DOC

key for Chapter10

By Steven Russell,2014-05-25 16:57
6 views 0
key for Chapter10for,key,Key,For,108

Chapter 10 - Shareholders’ Equity

Chapter 10 Shareholders’ Equity

QUESTIONS FOR REVIEW OF KEY TOPICS

Question 10-1

    The two primary sources of shareholders’ equity are amounts invested by shareholders in the

    corporation and amounts earned by the corporation on behalf of its shareholders. Invested capital is reported as paid-in capital and earned capital is reported as retained earnings.

    Question 10-2

    The three primary ways a company can be organized are (1) a sole proprietorship, (2) a partnership,

    or (3) a corporation. Transactions are accounted for the same regardless of the form of business organization with the exception of the method of accounting for capital the ownership interest in the

    company. Several capital accounts (as discussed in this chapter) are used to record changes in ownership interests for a corporation, rather than recording all changes in ownership interests in a single capital account for each owner, as we do for sole proprietorships and partnerships. Question 10-3

    In the eyes of the law, a corporation is a separate legal entity separate and distinct from its owners.

    The owners are not personally liable for debts of the corporation. So, shareholders generally may not lose more than the amounts they invest when they purchase shares. This is perhaps the single most important advantage of corporate organization over a proprietorship or a partnership. Question 10-4

    ―Not-for-profit‖ corporations, such as churches, hospitals, universities, and charities, are not organized for profit and do not sell stock. Some not-for-profit corporations, such as the Federal

    Deposit Insurance Corporation (FDIC), are government owned.

    Question 10-5

    Corporations that are organized for profit may be publicly held or privately (or closely) held. The stock of publicly held corporations is available for purchase by the general public. Shares might be traded on organized national stock exchanges available ―over-the-counter‖ from securities dealers.

    Privately held companies' shares are held by only a few individuals and are not available to the general public.

    10-1

Chapter 10 - Shareholders’ Equity

Question 18-6

    Corporations are formed in accordance with the corporation laws of individual states. The Model

    Business Corporation Act serves as the guide to states in the development of their corporation statutes, presently as the model for the majority of states.

    Answers to Questions (continued)

    Question 10-7

    The ownership rights held by common shareholders, unless specifically withheld by agreement with the shareholders, are:

    a. The right to vote on policy issues.

    b. The right to share in profits when dividends are declared (in proportion to the percentage of shares

    owned by the shareholder).

    c. The right to share in the distribution of any assets remaining at liquidation after other claims are

    satisfied.

    Question 10-8

    The ―preemptive right‖ is the right to maintain one’s percentage share of ownership when new shares are issued. When granted, each shareholder is offered the opportunity to buy the same percentage of any new shares issued as the percentage of shares he/she owns at the time. For reasons of practicality, the preemptive right usually is excluded.

    Question 10-9

    The typical rights of preferred shares usually include one or both of the following: a. A preference to a predesignated amount of dividends, i.e., a stated dollar amount per share or %

    of par value per share. This means that when the board of directors of a corporation declares

    dividends, preferred shareholders will receive the specified dividend prior to any dividends being

    paid to common shareholders.

    b. A preference over common shareholders in the distribution of assets in the event the corporation

    is dissolved.

    Question 10-10

    If preferred shares are noncumulative, dividends not declared in any given year need never be paid. However, if cumulative, when the specified dividend is not paid in a given year, the unpaid dividends

    accumulate and must be made up in a later dividend year before any dividends are paid on common

    shares. These unpaid dividends are called ―dividends in arrears.‖

    Question 10-11

    Par value was defined by early corporation laws as the amount of net assets not available for distribution to shareholders (as dividends or otherwise). However, now the concepts of ―par value‖ and ―legal capital‖ have been eliminated entirely from the Model Business Corporation Act. Most shares

    continue to bear arbitrarily designated par values, typically nominal amounts. Although many states already have adopted these provisions, most established corporations issued shares prior to changes in the state statutes. So, most companies still have par value shares outstanding and continue to issue previously authorized par value shares.

    10-2

Chapter 10 - Shareholders’ Equity

Answers to Questions (continued)

    Question 10-12

    Comprehensive income is a broader view of the change in shareholders’ equity than traditional net

    income. It is the total nonowner change in equity for a reporting period. It encompasses all changes in equity except those caused by transactions with owners. Transactions between the corporation and its owners (shareholders) primarily include dividends and the sale or purchase of shares of the company’s stock. Most nonowner changes (e. g., revenues and expenses) are reported in the income statement. So, the changes other than the ones that are part of net income are those reported as ―other comprehensive

    income.‖

    Two attributes of other comprehensive income are reported: (1) components of comprehensive income created during the reporting period and (2) the comprehensive income accumulated over the

    current and prior periods.

    The components of comprehensive income created during the reporting period - can be reported

    either (a) as an additional section of the income statement, (b) as part of the statement of shareholders’ equity, or (c) in a disclosure note. Regardless of the choice a company makes, the presentation will report net income, other components of comprehensive income, and total comprehensive income. The second attribute - the comprehensive income accumulated over the current and prior periods is

    reported as a separate component of shareholders’ equity. This amount represents the cumulative sum

    of the changes in each component created during each reporting period throughout all prior years. Question 10-13

    As part of a joint project with the FASB, the International Accounting Standards Board (IASB) in 2007 issued a revised version of IAS No.1, ―Presentation of Financial Statements,‖ that revised the

    standard to bring international reporting of comprehensive income largely in line with U.S. standards. It provides the option of presenting revenue and expense items and components of other comprehensive income either in (a) a single statement of comprehensive income or (b) two statements: an income statement and a statement of comprehensive income, traditionally referred to as the Statement of Recognized Income and Expense, or ―SoRIE.‖ U.S. GAAP also allows reporting other comprehensive income in the statement of shareholders’ equity, which is the way most U.S. companies report it.

    Question 10-14

    The statement of shareholders’ equity reports the transactions that cause changes in its

    shareholders’ equity account balances. It shows the beginning and ending balances in primary shareholders’ equity accounts and any changes that occur during the years reported. Typical reasons

    for changes are the sale of additional shares of stock, the acquisition of treasury stock, net income, and the declaration of dividends.

    Question 10-15

    The measurement objective is that the transaction should be recorded at fair value. This might be the fair value of the shares or of the noncash assets or services received, whichever evidence of fair value seems more clearly evident. This is consistent with the general practice of recording any noncash transaction at market value.

    10-3

Chapter 10 - Shareholders’ Equity

Answers to Questions (continued)

    Question 10-16

    The cash received usually is the sum of the separate market values of the separate securities. However, when the total selling price is not equal to the sum of the separate market prices, the total selling price is allocated in proportion to their relative market values.

    Question 10-17

    Share issue costs reduce the net cash proceeds from selling the shares and thus paid-in capital

    excess of par. On the other hand, debt issue costs are recorded in a separate ―debt issue costs‖ account and amortized to expense over the life of the debt. The difference often is justified by the presumption that share issue costs and debt issue costs are fundamentally different because a debt issue has a fixed maturity, but that selling shares represents a perpetual equity interest. Concept Statement 6 disagrees,

    stating that debt issue costs should be treated the same way as share issue costs. But, Concept

    Statements do not constitute GAAP, and the currently prescribed practice is to record debt issue costs as assets and expense the asset over the maturity of the debt.

    Question 10-18

    The same accounts that previously were increased when the shares were sold are decreased when the shares are retired. Specifically, common (or preferred) stock and paid-in capital excess of par are

    reduced by the same amounts they were increased by when the shares were originally sold.

    If the cash paid to repurchase the shares differs from the amount originally paid in, accounting for the difference depends on whether the cash paid to repurchase the shares is less than or more than the price previously received when the shares were sold. When less cash is distributed to shareholders to retire shares than originally paid in, some of the original investment remains and is labeled paid-in capital share repurchase. When more cash is distributed to shareholders to retire shares than originally was paid in for those shares, the additional amount is viewed as a dividend on the original investment, and thus a reduction of retained earnings (unless previous share repurchases have created a balance in paid-in capital share repurchase which would be reduced first).

Question 10-19

    The purchase of treasury stock and its subsequent resale are considered to be a ―single transaction.‖

    The purchase of treasury stock is perceived as a temporary reduction of shareholders' equity, to be reversed later when the treasury stock is resold, so the cost of acquiring the shares is ―temporarily‖ debited to the treasury stock account. Allocating the effects to specific shareholders’ equity accounts is deferred until the shares are subsequently reissued.

    10-4

Chapter 10 - Shareholders’ Equity

Answers to Questions (concluded)

    Question 10-20

    For a stock dividend of less than 25%, a "small" stock dividend, the fair value of the additional shares distributed is transferred from retained earnings to paid-in capital. The reduction in retained earnings is the same amount as if cash dividends were paid equal to the market value of the shares issued. The treatment is consistent with the belief that per share prices remain unchanged by stock dividends.

    This is not logical. If the value of each share were to remain the same when additional shares are distributed without compensation, the total value of the company would grow simply because

    additional stock certificates are distributed. Instead, the market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend. Question 10-21

    The effect and maybe the motivation for the stock split is to reduce the per share market price (by half). This will likely increase the stock’s marketability by making it attractive to a larger number of

    potential investors. The appropriate accounting treatment of a stock split is to make no journal entry, which avoids the reclassification of ―earned‖ capital as ―invested‖ capital. However, if the stock distribution is referred to as a "stock split effected in the form of a stock dividend," and the per share par

    value of the shares is not changed, a journal entry is recorded that increases the common stock account by the par value of the additional shares. To avoid reducing retained earnings Brandon can reduce (debit) paid-in capital excess of par to offset the credit to common stock, although it’s permissible to

    debit retained earnings.

    Question 10-22

    When a company decreases, rather than increases, its outstanding shares a reverse stock split

    occurs. A 1 for 2 reverse stock split would cause one million $1 par shares to become one-half million $2 par shares. No journal entry would be recorded, so no account balances will change. But the market price per share would double, and the par amount per share would double.

    Question 10-23

    You would be entitled to 3.2 shares (4% x 80 shares). Since cash in lieu of payments usually are made when shareholders are entitled to fractions of whole shares, you probably would receive 3 shares

    1and cash equal to the market value of / of one share. Sometimes fractional share rights are issued for 5

    1the partial shares, which would entitle you to a fractional share right for / of a share. 5

    Question 10-24

    A quasi reorganization allows a company to (1) write down inflated asset values and (2) eliminate an accumulated deficit in retained earnings. The following steps are taken:

    1. Assets and liabilities are revalued to reflect their fair values, with corresponding credits or debits

    to retained earnings. This may temporarily increase the deficit.

    2. The debit balance in retained earnings is eliminated against additional paid-in capital. When

    additional paid-in capital is not sufficient to absorb the entire deficit, capital stock is debited.

    3. Disclosure is provided to indicate the date the deficit was eliminated and when the new

    accumulation of earnings began.

    10-5

Chapter 10 - Shareholders’ Equity

BRIEF EXERCISES

    Brief Exercise 10-1

    Two attributes of other comprehensive income are reported: (1) components of comprehensive income created during the reporting period ($15 million in this instance)

    and (2) the comprehensive income accumulated over the current and prior periods ($50 million at the end of this year).

    The $50 million represents the cumulative sum of the changes in each component created during each reporting period (the disclosure note) throughout all prior years.

    Since this amount increased by $15 million, the balance must have been $35 million last

    year.

Brief Exercise 10-2

     ($ in millions)

    Cash (8 million shares x $12 per share).................................. 96

     Common stock (8 million shares x $1 par per share) .............. 8

     Paid-in capital excess of par (remainder) .................... 88

    10-6

Chapter 10 - Shareholders’ Equity

Brief Exercise 10-3

    Lewelling’s paid-in capital excess of par will increase by $860,000: 4,000 hours x

    $240 less $100,000 par.

    Journal entry (not required):

    Legal expense (4,000 hours x $240) ................................... 960,000

     Common stock (100,000 shares x $1 par per share) ............... 100,000

     Paid-in capital excess of par (remainder) .................... 860,000

Brief Exercise 10-4

    Hamilton’s shareholders’ equity will increase by $3,500,000 as a result of this

    transaction.

    Journal entry (not required):

    Inventory of motors (1,000 x $3,500) ................................. 3,500,000

     Common stock ........................................................... 3,500,000

    10-7

Chapter 10 - Shareholders’ Equity

Brief Exercise 10-5

    MLS’s common shareholders’ will receive dividends of $18 million as a result of the

    2011 distribution.

     Preferred Common

     2009 $20 million* 0

     2010 20 million** 0

     2011 32 million*** $18 million (remainder)

    * $24 million current preference (6% x $400 million), thus $4 million dividends in

    arrears.

    ** $24 million current preference (6% x $400 million), thus another $4 million

    dividends in arrears.

    *** $8 million dividends in arrears plus the $24 million current preference.

Brief Exercise 10-6

    Horton’s total paid-in capital will decline by $17 million, the price paid to buy back

    the shares.

    Journal entry (not required):

     ($ in millions)

    Common stock (2 million shares x $1 par) .................................. 2

    *Paid-in capital excess of par (2 million shares x $9) ................. 18

     Paid-in capital share repurchase (difference) ..................... 3

     Cash (2 million shares x $8.50 per share) .................................. 17

    * Paid-in capital excess of par: $900 ? 100 million shares

    10-8

    Chapter 10 - Shareholders’ Equity

    Brief Exercise 10-7

    Agee’s total paid-in capital will decline by $18 million because recording the transaction involves a $1 million reduction of retained earnings and an $18 million

    reduction in paid-in capital accounts.

    Journal entries (not required):

First buyback ($ in millions)

    Common stock (1 million shares x $1 par) .................................. 1

    *Paid-in capital excess of par (1 million shares x $15) ............. 15

     Paid-in capital share repurchase (difference) ..................... 2

     Cash (1 million shares x $14) .................................................. 14 * $16 - $1 par

    Second buyback

    Common stock (1 million shares x $1 par) .................................. 1

    *Paid-in capital excess of par (1 million shares x $15) ............. 15

     share repurchase Paid-in capital (balance from first buyback) ... 2

    Retained earnings (difference).................................................. 1

     Cash (1 million shares x $19) .................................................. 19 * $16 - $1 par

    10-9

    Chapter 10 - Shareholders’ Equity

    Brief Exercise 10-8

    Jennings’ retained earnings will decline by $2 million because the $67 million sale price is less than the sum of the cost of the treasury stock ($70 million) and paid-in capital from the previous treasury stock sale ($1 million). Journal entries (not required):

    Purchase of treasury stock ($ in millions)

    Treasury stock (2 million shares x $70) ...................................... 140

     Cash .................................................................................. 140

    First sale of treasury stock

    Cash (1 million shares x $71) ..................................................... 71

     Treasury stock (1 million shares x $70)................................... 70

     Paid-in capital share repurchase (remainder) ..................... 1

    Second sale of treasury stock

    Cash (1 million shares x $67) ..................................................... 67 Paid-in capital share repurchase (balance from first sale) ......... 1

    Retained earnings (remainder) ................................................. 2

     Treasury stock (1 million shares x $70)................................... 70

    10-10

Report this document

For any questions or suggestions please email
cust-service@docsford.com