Exam 2: Chapter 15
List some of the items pertaining to stockholders' equity that must be disclosed in the notes to the financial statements
-dividends and liquidation preference -participation rights -call prices and dates -conversion or exercise price and pertinent dates -sinking fund requirements -unusual voting rights -significant terms of contracts to issue additional shares
There are two methods of accounting for a lump-sum purchase of stock: the proportional method (Illustration 15-1) and the incremental method (Illustration 15-2). When are each of these methods used?
1. Proportional method: if the fair value is available for each class of security 2. Incremental method: if the company can not determined the fair value of all classes of securities
Assuming there are no specified restrictions what are the four basic rights of common stockholders?
1. To share proportionately in profits and losses. 2. To share proportionately in management (the right to vote for directors). 3. To share proportionately in corporate assets upon liquidation. 4. To share proportionately in any new issues of stock of the same class—called the preemptive right.2
There are two types of stock splits
1. normal stock split (3-for-1) 2. Reverse stock split (1-for-3)
What are two reasons AGAINST the issuance of no-par common stock?
1. some states levy a high tax on these issues. 2. some states the total issue price for no-par stock may be considered legal capital, which could reduce the flexibility in paying dividends.
What are two ways a company may express a dividend preference on preferred stock?
1. specific dollar amount per share 2. percentage of par value
What rights does the corporation NOT have as a holder of the treasury stock?
1. the right to vote 2. to exercise preemptive rights as a stockholder 3. to receive cash dividend 4. to receive assets upon corporate liquidation
List five reasons why a company would reacquire its own stock.
1. to provide tax-efficient distributions of excess cash to shareholders 2. to increase earnings per share and return on equity. 3. to provide stock for employee stock compensation contracts or to med potential merger needs. 4. to thwart takeover attempts or to reduce the number of share holders 5. to make a market in the stock
Which of the following dividends would reduce stockholders' equity? 1. Cash dividends Yes No 2. Property dividends Yes No 3. Liquidating dividends Yes No 4. Stock dividends Yes No
1. yes 2. yes 3. yes 4. no
According to U.S. GAAP, accounting for a stock dividend depends on whether the stock dividend is a large stock dividend (in excess of ___% to ___% of the number of shares of stock outstanding at the time of the distribution) or a small stock dividend (less than ___% to ___% of the number of shares of stock outstanding at the distribution).
20% to 25% 20% to 25%
When a corporation sells its treasury stock two situations could occur: A. The corporation could sell the treasury stock for ________ than its cost. When this occurs the corporation will debit _______ for the selling price of the treasury stock, credit ____________ for the cost of the treasury stock, and credit __________ for the excess of the treasury stock's selling price over its cost. B. The corporation could sell the treasury stock for ________ than its cost. Two different journal entries could result depending on whether the excess of the total cost of the treasury stock sold over the cash received was less than or greater than the balance in the APIC - Treasury Stock account.
A. Greater; Cash; Treasury Stock; APIC - Treasury Stock **Note that the account, APIC - Treasury Stock, is credited (not APIC - Common Stock.) B. LESS
What are two reasons for the issuance of no-par common stock?
A. avoids the contingent liability that might occur if the corporation issued par value stock at a discount. B. The questionable treatment of using par value as a basis for fair value never arises
Related to cash dividends, is net income reduced on the following dates? Declaration date: Yes No Record date: Yes No Payment date: Yes No
All are NO.
Where is the account, Common Stock Dividends Distributable, shown on a company's financial statements?
Capital Stock in SE
Which class of stock generally has the voting rights of a corporation?
Common stock
What is the rule for stock issued for services or property (noncash transactions)
Companies should record stock issued for services or property other than cash at either the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.
Where is the account, Property Dividends Payable, shown on a company's balance sheet?
Current Liabilities
Of the four rights listed in #3 above which right is most likely restricted by corporations?
D. Preemptive right, Because this right makes it inconvenient for corporations to issue large amounts of additional stock, as they frequently do in acquiring other companies. Disney EXAMPLE
True or False: A corporation may only have preferred stock as its class of stock
False
True or False: A stock's par value equals its fair value.
False
True or False: A stockholder's ownership percentage will increase after the distribution of a stock dividend.
False
True or False: If a company issues no par common stock with a stated value, it would not use an APIC - Common Stock account
False
True or False: Par value may be used in determining the value of an exchange of stock for a noncash transaction.
False
True or False: Stocks par value equals its fair value
False
Participating preferred stock
Holders share ratably with the common stockholders in any profit distributions beyond the prescribed rate
The following journal entry is recorded on the declaration date of cash dividends: (D)Cash dividends XX (CR) Dividends payable XX The journal entry to record the declaration of cash dividends would increase _________________________ (assets, liabilities, stockholders' equity, revenues, expenses) and decrease __________________________________ (assets, liabilities, stockholders' equity, revenues, expenses). **Remember that a liability would not be recorded for cash dividends until the dividends are formally declared by the corporation's Board of Directors.
Liabilities; stockholder equity
Where is redeemable preferred stock shown on a corporation's balance sheet?
Liability
Are cash dividends paid on treasury stock?
NO
As shown on the previous page, both large and small stock dividends reduce retained earnings, but ______________ (increase, decrease, have no effect on) total stockholders' equity.
NO EFFECT
On the dividend record date what journal entry is made?
No entry. --Instead, this date is used to determine who owns the stock and will thus be entitled to the cash dividends.
Direct costs of issuing stock are debited to the _________ account.
Paid in Capital- common stock
Under what section of Stockholders Equity section would APIC - Treasury Stock be shown?
SE-APIC
True or False: APIC - Treasury Stock could have a debit balance.
TRUE
True or False: The retirement of treasury stock would reduce the number of shares of stock issued.
TRUE
What is a lump-sum purchase of stock?
The issuance of two or more classes of securities for a single payment (lump sum).
Define watered stock:
The overvaluation of the stockholders' equity resulting from inflated asset values creates
When treasury stock is purchased with cash the _______________________________ account is debited for the purchase price of the treasury stock and Cash is credited for the same amount. ***Note that neither the stock's par value nor its original issuance price is used under the cost method.
Treasury stock
True or False: A stock split has no effect on the financial statement account balances of a company.
True
True or False: Assume a company receives a noncash item in exchange for common stock the company originally acquired as treasury stock. The company should not use the acquisition price of the treasury stock as the fair value of the noncash transaction.
True
True or False: Dividends in arrears are not shown as liabilities; however, they are required to be disclosed in the corporation's notes to the financial statements.
True
True or False: If a corporation redeems its preferred stock, it must pay the dividends in arrears on this preferred stock.
True
True or False: The company does not make a formal journal entry to record a stock split.
True
What are examples of direct costs of issuing stock?
Under writing fees, accounting and legal fees, printing cost, taxes
Convertible preferred stock
allows shareholders, at their option, to exchange preferred shares for common stock at predetermined ratio.
what is legal capital
amount in SE that a corporation must key in SE and not pay in dividends.
What document does a corporation use to incorporate?
articles of incorporation
The following journal entry is recorded on the payment date of the cash dividends: (D)Dividends payable XX (Cr) Cash XX The journal entry to record the payment of cash dividends will decrease the corporation's _____________________ (assets, liabilities, stockholders' equity, revenues, expenses), and it will also decrease the corporation's _________________________ (assets, liabilities, stockholders' equity, revenues, expenses).
asset, liability
liquidating dividend will reduce the ________________________________________________ account.
corporate paid in capital
Treasury stock has a normal ____________________ (debit or credit) balance and should be classified as a reduction to _______________________________________ on a company's balance sheet.
debit; assets and stockholder equity
If the fair market value of the stock differs from the par value of the stock, large stock dividends and small stock dividends would have ________________ (the same, different) effects on a company's Retained Earnings.
different
Preferred stock has a preference to____________ before common stockholders; however, preferred stockholders generally do not have ___________________________________________________________ rate.
dividend, a voice in management or their right to share profits beyond stated rate.
Dividends in arrears
dividends that were past and must be paid back
Preferred stock generally has preferences as to ____________________________________ and as to ____________________ ____________________________________________________________________________________.
dividends; assets in the event of liquidation.
After a stock split the total par value _______________________ (increases, decreases, does not change) and the par value per share will change proportionately with a stock split.
does not change
what amount go in the accounts APIC-Preferred and APIC-Common Stock
excess of the issuance price/total par
Indirect costs of issuing stock are debited to an ______________________ account.
expense
With a small stock dividend Retained Earnings is reduced by the ____________________ (fair value, par value) per share of the stock.
fair value
Two journal entries occur on the declaration date of a property dividend. In the first journal entry the property being distributed is adjusted to its ______________________________ and an Unrealized Holding Gain or an Unrealized Holding Loss is recorded. Then the account, Property Dividends Declared (which is later closed to Retained Earnings), is debited and Property Dividends Payable is credited for _________________________________________________ (what amount?).
fair value; the fair value of the distributed property dividends payable
Redeemable preferred stock
has a mandatory redemption period or a redemption feature that the issuer cannot control; more like debt (legal obligation to pay.)
Passed dividend on preferred stock
if the director fails to report a dividend at the end of the year.
With a stock dividend the total par value, i.e., balance in the account, Common Stock, or the account, Preferred Stock, ______________________ (increases, decreases, remains the same); however, the par value per share ___________________________ (increases, decreases, remains the same).
increases, remains the same
Liquidating dividends are a return of the stockholders' ________________________________ .
investments rather than of profits
what amounts go in the account preferred stock and common stock?
issued*par value per share
Who has the option of calling the preferred stock?
issuing corporation
What are examples of indirect costs of issuing stock?
management salaries
Provide examples of property dividends.
merchandise, real estate, or investments, or whatever form the board of directors designates.
In how many states may a corporation incorporate?
only one state.
With a large stock dividend Retained Earnings is reduced by the _____________________ (fair value, par value) per share of the stock.
par value
Callable preferred stock
permits the corporation at its option to call or redeem the outstanding preferred shares at specified future dates and at stipulated prices.
Who has the option of converting the preferred stock?
preferred shareholders
At the distribution date of the property dividend the account, _________________________________________ , is debited and the property being distributed is credited for __________________________________________________ (what amount?).
property dividends payable; account containing distributed asset of fair value.
Define preemptive right
protects an existing stockholder from involuntary dilution of ownership interest, this privilege is referred to as a stock right or warrant
Cumulative preferred stock:
requires that if a corporation fails to pay a dividend in any year it must make it up in a later year before paying ant dividends on common stock
Stock dividends involve the distribution of ____________________ as a dividend to a company's investors.
stock
Where is callable preferred stock shown on a corporation's balance sheet
stockholder equity
Where is convertible preferred stock shown on a corporation's balance sheet?
stockholder equity
What does a dividend preference on preferred stock assure?
that the corporation must pay the stated dividend rate or amount applicable to the preferred stock before paying any dividends on common stock.
why would a company issue stock at a low par?
to avoid owning money to stockholders if price falls below par; lower legal for more dividends
Why do corporations generally have a stock split?
to reduce the price per share so more people will buy it
When a company reacquires its own stock it could either treat the shares of stock as ____________________ stock or _________________ them.
treasury; retire
True or False: Dividends in arrears are not shown as liabilities; however, they are required to be disclosed in the corporation's notes to the financial statements.
true
True or False: If a company issues true no par common stock, it would not use an APIC - Common Stock account.
true
True or False: If a corporation calls its preferred stock, it must pay the dividends in arrears on this preferred stock
true
True or False: If a corporation redeems its preferred stock, it must pay the dividends in arrears on this preferred stock.
true
Define secret reserves
undervaluation of the stockholders' equity