Chapter 18: Shareholders' Equity
Effective April 27, year 2, the stockholders of Bennett Corporation approved a two‐for‐one split of the company's common stock, and an increase in authorized common shares from 100,000 shares (par value $20 per share) to 200,000 shares (par value $10 per share). Bennett's stockholders' equity accounts immediately before issuance of the stock split shares were as follows: What should be the balances in Bennett's additional paid‐in capital and retained earnings accounts immediately after the stock split is effected? Additional paid‐in capital Retained earnings $ 0 $ 500,000 $ 150,000 $ 350,000 $ 150,000 $ 1,350,000 $1,150,000 $ 350,000
$ 150,000 $ 1,350,000 This answer is correct. A stock split results in a decrease in par value per share and an increase in the number of shares outstanding. The total par value of shares outstanding remains unchanged, as do the balances of additional paid‐in capital and retained earnings. No journal entries are recorded for a stock split.
Ray Corp. declared a 5% stock dividend on its 10,000 issued and outstanding shares of $2 par value common stock, which had a fair value of $5 per share before the stock dividend was declared. This stock dividend was distributed 60 days after the declaration date. By what amount did Ray's current liabilities increase as a result of the stock dividend declaration? $0 $500 $1,000 $2,500
$0 The declaration of a stock dividend does not cause a liability to be reported. The dividend is not an asset.
Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30% stock dividend. The market value was $50 per share, the par value was $10, and the average issue price was $30 per share. By what amount will Universe decrease stockholders' equity for the dividend? $0 $1,500,000 $4,500,000 $7,500,000
$0 This answer is correct because the stock dividend involves transferring an equal amount from retained earnings to invested capital. In this case, the dividend is a large stock dividend resulting in a transfer at par value. Total equity does not change.
Cobb Co. purchased 10,000 shares (2% ownership) of Roe Co. on February 12, year 2. Cobb received a stock dividend of 2,000 shares on March 31, year 2, when the carrying amount per share on Roe's books was $35 and the market value per share was $40. Roe paid a cash dividend of $1.50 per share on September 15, year 2. In Cobb's income statement for the year ended October 31, year 2, what amount should Cobb report as dividend income? $98,000 $88,000 $18,000 $15,000
$18,000 This answer is correct. No dividend revenue is recognized when an investor receives a proportional stock dividend, because the investor continues to own the same proportion of the investee as before the stock dividend. In addition the investee has not distributed any assets to the investor. Therefore, Cobb's dividend income includes only the cash dividend received [(10,000 + 2,000) × $1.50 = $18,000].
On May 18, year 1, Sol Corp's board of directors declared a 10% stock dividend. The market price of Sol's 3,000 outstanding shares of $2 par value common stock was $9 per share on that date. The stock dividend was distributed on July 21, year 1, when the stock's market price was $10 per share. What amount should Sol credit to additional paid‐in capital for this stock dividend? $2,100 $2,400 $2,700 $3,000
$2,100 The issuance of a stock dividend less than 20‐25% (a "small" stock dividend) requires that the fair value of the stock (on the date of declaration) be transferred from retained earnings, and a dividend greater than 20‐25% (a "large" stock dividend) requires that the par value of the stock be transferred from retained earnings. Thus, a 10% stock dividend is considered to be a "small" stock dividend and should be transferred from retained earnings at the FV on the date of declaration as follows: Retained earnings 2,700 (300 × $9) Common stock 600 (300 × $2) APIC 2,100 (excess) Thus, Sol should credit $2,100 to additional paid‐in capital.
On May 18, 20X4, Sol Corp.'s board of directors declared a 10% stock dividend. The market price of Sol's 3,000 outstanding shares of $2 par value common stock was $9 per share on that date. The stock dividend was distributed on July 21, 20X4, when the stock's market price was $10 per share. What amount should Sol credit to additional paid‐in capital for this stock dividend? $2,100 $2,400 $2,700 $3,000
$2,100 This question is difficult, because authoritative sources and textbooks disagree as to the market value that should be used to value stock dividends. Small stock dividends (less than 25%) are measured at the market value of the stock issued. But the market value can be measured at declaration or at issuance.
Wood Co. owns 2,000 shares of Arlo, Inc.'s 20,000 shares of $100 par, 6% cumulative, non‐participating preferred stock and 1,000 shares (2%) of Arlo's common stock. During 20X5, Arlo declared and paid dividends of $240,000 on preferred stock. No dividends had been declared or paid during 20X4. In addition, Wood received a 5% common stock dividend from Arlo when the quoted market price of Arlo's common stock was $10 per share. What amount should Wood report as dividend income in its 20X5 income statement? $12,000 $12,500 $24,000 $24,500
$24,000 The annual preferred dividend commitment is $120,000 (20,000 × $100 × .06).
On September 30, year 1, Grey Company issued 3,000 shares of its $10 par common stock in connection with a stock dividend. No entry was made on the stock dividend declaration date. The market value per share immediately after issuance was $15. Grey's stockholders' equity accounts immediately before issuance of the stock dividend shares were as follows: Common stock $10 par; 20,000 shares authorized outstanding $200,000 Additional paid‐in capital 300,000 Retained earnings 350,000 What should be the retained earnings balance immediately after the stock dividend? $305,000 $320,000 $327,500 $350,000
$305,000 This answer is correct. The stock dividend is a 15% dividend (3,000/20,000). A stock dividend of less than 20‐25% is recorded (on the date of declaration) at the FV of the shares to be issued. This amount is charged to Retained earnings and credited to the Stock dividend distributable and Paid‐in capital accounts. The FV of the stock on the date of declaration is not indicated in the problem; however, the FV immediately after issuance of the stock dividend is $15. This is the best choice based on the information available. Therefore, Retained earnings would be charged for $45,000 (3,000 × $15). The retained earnings balance would then be $305,000 ($350,000 − $45,000).
Pugh Co. reported the following in its statement of stockholders' equity on January 1, 20X4: Common Stock, $5 par value, authorized 200,000 shares, issued 100,000 shares $ 500,000 Additional paid‐in capital 1,500,000 Retained earnings 516,000 2,516,000 Less treasury stock, at cost, 5,000 shares 40,000 Total stockholders' equity $2,476,000 ======== The following events occurred in 20X4: May 1 − 1,000 shares of treasury stock were sold for $10,000. July 9 − 10,000 shares of previously unissued common stock were sold for $12 per share. October 1 ‐ The distribution of a 2‐for‐1 stock split resulted in the common stock's per share par value being halved. Pugh accounts for treasury stock under the cost method. Laws in the state of Pugh's incorporation protect shares held in treasury from dilution when stock dividends or stock splits are declared. In Pugh's December 31, 20X4 statement of stockholders' equity, the par value of the issued common stock should be $550,000 $518,000 $291,000 $275,000
$550,000 Treasury stock transactions do not affect shares issued, because treasury shares are included in issued shares. The only event during the year affecting the total par value of common stock issued is the July 9 issuance of shares that were not issued before. The stock split does not change total par of shares issued, because par is cut in half and the number of shares is doubled. Treasury shares are protected, meaning they are also doubled and have their par cut in half. The total par of issued common stock at year‐end is $550,000.
Godart Co. issued $4,500,000 notes payable as a scrip dividend that matured in five years. At maturity, each shareholder of Godart's three million shares will receive payment of the note principal plus interest. The annual interest rate was 10%. What amount should be paid to the stockholders at the end of the fifth year? $ 450,000 $2,250,000 $4,500,000 $6,750,000
$6,750,000 This answer is correct. The amount paid to stockholders should be $4,500,000 plus the interest earned during each of the five years. Using simple interest, the interest can be calculated as $4,500,000 × 10% = $450,000 each year × 5 years = $2,250,000 interest. The total amount due to the stockholders for the scrip dividend is $4,500,000 + $2,250,000 interest = $6,750,000.
How would the declaration of a 15% stock dividend by a corporation affect each of the following? Retained earnings Total stockholders' equity No effect No effect No effect Decrease Decrease No effect Decrease Decrease
Decrease No effect Retained earnings are debited in a stock dividend, and common stock and possibly additional paid‐in capital are credited. Therefore, retained earnings are reduced, but total owners' equity is unchanged, because all accounts affected by the stock dividend are owners' equity accounts.
How would the declaration of a 10% stock dividend by a corporation affect each of the following on its books? Retained earnings (RE) Total stockholders' equity (SE) Decrease No effect Decrease Decrease No effect Decrease No effect No effect
Decrease No effect This answer is correct. Regardless of the size of a stock dividend, RE is decreased and other SE accounts are increased. Since the dividend described in this question is small (< 20‐25% of the outstanding shares), the journal entry would be Retained earnings (FV) Common stock dividend distributable (par value) Additional paid‐in capital (plug) Accordingly, RE will decrease and, since all affected accounts are elements of SE, total SE will not change. Note that the entry for a large stock dividend would be Retained earnings (par) Common stock dividend distributable (par)
On May 1, year 1, Rhud Corp. declared and issued a 10% common stock dividend. Prior to this dividend, Rhud had 100,000 shares of $1 par value common stock issued and outstanding. The fair value of Rhud's common stock was $30 per share on May 1, year 1. As a result of this stock dividend, Rhud's total stockholders' equity Increased by $300,000. Decreased by $300,000. Decreased by $10,000. Did not change.
Did not change. This answer is correct. A stock dividend has no effect on total stockholders' equity. No assets are transferred to stockholders as in the case of a cash or property dividend. Stockholders merely receive more shares of stock. The journal entry to record a small stock dividend (less than 20‐25%) transfers an amount equal to the fair value of the stock to be issued from retained earnings to paid‐in capital. Therefore, one part of stockholders' equity decreases while another part increases. The journal entry below summarizes the net effect of the entries to record a stock dividend. Retained earnings (10,000 × $30) 300,000 Common stock (10,000 × $1) 10,000 Paid‐in capital 290,000
The following format was used by Gee, Inc. for its 20X5 statement of owners' equity: When both the 100% and the 5% stock dividends were declared, Gee's common stock was selling for more than its $1 par value. How would the 5% stock dividend affect the additional paid‐in capital and retained earnings amounts reported in Gee's 2005 statement of owners' equity? Additional paid‐in capital Retained earnings Increase Decrease Increase Increase No Change Decrease No Change Increase
Increase Decrease The stock dividend is a "small" stock dividend because it is less than 20% ‐ 25%. Small stock dividends are capitalized at market value, which exceeds par in this case. Retained earnings is reduced by the market value of the shares issued, common stock is increased by the par value of stock issued, and additional paid‐in capital is increased by the difference between market value and par value times the number of shares issued.
How would the declaration and subsequent issuance of a 10% stock dividend by the issuer affect each of the following when the market value of the shares exceeds the par value of the stock? Common stock Additional paid‐in capital No effect No effect No effect Increase Increase No effect Increase Increase
Increase Increase This answer is correct. The issuance of a stock dividend of 20‐25% or less requires that the market value of the stock be transferred from retained earnings. Retained earnings (fair market value) Common stock (par value) Additional paid‐in capital (excess)
The following format was used by Gee, Inc. for its 20X5 statement of owners' equity: When both the 100% and the 5% stock dividends were declared, Gee's common stock was selling for more than its $1 par value. How would the 100% stock dividend affect the additional paid‐in capital and retained earnings amounts reported in Gee's 20X5 statement of owners' equity? Additional paid‐in capital Retained earnings Increase Increase Increase Decrease No Change Increase No Change Decrease
No Change Decrease A 100% stock dividend is a "large" stock dividend because it exceeds 20% ‐ 25%. Large stock dividends are capitalized at par value. Retained earnings is reduced by the par value of the shares issued, and common stock is increased by the par value of stock issued. There is no effect on additional paid‐in capital because the entire decrease in retained earnings is recorded in common stock. A large stock dividend permanently capitalizes the par value of the issued shares into common stock.
How would a stock split affect each of the following? Assets Total stockholders' equity Additional paid‐in capital Increase Increase No effect No effect No effect No effect No effect No effect Increase Decrease Decrease Decrease
No effect No effect No effect This answer is correct because stock splits do not decrease the property of the corporation nor do they increase the property of the recipient. The only effects of a stock split are on the number of shares outstanding and on the par value of the stock. The assets, total stockholders' equity, and the additional paid‐in capital accounts of the company are not affected.
A company whose stock is trading at $10 per share has 1,000 shares of $1 par common stock outstanding when the board of directors declares a 30% common stock dividend. Which of the following adjustments should be made when recording the stock dividend? Treasury stock is debited for $300. Additional paid‐in capital is credited for $2,700. Retained earnings is debited for $300. Common stock is debited for $3,000.
Retained earnings is debited for $300. This is a large stock dividend (> 25%); therefore retained earnings is debited for par value. The amount is the par value of the shares distributed in the dividend, or 1,000(.30)($1) = $300. The credit is to common stock for the shares issued.
On July 1, year 1, Alto Corp. split its common stock 5‐for‐1 when the market value was $100 per share. Prior to the split, Alto had 10,000 shares of $10 par value common stock issued and outstanding. After the split, the par value of the stock Remained at $10. Was reduced to $8. Was reduced to $5. Was reduced to $2.
Was reduced to $2. This answer is correct. A stock split results in an increase or decrease in the number of shares outstanding and a corresponding decrease or increase in the par value per share. A 5‐for‐1 split in this case would increase the shares outstanding to 50,000 and decrease the par value per share to $2 ($10/5). Total par value is not affected by a stock split (10,000 × $10 before split; 50,000 × $2 after split).
Long Co. had 100,000 shares of common stock issued and outstanding at January 1, 20X6. During 20X6, Long took the following actions: March 15 ‐ Declared a 2‐for‐1 stock split, when the fair value of the stock was $80 per share. December 15 ‐ Declared a $.50 per share cash dividend. In Long's statement of stockholders' equity for 20X6, what amount should Long report as dividends? $50,000 $100,000 $850,000 $950,000
You Answered $50,000 This answer is one‐half the correct answer, because it fails to account for the doubling of shares that took place before the cash dividend. Correct Answer $100,000
How would retained earnings be affected by the declaration of each of the following? Stock dividend Stock split Decrease Decrease No effect Decrease No effect No effect Decrease No effect
Decrease No effect This answer is correct. When a stock dividend is declared by the board of directors, the following journal entry is made: Retained earnings (FV of stock) Common stock of dividend distributable (Par value of stock) Paid‐in capital in excess of par (Plug) Therefore, the declaration of a stock dividend will decrease retained earnings. When a stock split is declared, however, only a memo entry is made, and there is no effect on retained earnings.
The following stock dividends were declared and distributed by Sol Corp: Percentage of common shares outstanding at declaration date Fair value Par value 10 $15,000 $10,000 28 40,000 30,800 What aggregate amount should be debited to retained earnings for these stock dividends? $40,800 $45,800 $50,000 $55,000
$45,800 Small stock dividends (less than 25%) are capitalized at the fair value of stock issued and large stock dividends (greater than 25%) are capitalized at the par value of stock issued.
