Group’s share of common equity... 80% 100%

Group’s share of income after any preferred

stock dividends... $ 13,440 $ 6,800

Group’s initial equity... $375,000 $375,000 Group’s return on equity... 3.6% 1.8% 3. The difference between the answers for parts 1 and 2 arises from the

percent of return generated with the assets invested in the corporation. In part 1, the group’s return on equity is 15.4% for Plan A, which is less than the 16.5% for Plan B. However, the return on equity is only 3.6% in part 2 for Plan A, BUT this is more than the 1.8% for Plan B.

These results indicate that the 8% dividend rate on the preferred stock is advantageous to the group as long as the rate of return on the assets is greater than 8% (this is the same as saying net income is over $40,000). This means Plan B is preferred. Net income over $40,000 yields a return on assets greater than 8% (i.e., 8% equals $40,000/$500,000). If net income falls below $40,000 (or less than 8% return on assets), then Plan A is preferred.

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Hitting the Road

— BTN 13-8

There is no formal solution for this field activity. Students often find this assignment interesting as it highlights the relevance of their accounting studies. Instructors also sometimes assign a particular financial news show to watch on a certain day for the entire class—this can help encourage a general class discussion on the topics raised.

Global Decision

— BTN 13-9

1. Book value per common share = DSG’s book value per common share

= ₤1,304 / 1,843 = ₤ 0.71 2. Earnings per share =

DSG’s earnings per share

= ₤ 207 / 1,843 = ₤0.11

(Instructor’s note: At the date this problem was written, ₤1 was equal to about $2.05. This means that DSG’s BVPS is about $1.46, and its EPS is about $0.23) 3. DSG’s EPS is ₤0.11, and its paid dividends of ₤0.07 It appears that DSG

is paying out about 64% of its income as dividends. In comparison with most companies, this is a large proportion of income in the form of cash dividends.