Accounting Chapter 16

On January 1, 2020, Shrub, Inc. has $100,000 convertible debenture bonds which were sold at par ($1,000 per bond). The bonds are due in 10 years and pay 8% interest. Each bond is convertible into 20 shares of common stock. Shrub has a 35% tax rate. None of the bonds were converted during 2020. When Shrub computes diluted EPS on December 31, 2020, which of the following occurs?

$5,200 is added to the basic numerator. 2,000 shares are added to the basic number of shares outstanding. Reason: $100,000 x 8% x (1 - 35%) = $5,200.

Flower, Inc. had 100,000 shares of common stock outstanding on January 1, 2020. On April 1, 2020, the company issued 10,000 new shares and on September 1, 2020, the company purchased 12,000 shares of treasury stock. The number of shares Flower should use in the denominator of its EPS calculation is

103,500 Reason: (100,000 x 3/12) + (110,000 x 5/12) + (98,000 x 4/12) = 103,500

Which of the following statements are true? Firms may reacquire their own common shares for employee stock option redemptions. Firms may reacquire their own common shares because they believe they are overvalued at the current market price. Firms are prohibited from reacquiring their common shares. Firms may reacquire their own common shares to redistribute surplus cash to shareholders.

Firms may reacquire their own common shares for employee stock option redemptions. Firms may reacquire their own common shares to redistribute surplus cash to shareholders.

Which of the following is an advantage for a shareholder who takes the stock repurchase?

Gains are taxed at capital gains rates.

Which of the following are key provisions of the current authoritative guidance for accounting for stock options?

Grant-date compensation cost is recognized as an expense on a straight-line basis over the vesting period. Compensation cost is determined by the grant-date fair value measured using option-pricing models.

Which of the following are reasons cited by parties who agree with expensing employee stock options?

Helps restore investor confidence Reduces incentive of top executives to pump stock through short-term earnings maneuvers.

Which of the following are concerns regarding companies who complete stock buyback programs?

May be motivated solely to increase EPS. Companies may be replacing equity with debt.

Which of the following statements is correct regarding preferred stock?

Nonparticipating preferred stock is only entitled to receive the stipulated dividend.

On January 2, Patent Co. issued 10,000 shares of $1 par value common stock for $10 per share. On June 1, Patent reacquired 2,000 shares for $12 per share. On November 1, Patent resold 500 of the shares for $15 per share. If Patent uses the cost method, which of the following statements is true?

On November 1, Treasury stock will be credited for $6,000. On June 1, Treasury stock will be debited for $24,000.

On January 2, Patent Co. issued 10,000 shares of $1 par value common stock for $10 per share. On June 1, Patent reacquired 2,000 shares for $12 per share. On November 1, Patent resold 500 of the shares for $15 per share. On December 20, Patent resold 500 shares for $11 per share. If Patent uses the cost method, on December 20

Paid-in capital from treasury stock will be debited for $500.

On January 2, Patent Co. issued 10,000 shares of $1 par value common stock for $10 per share. On June 1, Patent reacquired 2,000 shares for $12 per share. On November 1, Patent resold 500 of the shares for $15 per share. On December 20, Patent resold 500 shares for $11 per share. If Patent uses the cost method, on December 20,

Paid-in capital from treasury stock will be debited for $500.

Which of the following are true when a company borrows to finance a stock repurchase program?

Shareholders will own a more leveraged company. The company faces the risk that an economic downturn could make it more difficult to service debt.

Which of the following parties did not lobby the FASB in an attempt to influence reporting rules related to employee stock options?

The IRS

Which of the following parties lobbied the FASB in an attempt to influence reporting rules related to employee stock options?

The U.S. Senate Auditors The SEC

Which of the following are true of convertible debt?

The conversion price is the dollar value that the debt can be converted into common stock. Convertible bonds are usually callable.

Which of the following are true of the legality of corporate dividend distributions?

The intent of laws governing corporate dividend distributions is to prevent insolvency from distributing excessive dividends. State laws govern corporate dividend distributions.

Which of the following criteria must be met in order for a plan to qualify as an ISO?

The option is granted with 10 years from the date the plan is adopted.The option is nontransferable.

Which of the following criteria must be met in order for a plan to qualify as an ISO

The option is nontransferable. The option is granted with 10 years from the date the plan is adopted.

Which of the following are reasons that companies use stock options to augment cash compensation?

To attract talented employees while conserving cash. To provide tax savings to employer or employee. To align employee's interests with interests of stockholders.

Which of the following is not a reason companies use stock options to augment cash compensation?

To avoid dilution of EPS.

trust preferred security

When a company creates a special purpose entity that then sells redeemable preferred stock to outside investors,

The dollar value at which the debt can be converted into common stock is known as the

conversion price.

When a lending agreement restricts allowable debt-to-equity levels it is referred to as a

covenant.

There was strong and widespread opposition to the FASB's stock options initiative. The arguments raised included

legality of corporate distributions to owners. appropriate income measurement. linkage to equity valuation.

The method that accounts for treasury stock by reducing contributed capital accounts for the amount of the stock's original issuance proceeds is known as the

par value method.

When a borrower has the right to pay some or all of the value of convertible debt in cash rather than in shares of stock, GAAP requires

separate recognition of the debt and equity components.

What structure exists when a company has no convertible securities and no stock options or warrants outstanding?

simple capital

A ____ _____ reduces the per share par value and increases the number of share proportionately.

stock split

Financial statement analysts must understand how owners' equity is reported

to determine whether a company is in compliance with its equity-based covenants.

Companies reacquire their own shares for all of the following reasons except

to generate income.

When using the par value method of accounting for treasury stock,

treasury stock is deducted from the Common stock account.

Under GAAP guidance, when using the _________ method, the company assumes that any proceeds received from the exercise of options is used to buy back shares at the ______.

treasury stock; average market price for the period

When a company creates a special purpose entity that then sells redeemable preferred stock to outside investors, the shares are called

trust preferred.

A typical employee stock option gives the employee the right to purchase a specified number of common shares within a specified time period at a specified price. This price is

usually equal to or higher than the market price at the time the options are issued.

which of the following are reasons cited by parties who disagree with expensing employee stock options?

Limits a key tool used to lure talent and will hurt morale Reduction in the accuracy of income statements No cash outlay is required

____ ____ preferred stock requires the issuing company to retire it at some future date.

Mandatorily redeemable

Which of the following is required to be retired at some future date?

Mandatorily redeemable preferred stock

An ISO represents a ______ tax difference.

permanent

When a firm has a complex capital structure, financial instruments entitle holders to obtain common stock under specified conditions. This possible increase in the number of shares is called

potential dilution

On January 1, 2020, Shrub, Inc. has $100,000 convertible debenture bonds which were sold at par ($1,000 per bond). The bonds are due in 10 years and pay 6% interest. Each bond is convertible into 10 shares of common stock. Shrub has a 30% tax rate. None of the bonds were converted during 2020. When Shrub computes diluted EPS on December 31, 2020, which of the following occurs?

$4,200 is added to the basic numerator. Reason: $100,000 x 6% x (1 - 30%) = $4,200.

When a company has a simple capital structure it computes EPS as

(Net income - Preferred dividends)/Weighted average number of common shares.

A criterion for an ISO plan is that the option cannot be exercised after ________ years from the date of the grant.

10

Which of the following statements are true regarding preferred stock?

70% - 80% of dividends are a tax deductible expense.

Raoul, Inc. has 1,000,000 shares authorized and 800,000 shares have been issued. During 2020, the company purchased 26,000 shares of treasury stock that are accounted for using the cost method. The number of shares outstanding is

774,000. Shares issued - treasury shares = shares outstanding.

Which of the following are true of the difference between tax and financial accounting?

A difference that relates to the timing of expense recognition is a temporary difference. A difference that results from an expense deduction in GAAP that is not deductible for tax purposes is a permanent difference.

Which of the following is not an assumptions necessary when computing diluted EPS?

After-tax net income decreases when the debt interest payments are eliminated after conversion.

Treating stock options as an expense is inappropriate because stock options do not involve a cash outflow was the argument categorized as

Blank 1: appropriate Blank 2: income Blank 3: measurement

The argument against expensing employee stock options because it would increase compensation expense and lower earnings and thus lower stock price is categorized as ________ ________

Blank 1: equity Blank 2: valuation

Which of the following are assumptions necessary when computing diluted EPS?

Cash received when an option is exercised is used to acquire treasury stock. New shares are issued upon conversion.

Which of the following are concerns regarding companies who complete stock buyback programs?

Companies may be replacing equity with debt. May be motivated solely to increase EPS.

Which of the following statements are true regarding preferred stock?

Companies must clearly differentiate between common and any type of preferred stock. The disclosure of the dollar amount of preferred stock redemption requirements for 5 years following the balance sheet date.

Which of the following are key provisions of the current authoritative guidance for accounting for stock options?

Compensation cost is determined by the grant-date fair value measured using option-pricing models. Grant-date compensation cost is recognized as an expense on a straight-line basis over the vesting period.

There was strong and widespread opposition to the FASB's stock options initiative. Which of the following is not one of the arguments raised

Compliance with state and local laws

There was strong and widespread opposition to the FASB's stock options initiative. Which of the following is not one of the arguments raised?

Compliance with state and local laws

Which of the following is correct regarding opposition to the FASB's move toward expensing stock options?

Congress initiated legislation which would have eliminated the FASB's independence. The FASB allowed a choice in accounting methods between the intrinsic value approach and measurement of the fair value of the option.

Which of the following are true of diluted EPS?

Diluted EPS presumes the minimum earnings flow to each share. Diluted EPS presumes the maximum possible new share creation. Diluted EPS is a conservative measure.

Which of the following are limits that states may place on corporate dividend distributions?

Dividends are limited to the amount of retained earnings plus paid-in capital in excess of par. Dividends are limited to the amount of retained earnings.

Under U.S. GAAP, which of the following is true for convertible debt that may be settled in cash?

GAAP requires separate recognition of debt and equity components.

Which of the following are true of specific employee stock option contracts?

Incentive stock options provide tax benefits to employees. Nonqualified stock option plans provide tax benefits to employers.

Which of the following are true regarding a trust preferred security?

It allows the company to gain tax advantages associated with debt. It is a form of mandatorily redeemable preferred stock.

Which of the following are true regarding a trust preferred security

It is a form of mandatorily redeemable preferred stock. It allows the company to gain tax advantages associated with debt.

Which of the following are true of compensation cost according to GAAP?

It is measured at the grant date. It is measured only once.

Which of the following is incorrect regarding preferred stock

It is preferred relative to debt holders.

Which of the following is incorrect regarding preferred stock? If the company is liquidated, preferred stockholders receive assets at least equal to their par value before common stockholders receive anything. It is preferred relative to debt holders. It usually does not carry voting rights. It may be participating or nonparticipating.

It is preferred relative to debt holders.

Which of the following are true of earnings per share?

It is required to be shown on the income statement. It is how much of the company's total earnings accrue to each share of common stock.

Which of the following are true of APB Opinion No. 25?

It was issued in 1972. It based compensation on the option's intrinsic value.

Which of the following statements is correct regarding GAAP's ownership perspective?

Net capital deployed is defined as Assets - Liabilities.

Which of the following is a reason for not assigning a value to the conversion privilege of convertible bonds?

Practical problems of determining separate values for the debt and the conversion option. Inseparability of the conversion feature from the debt component.

Which of the following is not a preferred stock disclosure requirement?

Preferred stock can be combined with common stock on the balance sheet.

Which of the following are reasons corporations may issue preferred stock?

Preferred stock is less risky than debt. Preferred stock is treated as equity rather than debt on financial statements.

Which of the following are reasons corporations may issue preferred stock? Preferred stock is treated as debt rather than equity on financial statements. Preferred stock will always have greater tax advantages than debt. Preferred stock is less risky than debt. Preferred stock is treated as equity rather than debt on financial statements.

Preferred stock is less risky than debt. Preferred stock is treated as equity rather than debt on financial statements.

Which of the following are true regarding GAAP's ownership perspective?

Shareholders are insiders and dividends are not an expense to the company. No income or loss can arise from transactions between the firm and its owners.

Which of the following are true when a company borrows to finance a stock repurchase program?

Shareholders will own a more leveraged company. The company faces the risk that an economic downturn could make it more difficult to service debt

For which method does the company assume that any proceeds received from the exercise of options are used to buy back shares at the average market price for the period?

Treasury stock method

Which of the following are true regarding surplus cash?

Using surplus cash for stock repurchases rather than dividend payments can save shareholders on taxes. Surplus cash can be used by outside companies or investors to finance a hostile takeover.

property dividend

a dividend involves noncash assets.

Small stock dividends are

accounted for at market value under U.S. GAAP. less than 25% of shares outstanding.

Stock repurchases do not involve accounting gains and losses because they

are transactions between the company and its owners.

Under the Revised Model Business Corporation Act,

as long as the fair value of assets exceeds the fair value of liabilities after distribution, the company is considered solvent.

Unlike U.S. GAAP, IFRS guidance requires the liability and equity components in convertible debt.

be separated regardless of whether the issuer can exchange the debt for cash upon conversion.

GAAP permits companies to record debt conversion using the

book value method. market value method.

Specific employee stock option contracts

can provide tax benefits to either employees or employers, but not both. can be categorized as nonqualifed stock option plans which provide tax benefits to employers.

Book value per share is computed by dividing

common equity by number of shares outstanding

Flower, Inc. has common stock, preferred stock, redeemable preferred stock, employee stock options, call options, and convertible bonds in its capital structure. Flower has a ______ capital structure and is required to present an additional measure called ______.

complex; diluted EPS

The Revised Model Business Corporation Act

considers solvency to mean the fair value of assets exceeds the fair value of liabilities. has been adopted by the majority of states.

What is the term used to describe how much of the company's total earnings accrue to each share of common stock?

earnings per share

True Stock Split

educes the per share par value and increases the number of share proportionately.

A typical employee stock option gives the employee the right to purchase a specified number of common shares within a specified time period at a specified price called the

exercise price

The _____ date is the date when both the stock options are awarded to individual employees and the grant's terms are set.

grant

The ________ date is the date when both the stock options are awarded to individual employees and the grant's terms are set.

grant

Under APB Opinion No. 25,

if the exercise price equaled or exceeded the stock price on the grant date no compensation expense was recorded.

Which of the following is not a key provision of the current authoritative guidance for accounting for stock options?

incremental compensation cost arising from modifications to the original award terms is recognized in the period the modification is made.

Dividends paid on mandatorily redeemable preferred stock are recorded as

interest expense.

For nonqualified stock option plans, employees owe tax on the ____ value at the date of ____.

intrinsic exercise

GAAP specifies that compensation cost

is measured only once, on the grant date.

Mandatorily redeemable preferred stock is reported as a(n) _____ on the balance sheet.

liability

How a company's options, warrants, and convertible securities affect its earnings per share is the accounting procedure/reporting convention known as

linkage to equity valuation.

Diluted EPS is a conservative measure because the diluted EPS measure presumes the _______ possible new share creation and therefore the ________ earnings flow to each share.

maximum; minimum

U.S. GAAP specifies that convertible bonds

must be recorded as debt only, with no value assigned to the conversion privilege.

The number of shares outstanding is generally

not shown in the balance sheet.

If a dividend involves noncash assets, it is called a

property dividend

Specific employee stock option contracts

recognizes no gain or loss at retirement.

mandatorily redeemable , preferred stock

requires the issuing company to retire it at some future date.

A nonqualified stock option plan

results in employees owing tax on the intrinsic value at the date of exercise. is any plan that does not qualify as an ISO plan.

Antidilutive

securities are ignored when computing EPS because they increase EPS.

An option will be antidilutive when

the average market price is less than the exercise price.

When computing book value per share

the carrying amount of preferred stock is subtracted from total equity to obtain common equity.

If a company declares a property dividend to be paid from an investment with a carrying value of $100,000 and a fair value of $142,000,

the investment will be adjusted to fair value and a gain of $42,000 will be recognized.

The accounting procedure/reporting convention known as the legality of corporate distributions to owners addresses

the priority of cash payouts when a company liquidates.

The limited liability aspect of common stock limits

the risk of loss.

When purchasers of common stock can only lose the amount invested to purchase the shares

the shares were purchased for more than the par value.

The grant date is the date when

the stock options are awarded to individual employees. the grant's terms are set.

A contra-equity account is used to account for purchases of

treasury stock.