BAT4M - Chapter 15 ANSWERS TO QUESTIONS

Transcription

1 BAT4M - Chapter 15 ANSWERS TO QUESTIONS 01. (a) A dividend is a distribution by a corporation to its shareholders on a pro rata (equal) basis, per share. (b) Disagree. Dividends may take four forms: cash, property, scrip (promissory note to pay cash), or shares. 02. Robin is not correct. Adequate cash is only one of the conditions. In order for a cash dividend to occur, a corporation must also have sufficient retained earnings and the dividend must be declared by the board of directors. 03. (a) The three dates are: Declaration date is the date when the board of directors formally declares the cash dividend and announces it to shareholders. The declaration commits the corporation to a binding legal obligation that cannot be rescinded. Record date is the date that marks the time when ownership of the shares is determined from the shareholder records maintained by the corporation. The purpose of this date is to identify the persons or entities that will receive the dividend. Payment date is the date on which the dividend cheques are mailed to the shareholders. (b) The accounting entries and their dates are: Declaration date Debit Cash Dividends and Credit Dividends Payable. No entry is made on the record date. Payment date Debit Dividends Payable and Credit Cash.

2 Questions Chapter 15 (Continued) 0 4. From the perspective of the corporation, cash dividends decrease assets, retained earnings, and total shareholders' equity. A stock dividend decreases retained earnings, increases share capital (contributed capital if the shares have a stated or par value), and has no effect on total assets and total shareholders' equity. If a cash dividend is paid, an individual shareholder s personal financial position will increase by the amount of cash received. If a stock dividend is received, the shareholder s personal financial position will increase by the market value of the share multiplied by the number of shares received. 5. A corporation generally issues stock dividends for one of the following reasons: 1. To satisfy shareholders' dividend expectations without spending cash. 2. To increase the marketability of its share by increasing the number of shares and thereby decreasing the market price per share. Decreasing the market price of the share makes the shares easier to purchase for smaller investors. 3. To emphasize that a portion of shareholders' equity that had been reported as retained earnings has been permanently reinvested in the business and therefore is unavailable for cash dividends. 6. In the Pella Corporation the number of shares will increase to 20,000 (10,000 X 2). The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $70 per share ($140 2). 7. The different effects of a stock split versus a stock dividend are: Item Stock Split Stock Dividend Total contributed capital Total retained earnings Total value recorded for common shares Legal capital per share No Change No Change No Change Decrease Increase Decrease Increase No Change

3 Questions Chapter 15 (Continued) 8. A prior period adjustment is a correction of a material error in reporting income of a prior period. The correction is reported in the current year's statement of retained earnings as an adjustment of the beginning balance of retained earnings. 9. The understatement of amortization in a prior year overstates the beginning retained earnings balance. The statement of retained earnings presentation is: Balance, January 1, as previously reported... $240,000 Less: Correction for understatement of prior prior year's amortization (net of $22,500 income tax saving)... 67,500* Balance, January 1, as adjusted... $172,500 *$90,000 ($90,000 X 25% tax savings) = $67, The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends. Restrictions may be either contractual or voluntary. 11. Retained earnings restrictions are generally reported in the notes to the financial statements. (Occasionally, separate accounts are created, within the shareholders equity section of the balance sheet, for the restricted or appropriated amounts.) 12. The debits and credits to retained earnings are: Debits 1. Net loss 2. Prior period adjustments for overstatements of net income 3. Cash and stock dividends 4. Cumulative effect of a change in accounting principle that decreased net income Credits 1. Net income 2. Prior period adjustments for understatements of net income 3. Cumulative effect of a change in accounting principle that increased net income

4 Questions Chapter 15 (Continued) 13. The cumulative effect of a change in accounting principle on net income is reported, net of applicable income tax, as an adjustment to the opening balance of retained earnings. Thus, your friend is correct. 14. Omar is incorrect. Only the ending balance of retained earnings is reported in the shareholders' equity section of the balance sheet. (The beginning balance appears in the statement of retained earnings, however. It would also appear as the ending balance of retained earnings for the preceding period, in a set of comparative financial statements.) 15. (a) Contributed Capital Share Capital (b) Contributed Capital Share Capital (c) Contributed Capital Share Capital (d) Contributed Capital Additional Contributed Capital (e) Retained Earnings 16. Nels should be told that although many factors affect the market price of a share at a given time, the reported net income is one of the most significant factors. When companies announce increases or decreases in net income, the market price of its share usually increases or decreases immediately. Net income also provides an indication of the amount of dividends that a company can distribute. In addition, net income leads to a growth in retained earnings, which is often reflected in a share's market price. Because net income is found on the income statement not the balance sheet, it is important to analyze all the financial statements when making investment decisions. 17. The unique feature of a corporation income statement is a separate section that shows income tax expense. The presentation is as follows: Income before income tax... $500,000 Income tax expense* ,000 Net income $350,000

5 * This is usually subdivided, to show the portion which is currently due and the portion which is due in future periods.

6 Questions Chapter 15 (Continued) *18. Intraperiod tax allocation refers to assigning income tax within the financial statements (income statement and statement of retained earnings) to each item that directly affects the income tax for the period. As a result, income tax expense is allocated to income before income tax and to each nontypical item (discontinued operations, extraordinary items, and changes in accounting principles). Intraperiod tax allocation is important because it reflects the true effective tax rate in the income statement, and matches the income tax expense to the items which affect the tax. *19. Discontinued operations refer to the disposal of a significant segment of the business, such as the cessation of an entire activity or the elimination of a major class of customers. It is important to report discontinued operations separately from income from continuing operations because the discontinued segment will not affect future income statements. Thus, the predictive value of the income statement is enhanced. 20. Items (a), (d), and (g) are extraordinary items. *21. Earnings per share (EPS) on income before extraordinary items usually is more relevant to an investment decision than EPS on net income. Income before extraordinary items represents the results of continuing and ordinary business activity. It is therefore a better basis for predicting future operating results than an EPS figure which includes the effect of extraordinary items that are not expected to recur again in the foreseeable future. 22. (a) Favourable (b) Unfavourable (c) Favourable (d) Unfavourable

7 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15-1 Nov. 1 Cash Dividends ,000 Dividends Payable ,000 Dec. 1 No entry required on record date. Dec. 31 Dividends Payable ,000 Cash ,000 BRIEF EXERCISE 15-2 Dec. 1 Stock Dividends (8,000 X $15) ,000 Stock Dividends Distributable , Stock Dividends Distributable ,000 Common Shares ,000 BRIEF EXERCISE 15-3 (a) Shareholders' equity Common shares Retained earnings Total shareholders' equity (b) Shares issued (c) Book value per share Before Stock Dividend $1,000, ,000 $1,300, ,000 $13.00 After Stock Dividend $ 1,160, ,000 $ 1,300, ,000 $11.82

8 BRIEF EXERCISE 15-4 I would anticipate the market price after the split would be $8 ($12 x 2/3 = $8). The reason for a stock split is usually to increase the marketability of the shares by reducing its price. BRIEF EXERCISE 15-5 CADIEN INC. Statement of Retained Earnings For the Year Ended December 31, 2003 Balance, January 1... $220,000 Add: Net income , ,000 Less: Dividends ,000 Balance, December $285,000 BRIEF EXERCISE 15-6 The cumulative prior income effect of a change in accounting principle is reported as an adjustment to the opening balance of retained earnings. In this case, the adjustment would be a deduction of $49,000, as follows: Cumulative effect of change in accounting principle Effect on prior years' income of change in amortization method, net of $21,000 ($70,000 X 30%) income tax saving... $49,000 Changes for the current year are reported in the current year s income statement. The $8,000 would be included in the current year s amortization expense.

9 BRIEF EXERCISE 15-7 MÉNARD CORPORATION Partial Balance Sheet December 31, 2003 Shareholders' equity Share capital Common shares, no par value, unlimited shares authorized, 5,000 shares issued... $50,000 Common stock dividend distributable... 15,000 Total share capital... 65,000 Retained earnings (see Note 3)... 29,000 Total shareholders' equity... $94,000 Note 3: Retained earnings of $20,000 has been restricted for loan agreements BRIEF EXERCISE 15-8 TEC.COM CORPORATION Partial Income Statement For the Year Ended November 30, 2003 Income before income tax... $300,000 Income tax expense ($300,000 X 25%) ,000 Income before extraordinary item ,000 Extraordinary loss from flood, net of $20,000 ($80,000 X 25%) income tax saving ,000 Net income... $165,000

10 BRIEF EXERCISE 15-9 OSBERN CORPORATION Partial Income Statement For the Year Ended December 31, 2003 Discontinued operations Loss from operations of Mexico facility, net of $105,000 ($300,000 X 35%) income tax savings... $195,000 Loss on disposal of Mexico facility, net of $56,000 ($160,000 X 35%) income tax savings ,000 $299,000 BRIEF EXERCISE Net income ($580,000 $200,000 $90,000)... $290,000 Earnings per share: Income from continuing operations... $5.80 Loss from discontinued operations... (2.00) Income before extraordinary item Extraordinary loss... (0.90) Net income... $2.90 BRIEF EXERCISE (a) Earnings per share = $1.85 ($370, ,000) (b) Earnings per share = $1.75 [($370,000 $20,000) 200,000] (c) There would be no difference. Since the preferred shares are cumulative, they need to be paid before any of the earnings become available to the common shareholders. Therefore, cumulative preferred dividends must be deducted from net income in calculating earnings per share, whether they are declared and paid or not.

11 BRIEF EXERCISE Share Price Earnings per Share Price- Earnings Current $52.50 $ After 2% stock dividend $ $ After 2-for-1 stock split $ $ $52.50 x 98% = $ $ = $ $5.00 x 98% = $ $ = $2.50 Both the stock dividend and the stock split will increase the number of shares, without changing the overall value of the company. Therefore, both will (theoretically) decrease the market price per share proportionately. Both will also decrease the earnings per share proportionately. Consequently, the price-earnings ratio should not be affected by either of these events. However, the stock markets may react favourably to the stock dividend and/or the stock split, with the result that the share price does not decrease proportionately, and hence the price-earnings ratio increases. BRIEF EXERCISE Payout ratio = Cash dividends per share Earnings per share = $1.00 $ 3.75 = 26% Dividend yield = Cash dividends per share Share price = $1.00 $25.00 = 4%

12 SOLUTIONS TO EXERCISES EXERCISE 15-1 (a) Total dividend declaration Allocation to preferred shares Remainder to common shares $6,000 06,000 $ 0 $12, ,000 $ 4,000 $28, ,000 $20,000 (b) Total dividend declaration Allocation to preferred shares Remainder to common shares $6,000 06,000 $ 0 $12,000 12,000 1 $ 0 1 Cumulative dividend for 2002, $4,000, plus $8,000 for Cumulative dividend for 2003, $2,000, plus $10,000 for 2004 $28, ,000 2 $16,000 (c) Dec. 31 Cash Dividends Preferred... 8,000 Cash Dividends Common... 20,000 Dividends Payable... 28,000 Dec. 31 Cash Dividends Preferred... 12,000 Cash Dividends Common... 16,000 Dividends Payable... 28,000

13 EXERCISE 15-2 Before Action After Stock Dividend After Stock Split Shareholders' equity Common shares Retained earnings Total shareholders' equity $ 800, ,000 $ 1,200,000 $ 856,000* 344,000 $1,200,000 $ 800, ,000 $ 1,200,000 Shares issued 80,000 84, ,000 Book value per share $15.00 $14.29 $7.50 * $800,000 + (80,000 shares X 5% X $14) = $856,000 Note that the total shareholders equity is the same in each case. EXERCISE 15-3 (a) (1) Book value before the stock dividend was $20.00 ($400,000 20,000 = $20.00) (2) Book value after the stock dividend is $18.18 ($400,000 22,000 = $18.18) (b) Share capital Balance before dividend... $225,000 Stock dividend (2,000 x $18) ,000 New balance... $261,000 Retained earnings Balance before dividend... $175,000 Stock dividend (2,000 X $18) ,000 New balance... $139,000

14 EXERCISE Dec. 31 Cash Dividends... 30,000 Dividend Expense... 30, Dec. 31 Stock Dividends*... 10,000 Dividends Payable... 10,000 Common Stock Dividends Distributable 10,000 Retained Earnings*... 10, Dec. 31 Preferred Shares... 2,000,000 Retained Earnings... 2,000,000 No entry is required for a stock split * Note: This portion of the correcting entry could be omitted since the Stock Dividend account is closed into the Retained Earnings account at year end. EXERCISE 15-5 (a) April 1 Cash... 85,000 Common Shares... 85,000 June 15 Cash Dividends (80,000 X $1)... 80,000 Dividends Payable... 80,000 July 10 Dividends Payable... 80,000 Cash... 80,000 Dec. 15 Cash... 38,000 Common Shares... 38,000 Cash Dividends (82,000 X $1.30) ,600 Dividends Payable ,600 (b) In the statement of retained earnings, cash dividends of $186,600 will be deducted. In the balance sheet, dividends payable of $106,600 will be reported as a current liability.

15 EXERCISE 15-6 WINDSOR CORPORATION Statement of Retained Earnings For the Year Ended December 31, 2003 Balance, January 1, as previously reported... $580,000 Less: Correction for overstatement of 2002 net income due to amortization error, net of $15,000 income tax saving... 20,000 Balance, January 1, as adjusted ,000 Add: Net income , ,000 Less: Cash dividends... $120,000 Stock dividends , ,000 Balance, December $730,000 EXERCISE 15-7 Contributed Capital Item Share Capital Additional Retained Earnings Total Shareholders Equity 1. D D 2. I I I D 5. D D I I I

16 EXERCISE 15-8 (a) Stock Dividends Common (30,000* X $16) ,000 Stock Dividends Distributable ,000 * (150, ,000) X 15% = 30,000 (b) KNOWLEDGE CORPORATION Partial Balance Sheet December 31, 2003 Shareholders' equity Share capital Common shares, no par value, unlimited number authorized, 200,000 issued... Common stock dividends distributable... Total share capital... Retained earnings... Total shareholders' equity... $ 2,200, ,000 2,680, ,000* $ 3,350,000 * $750,000 + $400,000 $480,000 = $670,000

17 EXERCISE 15-9 BYUNG KEE INC. Partial Balance Sheet December 31, 2003 Shareholders' equity Contributed capital Share capital 8% preferred shares, $5 stated value, cumulative, 40,000 shares authorized, 30,000 shares issued $0,150,000 Common shares, no par value, 400,000 shares authorized, 300,000 shares issued ,000 Common stock dividends distributable... 75,000 Total share capital... 1,091,000 Additional contributed capital Contributed capital in excess of stated value preferred shares ,000 Total contributed capital... 1,335,000 Retained earnings (See Note R) ,000 Total shareholders' equity... $2,235,000 Note R: Retained earnings restricted for plant expansion, $100,000.

18 EXERCISE (a) GROMETER CORPORATION Partial Income Statement For the Year Ended October 31, 2003 Income before income tax... $640,000 Income tax expense ($640,000 X 30%) ,000 Income before extraordinary item ,000 Extraordinary loss from fire, net of $30,000 ($100,000 X 30%) income tax saving ,000 Net income... $378,000 (b) To: From: Dave Grometer Corporation Independent Auditor After reviewing your income statement for the year ended October 31, 2003, we believe it is misleading for the following reasons: The amount reported for income before extraordinary items is overstated by $30,000. The income tax expense should be 30% of $640,000, or $192,000, not $162,000. The after-tax income from operations was only $448,000, not $478,000. Also, the effect of the extraordinary loss on net income is only $70,000, not $100,000. An income tax savings of $30,000 should be netted against the extraordinary loss. Taking these tax savings into consideration, the real cost of the fire damage was only $70,000, not $100,000.

19 EXERCISE (a) DASOLA CORPORATION Partial Income Statement For the Year Ended December 31, 2003 Income from continuing operations... $240,000 Discontinued operations Gain on discontinued division, net of $15,000 income tax expense... 35,000 Income before extraordinary item ,000 Extraordinary loss, net of $24,000 income tax saving... 56,000 Net income... $219,000 (b) The correction of an error in last year's financial statements is a prior period adjustment. The correction is reported in the 2003 statement of retained earnings as an adjustment that increases the reported beginning balance of retained earnings by $14,000, after income tax expense [$20,000 ($20,000 X 30%)]. The effect on prior years of the change in accounting principle (amortization method) should also be treated as an adjustment to the reported beginning balance of retained earnings. It would reduce the retained earnings by $24,500, after income tax expense. [$35,000 ($35,000 x 30%)] EXERCISE (a) $ 547,000 $16,000 = $531, ,000 = $5.31 (b) $ 547,000 $16,000 = $531, ,000 = $5.31 Note that, since the preferred dividends are cumulative, there is no difference between parts (a) and (b)

20 EXERCISE Earnings per share $6.99 $5.20 $5.14 Price-earnings ratio 6.6X 6.3X 7.1X Payout ratio 28.6% 36.2% 34.3% Dividend yield ratio 4.4% 5.7% 4.8% Calculations: Earnings per share 2000: $1,857,000, ,659,000 = $ : $1,382,000, ,862,000 = $ : $1,350,000, ,511,000 = $5.14 Price-earnings 2000: $45.88 $6.99 = 6.6 times 1999: $32.72 $5.20 = 6.3 times 1998: $36.65 $5.14 = 7.1 times Payout 2000: $2.00 $6.99 = 28.6% 1999: $1.88 $5.20 = 36.2% 1998: $1.76 $5.14 = 34.2% Dividend yield 2000: $2.00 $45.88 = 4.4% 1999: $1.88 $32.72 = 5.7% 1998: $1.76 $36.65 = 4.8%

21 EXERCISE (Continued) Earnings per share have improved over the past year, moving from $5.14 to $6.69. This indicates that the company is earning more income for each of its common shareholders. This increase occurred partially because net income is higher and partially because the number of common shares issued has decreased. The PE ratio declined in 1999, then rebounded slightly in This number should be compared to other companies in the industry to see if a multiple of around seven (6.6 in 2000) is good for this type of business. Even though the dividend is increasing, the dividend yield and the payout ratios have generally decreased. The company is earning more income but is not increasing its dividend proportionally. Although some investors who like receiving dividends may be concerned, the company may simply be retaining the remaining income to finance further growth. SOLUTIONS TO PROBLEMS PROBLEM 15-1A (a) Cash Dividend Stock Dividend Assets $13,500,000 - $80,000 a = $13,420,000 No effect = $13,500,000 Liabilities No effect = $1,500,000 No effect = $1,500,000 Share capital No effect = $2,000,000 $2,000,000 + $80,000 b = $2,080,000 Retained earnings $10,000,000 - $80,000 = $9,920,000 $10,000,000 - $80,000 $ 9,920,000 Total shareholders equity $12,000,000 - $80,000 = $11,920,000 No effect ($12,000,000 + $80,000 - $80,000 = $12,000,000)

22 Number of shares No effect = 40,000 2,000 increase (2, ,000 = 42,000) a 40,000 X $2 = $80,000 b 40,000 X 5% = 2,000 x $40 = $80,000 (b) 1. Cash dividend Cash dividend 1,000 X $2 = $2,000 Market value of shares 1,000 X $40 = $40,000 Stock Dividend Stock dividend 1,000 x 5% = 50 x $40 = $2,000 Market value of shares 1,050 X $40 = $42,000

23 PROBLEM 15-1A (Continued) (b) 1. (Continued) In terms of final value the shareholder would be in the same position having received either a cash or a stock dividend. However, a stock dividend would allow the shareholder to control the receipt of the cash and the related tax payment. Since the shareholder can control when the shares are sold, they can control when the income tax would have to be paid on any gains. Alternatively, some shareholders may prefer to receive a cash dividend since they do not have to sell the shares to obtain the cash. As well, there are often brokerage fees associated with selling shares. The decision as to whether a cash or stock dividend would be more beneficial really depends on the preferences of the shareholder and their tax situation. (b) 2. The shareholder would record the cash dividend as a debit to Cash and a credit to Dividend Revenue. The stock dividend would be recorded only as an increase in the number of shares held.

24 PROBLEM 15-2A Journal entries not required July 1 Cash Dividends Common... 45,000 (180,000 X $0.25) Dividends Payable Common... 45,000 Aug. 1 Accumulated Amortization... 72,000 Income Tax Payable... 22,000 Retained Earnings... 50,000 Sept. 1 Dividends Payable Common... 45,000 Cash... 45,000 Dec. 01 Stock Dividends Common (18,000 X $15) ,000 Common Stock Dividends Distributable 270, Cash Dividends Preferred (4,000 X $10)... 40,000 Dividends Payable Preferred... 40,000

25 PROBLEM 15-2A (Continued) TMAO INC. Statement of Retained Earnings For the Year Ended December 31, 2003 Balance, January 1, as previously reported... $500,000 Add: Correction for overstatement of amortization in 2002, net of income tax expense of $22, ,000 Balance, January 1, as adjusted ,000 Add: Net income , ,000 Less: Cash dividends preferred... $040,000 Cash dividends common... 45,000 Stock dividends common , ,000 Balance, December $545,000

26 PROBLEM 15-3A GERAL JOURNAL Date Account Titles and Explanation Debit Credit Jan. 20 Stock Dividend Distributable ,000 Common Shares ,000 Feb. 12 Cash ,000 Common Shares ,000 Mar. 31 Income Tax Payable... 20,000 Retained Earnings... 50,000 Inventory... 70,000 Dec. 31 Cash Dividends ,000 Cash , Revenues ,000 Retained Earnings , Retained Earnings ,000 Expenses , Retained Earnings ,000 Cash Dividends ,000 J1

27 PROBLEM 15-3A (Continued) (b) Common Shares Date Explanation Ref. Debit Credit Balance Jan Feb. 12 J1 J1 200, ,000 1,500,000 1,700,000 1,850,000 Common Stock Dividends Distributable Date Explanation Ref. Debit Credit Balance Jan J1 J1 0200, , , ,000 Cash Dividends Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 Closing entry J1 J1 100, , ,000 0 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Mar. 31 Dec Closing entry Closing entry Closing entry J1 J1 J1 J1 50, , , , , ,000 1,450, , ,000

28 PROBLEM 15-3A (Continued) (c) CEDENO INC. Partial Balance Sheet December 31, 2003 Shareholders' equity Share capital Common shares, no par value, unlimited number of shares authorized, 580,000 shares issued... $1,850,000 Retained earnings... 00,750,000 Total shareholders' equity... $2,600,000 PROBLEM 15-5A (a) Total dividend $600,000 Allocated to preferred shares current year only (10,000 X $10) 0100,000 Remainder to common shares $500,000 Note: the preferred shares are noncumulative and therefore no dividends in arrears have to be paid (b) JAJOO CORPORATION Statement of Retained Earnings For the Year Ended December 31, 2003 Balance, January 1... $ 2,450,000 Add: Net income ,000 3,330,000 Less: Cash dividends Preferred... $100,000 Cash dividends Common ,000 Stock dividends ,000* 740,000 Balance, December $2,590,000 * 400,000 x 5% = 20,000 x $7 = $140,000

29 PROBLEM 15-5A (Continued) (c) JAJOO CORPORATION Partial Balance Sheet December 31, 2003 Shareholders' equity Contributed capital Share capital $10 preferred shares, no par value, noncumulative, 20,000 shares authorized, 10,000 shares issued... $1,200,000 Common shares, $5 stated value, 600,000 shares authorized, 400,000 shares issued 2,000,000 Common stock dividends distributable, 20,000 shares ,000 Total share capital... 3,340,000 Additional contributed capital Contributed capital in excess of stated value common shares... 1,100,000 Total contributed capital... 4,440,000 Retained earnings (See Note 3)... 2,590,000 Total shareholders' equity... $7,030,000 Note 3: $100,000. Retained earnings restricted for plant expansion,

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31 SOLUTIONS TO PROBLEMS PROBLEM 15-1A (a) Cash Dividend Stock Dividend Assets $13,500,000 - $80,000 a = $13,420,000 No effect = $13,500,000 Liabilities No effect = $1,500,000 No effect = $1,500,000 Share capital No effect = $2,000,000 $2,000,000 + $80,000 b = $2,080,000 Retained earnings $10,000,000 - $80,000 = $9,920,000 $10,000,000 - $80,000 $ 9,920,000 Total shareholders equity $12,000,000 - $80,000 = $11,920,000 No effect ($12,000,000 + $80,000 - $80,000 = $12,000,000) Number of shares No effect = 40,000 2,000 increase (2, ,000 = 42,000) a 40,000 X $2 = $80,000 b 40,000 X 5% = 2,000 x $40 = $80,000 (b) 1. Cash dividend Cash dividend 1,000 X $2 = $2,000 Market value of shares 1,000 X $40 = $40,000 Stock Dividend Stock dividend 1,000 x 5% = 50 x $40 = $2,000 Market value of shares 1,050 X $40 = $42,000

32 PROBLEM 15-1A (Continued) (b) 1. (Continued) In terms of final value the shareholder would be in the same position having received either a cash or a stock dividend. However, a stock dividend would allow the shareholder to control the receipt of the cash and the related tax payment. Since the shareholder can control when the shares are sold, they can control when the income tax would have to be paid on any gains. Alternatively, some shareholders may prefer to receive a cash dividend since they do not have to sell the shares to obtain the cash. As well, there are often brokerage fees associated with selling shares. The decision as to whether a cash or stock dividend would be more beneficial really depends on the preferences of the shareholder and their tax situation. (b) 2. The shareholder would record the cash dividend as a debit to Cash and a credit to Dividend Revenue. The stock dividend would be recorded only as an increase in the number of shares held.

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