Chapter 18 Shareholders Equity

Transcription

1 Chapter 18 Shareholders Equity AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions AACSB Tags Exercises AACSB Tags 18 1 Reflective thinking 18 1 Reflective thinking 18 2 Reflective thinking, Communications 18 2 Communications 18 3 Reflective thinking, Communications 18 3 Reflective thinking 18 4 Reflective thinking 18 4 Analytic 18 5 Reflective thinking 18 5 Analytic 18 6 Reflective thinking 18 6 Reflective thinking 18 7 Reflective thinking 18 7 Analytic, Communications 18 8 Reflective thinking 18 8 Analytic 18 9 Reflective thinking 18 9 Analytic Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Analytic, Communications Reflective thinking Analytic Reflective thinking, Communications Analytic, Communications Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Analytic Reflective thinking Reflective thinking, Analytic Analytic Communications Analytic Analytic, Communications Reflective thinking, Communications Reflective thinking, Analytic Brief Exercises Diversity, Reflective thinking 18 1 Analytic CPA/CMA 18 2 Reflective thinking 1 Analytic 18 3 Analytic 2 Analytic 18 4 Analytic 3 Analytic 18 5 Analytic 4 Analytic 18 6 Analytic 5 Reflective thinking 18 7 Analytic 6 Analytic 18 8 Analytic 7 Diversity, Reflective thinking 18 9 Analytic 8 Diversity, Reflective thinking Analytic 1 Reflective thinking Analytic 2 Analytic Analytic 3 Reflective thinking Analytic Analytic Analytic Diversity, Reflective thinking Solutions Manual, Vol.2, Chapter

2 Problems 18 1 Analytic 18 2 Analytic 18 3 Analytic 18 4 Analytic 18 5 Analytic 18 6 Analytic 18 7 Reflective thinking, Analytic 18 8 Analytic 18 9 Analytic Reflective thinking Analytic Analytic Analytic 18 2 Intermediate Accounting, 7e

3 QUESTIONS FOR REVIEW OF KEY TOPICS Question 18 1 The two primary sources of shareholders equity are amounts invested by shareholders in the corporation and amounts earned by the corporation on behalf of its shareholders. Invested capital is reported as paid-in capital and earned capital is reported as retained earnings. Question 18 2 The three primary ways a company can be organized are (1) a sole proprietorship, (2) a partnership, or (3) a corporation. Transactions are accounted for the same regardless of the form of business organization with the exception of the method of accounting for capital the ownership interest in the company. Several capital accounts (as discussed in this chapter) are used to record changes in ownership interests for a corporation, rather than recording all changes in ownership interests in a single capital account for each owner, as we do for sole proprietorships and partnerships. Question 18 3 In the eyes of the law, a corporation is a separate legal entity separate and distinct from its owners. The owners are not personally liable for debts of the corporation. So, shareholders generally may not lose more than the amounts they invest when they purchase shares. This is perhaps the single most important advantage of corporate organization over a proprietorship or a partnership. Question 18 4 Not-for-profit corporations such as churches, hospitals, universities, and charities, are not organized for profit and do not sell stock. Some not-for-profit corporations, such as the Federal Deposit Insurance Corporation (FDIC), are government owned. Question 18 5 Corporations that are organized for profit may be publicly held or privately (or closely) held. The stock of publicly held corporations is available for purchase by the general public. Shares might be traded on organized national stock exchanges or available over-the-counter from securities dealers. Privately held companies' shares are held by only a few individuals and are not available to the general public. Question 18 6 Corporations are formed in accordance with the corporation laws of individual states. The Model Business Corporation Act serves as the guide to states in the development of their corporation statutes, presently as the model for the majority of states. Solutions Manual, Vol.2, Chapter

4 Answers to Questions (continued) Question 18 7 The ownership rights held by common shareholders, unless specifically withheld by agreement with the shareholders, are: a. The right to vote on policy issues. b. The right to share in profits when dividends are declared (in proportion to the percentage of shares owned by the shareholder). c. The right to share in the distribution of any assets remaining at liquidation after other claims are satisfied. Question 18 8 The preemptive right is the right to maintain one s percentage share of ownership when new shares are issued. When granted, each shareholder is offered the opportunity to buy the same percentage of any new shares issued as the percentage of shares he/she owns at the time. For reasons of practicality, the preemptive right usually is excluded. Question 18 9 The typical rights of preferred shares usually include one or both of the following: a. A preference to a predesignated amount of dividends, that is, a stated dollar amount per share or percent of par value per share. This means that when the board of directors of a corporation declares dividends, preferred shareholders will receive the specified dividend prior to any dividends being paid to common shareholders. b. A preference over common shareholders in the distribution of assets in the event the corporation is dissolved. Question If preferred shares are noncumulative, dividends not declared in any given year need never be paid. However, if cumulative, when the specified dividend is not paid in a given year, the unpaid dividends accumulate and must be made up in a later dividend year before any dividends are paid on common shares. These unpaid dividends are called dividends in arrears. Question Par value was defined by early corporation laws as the amount of net assets not available for distribution to shareholders (as dividends or otherwise). However, now the concepts of par value and legal capital have been eliminated entirely from the Model Business Corporation Act. Most shares continue to bear arbitrarily designated par values, typically nominal amounts. Although many states already have adopted these provisions, most established corporations issued shares prior to changes in the state statutes. So, most companies still have par value shares outstanding and continue to issue previously authorized par value shares Intermediate Accounting, 7e

5 Answers to Questions (continued) Question Comprehensive income is a broader view of the change in shareholders equity than traditional net income. It is the total nonowner change in equity for a reporting period. It encompasses all changes in equity except those caused by transactions with owners. Transactions between the corporation and its owners (shareholders) primarily include dividends and the sale or purchase of shares of the company s stock. Most nonowner changes (e. g., revenues and expenses) are reported in the income statement. So, the changes other than the ones that are part of net income are those reported as other comprehensive income. Two attributes of other comprehensive income are reported: (1) components of comprehensive income created during the reporting period and (2) the comprehensive income accumulated over the current and prior periods. The components of comprehensive income created during the reporting period can be reported in either (a) an expanded version of the income statement or (b) a separate statement immediately following the income statement. Regardless of the choice a company makes, the presentation will report net income, other components of comprehensive income, and total comprehensive income. The second attribute the comprehensive income accumulated over the current and prior periods is reported as a separate component of shareholders equity. This amount represents the cumulative sum of the changes in each component created during each reporting period throughout all prior years. Question Components of comprehensive income created during the reporting period can be reported in either (a) an expanded version of the income statement or (b) a separate statement immediately following the income statement. Regardless of the placement a company chooses, the presentation is similar. It will report net income, other components of comprehensive income, and total comprehensive income. Question The statement of shareholders equity reports the transactions that cause changes in its shareholders equity account balances. It shows the beginning and ending balances in primary shareholders equity accounts and any changes that occur during the years reported. Typical reasons for changes are the sale of additional shares of stock, the acquisition of treasury stock, net income, and the declaration of dividends. Question The measurement objective is that the transaction should be recorded at fair value. This might be the fair value of the shares or of the noncash assets or services received, whichever evidence of fair value seems more clearly evident. This is consistent with the general practice of recording any noncash transaction at market value. Solutions Manual, Vol.2, Chapter

6 Answers to Questions (continued) Question The cash received usually is the sum of the separate market values of the separate securities. However, when the total selling price is not equal to the sum of the separate market prices, the total selling price is allocated in proportion to their relative market values. Question Share issue costs reduce the net cash proceeds from selling the shares and thus paid-in capital excess of par. On the other hand, debt issue costs are recorded in a separate debt issue costs account and amortized to expense over the life of the debt. The difference often is justified by the presumption that share issue costs and debt issue costs are fundamentally different because a debt issue has a fixed maturity, but that selling shares represents a perpetual equity interest. Concept Statement 6 disagrees, stating that debt issue costs should be treated the same way as share issue costs. But, Concept Statements do not constitute GAAP, and the currently prescribed practice is to record debt issue costs as assets and expense the asset over the maturity of the debt. Question The same accounts that previously were increased when the shares were sold are decreased when the shares are retired. Specifically, common (or preferred) stock and paid-in capital excess of par are reduced by the same amounts they were increased by when the shares were originally sold. If the cash paid to repurchase the shares differs from the amount originally paid in, accounting for the difference depends on whether the cash paid to repurchase the shares is less than or more than the price previously received when the shares were sold. When less cash is distributed to shareholders to retire shares than originally paid in, some of the original investment remains and is labeled paid-in capital share repurchase. When more cash is distributed to shareholders to retire shares than originally was paid in for those shares, the additional amount is viewed as a dividend on the original investment, and thus a reduction of retained earnings (unless previous share repurchases have created a balance in paid-in capital share repurchase, which would be reduced first). Question The purchase of treasury stock and its subsequent resale are considered to be a single transaction. The purchase of treasury stock is perceived as a temporary reduction of shareholders' equity, to be reversed later when the treasury stock is resold, so the cost of acquiring the shares is temporarily debited to the treasury stock account. Allocating the effects to specific shareholders equity accounts is deferred until the shares are subsequently reissued Intermediate Accounting, 7e

7 Answers to Questions (concluded) Question For a stock dividend of less than 25%, a "small" stock dividend, the fair value of the additional shares distributed is transferred from retained earnings to paid-in capital. The reduction in retained earnings is the same amount as if cash dividends were paid equal to the market value of the shares issued. The treatment is consistent with the belief that per share prices remain unchanged by stock dividends. This is not logical. If the value of each share were to remain the same when additional shares are distributed without compensation, the total value of the company would grow simply because additional stock certificates are distributed. Instead, the market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend. Question The effect and maybe the motivation for the 2-for-1 stock split is to reduce the per share market price (by half). This will likely increase the stock s marketability by making it attractive to a larger number of potential investors. The appropriate accounting treatment of a stock split is to make no journal entry, which avoids the reclassification of earned capital as invested capital. However, if the stock distribution is referred to as a "stock split effected in the form of a stock dividend," and the per share par value of the shares is not changed, a journal entry is recorded that increases the common stock account by the par value of the additional shares. To avoid reducing retained earnings Brandon can reduce (debit) paid-in capital excess of par to offset the credit to common stock, although it s permissible to debit retained earnings. Question When a company decreases, rather than increases, its outstanding shares, a reverse stock split occurs. A 1-for-2 reverse stock split would cause one million $1 par shares to become one-half million $2 par shares. No journal entry would be recorded, so no account balances will change. But the market price per share would double, and the par amount per share would double. Question You would be entitled to 3.2 shares (4% x 80 shares). Since cash in lieu of payments usually are made when shareholders are entitled to fractions of whole shares, you probably would receive 3 shares and cash equal to the market value of 1 /5 of one share. Sometimes fractional share rights are issued for the partial shares, which would entitle you to a fractional share right for 1 /5 of a share. Question A quasi reorganization allows a company to (1) write down inflated asset values and (2) eliminate an accumulated deficit in retained earnings. The following steps are taken: 1. Assets and liabilities are revalued to reflect their fair values, with corresponding credits or debits to retained earnings. This may temporarily increase the deficit. 2. The debit balance in retained earnings is eliminated against additional paid-in capital. When additional paid-in capital is not sufficient to absorb the entire deficit, capital stock is debited. 3. Disclosure is provided to indicate the date the deficit was eliminated and when the new accumulation of earnings began. Solutions Manual, Vol.2, Chapter

8 BRIEF EXERCISES Brief Exercise 18 1 Two attributes of other comprehensive income are reported: (1) the components of comprehensive income created during the reporting period ($15 million in this instance) and (2) the comprehensive income accumulated over the current and prior periods ($50 million at the end of this year). The $50 million represents the cumulative sum of the changes in each component created during each reporting period throughout all prior years. Since this amount increased by $15 million, the balance must have been $35 million last year. Brief Exercise 18 2 ($ in millions) Cash (8 million shares x $12 per share) Common stock (8 million shares x $1 par per share)... 8 Paid-in capital excess of par (remainder) Intermediate Accounting, 7e

9 Brief Exercise 18 3 Lewelling s paid-in capital excess of par will increase by $860,000: 4,000 hours x $240 less $100,000 par. Journal entry (not required): Legal expense (4,000 hours x $240) ,000 Common stock (100,000 shares x $1 par per share) ,000 Paid-in capital excess of par (remainder) ,000 Brief Exercise 18 4 Hamilton s shareholders equity will increase by $3,500,000 as a result of this transaction. Journal entry (not required): Inventory of motors (1,000 x $3,500)... 3,500,000 Common stock... 3,500,000 Solutions Manual, Vol.2, Chapter

10 Brief Exercise 18 5 MLS s common shareholders will receive dividends of $18 million as a result of the 2013 distribution. Preferred Common 2011 $20 million* million** million*** $18 million (remainder) * $24 million current preference (6% x $400 million), thus $4 million dividends in arrears. ** $24 million current preference (6% x $400 million), thus another $4 million dividends in arrears. *** $8 million dividends in arrears plus the $24 million current preference. Brief Exercise 18 6 Horton s total paid-in capital will decline by $17 million, the price paid to buy back the shares. Journal entry (not required): ($ in millions) Common stock (2 million shares x $1 par)... 2 Paid-in capital excess of par (2 million shares x $9 * ) Paid-in capital share repurchase (difference)... 3 Cash (2 million shares x $8.50 per share) * Paid-in capital excess of par: $ million shares Intermediate Accounting, 7e

11 Brief Exercise 18 7 Agee s total paid-in capital will decline by $18 million because recording the transaction involves a $1 million reduction of retained earnings and an $18 million reduction in paid-in capital accounts. Journal entries (not required): First buyback ($ in millions) Common stock (1 million shares x $1 par)... 1 Paid-in capital excess of par (1 million shares x $15 * ) Paid-in capital share repurchase (difference)... 2 Cash (1 million shares x $14) * $16 $1 par Second buyback Common stock (1 million shares x $1 par)... 1 Paid-in capital excess of par (1 million shares x $15 * ) Paid-in capital share repurchase (balance from first buyback).. 2 Retained earnings (difference)... 1 Cash (1 million shares x $19) * $16 $1 par Solutions Manual, Vol.2, Chapter

12 Brief Exercise 18 8 Jennings s retained earnings will decline by $2 million because the $67 million sale price is less than the sum of the cost of the treasury stock ($70 million) and paid-in capital from the previous treasury stock sale ($1 million). Journal entries (not required): Purchase of treasury stock ($ in millions) Treasury stock (2 million shares x $70) Cash First sale of treasury stock Cash (1 million shares x $71) Treasury stock (1 million shares x $70) Paid-in capital share repurchase (remainder)... 1 Second sale of treasury stock Cash (1 million shares x $67) Paid-in capital share repurchase (balance from first sale)... 1 Retained earnings (remainder)... 2 Treasury stock (1 million shares x $70) Intermediate Accounting, 7e

13 Brief Exercise 18 9 Cox s paid-in capital share repurchase will increase by $7 million as determined in the following journal entry: ($ in millions) Cash (1 million shares x $29) Paid-in capital share repurchase (difference)... 7 Treasury stock (1 million shares x $22*) * 2 million shares x $20 = $40 million 1 million shares x $26 = 26 million 3 million shares $66 million $66 million 3 million shares = $22 average cost per share Brief Exercise Cox s paid-in capital share repurchase will increase by $9 million as determined in the following journal entry: ($ in millions) Cash (1 million shares x $29) Paid-in capital share repurchase (difference)... 9 Treasury stock (1 million shares x $20*) * 2 million shares x $20 = $40 million (first million at $20) 1 million shares x $26 = 26 million $66 million Solutions Manual, Vol.2, Chapter

14 Brief Exercise Declaration date ($ in millions) Retained earnings... 1,387 Cash dividends payable (8,668 million shares x $.16)... 1,387 Date of record no entry Payment date Cash dividends payable... 1,387 Cash... 1,387 Brief Exercise Declaration date Loss on investment ($37,000 35,000)... 2,000 Investment in GE stock... 2,000 Retained earnings (1,000 shares at $35 per share)... 35,000 Property dividends payable... 35,000 Payment date Property dividends payable... 35,000 Investment in GE stock... 35,000 Brief Exercise ($ in millions) Retained earnings (3 million* shares at $25 per share) Common stock (3 million* shares at $1 par per share)... 3 Paid-in capital excess of par (remainder) * 5% x 60 million shares = 3 million shares Intermediate Accounting, 7e

15 Brief Exercise If a stock split is not to be effected in the form of a stock dividend, no entry is recorded. Since the shares double, but the balance in the common stock account is not changed, the par per share is reduced, to $.50 in this instance. Brief Exercise ($ in millions) Paid-in capital excess of par** 60 Common stock (60 million shares* x $1 par per share) 60 **alternatively, retained earnings may be debited * 100% x 60 million shares = 60 million shares If the per share par value of the shares is not to be changed, the stock distribution is referred to as a "stock split effected in the form of a stock dividend." In that case, the journal entry increases the common stock account by the par value of the additional shares. This prevents the increase in shares from reducing (by half in this case) the par per share. The par is $1 before and after the split. Brief Exercise If Nestle used U.S. GAAP: Ordinary share capital would be common stock, Share premium would be paid-in capital excess of par, and Translation reserve would be net gains (losses) from foreign currency translation AOCI. Solutions Manual, Vol.2, Chapter

16 EXERCISES Exercise 18 1 Requirement 1 Comprehensive income is a more expansive view of the change in shareholders equity than traditional net income. It is the total nonowner change in equity for a reporting period. In fact, it encompasses all changes in equity other than from transactions with owners. Transactions between the corporation and its shareholders primarily include dividends and the sale or purchase of shares of the company s stock. Most nonowner changes are reported in the income statement. So, the changes other than those that are part of net income are the ones reported as other comprehensive income. Requirement 2 Two attributes of other comprehensive income are reported: (1) the components of comprehensive income created during the reporting period and (2) the comprehensive income accumulated over the current and prior periods. The second measure the comprehensive income accumulated over the current and prior periods is reported in the balance sheet as a separate component of shareholders equity. This is what Kaufman reported in its balance sheet ($107 million in 2013). Be sure to realize this amount represents the cumulative sum of the changes in each component created during each reporting period (the disclosure note) throughout all prior years Intermediate Accounting, 7e

17 Exercise 18 1 (continued) Requirement 3 Kaufman's 2013 balance sheet amount ($107 million) differs from the 2013 amount reported in the disclosure note. On the other hand, the comprehensive income created during the reporting period can be reported in either (a) an expanded version of the income statement or (b) a separate statement immediately following the income statement. Regardless of the placement a company chooses, the presentation is similar. It will report net income, other components of comprehensive income, and total comprehensive income, similar to the following: ($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments (net of tax) $ x Gains (losses) from and amendments to postretirement plans (net of tax) (x) Deferred gains (losses) from derivatives (net of tax) x Gains (losses) from foreign currency translation (net of tax) * x xx Comprehensive income $xxx Changes in the fair value of some securities (described in Chapter 12).. Gains and losses due to revising assumptions or market returns differing from expectations and prior service cost from amending the plan (described in Chapter 17). When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text). * Gains or losses from changes in foreign currency exchange rates from the translation of foreign subsidiary financial statements. The amount could be an addition to or reduction in shareholders equity. (This item is discussed elsewhere in your accounting curriculum.) Notice that each component is reported net of its related income tax expense or income tax benefit. Solutions Manual, Vol.2, Chapter

18 Exercise 18 1 (concluded) Requirement 4 From the information Kaufman's financial statements provide, we can determine how the company calculated the $107 million accumulated other comprehensive income in 2013: ($ in millions) Accumulated other comprehensive income, 2012 $75 Change in net unrealized gains on investments 34 Change in other (2) Accumulated other comprehensive income, 2013 $ Intermediate Accounting, 7e

19 Exercise 18 2 Requirement 1 The specific citation that describes the guidelines for presenting accumulated other comprehensive income on the statement of shareholders equity is FASB ACS : Comprehensive Income Overall Other Presentation Matters Reporting Other Comprehensive Income in the Equity Section of a Statement of Financial Position. Requirement The total of other comprehensive income for a period shall be transferred to a component of equity that is displayed separately from retained earnings and additional paid-in capital in a statement of financial position at the end of an accounting period. A descriptive title such as accumulated other comprehensive income shall be used for that component of equity. An entity shall disclose accumulated balances for each classification in that separate component of equity on the face of a statement of financial position, in a statement of changes in equity, or in notes to the financial statements. The classifications shall correspond to classifications used elsewhere in the same set of financial statements for components of other comprehensive income. Solutions Manual, Vol.2, Chapter

20 Exercise 18 3 Indicate by letter whether each of the items listed below most likely is reported in the income statement as Net Income (NI) or in the statement of comprehensive income as Other Comprehensive Income (OCI). OCI 1. NI 2. OCI 3. OCI 4. NI 5. OCI 6. NI 7. OCI 8. NI 9. OCI 10. Items Increase in the fair value of securities available-for-sale Gain on sale of land Loss on pension plan assets (actual return less than expected) Gain from foreign currency translation Increase in the fair value of trading securities Loss from revising an assumption related to a pension plan Loss on sale of patent Prior service cost Increase in the fair value of bonds outstanding; fair value option Gain on postretirement plan assets (actual return more than expected) Exercise 18 4 Cash (3 million shares x $17.15 per share)... 51,450,000 Common stock (3 million shares x $.01 par per share)... 30,000 Paid-in capital excess of par (remainder)... 51,420, Intermediate Accounting, 7e

21 Exercise 18 5 February 12 Cash (2 million shares x $9 per share)... 18,000,000 Common stock (2 million shares x $1 par)... 2,000,000 Paid-in capital excess of par (difference)... 16,000,000 February 13 Legal expenses (40,000 shares x $9 per share) ,000 Common stock (40,000 shares x $1 par)... 40,000 Paid-in capital excess of par (difference) ,000 Note: Because 2 million shares sold the previous day for $9 per share, it s reasonable to assume a $9 per share fair value. February 13 Cash ,000 Common stock (80,000 shares x $1 par)... 80,000 Paid-in capital excess of par, common* ,000 Preferred stock (4,000 shares x $50 par) ,000 Paid-in capital excess of par, preferred**... 25,000 * 80,000 shares x [$9 market value $1 par] ** Since the value of the common shares is known ($720,000), the market value of the preferred ($225,000) is assumed from the total selling price ($945,000). November 15 Property, plant, and equipment (cash value)... 3,688,000 Common stock (380,000 shares at $1 par per share) ,000 Paid-in capital excess of par (difference)... 3,308,000 Solutions Manual, Vol.2, Chapter

22 Exercise 18 6 Williams Industries must report the 20 million Class B shares among its longterm liabilities in its balance sheet, not as part of shareholders equity. The triggering event, the death of J.P Williams, is certain to occur even though its timing may not be. A share or other financial instrument is considered to be mandatorily redeemable if it embodies an unconditional obligation that requires the issuer to redeem the instrument with cash or other assets at a specified or determinable date or upon an event certain to occur. Events certain to occur include the death or termination of employment of an individual, since both events, like taxes, are inevitable. Because Williams has the right but not the obligation to repurchase the Class A shares if a change in ownership of the voting common shares changes, there is no unconditional obligation to repurchase the Class B shares. They are classified as equity Intermediate Accounting, 7e

23 Exercise 18 7 Requirement 1 ($ in millions) Cash ($424 million 2 million) Common stock (15 million shares at $1 par per share) Paid-in capital excess of par (difference) Requirement 2 In recording the sale of shares above, the cost of services related to the sale reduced the net proceeds from selling the shares. Since paid-in capital excess of par is credited for the excess of the proceeds over the par amount of the shares sold, the effect of share issue costs is to reduce the amount credited to that account. On the other hand, the costs associated with a debt issue are recorded in a separate debt issue costs account and amortized to expense over the life of the debt (Chapter 14). Some argue that share issue costs and debt issue costs are fundamentally different. This view is that a debt issue has a fixed maturity so, like interest expense, debt issue costs are part of the expense of borrowing funds for that period of time (recorded in a separate expense account debt issue expense ). On the other hand, selling shares represents a perpetual equity interest. Just as dividends paid on that capital investment are not an expense, neither are the share issue costs of obtaining that capital investment. Expensing debt issue costs presently is required by GAAP. However, the FASB has suggested in Concept Statement 6 that those costs should be treated the same way as share issue costs, meaning that the debt issue costs would reduce the recorded amount of the debt instead of being recorded separately as an asset. Solutions Manual, Vol.2, Chapter

24 Exercise 18 8 Requirement 1 The base amount of the preferred shares is $2,500, ,000 shares = $25. The dividend preference is 6.785%. So, the dividends paid annually to a preferred shareholder owning 100 shares are: $25 x 100 shares x 6.785% = $ Requirement 2 If dividends are not paid in 2014 and 2015, but are paid in 2016, the shareholder will receive $ x 3 = $ The prior years unpaid dividends are paid because the shares are cumulative. Otherwise, only the $ current year dividend would be paid. When preferred shares are cumulative, this means that if the specified dividend is not paid in a given year, the unpaid dividends (called dividends in arrears ) accumulate and must be made up in a later dividend year before any dividends are paid on common shares. Requirement 3 If the investor chooses to convert the shares in 2014, the investor will receive $25 $30.31 x 100 shares = shares of common stock for his/her 100 shares. This can be calculated also as 82, ,000, or $ per share times 100 shares. The.48 fractional share likely would be paid in cash equal to the current market price per share times.48. Requirement 4 If Ozark chooses to redeem the shares on June 18, 2014, the investor will be paid $2,744 for his/her 100 shares: The redemption price is $28 ($25 x 112%), reduced by 2% because redemption would be two years after the initial redemption date. Hence, the price would be $28 x 98% = $ The total payment would be $27.44 x 100 shares, or $2, Intermediate Accounting, 7e

25 Exercise 18 9 AMTC Cash (7.5 million shares x $13.546) ,595,000 Common stock (7.5 million shares x $.001 par) 7,500 Paid-in capital excess of par (difference) ,587,500 PSI Cash (9 million shares x $15.20) ,800,000 Common stock (9 million shares x $.01 par).. 90,000 Paid-in capital excess of par (difference) ,710,000 Solutions Manual, Vol.2, Chapter

26 Exercise Preferred Common 2013 $ 8 million $ million* million** 130 million (remainder) * $8 million dividends in arrears plus $12 million of the $16 million current preference. ** $4 million dividends in arrears plus the $16 million current preference Intermediate Accounting, 7e

27 Exercise January 7, 2013 ($ in millions) Common stock (2 million shares x $1 par)... 2 Paid-in capital excess of par (2 million shares x $3 * )... 6 Retained earnings (difference)... 2 Cash (2 million shares x $5 per share) * Paid-in capital excess of par: $ million shares 2. August 23, 2013 Common stock (4 million shares x $1 par)... 4 Paid-in capital excess of par (4 million shares x $3) Paid-in capital share repurchase (difference)... 2 Cash (4 million shares x $3.50 per share) July 25, 2014 Cash (3 million shares x $6 per share) Common stock (3 million shares x $1 par)... 3 Paid-in capital excess of par (difference) Solutions Manual, Vol.2, Chapter

28 Exercise January 2, 2013 ($ in millions) Common stock (10 million shares x $1 par) Paid-in capital excess of par (10 million shares x $33 * ) Paid-in capital share repurchase (difference) Cash (10 million shares x $32.50) * $34 $1 par 2. March 3, 2013 Common stock (10 million shares x $1) Paid-in capital excess of par (10 million shares x $33 * ) Paid-in capital share repurchase (available balance) Retained earnings (remainder)... 5 Cash (10 million shares x $36) * $34 $1 par 3. August 13, 2013 Cash (1 million shares x $42) Common stock (1 million shares x $1)... 1 Paid-in capital excess of par (remainder) December 15, 2013 Cash (2 million shares x $36) Common stock (2 million shares x $1)... 2 Paid-in capital excess of par (remainder) Intermediate Accounting, 7e

29 Exercise January 23, 2013 ($ in millions) Treasury stock (10 million shares x $20) Cash September 3, 2013 Cash (1 million shares x $21) Treasury stock (1 million shares x $20) Paid-in capital share repurchase (remainder) November 4, 2013 Cash (1 million shares x $18) Paid-in capital share repurchase (available balance from req. 2.) 1 Retained earnings (remainder)... 1 Treasury stock (1 million shares x $20) Solutions Manual, Vol.2, Chapter

30 Exercise February 12, 2013 ($ in millions) Treasury stock (1 million shares x $13) Cash June 9, 2014 Treasury stock (2 million shares x $10) Cash May 25, 2015 Cash (2 million shares x $15) Paid-in capital share repurchase (difference)... 8 Treasury stock (2 million shares x $11*) * 1 million shares x $13 = $13 million 2 million shares x $10 = 20 million 3 million shares $33 million $33 million 3 million shares = $11 average cost per share 4. May 25, 2015 Cash (2 million shares x $15) Paid-in capital share repurchase (difference)... 7 Treasury stock (FIFO cost*) * 1 million shares x $13 = $13 million 1 million shares x $10 = 10 million $23 million Intermediate Accounting, 7e

31 Exercise Requirement 1 Method A Reacquired shares are treated as treasury stock. Method B Reacquired shares are retired with their status restored to that of authorized but unissued shares. Requirement 2 Reacquired shares that are retired have their status restored to that of authorized but unissued shares. Although theoretically identical to retired shares, treasury shares are treated as issued, but not outstanding shares at the same time both (a) issued and (b) not outstanding. This artificial status has provided companies an effective device to evade the superficial constraints imposed on par value shares. Treasury stock is reported as a reduction in total shareholders' equity, not associated with any specific shareholders equity account. By either method, total shareholders equity is the same. Retiring shares clearly is conceptually superior because it effectively restores the shares to the status of being authorized, but unissued, shares. Treated as treasury stock, the cost of acquiring the shares is debited to the treasury stock account. Recording the effects on specific shareholders equity accounts is delayed until later when the shares are reissued. In the meantime, the shares assume the artificial status of being neither unissued nor outstanding. Solutions Manual, Vol.2, Chapter

32 Exercise This is a change in accounting principle. ($ in millions) Common stock ($1 par x 4 million shares retired)... 4 Paid-in capital excess of par (average amount above par at which the retired shares originally sold: $800 million million shares = $4; $4 x 4 million shares retired) Retained earnings (difference)... 5 Treasury stock (cost of the shares retired) UMC applies the new way of reporting reacquired shares retrospectively; that is, to all prior periods as if it always had used that method. In other words, all financial statement amounts for individual periods affected by the change and that are included for comparison with the current financial statements are revised. In each prior period reported, then, UMC would reduce Common stock by $4 million, Paid-in capital excess of par by $16 million, Retained earnings by $5 million, and Treasury stock by $25 million. The effect of the change on each line item affected should be disclosed for each period reported as well as any adjustment for periods prior to those reported. Also, the nature of and justification for the change should be described in the disclosure notes Intermediate Accounting, 7e

33 Exercise Requirement 1 ($ in millions) Treasury stock 1,980 Cash (36 million shares x $55) 1,980 Requirement 2 ($ in millions) Common stock (36 million shares x $.30) Paid-in capital excess of par (36 million shares x $9.19) Retained earnings (difference) 1, Cash (36 million shares x $55) 1, Requirement 3 DuPont is referring to the fact that stock options and stock awards increase the number of shares and thus decrease earnings per share, other things being equal. This effect would partially be offset by decreasing the number of shares through share repurchase. Solutions Manual, Vol.2, Chapter

34 Exercise Requirement 1 Retirement of common shares ($ in millions) Common stock (5 million shares x $1 par per share)... 5 Paid-in capital excess of par ($22 5 2) Retained earnings (given)... 2 Cash (given) Net income closed to retained earnings Income summary Retained earnings (given) Declaration of a cash dividend Retained earnings (given) Cash Declaration of a stock dividend Retained earnings (given) Common stock ([105 5] x 4%) million shares at $1 par per share) 4 Paid-in capital excess of par (difference) Requirement 2 BRENNER-JUDE CORPORATION Statement of Retained Earnings FOR THE YEAR ENDED DECEMBER 31, 2013 ($ in millions) Balance at January 1 $ 90 Net income for the year 88 Deductions: Retirement of common stock (2) Cash dividends of $.33 per share (33) 4% stock dividend (20) Balance at December 31 $ Intermediate Accounting, 7e

35 Exercise April 1, 2013 Retained earnings (300,000* shares at $30 per share)... 9,000,000 Common stock (300,000* shares at $1 par per share) ,000 Paid-in capital excess of par (remainder)... 8,700,000 * 10% x 3 million shares issued and outstanding or, alternatively: April 1, 2013 Retained earnings... 9,000,000 Common stock dividends distributable ,000 Paid-in capital excess of par... 8,700,000 June 1, 2013 Common stock dividends distributable ,000 Common stock ,000 Solutions Manual, Vol.2, Chapter

36 Exercise Requirement 1 Paid-in capital excess of par** 24,500 Common stock (24.5 million shares* x $.001 par per share) 24,500 **alternatively, retained earnings may be debited * 100% x 24.5 million shares = 24.5 million shares Requirement 2 If the per share par value of the shares is not to be changed, the stock distribution is referred to as a "stock split effected in the form of a stock dividend." In that case, the journal entry in requirement 1 increases the common stock account by the par value of the additional shares. This prevents the increase in shares from reducing (by half in this case) the par per share. Requirement 3 If Hanmi s stock price had been $36 at the time of the split, its approximate value after the split (other things equal) would be $18. The same pie is sliced into twice as many pieces, so each piece is worth half as much Intermediate Accounting, 7e

37 Exercise Requirement 1 A stock dividend or stock split usually results in some shareholders being entitled to fractions of whole shares. For instance, if a company declares a 25% stock dividend, or equivalently a 5-for-4 stock split, a shareholder owning 10 shares would be entitled to 2 1 /2 shares. Another shareholder with 15 shares would be entitled to 3 3 /4 shares. Paying shareholders the cash equivalent of the fractional shares simplifies matters for both the corporation and shareholders. Requirement 2 ($ in millions) Retained earnings (36 million* x $21 per share) Common stock ([36 million* 2 million] x $1 par) Paid-in capital excess of par ([36 million* 2 million] x [$21 1 = $20 per share]) Cash (2 million shares at $21 market price per share) * 4% x 900 million shares = 36 million additional shares Solutions Manual, Vol.2, Chapter

38 Exercise The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Disclosure for the pertinent rights and privileges of the various securities outstanding: FASB ACS : Equity Overall Disclosure. 2. Requirement to record a small stock dividend at the fair value of the shares issued: FASB ASC : Equity Stock Dividends and Stock Splits Initial Measurement Stock Dividend. Another citation that describes what qualifies as a small stock dividend is FASB ASC Notice, though, that this paragraph does not say fair value, so it can t be considered the best answer. 3. Requirement to exclude from the determination of net income gains and losses on transactions in a company s own stock: FASB ACS : Equity Overall Recognition Intermediate Accounting, 7e

39 Exercise Requirement 1 a. March 3 declaration date Investment in Leasco International stock... 20,000 Gain on appreciation of investment ($720, ,000) 20,000 Retained earnings (240,000 shares at $3 per share) ,000 Property dividends payable ,000 March 15 date of record no entry March 31 payment date Property dividends payable ,000 Investment in Leasco International stock ,000 b. May 3 Paid-in capital excess of par, common*... 90,000 Common stock (25% x [364,000 4,000] shares at $1 par).. 90,000 *alternatively, retained earnings may be debited. c. July 5 Retained earnings (9,000* x $11 per share)... 99,000 Common stock (9,000* x $1 par)... 9,000 Paid-in capital excess of par, common (difference)... 90,000 * 2% x [360, ,000 shares] = 9,000 additional shares Solutions Manual, Vol.2, Chapter

40 Exercise (concluded) d. December 1 declaration date Retained earnings... 7,920 Cash dividends payable ($90,000 par x 8.8%)... 7,920 December 20 date of record no entry December 28 payment date Cash dividends payable... 7,920 Cash... 7,920 e. December 1 declaration date Retained earnings ,500 Cash dividends payable (459,000* x $.50) ,500 * 360, , ,000 = 459,000 shares December 20 date of record no entry December 28 payment date Cash dividends payable ,500 Cash ,500 Requirement 2 CONSOLIDATED PAPER, INC. [Shareholders Equity section] December 31, 2013Paid-in capital: Preferred stock, 8.8%, 90,000 shares at $1 par $ 90,000 Common stock, 463,000 1 shares at $1 par 463,000 Paid-in capital excess of par, preferred 1,437,000 Paid-in capital excess of par, common 2,574,000 2 Retained earnings 9,488,580 3 Treasury stock, at cost; 4,000 common shares (44,000) Total shareholders equity $14,008, , , ,000 = 463,000 shares 2 $2,574,000 90, ,000 = $2,574,000 3 $9,735, ,000 99,000 7, , ,000 = $9,488, Intermediate Accounting, 7e

41 Exercise The return on shareholders' equity is computed by dividing net income by average shareholders' equity. [$ ]* ([$ ] 2) = 14.29% * Increase in retained earnings, which equals net income since no dividends were paid. The ratio is a summary measure of profitability often used by investors and potential investors, particularly common shareholders. It measures the ability of company management to generate net income from the resources that owners provide. However, because shareholders equity is a measure of the book value of equity, investors often relate earnings to the market value of equity, calculating the earningsprice ratio. Information available in the exercise is insufficient to do so. Solutions Manual, Vol.2, Chapter

42 Exercise Indicate by letter whether each of the terms or phrases listed below is more associated with financial statements prepared in accordance with U.S. GAAP (U) or International Financial Reporting Standards (I). Terms and phrases U 1. Common stock I 2. Preference shares U 3. Liabilities often listed before Equity in the balance sheet (statement of financial position) I 4. Asset revaluation reserve U 5. Accumulated other comprehensive income I 6. Share premium I 7. Equity often listed before Liabilities in the balance sheet (statement of financial position) I 8. Translation reserve I 9. Ordinary shares U 10. Paid-in capital excess of par U 11. Net gains (losses) on investments AOCI I 12. Investment revaluation reserve U 13. Preferred stock Intermediate Accounting, 7e

43 CPA / CMA REVIEW QUESTIONS CPA Exam Questions 1. b. The entries to record the stock issuance and subsequent acquisition and retirement (per share) are as follows: Issuance Cash Common stock Paid-in capital excess of par Retirement Common stock Paid-in capital excess of par Paid-in capital share repurchase... 5 Cash The net result is a decrease in Paid-in capital excess of par (additional paid-in capital) of $10 per share retired. 2. c. A treasury stock account is created when a company reacquires its own stock as treasury stock. The full purchase price (cost) is debited to Treasury Stock. When treasury stock is sold, the Treasury Stock account is credited for the cost per share, with an additional credit to Paid-in Capital, Treasury Stock (or Paid-in Capital Repurchased Shares), if the sale price exceeds the reacquisition price. The 2012 repurchase is accounted for with a debit to Treasury Stock for $100,000. When half of the treasury stock is resold, $50,000 is credited to Treasury Stock and $30,000 is credited to Paid-In Capital, Treasury Stock. The balance in the Treasury Stock account is ($100,000-50,000 =) $50,000. Solutions Manual, Vol.2, Chapter

44 CPA Exam Questions (concluded) 3. b. Property dividends are recorded at the fair value of the property distributed as of the date of declaration, with any gain or loss being recognized in the current period. Fair market value of property dividend $2.50 x 100,000 shares $250,000 Carrying value $2.00 x 100,000 shares 200,000 Gain on disposal of investment $ 50, c. The number of shares issued is less than 20 25%. Therefore, the transaction is considered a small stock dividend and retained earnings should be debited for the FV at date of declaration. 600,000 shares x 1/6 = 100,000 shares x $8 = $800, a. When a company issues a stock dividend, earnings per share decreases as the number of shares outstanding increases. There is no effect on total assets, total liabilities, or total stockholders equity. 6. b. $100,000 Jan. 1 Shares issued and outstanding 100,000 Mar for-1 stock split x 2 Mar. 15 Shares issued and outstanding 200,000 Dec. 15 Cash dividend declared (per share) x $.50 Dividends for the year $100, Intermediate Accounting, 7e