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Dr. M. D. Chase Beach State University Intermediate Accountng-44A : Stockholder's / Page 1

CORPORATIONS: STOCKHOLDERS' EQUITY and DIVIDENDS

I. Types of Business Organizations:

Proprietorship: A proprietorship is a business operated one owner, the proprietor. The proprietor may have any number of employees, but is the only individual responsible for the operation of the business. A proprietorship is an accounting entity but it is not an entity for legal or tax purposes. 1. Principal advantages: a. ease of formation b. flexibility due to freedom from outside constraints 2. Principal disadvantages: a. unlimited liability of the proprietor because the proprietorship is not a legal entity;

Partnerships: Same as proprietorship except two or more owners

Corporation: Corporations differ from proprietorships and partnerships in that they are legal and taxable entities in addition to being an accounting entity. They are characterized by , which represents ownership shares. Individuals purchase stock to own part of the . 1. Principle advantages: a. separation of ownership (stockholders) from management usually insures a more professional management team; b. ability to raise capital through the sale of c. owners (stockholders) liability is limited to the amount of their investment (purchase price of their stock)

2. Principle disadvantages: a. Strict regulations must be adhered to on formation to protect creditors, owners and other outsiders result in high initial costs; b. Because the corporation is a legal and taxable entity in addition to being an accounting entity, income is taxed at the corporate level and taxed again at the ownership level when dividends are declared.

II. Corporations: A. Public Corporations: Government owned corporations to meet a social need. Examples include the FDIC (Federal Deposit Insurance Corporation), FSLIC (Federal Savings and Loan Insurance Corporation) among others.

B. Mutual Corporations: Cooperatives formed to benefit specific consumer groups. There are many insurance companies and savings and loans operated as mutual corporations.

C. Private Corporations: 1. Publicly held corporations: This is the type of "corporation" most commonly thought of when we think of the corporate form of business. The stock is actively traded on organized stock exchanges and changes hands on a regular basis. There is a ready "" for such stock as a result of being traded on the . The discussion about corporations above and to follow refers to publicly held corporations.

2. Closely held corporations: a. Professional Corporations: Limited stock ownership to members of legally recognized professions and shares are not actively traded on organized exchanges.

b. Subchapter S Corporations: Small business corporations allowed under Subchapter S of the Internal Revenue Code to prevent double taxation of owners while still allowing other benefits that accrue to legal entities (corporations) such as certain types of health plans, retirement benefits, ownership of assets etc. Ownership is limited to 35 individuals (70 if spouses are owners) and shares are not traded on organized exchanges.

III. The Nature of Stockholders' Equity A. "Equity" means ownership interest. Therefore stockholders' equity represents that part of the corporation "owned" by the stockholders (in concept). This ownership is "in concept" because stockholder equity represents the of the stockholders ownership interest, which usually bears little if any relationship to the fair market value of the corporation. This concept will be illustrated in the following discussion and examples. Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 2

B. The terminology of Stockholders Equity. 1. : An arbitrary value assigned to each of stock issued by a corporation. This value is determined by the issuing corporation and is imprinted on each issued. The number of shares issued multiplied by the par value per share becomes the legal capital of the corporation. The par value of the stock has absolutely no effect on the market value of the stock.

Note: The value of capital stock on the is always equal to the number of shares issued and outstanding multiplied by the par or stated value of the common stock.

2. No Par Stock: If allowed by the State in which the corporation is chartered stock may be issued without a par value. In this case no value is imprinted on the stock certificates issued. All no par stock must have a "stated value" in lieu of par value. In the case of no par stock, the legal capital is the number of shares issued multiplied by the stated value of the stock. If no stated value exists, legal capital is the total amount received.

3. Legal Capital: Legal capital is the number of shares issued and outstanding multiplied by the par or stated value of the stock. Because assets must equal labilities plus owners equity, Legal capital provides protection for the creditors by guaranteeing that the corporation maintain a certain amount of assets on the books. Further, legal capital may have the effect of restricting the amount of cash dividends that can be distributed to stockholders because cash is an asset and the payment of dividends would reduce the asset side of the equation. Dividends can generally only be distributed to the extent that a company has retained earnings.

Legal Capital

The concept of Legal Capital is illustrated below: Assume that 100,000 shares of $10 par value stock is issued at par and that the corporation has $50,000 in liabilities:

Assets = Labilities + Stockholders Equity $ 1,050,000* $ 50,000 $ 1,000,000 (100,000 x $10) * We can compute the value of assets by definition

Note that because the equation must by definition be "in balance", the asset side of the equation must always be maintained at a certain minimum. By definition, this provides protection to creditors. If not for the concept of legal capital (a result of the of 1929) the stock holders equity portion of the equation could be reduced an thereby put creditors at much greater risk. To illustrate, assume that the par value of the stock is $1. Note the effect on assets.

Assets = Labilities + Stockholders Equity $ 150,000* $ 50,000 $ 100,000 (100,000 x $1)

Obviously, the lower the par or stated value, the less protection is provided to creditors in the form of mandatory assets that must be maintained. It should be noted that the value of assets is historical cost, and may bear little or no relationship to the actual fair market value of the assets.

4. Classes of Stock: a. Common Stock: CS has the following rights: 1. Voting rights: The right to vote for the and on other important issues. A stockholder has one vote for each share of common stock owned.

2. rights: The right to receive dividends (distribution of earnings from retained earnings) WHEN DECLARED by the Board of Directors.

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 3

3. Liquidation Rights: A right to share in the distribution of assets upon liquidation of the corporation. Liquidation rights are residual. This means that when the corporation is liquidated, the common stockholders receive their share of the liquidating proceeds only after the preferred stockholders liquidation rights are satisfied (preferred stockholder receive par value of the ).

4. Preemptive Right: The right to maintain a proportionate share of ownership in the corporation.

b. Preferred Stock: PS has the following rights: 1. No voting rights.

2. Preference rights to dividends. Preferred stockholders' dividends must be paid before common stock dividends are paid. Dividends are fixed but are still only paid if declared by the Board of Directors.

3. Preference of liquidation distribution. Preferred stockholders get residual distribution before common stockholders.

4. No preemptive rights.

5. Preferred Stock "Sweeteners": In order to make preferred stock more attractive and thereby reduce the stated interest rate that will be paid to preferred stockholders, some corporations add characteristics to the preferred stock to make it more attractive. These enticing characteristics are commonly referred to as "sweeteners".

a. Cumulative Preferred: Dividends not paid in one year accumulate and must be paid in succeeding years. The unpaid dividends are generally referred to as DIVIDENDS IN ARREARS. The total amount of dividends in arrears plus the current year's dividends must be paid to the preferred stockholders before common stockholders have rights to dividend payments declared by the Board of Directors in the current year.

Note: Dividends in arrears are not liabilities but they should be disclosed as footnotes to the financial statements.

b. Participating Preferred: When the board of directors declares a dividend large enough exceed the amount due to preferred stockholders (par value of the preferred stock multiplied by the stated dividend rate) and the same rate applied to the common stock (par value of the common stock multiplied by the preferred stated dividend rate), the participation feature entitles preferred stockholders to participate in the excess dividends ratably (based on relative par values) with the common stockholders. Participating preferred stock may be either fully or partially participating. Fully participating preferred stock shares dividends with common stock on the basis of the relative par value of the stock, without limitation. Partially participating preferred stock is limited by the terms of the participation agreement, usually a stated percentage of par value.

5. Authorized Stock: The corporate charter of a corporation permits the issuance of a specified number of shares. Sometimes all of the stock is issued at once, but more often, some shares are not issued, but are held in reserve to raise more capital. A company may only issue the authorized number of shares. If more shares are needed to raise additional capital, the company must return to the state corporation commission and receive authorization for any additional shares.

6. Issued, Outstanding and : Authorized shares of stock that are sold by the corporation are referred to as issued stock. Issued stock can be either outstanding stock or treasury stock. Outstanding stock is stock that has been issued but not reacquired by the corporation; Treasury Stock is stock that has been issued but then subsequently reacquired by the corporation from the open market. Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 4

Cumulative and Participating Preferred Stock Illustrated

Assume the following facts for Shane, Inc. at 12/31/x5: 8% Preferred stock outstanding 10,000 shares @ $100 par,...... $ 1,000,000 Common stock outstanding 300,000 shares @ $10 par...... 3,000,000 Total par value ...... $ 4,000,000

Required:For each of the following independent situations computed the distribution of the dividend to preferred and common stock holders. Situation One: --The preferred stock is cumulative, and two years in arrears (including the current year). --Shane, Inc. declares a $500,000 dividend Distribution: Total Dividend declared...... $ 500,000 To Preferred Stock: (2yrs x .08 x 1,000,000)...... (160,000) Balance to common stock...... ………………….. 340,000 Total distribution...... $ 500,000

Situation Two: --The preferred stock is cumulative, and two years in arrears (including the current year). --The preferred stock is fully participating. --Shane, Inc. declares a $500,000 dividend CS shares “ratably” with the PS; in this case 8% Distribution: Total Dividend declared...... $ 500,000 To Preferred Stock: (2yrs x .08 x 1,000,000)...... ……….. (160,000) (Cumulative feature) Common stock: (3,000,000 x .08)...... …………………….. (240,000) Excess dividend available to preferred and common...... $ 100,000 Excess to preferred (1,000,000/4,000,000)(100,000)...... (25,000) (distrib. @ rel. par value) Excess to common stock (3,000,000/4,000,000)(100,000)...... (75,000) (distrib. @ rel. par value) Total distribution...... $ 500,000

Situation Three: --The preferred stock is cumulative, and two years in arrears (including the current year). --The preferred stock is partially participating (limited to 10% of par value). Distribution based on relative par values --Shane, Inc. declares a $500,000 dividend PS 1,000,000 CS 3,000,000 Total Par: 4,000,000

Distribution: Total Dividend declared...... …………………………… $ 500,000 To Preferred Stock: (2yrs x .08 x 1,000,000)...... (160,000) (Cumulative feature) To Common stock: (3,000,000 x .08)...... (240,000) Excess dividend available to preferred and common...... $ 100,000 Excess to preferred (100,000 x .02)...... …………… 20,000 Balance to common stock...... 80,000 Total distribution...... $ 500,000

7. Valuation of Corporate Stock: Corporate stock (either common or preferred) has both a book value and a market value. a. Book Value: 1. Preferred Stock: The book value of preferred stock is usually its par value if the corporation is solvent. If the corporation in danger of becoming insolvent, book value is the liquidating value (the value per share that will be available for distribution to the preferred stock). If it is cumulative preferred stock, any dividends in arrears are added to the liquidating value in calculating the book value.

a. Common Stock: The book value of common stock is the amount each share of common stock would receive if the corporation were liquidated on the basis of the amounts on the balance sheet i.e. book values were equal to market value. Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 5

Book Value of Common Stock Book value per common share is computed as follows: Common Stock + Common stock paid-in capital in excess of par* + Retained Earnings available to common ** + Donated Capital Number of Common

* Paid in capital in excess of par represents amounts received in excess of par value when the stock was sold, it is more fully explained below.

** Retained earnings available to common stock is total retained earnings reduced by any preferred stock or other claims.

b. Market Value: For common and preferred stock the market value is the amount the stock is selling for on the open market. If the stock is actively traded on a major , the market value is easily determined. If the stock is not actively traded or is stock of a closely held company, the market value is more difficult to determine.

III. Stockholders Equity: Stockholders equity consists of two components: A. Paid-in Capital: The contributed equity component of stockholder's equity. Paid-in capital (also known as contributed capital), paid-in capital has two components:

1. Value of the shares: # of shares x par value (this is the amount that is recorded on the books) 2. Paid in capital in excess of par value: the amount in excess of par value received when the shares were originally sold.

B. Retained Earnings: The earned equity component of stockholders' equity. Retained earnings represents the cumulative effect of all corporate earnings, less dividends paid to stockholders from the date the firm was founded to the date of the financial statements.

1. When presented in the stockholders' equity section, retained earnings is the year end retained earnings (retained earnings as of the date of the financial statements. 2. Retained earnings is sometimes presented in its own statement (the Retained Earnings Statement); in this case, all components comprising retained earnings are included in detail with the end result being the year end retained earnings. 3. Retained earnings that is avaialable for any purpose is unrestriced. Retained earnings may be restricted for specific purposes by action of the board of directors. If restricted, such restrictions must be disclosed in the Stockholders' equity section of the balance sheet.

Stockholders' Equity Section Illustrated

Stockholders' Equity: Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding...... $ 1,000,000 Common stock: ($10 par, 400,000 shares authorized, 300,000 shares issued and outstanding...... 3,000,000 Paid-in capital in excess of par value...... 1,000,000 Total paid-in capital...... $ 5,000,000 Retained Earnings: Restricted for Plant replacement...... $ 500,000 Unrestricted...... 1,500,000 2,000,000 Total stockholders equity...... $ 7,000,000*

* When presented in the Stockholder's equity section, retained earnings always represents year-end retained earnings (End of Year).

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 6

Statement of Retained Earnings Illustrated

Statement of Retained Earnings Retained earnings, 1/1/x1...... $ 1,800,000 Prior period adjustment: Correction of depreciation error in prior period (net of $20,000 tax). (50,000) Retained earnings, 1/1/x1 restated...... $ 1,750,000 Add: Current year income...... $ 350,000 Less: Dividends...... (100,000) 250,000 Retained earnings, 12/31/x1...... $ 2,000,000

IV. Dividends: Dividends represent a nonreciprocal distributions of earnings to the stockholders. Dividends must be declared by the board of directors, they are never automatic. A. Legal requirements to pay dividends: In order to pay dividends a corporation must have 1. sufficient retained earnings (retained earnings must never be reduce below zero) and 2. sufficient assets to distribute (with the exception of stock dividends).

B. There are five types of dividend distributions (note: all dividends except stock dividends reduce stockholders equity) 1. Cash dividends: (illustrated in table above)

2. Property dividends (dividends in kind): property dividends may involve assets or services. Journal entries for property dividends are similar to cash dividends except that retained earnings is reduced by the FMV of the property distributed. Property dividends are valued at the FMV of the property distributed. This means that the property must be revalued at current FMV and gains and losses are recognized.

3. Scrip dividends: scrip is a special form of a note payable. A corporation issuing a scrip dividend is in effect issuing a note (creating a liability) for a dividend to be paid at some future time.

4. Liquidating dividends: Liquidating dividends are dividends in excess of retained earnings and are illegal in some states. In those states where liquidating dividends are legal, paid-in capital in excess of par is debited for the amount of dividend in excess of retained earnings. A technical “liquidating dividend” may occur if a company’s dividend in any given year exceeds its earnings for that year.

5. Stock dividends: Stock dividends are unique in that they are capitalizations of retained earnings. In stock dividends, total stockholders equity remains constant but retained earnings is reduced by the value of the dividend and paid-in capital is increased by the amount of the dividend in equal amounts. There are two types of stock dividends, large stock dividends and small stock dividends. a. Large stock dividends: Large stock dividends are dividends in excess of 25% of the outstanding common stock 1. large stock dividends reduce retained earnings by the number of shares issued times par value 2. Small stock dividends: Small stock dividends are dividends less than 20% of the outstanding common stock a. small stock dividends reduce retained earnings by the number of shares issued times market value. The difference between par and market value is credited to pain-in capital in excess of par

Stock Dividends Between 20% and 25% of Outstanding Common Stock For dividends between 20% and 25%, the accountant must make an election based on the assumption of how the dividend will affect the market price of the stock. If no change in market price is expected, the dividend would be treated as a small stock dividend, otherwise, it should be treated as a large stock dividend.

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 7

Summary of Dividend Entries

Action Nomenclature Journal Entry

Board declares dividend, specifying a Date of Date of Declaration Retained Earnings...... xxxx Record and a Date of Payment Dividends Payable.. xxxx To record dividend liability

Date of Record arrives. The date of record Date of Record As soon as the information about who owns is important because dividends are paid to the shares on the date of record, a Memo stockholders holding the stock on the date of entry to specific stockholders accounts record. After the date of record the stock (subsidiary record) is made to insure proper trades ex dividend (without dividend). No crediting for shares held as of the date of action takes place on the date of record record. because it takes the corporation some time to discern who held the stock on the date of record.

Dividends are paid Date of Payment Dividends payable...... xxxx Cash...... xxxx To record payment of cash dividend

Journal entries to record Property Dividends

Retained earnings (reduced by FMV of property distributed...... xxxx Accumulated depreciation-property (pro rata based on % distributed)...... xxxx Loss on property distribution (if FMV of property is less than BV)...... xxxx Gain on property distribution (if FMV of property is more than BV)... xxxx Property (taken off the books at book value)...... xxxx

Journal Entries to record Declaration and Payment of a Scrip Dividend

Date of declaration: Retained earnings (scrip dividend declared)...... xxxx Notes payable to stockholders...... xxxx To record declaration of a scrip dividend

Date of Payment: Notes payable to stockholders...... xxxx Interest expense...... xxxx cash...... xxxx To record payment of scrip dividend and accrued interest

Journal Entries to record Declaration and Payment of a Liquidating Dividend

Assume that retained earnings is $500,000, and the corporation declares and pays a $800,000 cash dividend (assume that this is permissible under the law of the state of and that Paid-in capital in excess of par totals $1,000,000).

Date of declaration: Retained earnings ...... 500,000 Paid-in capital in excess of par...... 300,000 Dividends payable...... 800,000 To record declaration of a scrip dividend

Date of Payment: Dividends payable...... 800,000 Cash...... 800,000 To record payment of cash dividend Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 8

Stock Dividends Illustrated

The stockholders' equity section of Dallas, Inc. on 12/31/x1 is presented below: --The market value of Dallas, Inc. common stock on 12/31/x1 is $45/share. Stockholders' Equity: Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding …. $ 1,000,000 Common stock: ($10 par, 500,000 shares authorized, 300,000 shares issued and outstanding...... 3,000,000 Paid-in capital in excess of par value...... 1,000,000 Total paid-in capital...... $ 5,000,000 Retained Earnings...... 2,000,000 Total stockholders equity...... ………………………………………………………………………………….. $ 7,000,000 Situation One: Large stock dividend The board of directors of Dallas, Inc. declares a 50% stock dividend. Required: 1. Present all necessary journal entries to record the dividend. Date of Declaration: Retained earnings (.5)(300,000)($10)...... 1,500,000 Common stock dividend distributable...... 1,500,000 Date of Distribution: Common stock dividend distributable...... 1,500,000 Common Stock...... 1,500,000 2. Present the stockholders' equity section of Dallas, Inc. after the dividend has been distributed. Stockholders' Equity after large stock dividend: Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding $ 1,000,000 Common stock: ($10 par, 500,000 shares authorized, 450,000 shares issued and outstanding……………………………… . 4,500,000 Paid-in capital in excess of par value...... …………………………………………………………………………………… 1,000,000 Total paid-in capital...... ……………………………………………………………………………………………….. $ 6,500,000 Retained Earnings...... 500,000 Total stockholders equity...... $ 7,000,000 Situation Two: Small stock dividend The board of directors of Dallas, Inc. declares a 10% stock dividend. Required: 1. Present all necessary journal entries to record the dividend. Date of Declaration: Retained earnings (.1)(300,000)($45)...... 1,350,000 Common stock dividend distributable (30,000)($10)...... 300,000 Paid-in capital in excess of par (30,000($45-$10)...... 1,050,000 Date of Distribution: Common stock dividend distributable...... 300,000 Common Stock...... 300,000 2. Present the stockholders' equity section of Dallas, Inc. after the dividend has been distributed. Stockholders' Equity after small stock dividend: Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding $ 1,000,000 Common stock: ($10 par, 500,000 shares authorized, 330,000 shares issued and outstanding………………………….. 3,300,000 Paid-in capital in excess of par value...... …………………………………………………………………………………… 2,050,000 Total paid-in capital...... ……………………………………………………………………………………………….. $ 5,350,000 Retained Earnings...... ……………………………………………………………………………………………….. 650,000 Total Stockholders equity...... ………………………………………………………………………………………………. $ 7,000,000

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 9

C. Stock Splits: A is a distribution of stock to existing stockholders designed to lower the market price of the stock. Stock splits result in a percentage increase in the number of common stock shares outstanding. The increase is usually expressed as a ratio (e.g. two for one). This means that if a common stockholder owned one share before the split, the common stockholder would own two shares after the split. Due to the relatively large increase in the number of shares outstanding after the split, the market price of the stock is initially reduced in value proportionately to the amount of shares issued. For example, if before a two for one stock split the market price of a share of stock for X Company is $100, the after split market price per share of X would be approximately $50. Because of the decrease in the market value of a share of stock after a stock split, the split is a technique often used by a company to promote activity in their stock by reducing the market price. 1. From an accounting standpoint, the only effect of a stock split is to change the par value of the stock. Unlike a stock dividend, stock splits do not change the value of the components of stockholders' equity. Both paid-in capital and retained earnings remain unchanged in a stock split. The only effect of a stock split is to change the par value per share and the number of shares outstanding.

Stock Split Illustrated

The stockholders' equity section of Dallas, Inc. on 12/31/x1 is presented below:

--The market value of Dallas, Inc. common stock on 12/31/x1 is $45/share.

Stockholders' Equity:

Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding $ 1,000,000

Common stock: ($10 par, 1,000,000 shares authorized, 300,000 shares issued and outstanding 3,000,000

Paid-in capital in excess of par value...... …………………………………………………………………………………. 1,000,000

Total paid-in capital...... ……………………………………………………………………………………………….. $ 5,000,000

Retained Earnings...... 2,000,000

Total stockholders equity...... ……………………………………………………………………………………………… $ 7,000,000

Situation One: 2 for 1 stock split

The board of directors of Dallas, Inc. declares a 2 for 1 stock split.

Required:

1. Present all necessary journal entries to record the dividend.

Date of Declaration:

Memo entry: Par is reduced 50% (to $5 per share) subsequent to a 2 for 1 stock split

Date of Distribution:

No entry

2. Present the stockholders' equity section of Dallas, Inc. after the dividend has been distributed.

Stockholders' Equity after a 2 for 1 stock split:

Preferred Stock: ($100 par, 8% cumulative, 15,000 shares authorized, 10,000 shares issued and outstanding $ 1,000,000

Common stock: ($5 par, 1,000,000 shares authorized, 600,000 shares issued and outstanding ………………………….. 3,000,000

Paid-in capital in excess of par value...... ……………………………………………………………………………………. 1,000,000

Total paid-in capital...... ………………………………………………………………………………………………… $ 5,000,000

Retained Earnings...... 2,000,000

Total stockholders equity...... ……………………………………………………………………………………………….. $ 7,000,000

Note: The stockholders' equity section is unchanged (except for the par value per share and the total number of shares issued and outstanding. Compare this effect to the stock dividends.

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 10

D. Special Issues Involving Stockholders' equity 1. Treasury stock: Treasury stock is stock that has been issued and then reacquired by the issuing corporation. Treasury stock is not an asset and it cannot vote or receive dividends or qualify for any of the other rights associated with common stock. Treasury stock is accounted for as a contra (reduction) to paid in capital. There are two methods of accounting for treasury stock, the cost method and the par method.

a. Cost Method: The cost method is based on the presumption that treasury stock is being purchased in order to reissue it at some future date. Because the company plans to reissue the stock in the future, it is justified in carrying the treasury stock at cost in the stockholders' equity section of the balance sheet.

1. Recording treasury stock at cost: Treasury stock account is debited at the cost of the acquired treasury stock. When the stock is reissued, treasury stock is credited at cost. If groups of treasury stock are acquired in different steps at different costs, records must be maintained that identify the cost of each share. If the proceeds from the reissuance of the treasury differs from the acquisition cost, the differences are credited (proceeds > cost) or debited to (proceeds < cost) the account paid-in capital from treasury stock of the same class. Notice that this is paid-in capital from treasury stock, not generic paid-in capital. If paid-in capital from preexisting treasury stock transactions does not exist or is insufficient, to cover the deficit, retained earnings is debited for the difference. This procedure is illustrated on the following page.

b. Par Method: The par method is based on the presumption that the purchase of treasury stock is a constructive retirement of the acquired shares. Because the shares are being retired, both the stock account and the Paid-in capital in excess of par account associated with it must be reduced proportionate to the constructive retirement. This means that when treasury stock is acquired, both the stock account and the Paid-in capital in excess of par account must be reduced. This is due to the presumption of retirement. When the par method is utilized, all adjustments to the stock account must be at par rather than cost. When the stock is reissued, the same rules (same as cost method) apply with respect to the creation of paid-in capital from treasury stock transactions. In other words, if the proceeds from the reissuance of the treasury differs from the acquisition cost, the differences are credited (proceeds > par) or debited to (proceeds < par) the account paid-in capital from treasury stock of the same class. Notice that this is paid-in capital from treasury stock, not generic paid-in capital. If paid-in capital from preexisting treasury stock transactions does not exist or is insufficient, to cover the deficit, retained earnings is debited for the difference. The only difference here is that proceeds are compared to par rather than cost. This procedure is illustrated on the following page.

2. Recording Transactions For Shares of Stock Issued For Consideration Other Than Cash: Shares issued for consideration other than cash are recorded at the fair market value of the stock or the consideration received whichever is more readily obtainable. If the fair market value of the stock is not readily available (e.g. stock is not traded on a major exchange) it is often difficult to determine the fair market value of the consideration other than cash.

3. Recording Donated Assets in the Accounts: Assets donated by stockholders or entities outside the corporation (e. g. state or city government) not in exchange for stock are recorded by DEBITING the ASSETS at their fair market value on the date they were donated. The account that is CREDITED in this transaction is the owner equity account DONATED CAPITAL. For example, if land with a FAIR MARKET VALUE of $75,000 and COST of $10,000 is donated by a city to a corporation for the purpose of creating jobs in that city, the journal entry would be:

DEBIT: Asset account at fair market value-LAND CREDIT: Owner equity account-DONATED CAPITAL

4. Stock Subscriptions: Sales of stock on a subscription basis can occur when a company is preparing a new issue and is offered to old stockholders, or when a new company is preparing to go public and wants employee participation in the company in the form of stock ownership. The accounting problem with stock subscriptions is that not all of the price of the stock is initially received. The accounting procedures to record subscriptions of stock are illustrated below: Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 11

a. Defaults on stock subscriptions: A potential problems exists when stock subscriptions are defaulted on by subscribers. The accounting treatment is a function of state law in the state of incorporation. The most common options are: 1. refund the subscribed amounts to subscribers; 2. write-off the remaining subscription receivable (subscriber forfeits funds invested); (this is most used) 3. subscriber is legally bound for full subscription amount.

Accounting for Stock Subscriptions

--Rhett, Inc is offering stock subscriptions to employees giving them the right to purchase 100 shares of $5 par stock at a

price of $2,500 per subscription (this indicates an initial market price of $2,500/100 or $25/share).

--500 employees accept the offer and agree to pay 50% down within one month of submitting the subscription, and 50% in six

months.

At the date signed stock subscriptions are received:

Subscriptions Receivable (500 x $2,500)...... 1,250,000

Common stock subscribed (500 x 100 x $5)...... 250,000

Paid-in capital in excess of par (500 x 100 x $20)...... 1,000,000

To record receipt of stock subscriptions

At the date the first installment is received: Cash (500 x $1,250)...... 625,000 Subscriptions Receivable ...... 625,000 To record receipt of first cash installment (1/2 of total) on stock subscriptions At the date the second installment is received: Cash (500 x $1,250)...... 625,000 Subscriptions Receivable ...... 625,000 To record receipt of second cash installment (1/2 of total) on stock subscriptions Common stock subscribed...... 250,000 Common stock (500 x 100 x $5)...... 250,000 To record issuance of stock upon receipt of final payment of subscriptions

Note: Some controversy exists with respect to whether the account subscriptions receivable should be reported as a current asset or a contra equity. Current accounting practice generally follows the contra equity approach, i.e. it is reported as a debit balance account in the stockholders equity section of the balance sheet (similar to the treatment of treasury stock)

5. Stock Issuance Costs: Stock issuance costs are the direct costs of issuing stock (professional fees, printing costs, taxes etc). These costs are unrelated to the operations of the corporation and should reduce any PIC in excess of par created in the stock issue.

Example: Assume that JSTRM, Inc. issues 100,000 shares of $10 Par stock for $1,180,000 and incurs $50,000 legal fees, $35,000 Accounting fees and $20,000 underwriting fees. JSTRM would make the following entry: Cash…………………………………. 1,180,000 CS……………………………… 1,000,000 The key point here is that direct costs of issuing stock Stock Issue Costs… 105,000 are not expensed; they are reductions of PIC. PIC in Excess of par 75,000 Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 12

Cost and Par Methods of Recording Treasury Stock Illustrated

Cost Method Illustrated: A. Issued 100,000 shares of $100 par common stock @ $110: Cash (100,000 x $110)...... …………………………………….. 11,000,000 Common stock (100,000 x $100)...... ………………………. 10,000,000 Paid-in capital in excess of par (100,000 x $10) ……………… 1,000,000 To record original issuance of common stock

B. 10,000 shares of the common stock are reacquired @ $112: TS recorded at Cost Treasury Stock (10,000 x $112)...... 1,120,000 Cash...... 1,120,000 To record purchase of 10,000 shares of treasury stock at $112 (cost method)

C. 1,000 shares of treasury stock are reissued @ $112: Cash (1,000 x $112)...... 112,000 Treasury stock...... 112,000 To record reissuance of treasury stock at acquisition price

D. 1,000 shares of treasury stock are reissued @ $130: Reissue price above par creates PIC from Cash (1,000 x $130)...... 130,000 TS transactions… Treasury stock (1,000 x $112)...... 112,000 Paid-in capital from treasury stock (100,000 x $18)...... … 18,000 If TS is issued at less than par, PIC from To record reissuance of treasury stock for more than acquisition price TS is debited until unavailable; then RE is debited E. 1,000 shares of treasury stock are reissued @ $ 98: Cash (1,000 x $ 98)...... ……………………………….. 98,000 Paid-in Cap from T/S Paid-in capital from treasury stock (1,000 x $112 - $98)...... 14,000 18,000 (D) Treasury stock (1,000 x $112)...... …………………. 112,000 14,000 (E) To record reissuance of treasury stock for less than acquisition 4,000 (F) price (paid-in capital from prior treasury stock transactions is sufficient to cover the deficit)

Only a total of 18,000 is available for TS F. 1,000 shares of treasury stock are reissued @ $105: transactions… Cash (1,000 x $105)...... ……………………………… 105,000 Paid-in capital from treasury stock (1,000 x $112 -$105)...... 4,000* Retained Earnings Retained earnings (to make up deficit it PIC-T/S)...... 3,000 100,000 Bal. Treasury stock (1,000 x $112)...... 112,000 3,000 (F) To record reissuance of treasury stock for less than acquisition price (paid-in capital from prior treasury stock transactions is not sufficient to cover the deficit) * Only $4,000 is available in PIC-T/S, Retained earnings is charged for the excess

If TS is retired, remaining shares must be converted back to par with appropriate adjustments to PIC and RE Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 13

Par Method Illustrated: Assume the same original issuance of stock, the corresponding entries utilizing the Par Method would be:

B. 10,000 shares of the common stock are reacquired @ $112: Treasury Stock (10,000 x $100)...... 1,000,000 TS recorded at Par Value Paid-in capital in excess of par (100,000 x $12)...... 100,000 Retained Earnings...... 20,000 Cash...... 1,120,000 To record purchase of 10,000 shares of treasury stock at $112 (cost method)

C. 1,000 shares of treasury stock are reissued @ $112: Cash (1,000 x $112)...... 112,000 Creates PIC from TS transactions Treasury stock (1,000 x $100)...... ………………………. 100,000 Paid-in capital reissuance of treasury stock...... ………………. 12,000 To record reissuance of treasury stock at acquisition price

D. 1,000 shares of treasury stock are reissued @ $130: Cash (1,000 x $130)...... 130,000 Treasury stock (1,000 x $100)...... 100,000 Paid-in capital from treasury stock (100,000 x $30)...... 30,000 To record reissuance of treasury stock for more than acquisition price

E. 1,000 shares of treasury stock are reissued @ $ 98: Cash (1,000 x $ 98)...... ……………………………………….. 98,000 Paid-in Cap from T/S Paid-in capital from treasury stock (1,000 x $100 - $98)...... ……….. 2,000 30,000 (D) Treasury stock (1,000 x $100)...... ………………………… 100,000 2,000 (E) To record reissuance of treasury stock for less than acquisition 5,000 (F) price (paid-in capital from prior treasury stock transactions is sufficient to cover the deficit) 33,000 Bal

F. 1,000 shares of treasury stock are reissued @ $105: Cash (1,000 x $105)...... 105,000 Paid-in capital from treasury stock (1,000 x $105 - $100)……… 5,000 Treasury Stock (1,000 x $100)...... 100,000 To record reissuance of Treasury stock

6. Prior Period Adjustments: adjustments for items that should have been included in net income of prior periods but were not due to: -- errors in reporting prior period income or -- adjustments that result from realization of income tax benefits of pre-acquisition operating loss carry-forwards of purchased subsidiaries.

1. Recall that the statement is always presented in a specific format. That format is presented below in its entirety for purposes of reference only. NOTE: For purposes of this class, prior period Retained earnings: Beginning of year...... $ xxxx adjustments will be limited to correction on the Add: Net income (or deduct net loss)...... xxxx financial statements of the current period of an Deduct: Dividends declared...... (xxx) error that was made in the financial statements of Prior Period Adjustments (net of tax effect)...... xxxx a prior period. Adjustments due to Quasi-reorganization...... (xxx) 1. Prior period adjustments are charged (debited) Retained earnings: End of year...... $ xxxx or credited directly to retained earnings net of any tax effect that relates to them.

--Prior period adjustments affect only the Balance Sheet (and Statement of retained earnings if presented); --Prior period adjustments have no effect on the net income of the current period;

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 14

V. Reporting the results of Operations: The following Income statement classifications appear after and separate from net income from operations (GAAP: APB-9; APB-30): A. Discontinued operations: When a firm disposes of a segment of the business it must report, net of applicable tax effects, both 1. the income or loss generated by the disposed segment during the current period and 2. he gain or loss on the disposal itself (sales price less book value of assets disposed of);

B. Extraordinary items: Extraordinary items are current period gains and/or losses that are both 1. infrequent in occurrence and 2. unusual in their nature --these extraordinary items and must be reflected in the current periods income statement after net of there tax effects and after the presentation of net income and the effects of discontinued operations.

C. Cumulative Effects of Changes in Accounting Principle: If the firm changes from one generally accepted accounting principle to another, the cumulative effect of the change on the retained earnings at the beginning of the period of change will normally be presented in the income statement of the period of change, net of income tax effects and will appear after extraordinary items, if any.

NOTE: The effect of each of these items on must be reported separately

D. Basic Financial Statement Analysis: The primary purpose of the financial statements is to convey useful financial information to owners, , creditors and other analysts so that scarce economic resources can be efficiently allocated to the best firms. Other constraints being equal, it can be assumed that the users of the financial statements are interested in allocating their scarce dollars to investments in firms that will the highest economic return. Two areas of analysis of interest to the users of the financial statements are -term solvency analysis and operations efficiency analysis.

1. Short-term Solvency Analysis: Solvency (liquidity) refers to the ability of a firm to meet its obligations; to pay its bills. Short-term solvency addresses a firms ability to pay its bills in the short term, i.e. the longer of the operating cycle or one year. Short-term solvency is usually evaluated by the use of ratios that are easily computed from the data presented in classified financial statements.

a. Current ratio: current assets/current liabilities --considered a "crude" measure of liquidity because it assumes that all current assets can be quickly and efficiently converted into cash to meet current liabilities

b. Acid-test ratio: cash + temporary investments + current receivables/current liabilities --also known as the "quick ratio" --recognizes that not all current assets can be quickly converted into cash

2. Analysis of Operations Efficiency: The ability of a firm to employ the assets at its disposal to earn a profit is termed operations efficiency. In general, the more risk an investment poses, the higher the potential return must be for an to provide funds. Measures of operations efficiency examine the firms ability to earn a return (earnings) as a percentage of the assets at its disposal. The more efficiently assets are utilized, the greater the return.

a. Return on total assets: income from continuing operations/average total assets --average total assets = (assets at beginning of year + total assets at end of year)/2 b. Return on Stockholders equity: income from continuing operations/average stockholders equity --average stockholders equity = (SHE at beginning of year + SHE at end of year)/2 --Stockholders equity = the sum of all paid in capital accounts (preferred stock, common stock, paid in capital in excess of par) and retained earnings c. Return on Sales: income from continuing operations/net sales

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 15

Completion: 1. The amount that each common share would receive if the corporation were liquidated is called the per share.

2. A is designed to reduce the market value of the corporation's shares.

3. Professional and subchapter S corporations have liability.

4. An arbitrary value assigned to stock in order to create legal capital is known as .

5. A corporation may issue both and stock.

6. When a corporation has no par-value shares, and no stated value is required by the state of incorporation, the amount credited to the stock account is .

7. Three principle advantages of the corporate form of businesses are: a. b. c.

8. The amount of retained earnings unavailable for dividends is shown as .

9. Donated capital is shown in the section of shareholders' equity.

10. Partial payment of stock subscriptions are normally recorded as .

11. If preferred stock is , the preferred shareholders are entitled to dividends for each year that they own the stock, and any unpaid dividends remain in until they are paid.

12. Dividends are paid to the shareholders owning the stock on the .

13.If preferred stock is preferred shareholders have the right to the same return on their investment as the common shareholders.

14. When there is insufficient cash to pay cash dividends, the board of directors may vote to issue a .

15. When treasury stock is originally recorded using the cost method and is subsequently reissued at a price below its cost, and there isn't a credit balance in the Paid-in capital in excess of par-Treasury Stock account, or the credit balance is insufficient, then the loss is recorded with a debit to the account.

16. A increases the number of shares held by each , and reduces the par value, book value and the market value of each share.

17. The of a dividend is the day the board of directors decided that the dividend will be paid at a later date.

18. When preferred shares are , dividends in arrears must be paid before any current year's dividends.

19. A stock dividend has the effect of retained earnings.

True and False: 1. Shareholders of a corporation have a liability equal to the amount of their investment. 2. Restricted retained earnings are shown in the liability section of the balance sheet. 3. Legal capital represents an amount of capital that must be maintained by the corporation at all times. 4. The concept of legal capital provides protection for creditors by insuring that a minimum amount of assets will be maintained the corporation. 5. Donated assets are recorded at the fair market value of the assets on the date of donation. 6. The market value of a common share of stock is normally lower than its book value. 7. Under normal circumstances, only common shareholders have voting rights in a corporation. Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 16

8. Common shares may only be issued for cash. 9. The book value of the common stock is determined by dividing the equity of the common shareholders by the authorized. 10. Retained earnings represents the earnings of the corporation from its inception less dividends paid and the net effects of prior period adjustments. 11. A stock split decreases the number of shares outstanding. 12. Common shareholders receive the same return as the preferred shareholders when the preferred shares are fully participating. 13. Dividends are paid each quarter. 14. Common shareholders receive dividends before the preferred shareholders. 15. The total shareholders' equity does not change when there is a stock split. 16. A stock dividend does not necessarily require any cash. 17. Non-participating, cumulative preferred shareholders receive dividends in arrears as well as their regular preferred dividends, when dividends are declared.

Problems Problem 1 (No par/stated value stock; share transactions, preparation of the shareholders' equity section of the balance sheet and the book value of the common stock)

6/1/x1 --Authorization was received by Nado Corp. to issue 200,000 no par value common shares and 10,000 no par-value $5 preferred shares.

6/2/x2 --Issued 20,000 common shares at $30 a share and 1000 shares of preferred at $60 for cash.

6/10/x1 --Received assets from Dallas Ltd. at their fair cash value, land worth $20,000, buildings worth $152,800, and equipment worth $75,000. Issued 8000 shares of common stock in exchange for these assets.

9/30/x1 --Received land worth $10,000 from the city of San Diego in return for the obligation to establish a manufacturing branch in this location.

10/31/x1 --Reacquired 2,000 shares of common stock at $25.

11/25/x1 --The shareholders approved a stock split of 2 shares for every 1 share previously held.

12/31/x1 --Net income for the year was $110,000.

Required: 1. Prepare journal entries for the above transactions. 2. Prepare the shareholders' equity section of the balance sheet as at December 31, 20X1. 3. Compute the book value of the common stock at December 31, 20X1.

Problem 2 (Shareholders' equity) Required: From the following selected accounts, prepare in proper form the shareholders' equity section of the balance sheet of Shane, Inc., at December 31, 20X4.

Common Stock, no par-value, authorized $ 2,000,000 Preferred Stock, $10, no par-value, authorized 200,000 Accumulated Depreciation 90,000 Allowance for Doubtful Accounts 45,000 Appraisal Increase on Revaluation of Fixed Assets 210,000 Cash 157,000 Common Stock, issued and outstanding, 1,500,000 shares 1,815,000 Earnings Appropriated for Redemption 55,000 Earnings Appropriated for Plant Expansion 116,000 Income Tax Expense 175,000 Income Tax Payable 110,000 Land Donated by the City of Lancaster 250,000 Preferred Stock, issued and outstanding, 150,000 shares 200,000 Total Retained Earnings 995,000 Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 17

Problem 3 (Shareholders' equity) From the information provided, prepare in proper form the shareholders' equity section of the balance sheet of Dallas, Inc. at December 31, 20X1. Dallas was incorporated in a state that permits par-value shares. Allowance for Doubtful Accounts $ 20,000 Building 130,000 Common Stock, $15 par-value, 30 000 shares authorized; issued and outstanding, 11,000 shares 165,000 Plant Site, Donated 90,000 Preferred Stock, 10%, $5 par value, 15,000 shares authorized; issued and outstanding, 8,000 shares 40,000 Paid-in capital in excess of par, common stock 25,000 Paid-in capital in excess of par, preferred stock 10,000 Reserve for Bond Redemption 150,000 Reserve for Plant Relocation 85,000 Retained Earnings 210,000

Problem 4 (Shares sold through subscription plans and the shareholders' equity section of the balance sheet) -- L. Young Inc. was incorporated on January 4, 20X1. Its authorized capital was 80,000 shares of $8 no par-value preferred stock and 500,000 shares of no par-value common stock. -- During the year, the following transactions affecting shareholders' equity occurred: 1. On January 18, 20X1, 6,000 common shares were issued in exchange for land and buildings. The land was appraised at $30,000 and the building was appraised at $70,000. 2. On February 6, received subscriptions for 20,000 preferred shares at $110 per share. A down payment of 20 percent accompanied each subscription; the balance is to be paid in two equal installments on April 30 and August 15, 20X1. 3. On March 1, subscriptions were received for 200,000 common shares at $20 per share. A down payment of 50 percent accompanied each subscription; the balance is due on April 10. 4. The final instalment on the common stock was received on April 10. 5. The first instalment on the preferred stock was received on April 30, 20X1. 6. Cash was received on August 15, 20X1 for the balance of the amount owed on the preferred stock subscriptions. 7. The after-tax earnings of the company from the date of incorporation to the year-end December 31, 20X1 were $140,000.

Required: 1. Prepare journal entries to record these transactions. 2. Prepare the shareholders' equity section of the balance sheet at December 31, 20X1.

Problem 5 (A stock dividend and portfolio review) The shareholders' equity section of Moose Ltd.'s balance sheet consists of the following accounts: Moose Ltd. PARTIAL BALANCE SHEET At December 31, 20X2

Common Stock, $10 Par-value: Authorized, Issued and Outstanding 10,000 Shares...... $ 100,000 Retained Earnings...... 65,000 Total Shareholders' Equity ...... $ 165,000

Required: 1. Moose declares a stock dividend instead on 6/1/x2. Each shareholder is to receive 1 dividend share for each 8 shares he/she now holds. Market value of the stock is $60 and the distribution is to be made on 8/1/x2. a. Prepare the journal entries to record the declaration and distribution of the stock dividend. b. Compute the book value per share of the common stock immediately before the declaration of the stock dividend. c. Compute the book value per share of the common stock immediately after the distribution of the stock dividend.

2. Bozo owns 48 shares of Moose Ltd. stock. What is his equity: a. before the stock dividend? b. after the stock dividend? Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 18

Problem 6(Payment of dividends to shareholders; calculation of dividends payable to the preferred and common shareholders, with various different types of preferred stock)

The Coronado Company Ltd. had outstanding as follows: 2,000 shares $7, Preferred Stock, $100 Par-value 80,000 shares Common Stock, $10 Par-value

For the years 20X2 through 20X6 dividends were declared $42,000; $35,000; $3,500; $84,500; and $38,500, respectively. There were no dividends in arrears on December 31, 20X1 .

Required: 1. Calculate for 20X2 through 20X6 the total amount of dividends for each class of stock, assuming: a. the preferred is cumulative and non-participating. b. the preferred is cumulative and fully participating. c. the preferred is non-cumulative and fully participating. d. the preferred is non-cumulative and non-participating.

Use the form below for your answer.

Year Stock Requirement a. Requirement b. Requirement c. Requirement d.

20X2 Preferred

Common

20X3 Preferred

Common

20X4 Preferred

Common

20X5 Preferred

Common

20X6 Preferred

Common

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 19

Problem 7 (Shareholders' equity section of the balance sheet) DMC Inc. pays dividends on the issued and outstanding preferred and common shares semiannually. In December 20X3, the directors declared the semi-annual dividend on the preferred shares and $1 per share dividend on the common shares. The dividends are to be paid January 15, 20X4. The shareholders' equity section of DMC's balance sheet appears below: DMC Inc. PARTIAL BALANCE SHEET At December 31, 20X3 Shareholders' Equity Paid-in Capital: Preferred Stock, $4, $100 Par-value: Authorized 15,000 Shares, Issued and Outstanding 4,000 Shares $ 400,000 Common Stock, $10 Par value: Authorized 100,000 Shares, Issued and Outstanding 50,000 Shares 500,000 Retained Earnings:…………………………………………………………………………………………………………………………………………………………… 240,120 Total stockholders' equity ………………………………………………………………………………………………………………………………………….. $ 1,140,120

In 20X4 the following transactions affecting the company shares took place:

1/15/x4 Paid the dividends declared in December 20X3. 3/10/x4 Sold 5,000 common shares at $25 per share. 6/29/x4 Declared the regular semi-annual dividend on the preferred shares and a $1 per share dividend on the common shares, payable July 15, 20X4. 7/15/x4 Paid the dividends declared in June. 9/5/x4 Declared a 5% stock dividend on the outstanding common shares to be issued October 10 to the shareholders of record on September 30. The market price of $12 is to be used. 10/10/x4 Issued the stock dividend declared in September. 12/29/x4 Declared the regular semi-annual preferred share dividend and a cash dividend of $1 per share on the common shares outstanding, payable on January 15, 20X5. 12/31/x4 Net income for the period was $215,000.

Required: 1. Prepare the journal entries for the above transactions. 2. Prepare the shareholders' equity section of DMC Inc.'s balance sheet as at December 31, 20X4.

Problem 8 (Journal entries for stock transactions; the purchase of treasury stock and its subsequent sale)

MDC Ltd. was incorporated in February 20X2 and was authorized to issue 80,000 shares of common stock at $25 par-value. On May 31, 20X3 MDC Ltd. had 8,500 shares issued and outstanding.

6/10/x3 Declared a cash dividend of $3 per share to shareholders of record on June 25, 20X3, payable on July 4, 20X3. 7/4/x3 Paid the dividend declared on June 10, 20X3. 7/5/x3 Purchased 1,000 shares of treasury stock at $32 per share. 8/10/x3 Sold for cash 300 shares of treasury stock at $36 per share. 8/15/x3 Sold for cash 700 shares of treasury stock at $30 per share. 8/30/x3 hares were trading on the Toronto Stock Exchange for $42 per share, when the board of directors voted a 10% stock dividend to the common shareholders of record on September 15, 20X3, to be distributed on September 25, 20X3.

Required: Prepare the journal entries to record the transactions for MDC Ltd.

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 20

SOLUTIONS

Completion: 1. book value per share of common stock 2. stock split 3. unlimited 4. par value 5 .preferred / common 6. the entire amount invested 7. a. professional management b. ability to raise capital through stock sales c. limited liability to owners 8. restricted retained earnings 9. contributed capital 10. contra equity accounts 11. Cumulative / arrears 12. date of record 13. Fully participating 14. stock dividend 15. Retained Earnings 16. stock split 17. date of declaration 18. cumulative 19. capitalizing

True or False

1. T 2. F Restricted retained earnings are shown in the shareholders' equity section of the balance sheet under the retained earnings sub-heading. 3. T 4. T 5. T 6. F There is no relationship between the market value and the book value of a corporation's shares, but in most cases, book value will be less than market value. 8. F Shares may be issued for cash, assets, and/or services. 9. F The book value of the common stock of a corporation is computed by dividing the total number of common shares outstanding into the total shareholders' equity less the equity of the preferred and/or other claims on retained earnings. 10. T 11. F A stock split increases the number of shares outstanding. 12. T 13. F Dividends are paid only after they are declared by the board of directors. 14. F Common shareholders receive dividends after the preferred shareholders receive their regular dividend. 15. T 16. T 17. T Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 21

Solution Problem 1 Requirement 1. Prepare journal entries for the above transactions.

GENERAL JOURNAL Date Description 6/1/x1 Memorandum Authorization received to issue 200,000 no par $5 preferred stock 6/2/x1 Cash 660,000 Common Stock 600,000 Preferred Stock 60,000 To record the issue of 20,000 shares of common stock at $30 per share, and 1000 shares of preferred stock at $60 per share 6/10/x1 Land 20,000 Buildings 150,000 Equipment 75,000 Common Stock 245,000 To record the issue of 8,000 shares common stock for land, buildings and equipment at their FMV 9/30/x1 Land 10,000 Donated Capital-Land 10,000 To record the receipt of land donated by the city of San Diego 10/31/x1 Common Stock 50,000 Cash 50,000 To record the purchase of 2,000 shares of common stock at cost 11/25/x1 Memorandum Board of Dir approval to split common stock, 2 shares for each outstanding share; number of shares doubled from 26,000 to 52,000 shares outstanding 12/31/x1 Income Summary 110,000 Retained earnings 110,000 To close the income summary account to retained earnings

Requirement 2. Prepare the shareholders' equity section of the balance sheet as at December 31, 20X1.

Nado Corp. PARTIAL BALANCE SHEET At December 31, 20X1

Shareholders' Equity Paid-In Capital: Preferred Stock, $5, No Par-value: Authorized 10,000 Shares Issued and Outstanding 1,000 Shares $ 60,000 Common Stock, No Par-value: Authorized 200,000 Shares Issued and Outstanding 52,000 Shares 797,800 Total Paid-in Capital $ 857,800

Donated Capital-Land 10,000 Retained Earnings: 100,000 Total Shareholders' Equity $ 977,800

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 22

Requirement 3. 1. Compute the book value of the common stock at December 31, 20X1. Book value per common share is computed as follows:

Common Stock + Common stock paid-in capital in excess of par* + Retained Earnings available to common shareholders** + Donated Capital Number of Common Shares Outstanding

797,800 + 0 + 110,000 + 10,000 = $17.65 52,000

* ** Paid in capital in excess of par represents amounts received in Retained earnings available to common stock is total retained excess of par value when the stock was sold, it is more fully explaine earnings reduced by any preferred stock or other claims. below. Solution Problem 2 Shane, Inc. PARTIAL BALANCE SHEET At December 31, 20X4 Shareholders' Equity Paid-in Capital: Preferred Stock, $10, No Par-value: Authorized 200,000 Shares, Issued and Outstanding 150,000 Shares $ 200,000 Common Stock, No Par-value: Authorized 2,000,000 Shares, Issued and Outstanding 1,500,000 Shares 1,815,000 Total Paid-in Capital $ 2,015,000 Donated Capital: Land Donated by the City of Lancaster ……………………………………………………………. $ 250,000 Retained Earnings: Restricted: For Bond Redemption ……………………………………………………………………. $ 55,000 For Plant Expansion …………………………………………………………………… 116,000 $ 171,000 Unrestricted ………………………………………………………………………………………………………... 824,000 Total Retained Earnings …………………………………………………………………………………….. 995,000 Appraisal Capital-Fixed Assets ………………………………………………………………………………. 210,000 Total stockholders' equity ………………………………………………………………………………………. $ 3,470,000

Solution Problem 3

Dallas, Inc. PARTIAL BALANCE SHEET At December 31, 20X1 Shareholders' Equity Paid-in Capital: Preferred Stock, 10%, $5 Par-value: Authorized 15,000 Shares, Issued and Outstanding 8,000 Shares $ 40,000 Common Stock, $15 Par value: Authorized 30,000 Shares, Issued and Outstanding 11,000 Shares 165,000 Additional paid-in capital: Paid-in capital in excess of par, preferred stock …………………………………………………………………………………….. 10,000 Paid-in capital in excess of par, common stock ……………………………………………………………………………………. 25,000 Total Paid-in Capital ……………………………………………………………………………………………………………………………………………………… $ 240,000 Donated Capital: Land Donated - Plant cite…………………………………………………………………………………………………………………………………………………………. 90,000 Retained Earnings: Restricted: For Bond Redemption …………………………………………………………………… $ 150,000 For Plant Relocation ……………………………………………………………………… 85,000 $ 235,000 Unrestricted ……………………………………………………………………………………………………………………. 210,000 Total Retained Earnings ………………………………………………………………………………………………………… 445,000 Total stockholders' equity $ 775,000 Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 23

Solution Problem 4 GENERAL JOURNAL Date Description 1/4/x1 Memorandum Authorization received to issue 80,000 shares of $8 no par preferred stock and 500,000 share no par common stock │ 1/18/x1 Land 30,000 Building 70,000 Common Stock 100,000 To record the issue of 6,000 shares of common stock for land and building (assets recorded @ FMV) 2/6/x1 Cash 440,000 Subscriptions receivable 1,760,000 Preferred stock subscribed 2,200,000 To record 20% down payment on subscriptions for 20,000 shares of no par preferred stock @ $110/share, 89% balance due in two equal payments on 4/30/x1 and 8/15/x1 (20,000 x $110 x 20% = $440,000) 3/1/x1 Cash 2,000,000 Subscriptions receivable 2,000,000 Common stock subscribed 4,000,000 To record 50% downpayment on subscriptions for 200,000 shares of no par common stock @ $20/share, remaining 50% due 4/10/x1 (200,000 x $20 x 50%) 4/10/x1 Cash 2,000,000 Subscriptions receivable 2,000,000 To record final 50% payment on subscription for 200,000 shares of no par common stock @ $20/share, (200,000 x $20 x 50% = $2,000,000) 4/10/x1 Common stock subscribed 4,000,000 Common stock 4,000,000 To record the issuance of stock subscription 3/1/x1 4/30/x1 Cash 880,000 Subscriptions receivable 880,000 To record first 40% installment on subscriptions for 20,000 shares of no par preferred stock @$110/share,remaining 40% due 8/15/x1 (20,000 x $110 x 40%) 8/15/x1 Cash 880,000 Subscriptions receivable 880,000 To record final 40% installment on subscriptions for 20,000 shares of no par preferred stock @$110/share (20,000 x $110 x 40%) 8/15/ Preferred stock subscribed 2,200,000 Preferred stock 2,200,000 To record issuance of preferred stock subscription of 2/6/x1 12/31/ Income Summary 140,000 Retained earnings 140,000 To close the income summary account to retained earnings account

L. Young Inc. PARTIAL BALANCE SHEET At December 31, 20X1 Shareholders' Equity Paid-in Capital: Preferred Stock, $8 No Par-value: Authorized 80,000 Shares, Issued and Outstanding 82,000 Shares $ 2,200,000 Common Stock, No Par value: Authorized 500,000 Shares, Issued and Outstanding 206,000 Shares 4,100,000* Retained Earnings: 140,000 Total stockholders' equity $ 6,440,000

* 6,000 shares issued for FMV of Land and Building $ 100,000 200,000 shares issued @ $20/share by subscription 4,000,000 $ 4,100,000

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 24

Solution Problem 5

Requirement 1a. Prepare journal entries to record the declaration and distribution of the stock dividend.

GENERAL JOURNAL Date Description 6/1/x2 Retained earnings (1,250 x $60) 75,000 Common stock dividend distributable (1,250 x $10) 12,500 Paid-in capital in excess of par (1,250 x $50) 62,500 To record declaration of a 1 for 8 stock dividend; 10,000 shares/8 - 1,250 shares to be distributed (small stock dividend so Retained Earnings is charged at FMV of stock issued) 8/1/x2 Common stock dividend distributable 12,250 Common Stock 12,250 To record payment of small stock dividend

Requirement 1b. Compute the book value per share of the common stock immediately before the declaration of the stock dividend.

Book value per common share is computed as follows: Common Stock + Common stock paid-in capital in excess of par* + Retained Earnings available to common shareholders** + Donated Capital Number of Common Shares Outstanding

165,000 = $16.50 per share 10,000

Requirement 1c: Compute the book value per share of the common stock immediately after the distribution of the stock dividend. 165,000 = $14.67 11,250

Requirement 2: Bozo owns 48 shares of Moose Ltd. stock. What is his equity: a. before the stock dividend? 48 x $16.50 = $792 (note: this is the book value of his investment, the market value is 48 x $60 = $2,880)

b. after the stock dividend? (48 + 6) x $14.67 = $792(note: this is the book value of his investment, the market value will probably increase to approximately is 54 x $60 = $3,240) because this is a small stock dividend and it would be unlikely that the market would reflect the change in the number of outstanding shares Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 25

Problem 6 1. Calculate for 20X2 through 20X6 the total amount of dividends for each class of stock, assuming: a. the preferred is cumulative and non-participating. b. the preferred is cumulative and fully participating. c. the preferred is non-cumulative and fully participating. d. the preferred is non-cumulative and non-participating.

Use the form below for your answer.

Year Stock Requirement a. Requirement b. Requirement c. Requirement d.

20X2 Preferred $14,000 $14,000 $14,000 $14,000

Common 28,000 28,000 28,000 28,000

20X3 Preferred 14,000 14,000 14,000 14,000

Common 21,000 21,000 21,000 21,000

20X4 Preferred 3,500 3,500 3,500 3,500

Common -0- -0- -0- -0-

20X5 Preferred 24,500 25,300 16,900 14,000

Common 60,000 59,200 67,600 70,000

20X6 Preferred 14,000 14,000 14,000 14,000

Common 24,500 24,500 24,500 24,500

Year 5 computations (requirement b:) Preferred Common Total Total dividends available...... $ 84,500 To Preferred stock: Arrears from year 4 (14,000 - 3,500)...... $ 10,500 current year dividend...... 14,000 (24,500) Dividend remaining...... ……………………………….. $ 60,000 Pro rata distribution to CS (7% rate to match preferred) (7% x 80,000 x $100).... $ 56,000 (56,000) Dividend remaining...... ………………………………………… 4,000 To preferred based on relative par value ($200,000/$1,000,000)(4,000)...... 800 (800) To common based on relative par value ($800,000/$1,000,000)(4,000)...... 3,200 (3,200) Total distribution...... $ 25,300 $ 59,200 -0- Year 5 computations (requirement c:) Preferred Common Total Total dividends available...... $ 84,500 To Preferred stock: current year dividend...... ………………………… 14,000 (14,000) Dividend remaining...... $ 70,500 Pro rata distribution to common stock (7% rate to match preferred) (7% x 80,000 x $100).... $ 56,000 (56,000) Dividend remaining...... 14,500 To preferred based on relative par value ($200,000/$1,000,000)(14,500)...... 2,900 (2,900) To common based on relative par value ($800,000/$1,000,000)(4,000)...... 11,600 (11,600) Total distribution...... $ 16,900 $ 67,600 -0-

Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 26

Solution Problem 7 Requirement 1. Prepare journal entries for the above transactions. GENERAL JOURNAL Date Description 1/15/ Dividends payable-Preferred stock 8,000 Dividends payable-Common stock 50,000 Cash 58,000 To record payment of dividends declared 12/31/x3 (Preferred: $4 x 4,000 x 1/2 year = $8,000) Common: $1 x 50,000 = $50,000) 3/10/ Cash 125,000 Common Stock (5,000 x $10) 50,000 Paid-in capital in excess of par (5,000 x $15) 75,000 To record the issue of 5,000 common shares at $25 6/29 Retained Earnings 63,000 Dividends payable-Preferred stock 8,000 Dividends payable-Common stock 55,000 To record declaration of stock dividend (Preferred: $4 x 4,000 x 1/2 year = $8,000) (Common: $1 x 55,000 = $50,000) 7/15 Dividends payable-Preferred stock 8,000 Dividends payable-Common stock 55,000 Cash 63,000 To record payment of dividends declared 6/29/x4 (Preferred: $4 x 4,000 x 1/2 year = $8,000) (Common: $1 x 55,000 = $50,000) 9/5 Retained earnings 33,000 Stock dividend payable 33,000 To record declaration of 5% stock dividend payable 10/10/x4 to owners of record on 9/30/x4. (FMV on 9/9/x4 = $12; 5% x 55,000 x $12 = $33,000) 10/10 Stock dividend payable 33,000 Common stock (55,000 x .05 x $10) 27,500 Paid-in capital in excess of par (2,750 x $2) 5,500 To record issuance of 5% stock dividend 12/29 Retained Earnings 65,750 Dividends payable-Preferred stock 8,000 Dividends payable-Common stock 57,250 To record declaration of stock dividend (Preferred: $4 x 4,000 x 1/2 year = $8,000) (Common: $1 x 57,250 = $57,250) 12/3 Income Summary 215,000 Retained earnings 215,000 To close the income summary account to retained earnings

2. Prepare the shareholders' equity section of DMC Inc.'s balance sheet as at December 31, 20X4. DMC Inc. PARTIAL BALANCE SHEET At December 31, 20X4 Shareholders' Equity Paid-in Capital: Preferred Stock, $4, $100 Par-value: Authorized 15,000 Shares, Issued and Outstanding 4,000 Shares $ 400,000 Common Stock, No Par value: Authorized 100,000 Shares, Issued and Outstanding 57,750 Shares 577,500* Retained Earnings: 293,370** Total stockholders' equity $ 1,270,870

* ** 50,000 shares at beginning of year $ 500,000 Retained earnings: Beginning Balance: $ 240,120 5,000 shares issued on 3/10/x4 50,000 Stock dividend 6/29/x4 .... $ 63,000 2,750 shares issued on 1/10/x4 27,500 Stock dividend 9/5/x4...... 33,000 $ 577,500 Stock dividend 12/29/x4.... 65,750 (161,750) Add: Net income...... 215,000 Retained earnings 12/31/x4 $ 293,370 Dr. M. D. Chase Long Beach State University Intermediate Accountng-44A Corporations: Stockholder's Equity/Dividends Page 27

Solution Problem 8 Requirement 1: Prepare the journal entries to record the transactions for MDC Ltd.

GENERAL JOURNAL Date Description 6/10/ Retained earnings 25,500 Dividends payable-Common stock 25,500 To record declaration of dividends payable 7/4/x3 to holders of record on 6/25/x3 (Common: $3 x 8,500 = $25,500) 7/4 Dividend payable-Common stock 25,500 Cash 25,500 To record payment of cash dividend declared 6/10/x3 7/5 Treasury Stock (1,000 shares @ $32) 32,000 Cash 32,000 To record purchase of 1,000 shares of common at cost of $32/share 8/10 Cash (300 x $36) 10,800 Treasury stock (300 x $32) 9,600 Paid-in capital-Treasury stock 1,200 To record sale of treasury stock @ $36/share 8/15 Cash (700 x $30) 21,000 Paid-in capital-Treasury stock 1,200 Retained earnings 200 Treasury Stock (700 x $32) 22,400 To record sale of treasury stock @ $30/share 8/30 Retained earnings (8,500 x .1 x $42) 35,700 Stock dividend payable (8,500 x .1 x $25) 21,250 Paid-in capital in excess of par (850 x $17) 14,450 To record issuance of 10% stock dividend