Preferred Stock

Under what condition is retained earnings debited on conversion?

Total recorded value of preferred is less than par value of common on conversion.

(Start of CPAexcel Flashcards) What is the accounting treatment for the retirement of preferred stock?

1. All related Owner's Equity accounts are removed; 2. Debit differences go to retained earnings; 3. Credit differences go to contributed capital.

What is the accounting treatment for the conversion of preferred stock?

1. Preferred stock accounts are transferred to common stock accounts; 2. If total preferred stock value is less than common stock par value, debit retained earnings.

For what amount is Preferred Stock Additional Paid in Capital debited when called or redeemed?

Amount recorded from original issuance.

Issuance

A. Preferred stock often has a larger par value than common stock, and has a dividend stated in dollar terms or a percentage of face value. An issue of 6%, $100 par preferred stock is equivalent to an issue of $6, $100 par preferred stock for example. Upon issuance, any excess of proceeds over total par value of shares issued is credited to contributed capital in excess of par. Dr:Cash issue price less any issue costs Cr:Preferred stock total par value Cr:Contributed capital in excess of par-preferred difference

Redeemable Preferred Stock

A. Redeemable preferred stock may require the issuing firm to (1) redeem the stock (purchase the stock from the shareholder) at a specified future date at a specified price, or (2) redeem the stock at the option of the shareholder. A preferred stock or other financial instrument issued in the form of shares is mandatorily redeemable if the issuer is unconditionally required to redeem the instrument by transferring its assets at a specified or determinable date(s) or when an event certain to occur takes place. If the obligation to redeem is dependent on a future uncertain event, the instrument is considered to be mandatorily redeemable when that event occurs, or when the event becomes certain to occur. 1. Only the first of the two types noted above is considered mandatorily redeemable.

U.S. GAAP - IFRS Differences

A. Under international standards, when (1) preferred stock provides for mandatory redemption for a fixed or determinable amount at a fixed or determinable date, or (2) gives the holder the right to require the issuer to redeem the stock at or after a particular date for a fixed or determinable amount, then it is classified as a liability. As such, more preferred stock is reported as debt for international reporting. 1. Under international standards, the feature that makes an item debt is that the issuer is currently, or can be required to, deliver cash or other financial instrument to the holder of the instrument with terms that are potentially unfavorable to the issuer.

When called or redeemed, which Owners' Equity accounts are removed?

All related Owners' Equity accounts, including retained earnings from dividends in arrears and retained earnings debited for any difference.

Redeemable Preferred Stock (Balance sheet classification)

B. Balance sheet classification -- Mandatorily redeemable financial instruments (such as redeemable preferred stock) must be classified as debt (rather than owners' equity) unless the redemption is required to occur only if the issuing firm goes out of business. Such items are not to be presented between the liabilities section and the equity section of the statement of financial position. Rather, they are to be presented as liabilities. In the past, GAAP did not require redeemable preferred stock to be classified as debt, and SEC rules required such stock to be disclosed between the liabilities and owners' equity sections - the "mezzanine." 1. At the end of each year the liability is reported at the present value of the amount to be paid at maturity. The implicit rate at date of issuance is used for the discounting. Interest expense is recorded for the amount of cash dividends paid, as adjusted for the change in present value for the maturity amount. 2. If either the maturity date or maturity value (redemption price) is not known, the fair value is used for balance sheet reporting and the change in fair value is used for interest expense measurement.

Issuance

B. Convertible preferred stock allows the preferred shareholder to convert the preferred shares to common shares. The journal entry for issuance of convertible preferred stock does not allocate any of the proceeds to the conversion feature. As with convertible bonds, the securities are recorded at issuance in the same way nonconvertible securities would be.

U.S. GAAP - IFRS Differences

B. If a preferred stock issue does not explicitly meet either of the two criteria above but is expected to meet one later during its term, then again it is treated as a liability. 1. An example is preferred stock with a dividend that increases over time such that the issuer will be required to redeem the preferred stock. Another is if the holder has the option to require redemption if a future event occurs, and that event is probable, then the instrument is classified as debt.

Issuance

C. Preferred stock with warrants. Preferred stock, like bonds, may be issued with warrants for the purchase of common stock entitling the holder to purchase common stock at a fixed price. The same procedure for bonds with detachable warrants is applied. The issue price of the preferred stock is allocated to (1) the preferred stock accounts, and (2) another OE account for the common stock warrants. The allocation is based on fair value. When the warrants are exercised, cash is debited, the warrant account is closed, common shares are issued, and the common stock accounts are established.

Calling and Redeeming Preferred Stock

Calling and Redeeming Preferred Stock A. Any debit difference is recorded in retained earnings; B. Any credit difference is recorded in a contributed capital account. C. Any dividends in arrears must be paid when the shares are acquired (retained earnings is debited). D. The general journal entry is -- Dr:Preferred stock par value of stock called or redeemed Dr:Contributed capital in excess of par amount recorded on original issuance* Dr:Retained earnings if difference is a debit Cr:Cash amount paid to the shareholders Cr:Contributed capital from retirement of Preferred stock if difference is a credit * this amount is limited to the original recorded amount on the shares now acquired back by the issuing firm

example: Calling and Redeeming Preferred Stock

Example:100 shares of 6%, $50 par callable cumulative preferred stock with two years of dividends in arrears are called at $53. The shares were issued for $51 a share. Journal entries: Dr:Retained earnings 2(.06)($50)(100) 600 Cr:Cash (for dividends in arrears) 600 Dr:Preferred stock ($50)(100) 5,000 Dr:Contributed capital in excess of par, preferred ($51-$50)100 100 Dr:Retained earnings ($53 - $51)100 200 Cr:Cash $53(100) 5,300

Example: Conversion of Preferred Stock

Example:100 shares of 6%, $50 par convertible preferred stock is converted into $10 par common stock at a rate of two shares of common per share of preferred. The preferred stock was for $51 a share. Journal entry: Dr:Preferred stock ($50)(100) 5,000 Dr:Contributed capital in excess of par, preferred ($51-$50)100 100 Cr:Common stock 100(2)($10) 2,000 Cr:Contributed capital in excess of par, common 3,100 If each share of preferred stock was convertible into six shares of common stock, the conversion entry would be: Dr:Preferred stock ($50)(100) 5,000 Dr:Contributed capital in excess of par, preferred ($51-$50)100 100 Dr:Retained earnings 900 Cr:Common stock 100(6)($10) 6,000

500 shares of 6%, $100 par callable preferred stock are called at $101. The shares were issued at $103 per share. The journal entry to record the retirement includes which of the following?

The $2 difference multiplied by 500 shares yields $1,000 paid in capital kept by the firm. The journal entry is: DR: Preferred stock 500($100) 50,000 DR: PIC-preferred 500($103 - $100) 1,500 CR: PIC-retirement of preferred 1,000 CR: Cash 500($101) 50,500

500 shares of 6%, $100 par convertible preferred stock were issued at $103 per share. Each share is convertible into 20 shares of $5 par common stock. The journal entry to record conversion includes which of the following?

The contributed capital accounts for the preferred are closed and the total amount is transferred to the common stock accounts resulting from issuance upon conversion. The total par value of common stock is first credited to the common stock account. If there is a credit remainder, it is recorded in paid in capital in excess of par, common. If there is a debit remainder, retained earnings is debited. In this case, there is no remainder. The journal entry is: DR: Preferred stock 500($100) 50,000 DR: PIC-preferred 500($103 - $100) 1,500 CR: Common stock 500(20)($5) 50,000 CR: PIC-common 1,500

Cross Corp. had outstanding 2,000 shares of 11% preferred stock, $50 par. On August 8, 1992, Cross redeemed and retired 25% of these shares for $22,500. On that date, Cross' additional paid-in capital from preferred stock totaled $30,000. To record this transaction, Cross should debit (credit) its capital accounts as follows for Preferred stock, Additional paid-in capital and Retained earnings

The journal entry for retirement: Dr:Preferred stock 2,000(.25)($50) 25,000 Dr:Additional paid-in capital, preferred stock $30,000(.25) 7,500 Cr:Additional paid-in capital from retirement of preferred stock 10,000 Cr:Cash 22,500 The additional paid-in capital from retirement of preferred stock is the net difference between the other amounts in the entry. When preferred stock is retired, the par value of the stock retired is removed from the preferred stock account, and the pro-rata share of the additional paid-in capital from original issuance is removed. If the total of these two amounts exceeds the amount paid to redeem and retire the stock, as is the case here, additional paid-in capital from retirement of preferred stock is credited. The net effect on additional paid-in capital is an increase of $2,500 ($10,000 - $7,500). Retained earnings is unaffected.

When preferred stock is called and retired, which account or aggregate category of accounts can be increased?Total Owners' Equity and or Retained Earnings?

When a firm retires preferred stock, cash is paid to the shareholders reducing total owners' equity. Retained earnings can never be increased when shares are retired, redeemed, or converted into another class of stock.

Conversion of Preferred Stock

When convertible preferred stock is converted into common stock, the preferred stock accounts are transferred to the common stock accounts. Again, there is no gain or loss. A. Retained Earnings Debited -- If the total recorded value of the preferred stock is less than the par value of the common stock issued on conversion, retained earnings is debited for the difference. B. The general journal entry is -- Dr:Preferred stock par value of stock converted Dr:Contributed capital in excess of par amount recorded on original issuance* Dr:Retained earnings if needed Cr:Common stock par value of common stock issued Cr:Contributed capital in excess of par, common if difference is a credit * this amount is limited to the original recorded amount on the shares now being converted to common

Calling and Redeeming Preferred Stock

When preferred stock is called (by the issuer) or redeemed (by the stockholder) or is acquired and retired, all related OE accounts are removed. Callable preferred stock can be called in by the issuer at a specified price during a specified period. No gain or loss is recognized for these events because the transactions are between the firm and its owners.