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nonparticipating

Module 8

Reporting and Analyzing

    Owner Financing

    QUESTIONS

    Q8-1. Par value stock is stock that has a face value printed (identified) on the stock

    certificate.

    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

    voting rights.

    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 corporationcalled 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' equityknown as a contra equity

    account.

    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 issuedvarious 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

    adjustments.

    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

    MINI-EXERCISES

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

    per share