Chapter 18 Shareholders’ Equity

Q 18-10 Most preferred shares are cumulative. Explain what this means.

If preferred shares are noncumulative, dividends not declared in any given year need never be paid. However, if cumulative, when the specified dividend is not paid in a given year, the unpaid dividends accumulate and must be made up in a later dividend year before any dividends are paid on common shares. These unpaid dividends are called "dividends in arrears."

Q 18-22 What is a reverse stock split? What would be the effect of a reverse stock split on one million $1 par shares? On the accounting records?

When a company decreases, rather than increases, its outstanding shares, a reverse stock split occurs. A 1-for-2 reverse stock split would cause one million $1 par shares to become one-half million $2 par shares. No journal entry would be recorded, so no account balances will change. But the market price per share would double, and the par amount per share would double.

Q 18-23 Suppose you own 80 shares of Facebook common stock when the company declares a 4% stock dividend. What will you receive as a result?

You would be entitled to 3.2 shares (4% x 80 shares).

Q 18-9 Terminology varies in the way companies differentiate among share types. But many corporations designate shares as common or preferred. What are the two special rights usually given to preferred shareholders?

a. A preference to a predesignated amount of dividends, that is, a stated dollar amount per share or percent of par value per share. b. A preference over common shareholders in the distribution of assets in the event the corporation is dissolved.

Q 18-7 The owners of a corporation are its shareholders. If a corporation has only one class of shares, they typically are labeled common shares. Indicate the ownership rights held by common shareholders, unless specifically withheld by agreement.

a. The right to vote on policy issues. b. The right to share in profits when dividends are declared (in proportion to the percentage of shares owned by the shareholder). c. The right to share in the distribution of any assets remaining at liquidation after other claims are satisfied.

Q 18-13 How do we report components of comprehensive income created during the reporting period?

(a) an expanded version of the income statement or (b) a separate statement immediately following the income statement. It will report net income, other components of comprehensive income, and total comprehensive income.

Q 18-12 What is comprehensive income? How does comprehensive income differ from net income? Where do companies report it in a balance sheet?

Comprehensive income is a broader measure of the change in shareholders' equity for a reporting period, encompassing all nonowner changes in equity except those caused by transactions with owners. Comprehensive income differs from net income in that it includes all changes in equity due to nonowner transactions, while net income only includes changes reported in the income statement. Other comprehensive income includes the changes not part of net income. Comprehensive income is reported in two places: In the income section, either in an expanded income statement or in a separate statement following the income statement, showing net income, other comprehensive income, and total comprehensive income. In the equity section of the balance sheet, as a separate component of shareholders' equity, representing the cumulative sum of changes in each component over all reporting periods.

Q 18-17 The costs of legal, promotional, and accounting services necessary to effect the sale of shares are referred to as share issue costs. How are these costs recorded? Compare this approach to the way debt issue costs are recorded.

Share issue costs reduce the net cash proceeds from selling the shares and thus paid-in capital—excess of par. Paid-in capital—excess of par is credited for the excess of the proceeds over the par amount of the shares sold, and the issue costs are debited to that same account, thus reducing the account balance. Share issue costs are not subsequently amortized. While debt issue costs are similarly treated in that they reduce the proceeds from issuing debt, they differ in that debt issue costs are amortized to expense over the life of the debt. By doing so, debt issue costs change the effective rate of interest at which the debt is originally issued. The difference in accounting treatment often is justified by the presumption that share issue costs and debt issue costs are fundamentally different because a debt issue has a fixed maturity, but that selling shares represents a perpetual equity interest.

Q 18-8 What is meant by a shareholder's preemptive right?

The "preemptive right" is the right to maintain one's percentage share of ownership when new shares are issued.

Q 18-15 At times, companies issue their shares for consideration other than cash. What is the measurement objective in those cases?

The measurement objective is that the transaction should be recorded at fair value.

Q 18-14 The balance sheet reports the balances of shareholders' equity accounts. What additional information is provided by the statement of shareholders' equity?

The statement of shareholders' equity reports the transactions that cause changes in its shareholders' equity account balances. It shows the beginning and ending balances in primary shareholders' equity accounts and any changes that occur during the years reported. Typical reasons for changes are the sale of additional shares of stock, the acquisition of treasury stock, net income, and the declaration of dividends.

Q 18-1 Identify and briefly describe the two primary sources of shareholders' equity.

The two primary sources of shareholders' equity are amounts invested by shareholders in the corporation and amounts earned by the corporation on behalf of its shareholders. Invested capital is reported as paid-in capital and earned capital is reported as retained earnings.