Reporting and Analyzing
Q8-1. Par value stock is stock that has a face value printed (identified) on the stock
From an accounting standpoint, the par value of the common stock is the amount
added to the common stock portion of paid-in-capital upon the sale of stock. The
remainder of the sale price is added to the additional paid-in-capital portion of paid-
in-capital. There are no analysis implications of the par value of stock. Q8-2. Preferred stock usually takes priority over common stock in the receipt of a
specified amount of dividends and in the distribution of assets if the corporation is
ever liquidated. Also, preferred stock does not usually have voting rights.
Typically, preferred stock has the following features: 1) Preferential claim to
dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No
Q8-3. Preferred stock is similar to debt when
1. Dividends are cumulative.
2. Dividends are nonparticipating.
3. It has a preference to assets in liquidation.
Preferred stock is similar to common stock when
1. Dividends are not cumulative.
2. Dividends are fully participating.
3. It is convertible into common stock.
4. It does not have a preference to assets in liquidation.
Q8-4. Dividend arrearage on preferred stock is the aggregate amount of dividends on
cumulative preferred stock that has not been declared to date. The amount of
dividends in arrears and a current dividend must be paid to preferred stockholders
before common stockholders can receive any dividends. In the example, preferred
stockholders must receive $90,000 in dividends ($500,000 ; 0.06 * 3 years = $90,000)
before common stockholders receive any dividends.
Q8-5. A corporation's authorized stock is the maximum number of shares of stock it may
issue. The authorized amounts and classes of stock are enumerated in the
company's charter when the corporation is formed. A corporation can later amend
its charter to change the amount of authorized capital, but such action must have
?Cambridge Business Publishers, 2006
Solutions Manual, Module 8 1
the approval of the company’s shareholders. Shares that have been sold and issued
to stockholders are the company's issued stock.
Shares that have been sold and issued can be subsequently reacquired by the corporation—called treasury stock. When treasury stock is held, the issued shares exceed the outstanding shares.
Q8-6. Contributed capital represents the total investment that has been paid in to the company by its shareholders as a result of the purchase of stock. Earned capital represents the cumulative net income that has been earned, less the portion of that income that has been paid out to shareholders in the form of dividends.
When profit is earned, shareholders have the option of paying out that profit as a dividend or reinvesting the earnings in order to grow the company. In fact, many companies title the Retained Earnings account as Reinvested Earnings. Earned capital, thus, represents an implicit investment by the shareholders in the form of foregone dividends.
Q8-7. Paid-in capital is dividend into two accounts: the common or preferred stock account and additional paid-in capital. The common stock or preferred stock accounts are increased by the par value of the shares issued and the additional paid-in capital account is increased for the balance of the proceeds received from the sale of the shares. The balance of the paid-in capital account is affected by the par value of the stock; the higher (lower) the par value, the lower (higher) the additional paid-in capital. Although paid-in capital will, in general, be higher if the stock price is higher, the breakdown of paid-in capital between the common or preferred stock accounts and additional paid-in capital does not yield any inferences regarding the financial condition of the company.
Q8-8. A stock split refers to the issuance of additional shares of a class of stock to the current stockholders in proportion to their ownership interests, normally accompanied by a proportionate reduction in the par or stated value of the stock. For example, a 2-for-1 stock split doubles the number of shares outstanding and halves the par or stated value of the shares. Consequently, there is no change in the amount of contributed capital associated with that class of stock. The major reason for a stock split is to reduce the per share market price of the stock. Another possible reason is to influence shareholders’ in believing there has been some distribution of value.
Q8-9. Treasury stock is a corporation's issued stock that has been reacquired by the issuing corporation through purchases of its stock from its shareholders. A corporation often purchases treasury-stock for distribution to employees under stock option plans or to offset dilution resulting from such sales. It is also used by management to prop up stock price when management believes its stock is inappropriately under priced.
On the balance sheet, treasury stock should be carried at its cost and is shown as a deduction in deriving the total stockholders' equity—known as a contra equity
Q8-10. The $2,400 increase should not be shown on the income statement as any form of
income or gain. The $2,400 is properly treated as additional paid-in capital and is shown as such in the stockholders' equity section of the balance sheet. The latter treatment is justified because treasury stock transactions are considered capital rather than operating transactions.
?Cambridge Business Publishers, 2006 ndFinancial Accounting for MBAs, 2 Edition 2
Q8-11. The book value per share of common stock is the total stockholders' equity divided
by the number of shares outstanding, or $4,628,000/260,000 = $17.80. Q8-12. A stock dividend is the distribution of additional shares of a corporation's stock to
its stockholders. A stock dividend does not change a stockholder's relative
ownership interest, because each stockholder owns the same fractional share of the
corporation before and after the stock dividend. There is empirical evidence,
however, suggesting that the stock price does not decline fully for the additional
shares issued—various hypotheses, such as signaling theory, have been asserted
as explanations of this phenomenon.
Q8-13. The stock dividend transfers capital from retained earnings to contributed capital.
For a small stock dividend, this transfer is recorded at the market price of the
shares at the time of the dividend. For a large stock dividend, the transfer is made
at the par value of the stock.
Q8-14. Many companies repurchase shares (as Treasury Stock) in order to offset the
dilutive effects of exercised stock options which increase the number of
outstanding shares. This repurchase results in a cash outflow, and has been used
by those arguing for the expensing of employee stock options as evidence of the
cash effect of these options and linkage to the payment of wages.
Q8-15. The statement of stockholders' equity analyzes and reconciles changes in all
major components of stockholders' equity for an accounting period. The
statement begins with the beginning balances of those key stockholders' equity
components, reports the items causing changes in these components, and ends
with the period-end balances.
Q8-16. Other Comprehensive Income (OCI) represents changes in stockholders’ equity
that are caused by factors other than profit (loss) and the sale (repurchase) of
equity securities. Some examples include unrealized gains (losses) on available-
for-sale securities, foreign currency translation adjustments (current rate method
only), unrealized gains (losses) on derivatives, and minimum pension liability
Q8-17. A spin-off is the distribution of shares of a subsidiary company to shareholders in
the form of a dividend. In a split-off, the parent company exchanges shares that it
owns in a subsidiary for shares of the parent company owned by its shareholders.
Only a split-off can result in the recognition of a gain if the distribution of shares to
the shareholders is not pro rata.
Q8-18. When a convertible bond is converted, both the face amount and any associated
unamortized premium or discount is removed from the balance sheet. The stock is,
then, issued considering the ―purchase price‖ to be the book value (face amount ?
an unamortized premium or discount) of the bond. This purchase price is, then,
allocated to common stock and additional paid-in capital. No gain or loss is reported
upon the conversion.
?Cambridge Business Publishers, 2006
Solutions Manual, Module 8 3
M8-19 (10 minutes)
Income Transaction Balance Sheet Statement
Contrib. Noncash Liabi-Retained Revenues - Expenses Cash + = + + Capital Asset Assets lities Earnings Issue 8,000 shares of
$50 par value 1+544,000 +544,000 preferred stock at $68
cash per share
Issue 12,000 shares of
$1 par value common 2+120,000 +120,000 stock at $10 cash per
share 1 Consists of Preferred Stock of $400,000 and Additional Paid-in-Capital of $144,000. 2 Consists of Common Stock $12,000 and Additional Paid-in-Capital of $108,000.
M8-20 (10 minutes)
Income Transaction or event Balance Sheet Statement
Noncash Liabi-Retained Revenues Expenses Contrib. Cash + = + + capital Asset Assets lities Earnings Issue 18,000 shares of
$10 par value 1864,000 864,000 preferred stock at $48