Intermediate Accounting II - Exam 2

What is meant by dilution in EPS? When would a potential common share instrument be considered antidilutive?

Dilution is a reduction in earnings per share resulting from making assumptions that outstanding options are exercised and convertible instruments are converted. An instrument is antidilutive if assuming exercise or conversion increases earnings per share or reduces a loss per share.

Explain what the following terms used with respect to company stock mean: Authorized shares, issued shares, outstanding shares, and treasury stock.

The total shares authorized is the maximum number of shares of capital stock a company can issue as determined by its corporate charter. Issued shares are the number of shares of capital stock that have been legally issued by a company to third parties as of a specific date. Outstanding shares is the number of shares of issued stock still held by third party stockholders as of a specific date. Treasury stock is the number of shares of issued stock that have been repurchased but not retired. The difference between the number of shares issued and the number of outstanding shares is the number of shares of treasury stock.

In determining diluted earnings per share, if the company has convertible debt outstanding that is dilutive, what effect does the year's interest expense on that debt have on the computation? a. No effect. It is ignored in the diluted earnings per share computation as it is already included in net income. b. Interest expense net of taxes is added back to net income in the computation of diluted earnings per share. c. Interest expense is added back to net income in the computation of diluted earnings per share. d. Interest expense net of taxes is added to net income in the computation of diluted earnings per share only if the convertible debt is considered a common stock equivalent.

B

Tyler Inc had 1,000 shares of callable 8% $100 par preferred stock outstanding that had been issued for $125 per share. The shares were callable for $135. On June 30, 2012, the company acquired all of these shares at the call price and retired them. The journal entry to record the call of all of the preferred stock at the call price would include a: a. $10,000 debit to loss on call of preferred stock. b. $10,000 debit to retained earnings. c. $10,000 debit to additional paid in capital on preferred stock d. $35,000 debit to additional paid in capital on preferred stock

B

ABC Corporation owned 15,000 shares of XYZ Corporation's $5 par value common stock. These shares were purchased in 2008 for $225,000. On October 31, 2012, ABC Corp declared a dividend of one share of XYZ stock every twenty shares of ABC Corp stock held by a stockholder. On that date, when the market price of XYZ stock was $34 per share, there were 280,000 shares of ABC Corp stock outstanding. This is an example of a: a. liquidating dividend. b. large stock dividend. c. property dividend. d. small stock dividend. e. stock split.

C

At January 1, 2012, Flores Company had 300,000 shares of common stock issued and outstanding and 40,000 shares of $100 par 5% cumulative nonconvertible preferred stock. During 2012, Fultz declared and paid $0.70 per share cash dividends on the common stock. No dividends were declared or paid on the preferred stock in 2012. Net income for the year ended December 31, 2012, was $1,120,000. What is the company's basic earnings per common share for 2012, rounded to the nearest penny? a. $2.09 b. $2.36 c. $3.07 d. $3.73

C

Compensation expense resulting from a compensatory stock option plan is generally a. recognized in the period of exercise. b. recognized in the period of the grant. c. allocated to the periods benefited by the employee's required service. d. allocated over the periods of the employee's service life to retirement.

C

Which of the following is not a characteristic of a noncompensatory stock purchase plan? a. It is open to almost all full-time employees. b. The discount from market price is small. c. The plan offers no substantive option feature. d. All of these are characteristics of a noncompensatory stock purchase plan.

D

At the beginning of 2013, Katy Company had retained earnings of $360,000. During the year the company reported net income of $150,000, sold treasury stock at a "gain" of $54,000, declared a cash dividend of $90,000, and declared and issued a small stock dividend of 3,000 shares ($10 par value) when the fair value of the stock was $30 per share. The amount of retained earnings at the end of 2013 was: a. $330,000. b. $384,000. c. $420,000. d. $410,000.

A

The date on which to measure the compensation element in a stock option granted to a corporate employee ordinarily is the date on which the employee a. is granted the option. b. is fully vested in the option. c. may first exercise the option. d. exercises the option.

A

What is legal capital and how does it relate to stocks that have par value, stated value, or no par value?

A corporation's legal capital is the amount of stockholders' equity that cannot be distributed to stockholders under state law. Generally this amount is expected to be fully paid in at issuance. The corporation may not make dividend distributions or treasury stock purchases that would impair the company's legal capital. For stocks with a par or stated value, the legal capital is generally the stock's par value or stated value. For no par stocks, the legal capital can be the entire amount of proceeds from the stock's issuance, if there is no stated value. If shares are sold for less than the company's par value, then shareholders can be assessed for later to make up the deficiency between the issue price and the par value. Legal capital was originally intended partially as a protection for creditors.

What do the following terms related to preferred stock mean? Dividend preference, cumulative dividends, a participating preferred, convertible preferred, callable preferred, redeemable preferred.

A dividend preference is the right to a dividend of a predetermined amount before dividends are paid to common stockholders. Cumulative refers to the right of preferred stockholders to unpaid preferred dividends of previous years and the current year before a distribution of dividends may be made to common stockholders. Participating preferred stockholders share with common stockholders in any dividends dependent on the participation terms. Convertible preferred stock may be exchanged at the stockholders' option usually into common stock. Callable preferred stock can be called from the holders at a predetermined price. Redeemable preferred stock is either subject to mandatory redemption at a specified price on a specified future maturity date or is redeemable at the option of the holder.

On December 1, Boerne Corporation exchanged 3,000 shares of its $25 par value common stock for a parcel of land to be held for use for an all night truck stop. On the exchange date the common shares of the company had a fair value in an actively traded market of $49 per share. The company had an appraisal performed by a certified appraiser who determined that the value of the land at its highest and best use was $155,000. On the other hand the assessed value of the property for real estate tax purposes was $135,000. Based on these facts, the land should be capitalized at a. $75,000. b. $135,000. c. $147,000. d. $155,000.

C

In 2011, Brown Inc., issued for $105 per share, 7500 shares of $100 par value convertible preferred stock. One share of preferred stock can be converted into three shares of Berger's $30 par value common stock at the option of the preferred stockholder. In August 2012, all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $40 per share. What total amount should be credited to additional paid-in capital, common stock as a result of the conversion of the preferred stock into common stock? a. $37,500. b. $78,000. c. $225,000. d. $112,500.

D

On March 1, 2012, Abilene Corp. declared and issued 57,000 shares of common stock as a stock dividend. Prior to this dividend, the company had 1,000,000 shares authorized, 400,000 shares of $1 par value common stock issued and 20,000 shares of treasury stock. The dividend would be accounted for as a: a. liquidating dividend. b. large stock dividend. c. property dividend. d. small stock dividend.

D

How is total compensation cost for compensatory stock options computed and how much is recognized as expense each period?

The compensatory stock option plans are accounted for using the fair value method. If the award is considered an equity award then the total compensation cost is determined at the grant date as the fair value of the award adjusted for expected forfeitures. This estimated total compensation amount is revised each period for changes in estimated forfeitures. The compensation expense is generally recognized over the service period of the employees based on a method that is consistent with the vesting terms. The final total compensation represents the grant date fair value of the awards that vest. If the award is a liability award, for example a stock appreciation right, the value of the award is adjusted every period to reflect the changes in fair value until settlement.

Explain the difference between the cost method and the par value methods of accounting for treasury stock.

Under the cost method, a corporation reports treasury stock as a contra equity account deducted from total shareholder's equity before treasury stock. The purchase of treasury stock is recorded at its cost in the treasury stock account and when treasury shares are reissued they are removed from the treasury stock account at their cost. Under the par value method, the company reports the treasury stock account as a contra account to the related common stock account that has been repurchased. Upon purchase of treasury shares the treasury stock account is debited for the shares par value only. When treasury shares are reissued the shares are moved from the treasury stock account at their par value.

Explain the difference in accounting for large and small common stock dividends.

A stock dividend less than 20 to 25% of the previously outstanding shares is considered a small stock dividend. A stock dividend of more than 20%-25% of the previously outstanding shares is considered a large stock dividend. Neither a small nor a large stock dividend changes the amount of total stockholders' equity, although both affect the distribution of stockholders' equity to different equity accounts. For a small stock dividend, an amount equal to the fair value of the new shares is transferred from retained earnings to common stock and additional paid in capital on the date of declaration. For a large stock dividend, an amount equal to the par value of the newly issued shares is transferred from retained earnings to common stock on the date of declaration.

During 2013 Lost Maples Co. had stock options on common shares outstanding. The number of shares under outstanding options, at an option price of $30 per share was 12,000 shares. The average market price of the common stock during the year was $36. What is the assumed increment in common shares for computing dilutive earnings per share? a. 2,000 b. 12,000 c. 10,000 d. No increment. The options are antidilutive.

A

Llano Corporation has authorized 50,000 shares of $10 par common stock and 10,000 shares of $100 par value preferred stock. The following transactions took place during 2012, the first year of the corporation's existence: • Sold 10,000 shares of common stock for $18 per share for cash. • Issued 10,000 shares of common stock in exchange for a patent valued at $200,000. • Sold 1000 shares of preferred stock for $105 per share for cash. At the end of the company's first year, the company's paid-in capital accounts would have the following balances: Common Stock Preferred Stock Additonal Paid-in Capital a. $200,000 $100,000 $185,000 b. $180,000 $105,000 $200,000 c. $200,000 $100,000 $ 85,000 d. $380,000 $105,000 $ 0

A

On January 1, 2012, Lubbock Company granted each of ten employees options to buy 1,000 shares of the company's stock. The market price of the stock on January 1, 2012, was $25, which was equal to the exercise price of the options. The requisite service period is for three years beginning January 1, 2012. The company estimates employee turnover at 5% per year for the three year period and uses an option pricing model to determine that the fair value of each option at $7.50 on the grant date. What is the estimated compensation expense for the year ended December 31, 2012? (Round to the nearest dollar.) a. $21,434 b. $25,000 c. $64,303 d. $71,448

A

On June 30, 2012, when Bulverde Co.'s stock was selling at $65 per share, its capital accounts were as follows: Capital stock (par value $50; 40,000 shares issued) $2,000,000 Additional paid in capital 300,000 Retained earnings 2,100,000 If a 2 for 1 stock split were declared and distributed, the balance in the capital stock account after the split would be: a. $2,000,000. b. $2,300,000. c. $4,000,000. d. $4,400,000.

A

Travis Company has 2,000,000 shares of common stock outstanding on January 1, 2012. An additional 150,000 shares of common stock were issued on July 1, 2012, and 300,000 more on October 1, 2012. On April 1, 2012, the company issued 6,000, $1,000 face value, 8% convertible bonds. Each bond is convertible into 40 shares of common stock. No bonds were converted into common stock in 2012. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively, for the year ended December 31, 2012? a. 2,150,000 and 2,330,000 b. 2,450,000 and 2,690,000 c. 2,150,000 and 2,390,000 d. 2,450,000 and 2,630,000

A

What is a simple capital structure versus a complex capital structure? If a company has a simple capital structure how is earnings per share computed?

A simple capital structure is one that has only of common stock outstanding (or if it has preferred stock, such stock is not convertible). A company with a simple capital structure (assuming it is a public company) must present basic earnings per share on its income statement. Basic earnings per share is computed by dividing net income minus preferred dividends, if any, by the weighted average number of common shares outstanding during the period.

Comfort Company issues 10,000 shares of its $10 par value common stock having a market value of $50 per share and 3,000 shares of its $100 par value preferred stock for a lump sum of $750,000. The separate fair value of the preferred stock was not known. The proceeds allocated to the common and preferred stock is (Round to the nearest dollar.) Common Preferred Stock Stock a. $705,000 $ 0 b. $500,000 $250,000 c. $468,750 $281,250 d. $450,000 $300,000

B

If there are restrictions imposed on retained earnings by bond indentures, loan agreements, or the Board, this means there is cash being aside in a fund to satisfy the restrictions: a. True b. False

B

Stephensville, Inc. has 200,000 shares of $10 par value common stock and 100,000 shares of $10 par value, 6%, cumulative, participating preferred stock outstanding. Dividends on the preferred stock are one year in arrears. Assuming that the company wishes to distribute $540,000 as dividends, the common and preferred stockholders will receive are: Common Preferred Stockholders Stockholders a. $120,000 $420,000. b. $220,000 $320,000. c. $320,000 $220,000. d. $420,000 $120,000.

C

Which earnings per share amounts are reported in a complex capital structure? a. Basic EPS only. b. Diluted EPS only. c. Basic and diluted EPS. d. Primary and fully diluted EPS.

C

Which of the following dividends do not reduce total stockholders' equity? a. Liquidating dividends. b. Cash dividends. c. Stock dividends. d. All of the options reduce total stockholders' equity.

C

On January 1, 2012, the Dam Tubing Company. established a stock appreciation rights plan for 8 executives. It entitled them to receive cash at any time during the next five years for the difference between the market price of its common stock and a pre-established price of $20 on 1,000 shares for each of the 8 executives. No employees were expected to forfeit the awards and none did. The requisite service period is 3 years. The fair values of the SARs are as follows: 1/1/ 2012 $15; 12/31/12 $18; 12/31/13 $10; 12/31/14 $13. What amount of compensation expense should the company recognize each period for the three year period ended December 31, 2014? 2012 2013 2014 a. $40,000 $13,333 $50,667 b. $40,000 $40,000 $40,000 c. $48,000 $26,667 $34,667 d. $48,000 $ 5,333 $50,667

D

What is the difference between the treasury stock and the if-converted methods used in computing diluted earnings per share?

The treasury stock method is used for computing the incremental effect in diluted earnings per share of assuming exercise of options, warrants, and similar instruments. The incremental number of shares arises from assuming the options are exercised at the exercise price and then the assumed proceeds are used to buy back company stock at the average market price for the period. The difference between the assumed issued and assumed repurchased shares is the incremental shares added to the denominator for diluted EPS purposes. The if-converted method is applied to convertible instruments and is calculated by assuming the instrument is converted at the beginning of the period or at the date when issued, if later. The if-converted method assumes that for a convertible preferred stock, the preferred stock dividend is not paid, or for convertible debt the interest expense net of tax is not paid, since the instrument is assumed converted at the beginning of the period. So in the computation, the preferred stock dividend or net of tax interest expense is added back to the numerator of basic EPS and the number of shares that would have been issued if the instrument had converted at the beginning of the period (or when issued if later) is added to the denominator of basic EPS.