Chapter 15

Analysis of equity

Analysts use stockholders' equity ratios to evaluate a company's profitability and long-term solvency. Three ratios: -Rate of return on common stock equity. -Payout ratio. -Book value per share. -Rate of return on common stock equity: shows how many dollars of net income the company earned for each dollar invested by the owners. -Payout ratio: In the fourth quarter of 2014, 36 percent of the earnings of the S&P 500 was distributed via dividends. -Book value per share: Amount each share would receive if the company were liquidated on the basis of amounts reported on the balance sheet.

The type of preferred stock that would generate a dividend in arrears is:

Any passed dividend on cumulative preferred stock constitutes a dividend in arrears.

Redeemable preferred stock should be classified as a liability on the balance sheet.

FASB requires redeemable preferred stock to be listed as a liability on the balance sheet.

Gulfport Corporation was organized in January 2017 with authorized capital of $.0001 par value common stock. On February 1, 2017, shares were issued at par for cash. On March 1, 2017, the corporation's attorney accepted 5,000 shares of common stock in settlement for legal services with a fair value of $25,250. Additional paid-in capital would increase on 2/1/17 3/1/17

No Yes

Which of the following best describes a possible result of treasury stock transactions by a corporation?

Treasury stock transactions by a corporation may decrease but not increase retained earnings. Treasure stock transactions do not affect net income.

Preferred stock has no voting rights.

True In exchange for other preferences, preferred stockholders give up their voting rights.

At the date of declaration of a large common stock dividend, the entry should include

a debit to Retained Earnings

Cash dividends are paid on the basis of the number of shares

outstanding less the number of treasury shares. Dividends are paid on the basis of issued shares less treasury shares (or outstanding shares).

All of the following statements are true regarding preferred stock except: companies usually issue preferred stock with a par value. the dividend preference for preferred stock is expressed as a percentage of the par value. a company often issues preferred stock instead of debt, because of a high debt-to-equity ratio. a preference as to dividends assures the payment of dividends.

a preference as to dividends assures the payment of dividends.

On October 31, 2017, Lexington Corp. declared and issued a 12% common stock dividend. Prior to this dividend, Lexington had 302,000 shares of $.001 par value common stock issued and outstanding. The fair value of Lexington's common stock was $16.75 per share on October 31, 2017. As a result of this stock dividend, the company's total stockholders' equity

As a result of this stock dividend, Lexington's total stockholders' equity did not change.

Treasury stock sold for less than its cost decreases net income.

False

Presented below is information related to Polaris Corporation: Common Stock, $1 par $10,350,000 Paid-in Capital in Excess of Par—Common Stock 6,520,000 Paid-in Capital from Treasury Stock 400,000 Retained Earnings 9,543,000 Treasury Common Stock (at cost) 695,000 The total stockholders' equity of Polaris Corporation is

Common Stock, $10,350,000 + Paid-in Capital in Excess of Par - Common Stock, $6,520,000 + Paid-in Capital from Treasury Stock, $400,000 + Retained Earnings, $9,543,000 - Treasury Stock, $695,000 = $26,118,000, Total Stockholders' Equity.

Stock splits increase total stockholders' equity.

False Stock splits increase the number of shares issued and outstanding and reduce the par or stated value per share. But they do not affect the total amount of stockholders' equity.

Treasury stock is classified on the balance sheet as an asset.

False Treasury stock is a contra-stockholders' equity account, not an asset, on the balance sheet.

Which of the following features of preferred stock makes the security more like debt than an equity instrument?

Redeemable preferred stock is more like debt than the other choices.

Presentation of equity

Restrictions are best disclosed by note. Restrictions may be based on the retention of a certain retained earnings balance, the ability to maintain certain working capital requirements, additional borrowing, and other considerations.

Which of the following dividends does not reduce total stockholders' equity?

stock dividends.

Presented below is information related to Schoenthaler Corporation: Common Stock , $5 par $1,100,000 Paid-in Capital in Excess of Par - Common Stock 400,000 Preferred 5 ½% Stock, $100 par 1,500,000 Paid-in Capital in Excess of Par—Preferred Stock 500,000 Retained Earnings 2,000,000 Paid-in Capital from Treasury Stock 150,000 The total stockholders' equity of Schoenthaler Corporation is

$5,650,000. Total stockholders' equity is (Common Stock, $1,100,000 + Paid-in Capital in Excess of Par - Common Stock, $400,000 + Preferred Stock, $1,500,000 + Paid-in Capital in Excess of Par-Preferred Stock, $500,000 + Retained Earnings, $2,000,000 + Paid-in Capital from Treasury Stock, $150,000) = $5,650,000.

Durango Inc. had net income for 2017 of $2,120,000 and earnings per share on common stock of $5. Included in the net income was $300,000 of bond interest expense related to its long-term debt. The income tax rate for 2017 was 30%. Dividends on preferred stock were $400,000. The payout ratio on common stock was 25%. What were the dividends for common stock in 2017?

($2,120,000 net income - $400,000 P/S dividends) X 25% payout ratio equals $430,000 in dividends for common stock.

The residual interest in a corporation belongs to

The residual interest in a corporation belongs to the common stockholders.

Which of the following type of stock will not increase Additional Paid-in Capital when issued?

No-par value stock does not increase Additional Paid-in Capital because there is no excess over and above a par or stated value to be recorded. The issuance of par value, no par with a stated value, and preferred stock may all increase additional paid-in capital at issuance.

The rate of return on common stock equity is computed by dividing:

Return on common stock equity is computed by dividing net income less preferred dividends by average common stockholders' equity

On January 1, 2017, Vancleave Corporation had 110,000 shares of its $.001 par value common stock outstanding. On November 27, when the market price of the stock was $8, the corporation declared a 10% stock dividend to be issued to stockholders of record on December 28, 2017. What was the impact of the 10% stock dividend on the balance of the retained earnings account?

The amount transferred from retained earnings in a small stock dividend is based on the fair value of the stock: (110,000 original shares X .10 stock dividend) = 11,000 stock dividend shares X $8 market price = $88,000.

Before declaring a cash dividend, management must consider the

The availability of funds must be considered before declaring a cash dividend.

In every corporation the one class of stock that represents the basic ownership interest is called

The basic ownership of a corporation is represented by common stock.

McCaffrey Corporation owned 15,000 shares of Harper Corporation's $5 par value common stock. These shares were purchased in 2015 for $326,000. On May 4, 2017, McCaffrey declared a property dividend of one share of Harper for every twenty shares of McCaffrey stock held by a stockholder. On that date, when the market price of Harper was $34 per share, there were 280,000 shares of McCaffrey outstanding. What net reduction in retained earnings would result from this property dividend?

The fair value of the shares distributed is: 280,000 McCaffrey shares / 20 = 14,000 shares of Harper issued, times $34 current market price equals $476,000. Retained earnings is increased by the unrealized gain of $171,780 = 14,000*[$34 - ($326,000/15,000)] and decreased by the fair value of the shares distributed for a net reduction of $304,220 = $476,000 - $171,780.

Additional paid-in capital is not affected by the issuance of:

The issuance of no-par stock has no effect on additional paid-in capital. The issuance of no par with a stated value, par value and preferred stock may all affect additional paid-in capital at issuance.

Which of the following statements related to dividends is incorrect? Distributions to owners must be in compliance with the state laws. Dividends must be declared by the Board of Directors. Before declaring a dividend, management must consider availability of funds to pay the dividend. Dividends must be paid in the period declared.

The payment of a dividend does not have to be in the same period as it was declared. Thus, the incorrect statement is that dividends must paid in the period declared.

Which one of the following is not a right of common stockholders?

To share proportionately in all management decisions.

Presented below is information related to Kaenzig Corporation: Common Stock , $1 par $2,100,000 Paid-in Capital in Excess of Par - Common Stock 550,000 Preferred 8 ½% Stock, $50 par 1,700,000 Paid-in Capital in Excess of Par—Preferred Stock 950,000 Retained Earnings 2,350,000 Treasury Common Stock (at cost) 250,000 The total stockholders' equity of Kaenzig Corporation is

Total stockholders' equity is (Common Stock, $2,100,000 + Paid-in Capital in Excess of Par-Common Stock, $550,000 + Preferred Stock, $1,700,000 + Paid-in Capital in Excess of Par-Preferred Stock, $950,000 + Retained Earnings, $2,350,000 - Treasury Stock, $250,000) = $7,400,000.

On September 14, 2017, Gayot Company reacquired 12,000 shares of its $1 par value common stock for $40 per share. Gayot uses the cost method to account for treasury stock. The journal entry to record the reacquisition of the stock should debit

Treasury Stock is debited for the cost of the stock (not for par value): 12,000 shares X $40 = $480,000.