CHAPTER 11 Solutions STOCKHOLDERS EQUITY

CHAPTER 11 Solutions STOCKHOLDERS EQUITY Chapter 11, SE 1. 1. c 4. 2. a 5. 3. b 6. d e a Chapter 11, SE 2. 1. Advantage 4. 2. Disadvantage 5. 3. Advantage 6. Advantage Disadvantage Advantage Chapter 11, SE 3. 5/15 6/1 6/15 Dividends Dividends Payable Declaration of dividends: 140,000 shares outstanding $0.20 per share No entry necessary on record date Dividends Payable Cash Payment of dividends 28,000 28,000 28,000 28,000 Chapter 11, SE 4. Start-up and organization costs: Legal services, 24,000 shares of $1 par value common stock Incorporation fees Total start-up and organization costs Income Statement Effect: Start-up and organization costs Balance Sheet Effect: Cash Additional Paid-In Capital Retained Earnings $40,000 24,000 $64,000 ($64,000) ($24,000) 24,000 16,000 ( 64,000) 518

Chapter 11, SE 5. Fina Corporation Balance Sheet December 31, 2011 Stockholders Equity Contributed capital Common stock, $10 par value, 30,000 shares authorized, 20,000 shares issued, and 19,500 shares outstanding Additional paid-in capital Total contributed capital Retained earnings Total contributed capital and retained earnings Less: Treasury stock, common (500 shares, at cost) Total stockholders equity $200,000 100,000 $300,000 15,000 $315,000 7,500 $307,500 Chapter 11, SE 6. 2010 2011 Preferred Stock Dividends Dividends Total Per Per Dividends Amount Share Amount Share Allocated 2010 dividends in arrears $16,000 ( $200,000 0.08 ) 2011 dividends ( $200,000 0.08 ) 16,000 ( $40,000 $32,000 ) $ 8,000 Totals $32,000 $16.00 $ 8,000 $0.20 $40,000 2012 2012 dividends ( $200,000 0.08 ) $16,000 ( $80,000 $16,000 ) $64,000 Totals $16,000 $ 8.00 $64,000 $1.60 $80,000 519

Chapter 11, SE 7. 1. Cash 30,000 Additional Paid-In Capital Issued 2,500 shares of $5 par value common stock at $12 per share 2. Cash 30,000 Additional Paid-In Capital Issued 2,500 shares of $1 stated value common stock at $12 per share 12,500 17,500 2,500 27,500 Chapter 11, SE 8. 1. Land 112,000 Additional Paid-In Capital Issued 16,000 shares of $1 par value common stock for land; market value of common stock used to value transaction 16,000 shares at $7 $112,000 2. Land 100,000 Additional Paid-In Capital Issued 16,000 shares of $1 par value common stock for land; market value of land used to value transaction 16,000 96,000 16,000 84,000 520

Chapter 11, SE 9. Oct. 1 Treasury Stock, Common 40,000 Cash Acquired 2,000 shares of company s common stock for $40,000 ( 2,000 $20 per share ) 17 Cash 12,500 Treasury Stock, Common Paid-In Capital, Treasury Stock Sold 500 shares of treasury stock for $12,500 ( 500 $25 per share); cost was $10,000 ( 500 $20 per share) 40,000 10,000 2,500 Chapter 11, SE 10. Oct. 28 3,000 Additional Paid-In Capital 4,500 Retained Earnings 22,500 Treasury Stock, Common Retired 1,500 shares of $2 par value common stock that cost $20 per share and were originally issued at $5 per share 30,000 521

Chapter 11, SE 11. Feb. 15 Mar. 1 15 30 Stock Dividends Distributable Additional Paid-In Capital Declaration of a stock dividend of 4,400 shares (2% 220,000 shares) on $10 par value common stock, to be distributed on March 15 at the market value of stock of $66,000 (4,400 shares $15 per share) No entry required Distributable Distribution of a stock dividend of 4,400 shares declared on February 15 Dividends Dividends Payable Declaration of a cash dividend $0.50 224,400 shares $112,200 66,000 44,000 112,200 44,000 22,000 44,000 112,200 Chapter 11, SE 12. After Stock Split Pearl International Stockholders Equity August 10, 2011 Contributed capital Common stock, $3 par value, 400,000 shares authorized, 375,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity $1,125,000 3,000,000 $4,125,000 3,250,000 $7,375,000 No entry is required, but a memorandum entry for informational purposes should be prepared. 522

Chapter 11, SE 13. 1. $50 per share ( 2. $33.33* per share ( 3. $50 per share ( 4. $48 per share ( $500,000 $200,000 $380,000 $ 48,000 10,000 6,000 7,600 1,000 shares ) shares ) shares ) shares ) Chapter 11, SE 14. 1. 2. 3. 4. Total Assets No effect No effect No effect Decrease Total Liabilities No effect Increase No effect No effect Total Stockholders Equity No effect Decrease No effect Decrease Chapter 11, SE 15. Preferred Stock Book Value per Share ( 1,000 $108 ) + 1,000 shares $8,000* $116,000 1,000 $116 per share * ( 1,000 shares $100 0.08 ) $8,000 Book Value per Share $2,482,000 80,000 $116,000 shares $2,366,000 80,000 $29.58* per share *Rounded. 523

Chapter 11, E 1. 1. 2. 3. 4. Most large companies are formed as corporations rather than partnerships because corporations offer limited liability, ease of capital generation, ease of transfer of ownership, lack of mutual agency, continuous existence, centralized authority and responsibility, and professional management. Companies like to give stock options as compensation because even though under new rules stock options create an expense when issued, they do not rean interest in the future success of the business. quire a cash outflow. Also, the ownership of stock options gives the employees No. If an investor sells shares after the declaration date but before the date of record, the seller will not receive the dividend because the date of record is the date at which ownership of the stock of a company and the right to receive a dividend is determined. However, the dividend will usually be reflected in the price for the stock. After the declaration date, the stock price adjusts upward to include the dividend declared. After the date of record, the price of the stock will drop by the amount of the dividend. A company usually does not want to issue all of its authorized shares because doing so dilutes the ownership and the company wants the option of being able to offer shares at a later date. Chapter 11, E 2. 1. 2. 3. 4. Callable preferred stock gives the company greater flexibility. The company can eliminate the related dividends at some future date by redeeming the shares at a specified call price. The argument that could be given in treating preferred stock as debt instead of equity consists of its higher priority over common stock in case of liquidation (as in the case of debt) and its fixed dividend payment (as in the case of debt). Return on equity and debt to equity are computed using total stockholders equity, which includes the total issue price of the stock. Financial analysis does not generally find par or stated value of any relevance. Treasury stock is not considered an investment because it is stock that has been issued and then reacquired. The company does not own the stock in the sense that an outside investor does. For instance, no dividends are paid on treasury stock because the company would be paying itself. By buying and holding its own stock, the company is in effect reducing its stockholders equity. 524

Chapter 11, E 3. Dividends Yield Dividends per Share Market Price per Share $2.00 $66.00 3.0% Price/Earnings (P/E) Ratio Market Price per Share Earnings per Share $66.00 15.0 Times $4.40 Chapter 11, E 4. 6/5 Dividends 17,500 Dividends Payable Declaration of dividends 70,000 shares outstanding $0.25 per share 6/15 Record date: No entry necessary 6/25 Dividends Payable 17,500 Cash Payment of dividends 17,500 17,500 Chapter 11, E 5. 10/15 Dividends 90,000 Dividends Payable Declaration of dividends 180,000 shares outstanding $0.50 per share 11/1 Record date: No entry necessary 11/15 Dividends Payable 90,000 Cash Payment of dividends 90,000 90,000 525

Chapter 11, E 6. Quest Corporation Balance Sheet December 31, 2011 Stockholders Equity Contributed capital Preferred stock, $100 par value, 9 percent cumulative, 20,000 shares authorized, 6,000 shares issued and outstanding Common stock, $12 par value, 90,000 shares authorized, 30,000 shares issued, and 28,500 shares outstanding Additional paid-in capital Total contributed capital Retained earnings Total contributed capital and retained earnings Less: Treasury stock, common (1,500 shares, at cost) Total stockholders equity $ 600,000 $360,000 194,000 554,000 $1,154,000 23,000 $1,177,000 30,000 $1,147,000 Chapter 11, E 7. 1. P 4. P 7. C 2. C 5. C 8. P 3. P 6. P 9. P 526

Chapter 11, E 8. 1. Transactions recorded in T accounts Cash Mar. 1 450,000 Mar. 1 400,000 400,000 Preferred Stock Additional Paid-In Capital Mar. 1 150,000 Mar. 1 300,000 2. Stockholders equity section of the balance sheet prepared Rich Supply Corporation Balance Sheet March 1, 2011 Stockholders Equity Contributed capital Preferred stock, $100 par value, 6 percent noncumulative, 20,000 shares authorized, 4,000 shares issued and outstanding Common stock, $5 stated value, 100,000 shares authorized, 30,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity $150,000 300,000 $400,000 450,000 $850,000 $850,000 527

Chapter 11, E 9. Preferred Stock Dividends Dividends Total Per Per Dividends Amount Share Amount Share Allocated 2009 2010 2009 dividends in arrears ( $500,000 0.07 ) $35,000 2010 dividends ( $60,000 $35,000 ) 25,000 Totals $60,000 $12.00 $60,000 2011 2010 dividends in arrears ( $35,000 $25,000 ) $10,000 2011 dividends ( $500,000 0.07 ) 35,000 ( $70,000 $45,000 ) $25,000 Totals $45,000 $ 9.00 $25,000 $1.00 $70,000 2012 2012 dividends ( $500,000 0.07 ) $35,000 ( $70,000 $35,000 ) $35,000 Totals $35,000 $ 7.00 $35,000 $1.40 $70,000 528

Chapter 11, E 10. Preferred Common Stock Stock Dividends Dividends Total 1. 2009 dividends $40,000 $40,000 2010 dividends $30,000 $30,000 2011 dividends ( $1,000,000 0.06 ) $60,000 ( $90,000 $60,000 ) $ 30,000 $90,000 2. 2009 dividends ( $500,000 0.07 ) $35,000 ( $40,000 $35,000 ) $ 5,000 $40,000 2010 dividends $30,000 $30,000 2011 dividends 2010 dividends in arrears ( $35,000 $30,000 ) $ 5,000 2011 ( $500,000 0.07 ) 35,000 ( $90,000 $40,000 ) $50,000 Totals $40,000 $50,000 $90,000 529

Chapter 11, E 11. 1. Entry prepared $25 par value Aug. 1 Cash 125,000 Issued 5,000 shares of $25 par value common stock for $25 per share 125,000 2. Entry prepared $10 par value Aug. 1 Cash 125,000 Additional Paid-In Capital Issued 5,000 shares of $10 par value common stock for $25 per share 50,000 75,000 3. Entry prepared no par value Aug. 1 Cash 125,000 Issued 5,000 shares of no-par common stock for $25 per share 125,000 4. Entry prepared $1 stated value Aug. 1 Cash 125,000 Additional Paid-In Capital Issued 5,000 shares of $1 stated value common stock for $25 per share 5,000 120,000 530

Chapter 11, E 12. 1. Entry prepared $10 par value 2011 July 1 Building 1,200,000 Additional Paid-In Capital Issued 40,000 shares of $10 par value common stock for a building with a fair market value of $1,200,000 400,000 800,000 2. Entry prepared no par value 2011 July 1 Building 1,200,000 Issued 40,000 shares of no-par common stock for a building with a fair market value of $1,200,000 1,200,000 3. Entry prepared $4 stated value 2011 July 1 Building 1,200,000 Additional Paid-In Capital Issued 40,000 shares of $4 stated value common stock for a building with a fair market value of $1,200,000 160,000 1,040,000 531

Chapter 11, E 13. May 17 52,800 2 May 5 128,000 1 May 5 128,000 May 17 48,000 3 21 32,000 5 21 32,000 28 45,600 6 28 48,000 7 3,200 Cash shares $40 $128,000 $52,800 $48,000 shares $4,800 1 2 1,200 shares $44 3 1,200 shares $40 4 1,200 ($44 $40) 5 800 shares $40 6 1,200 shares $38 7 1,200 $40 8 1,200 shares ($38 $40) $32,000 $45,600 shares $48,000 $2,400 Bal. Treasury Stock, Common Paid-In Capital, Treasury Stock May 28 2,400 8 May 17 4,800 4 Bal. 2,400 532

Chapter 11, E 14. June 10 20 Cash 10,000 June 1 10,150 5 35,000 2 1 June Bal. Treasury Stock, Common 1 35,000 June 10 8,750 3 20 12,250 6 30 14,000 8 June Retained Earnings 7 20 850 30 5,600 11 Paid-In Capital, Treasury Stock June 20 1,250 June 10 1,250 4 Bal. June 30 9 6,000 June Additional Paid-In Capital 30 2,400 10 1 2 3 4 5 6 7 8 9 10 11 1,000 shares $35 $35,000 250 shares $40 $10,000 250 shares $35 $8,750 250 shares ( $40 $35 ) $1,250 350 shares $29 $10,150 350 shares $35 $12,250 $12,250 $10,150 $1,250 $850 400 shares $35 $14,000 400 shares $15 par value $6,000 400 shares ( $21 $15 ) $2,400 $14,000 $6,000 $2,400 $5,600 533

Chapter 11, E 15. July Aug. Sept. 17 Stock Dividends 30,000 Distributable Additional Paid-In Capital Declaration of a 6,000-share stock dividend (60,000 shares 0.10) on $1 par value common stock, to be distributed on August 10 at the market value of stock of $30,000 ( 6,000 shares $5 per share) 31 No entry required 10 Distributable 6,000 Distribution of a stock dividend of 6,000 shares declared on July 17 1 Dividends 33,000 Dividends Payable Declaration of a cash dividend 66,000 shares $0.50 $33,000 6,000 24,000 6,000 33,000 534

Chapter 11, E 16. Before Stock Split Agat Company Stockholders Equity May 15, 2011 Contributed capital Common stock, $1 par value, 250,000 shares authorized, 100,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity After Stock Split Agat Company Stockholders Equity May 15, 2011 Contributed capital Common stock, $0.50 par value, 250,000 shares authorized, 200,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity $100,000 10,000 $110,000 350,000 $460,000 $100,000 10,000 $110,000 350,000 $460,000 No entry is required, but a memorandum entry for informational purposes should be prepared. 535

Chapter 11, E 17. Before Stock Split Contributed capital Contributed capital Mendoza International Stockholders Equity January 15, 2011 Common stock, $12 par value, 1,600,000 shares authorized, 400,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity After Stock Split Mendoza International Stockholders Equity January 15, 2011 Common stock, $4 par value, 1,600,000 shares authorized, 1,200,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity $ 4,800,000 8,000,000 $12,800,000 16,000,000 $28,800,000 $ 4,800,000 8,000,000 $12,800,000 16,000,000 $28,800,000 No entry is required, but a memorandum entry for informational purposes should be prepared. 536

Chapter 11, E 18. Balance, December 31, 2011 a. Issued 5,000 shares of preferred stock b. Conversion of bonds into 20,000 shares of common stock c. Issued 4,400 common shares in a stock dividend* d. Purchased 5,000 treasury 9%, $100 Par Value Cumulative Preferred Stock $500,000 Ruff Corporation Statement of Stockholders Equity For the Year Ended December 31, 2012 Other $2 Accumulated Par Value Additional Compre- Common Paid-In Retained Treasury hensive Stock Capital Earnings Stock Income Total $400,000 $600,000 $2,100,000 $3,100,000 500,000 40,000 260,000 300,000 8,800 52,800 ( 61,600) shares, common ($80,000) ( 80,000) e. Net income 230,000 230,000 f. Cash dividends: Preferred ($500,000 0.09) ( 45,000) ( 45,000) Common (219,400 $0.40) ( 87,760) ( 87,760) g. Foreign currency translation adjustment ($50,000) ( 50,000) Balance, December 31, 2012 $500,000 $448,800 $912,800 $2,135,640 ($80,000) ($50,000) $3,867,240 *( 200,000 + 20,000 ) 0.02 $14 per share 537

Chapter 11, E 19. Preferred Stock ( 400 ) + Book Value per Share $105 400 Shares $2,400* $44,400 400 $111 per Share * ( 400 shares $100 0.06 ) $2,400 Book Value per Share $356,000 18,000 Shares $44,400 $311,600 18,000 $17.31 per Share 538

Chapter 11, P 1. 1. T accounts set up and transactions recorded in the accounts Sept. 1 500,000 Sept. 1 32,000 Sept. 1 100,000 Oct. 2 960,000 Oct. 15 150,000 Oct. 2 320,000 Bal. 1,278,000 1,460,000 182,000 Bal. 420,000 Dividends Payable Sept. 1 400,000 Nov. 30 48,000* Oct. 2 640,000 Bal. 48,000 Bal. 1,040,000 Start-up and Organization Costs Sept. 1 32,000 Nov. 30 48,000 Bal. 32,000 Bal. 48,000 Treasury Stock, Common Oct. 15 150,000 Bal. 150,000 Cash *120,000 shares $0.40 $48,000 Additional Paid-In Capital Dividends 539

Chapter 11, P 1. (Continued) 2. Stockholders equity section of the balance sheet prepared Dewey Corporation Balance Sheet November 30, 2011 Stockholders Equity Contributed capital Common stock, $8 par value, 300,000 shares authorized, 130,000 shares issued and 120,000 shares outstanding Additional paid-in capital Total contributed capital Retained earnings* Total contributed capital and retained earnings Less: Treasury stock, common (10,000 shares at cost) Total stockholders equity $1,040,000 420,000 $1,460,000 32,000 $1,492,000 150,000 $1,342,000 * $80,000 $48,000 $32,000 3. User Insight: Effects of cash dividend declaration discussed The cash dividend declaration on November 30 will not affect net income and will not affect cash flows in the current period since the cash will be paid out in the next period. It will, however, reduce retained earnings in the current period. 540

Chapter 11, P 2. 1. Dividends calculated for cumulative preferred stock and common stock Cumulative Preferred Stock Dividends Dividends Total Per Per Dividends Amount Share Amount Share Allocated 2011 $ 35,000 $ 3.50 $ 35,000 2012 Dividends in arrears, 2011 $ 35,000 2012 dividends 70,000 $ 95,000 Totals $105,000 $10.50 $ 95,000 $0.63 * $200,000 2013 $ 70,000 $ 7.00 $205,000 $1.37 * $275,000 2. Dividends calculated for noncumulative preferred stock and common stock 2011 2012 2013 Noncumulative Preferred Stock Dividends Dividends Total Per Per Dividends Amount Share Amount Share Allocated $35,000 $ 3.50 $ 35,000 $70,000 $ 7.00 $130,000 $0.87 * $200,000 $70,000 $ 7.00 $205,000 $1.37 * $275,000 3. The 2012 and 2013 dividends yield for common stock calculated Dividends Yield Dividends per Share Market Price per Share $0.87 $15.00 $1.37 $17.00 2012 5.8% 2013 8.1% *Rounded. 541

Chapter 11, P 2. (Continued) 4. User Insight: Preferred stock compared to long-term bonds Both cumulative and noncumulative preferred stock have a fixed level of dividends and are thus similar in this way to long-term bonds, which have a fixed level of interest. However, cumulative preferred stock would be more similar to long-term bonds in the sense that if dividends are declared in any given year, past dividends not paid must be made up. Likewise, any past interest missed on long-term bonds would have to be made up. The difference is that with noncumulative preferred stock, if no dividends are ever declared, then the past dividends do not need to be made up; however, any past interest on bonds becomes a liability of the company and is not under the control of the board of directors. Also, missing the payment of interest on long-term bonds will usually result in a default and possible bankruptcy of the company, whereas skipping a preferred dividend in any year does not have this result. 542

Chapter 11, P 3. 1. Account numbers and dollar amounts provided Account Number Debited Dollar Amount Account Account Number Credited Dollar Amount Jan. 19 310 $ 15,000 110 $ 31,500 312 16,500 21 310 5,000 510 11,000 312 6,000 Feb. 7 310 30,000 121 78,000 312 48,000 Mar. 22 350 30,000 110 30,000 July 15 310 5,000 110 15,000 312 10,000 Aug. 1 350 7,500 110 10,000 313 2,500 Sept. 1 341 7,125 * 220 7,125 15 25 220 no entry 7,125 110 no entry 7,125 Oct. 30 310 4,000 120 12,000 312 8,000 Dec. 15 110 110,000 305 110,000 * Common Shares 15,000 shares 5,000 30,000 (10,000) 5,000 2,500 47,500 $0.15 $7,125 543

Chapter 11, P 3. (Continued) 2. User Insight: Stockholders equity section of balance sheet discussed The stockholders equity section of the balance sheet is an important factor in analyzing a company s performance because it represents the ownership interest of the stockholders. For instance, a key performance measure is return on equity, which measures the earnings of the company against the ownership interest. 544

Chapter 11, P 4. 1. T accounts set up and transactions recorded in the accounts Cash Additional Paid-In Capital Aug. 3 110,000 Oct. 10 3,250 Aug. 3 100,000 22 250,000 31 4,775 15 40,000 Oct. 4 30,000 Oct. 4 25,000 390,000 8,025 Bal. 165,000 Bal. 381,975 Preferred Stock Aug. 3 10,000 Aug. 22 250,000 15 8,000 Bal. 250,000 Oct. 4 5,000 Bal. 23,000 Land Treasury Stock, Common Aug. 15 48,000 Oct. 10 3,250 Bal. 48,000 Bal. 3,250 Dividends Dividends Payable Oct. 15 4,775* Oct. 31 4,775 Oct. 15 4,775 Bal. 4,775 Bal. * $250,000 0.06 3/12 10,250 shares $0.10 Total $3,750 1,025 $4,775 Note: No entry necessary for October 25. 545

Chapter 11, P 4. (Continued) 2. Stockholders equity section of the balance sheet prepared Stas Corporation Balance Sheet October 31, 2011 Stockholders Equity Contributed capital Preferred stock, $100 par value, 6 percent, 5,000 shares authorized, 2,500 shares issued and outstanding Common stock, $2 stated value, 25,000 shares authorized, 11,500 shares issued, and 10,250 shares outstanding Additional paid-in capital Total contributed capital Retained earnings* Total contributed capital and retained earnings Less: Treasury stock, common (1,250 shares, at cost) Total stockholders equity $250,000 $ 23,000 165,000 188,000 $438,000 6,725 $444,725 3,250 $441,475 * $11,500 $4,775 $6,725 546

Chapter 11, P 4. (Continued) 3. User Insight: Performance ratios computed for the quarter Dividends Yield Dividends per Share Market Price per Share $0.10 $25.00 0.4% Price/Earnings (P/E) Ratio Market Price per Share Earnings per Share $25.00 $1.97 12.7 Times Return on Equity Net Income Average Stockholders Equity $11,500 ( $441,475 + $408,000* ) 2 $11,500 $424,738 2.7% * $110,000 + $48,000 + $250,000 $408,000 4. User Insight: Investors return discussed Stas Corporation s dividends yield is only 0.4 percent, which means that investors must also consider changes in the price of the company s stock. A return on equity of only 2.7 percent is low and will not encourage a rise in the company s stock or an expansion of the company s price/earnings ratio of 12.7 times net income. 547

Chapter 11, P 5. 1. Transactions recorded in T accounts Bal. 5/1 Bal. Additional Paid-In Capital Bal. 3/25 12/15 Bal. Stock Dividends 240,000 12,000 252,000 75,000 72,000 201,600 348,600 Distributable 5/1 12,000 3/25 12,000 12/15 25,200 Bal. 25,200 Retained Earnings Bal. 240,000 3/25 12/15 Bal. 84,000 226,800 310,800 1 2 1 2 80,000 0.05 $21 252,000 0.10 $9 $84,000 $226,800 Shares outstanding before split: 80,000 + 4,000 84,000 Shares outstanding after split: 84,000 3 252,000 April 20 no entry September 10 no entry 548

Chapter 11, P 5. (Continued) 2. Stockholders equity section of the balance sheet prepared Rigby Storage, Inc. Stockholders Equity December 31, 2012 Contributed capital Common stock, $1 par value, 1,000,000 shares authorized, 252,000 shares issued and outstanding Common stock distributable, 25,200 shares Additional paid-in capital Total contributed capital Retained earnings* Total stockholders equity $ 252,000 25,200 348,600 $ 625,800 423,200 $1,049,000 * $240,000 $310,800 + $494,000 $423,200 3. User insight: Effect of stock transactions determined If you owned 2,000 shares of Rigby Storage stock on March 1, 2012, you would own 6,930 shares on February 15, 2013 (calculation below). Your proportionate share would be the same because other shareholders would receive the same proportionate distributions. Mar. 1, 2012: Original holding Apr. 20, 2012: Stock dividend Sept. 10, 2012: Stock split Jan. 15, 2013: Stock dividend Feb. 15, 2013: Total owned 2,000 100 4,200 630 6,930 shares shares 549

Chapter 11, P 6. 1. Transactions recorded in T accounts Cash Mar. 1 100,000 Mar. 2 12,000 Mar. 1 60,000 1 Apr. 10 65,000 Apr. 15 25,000 Apr. 10 26,000 2 165,000 37,000 Bal. 86,000 Bal. 128,000 Additional Paid-In Capital Start-up and Organization Costs Mar. 1 40,000 Mar. 2 12,000 Apr. 10 39,000 Bal. 12,000 Bal. 79,000 Apr. Bal. May Bal. Treasury Stock, Common Dividends Payable 15 25,000 May 31 3,800 25,000 Bal. 3,800 Dividends 31 3,800 3 3,800 1 15,000 shares $4 par value 2 6,500 shares $4 par value 3 19,000 shares $0.20 par value $60,000 $26,000 $3,800 550

Chapter 11, P 6. (Continued) 2. Stockholders equity section of balance sheet prepared Contributed capital Common stock, $4 par value, 50,000 shares authorized, 21,500 shares issued and 19,000 shares outstanding Additional paid-in capital Total contributed capital Retained earnings* Total contributed capital and retained earnings Less: Treasury stock, common (2,500 shares, at cost) Total stockholders equity Algae Corporation Balance Sheet May 31, 2011 Stockholders Equity $ 86,000 79,000 $165,000 11,200 $176,200 25,000 $151,200 * $15,000 $3,800 $11,200 3. User Insight: Effects of cash dividend declaration discussed The cash dividend declaration on May 31 will not affect net income and will not affect cash flows in the current period since the cash will be paid out in the next period. It will, however, reduce retained earnings in the current period. 551

Chapter 11, P 7. 1. Dividends calculated for cumulative preferred stock and common stock 2010 2011 Dividends in arrears, 2010 2011 dividends Totals 2012 Dividends in arrears, 2011 2012 dividends Totals 2013 Cumulative Preferred Stock Dividends Per Per Dividends Amount Share Amount Share Allocated $ 30,000 $ 6.00 $ 30,000 $ 10,000 20,000 $ 30,000 $ 6.00 $ 30,000 $ 20,000 40,000 $ 34,000 Dividends Total $ 60,000 $12.00 $ 34,000 $ 0.34 $ 94,000 $ 40,000 $ 8.00 $ 90,000 $ 0.90 $130,000 2. Dividends calculated for noncumulative preferred stock and common stock 2010 2011 2012 2013 Noncumulative Preferred Stock Dividends Dividends Total Per Per Dividends Amount Share Amount Share Allocated $ 30,000 $ 6.00 $ 30,000 $ 30,000 $ 6.00 $ 30,000 $ 40,000 $ 8.00 $ 54,000 $ 0.54 $ 94,000 $ 40,000 $ 8.00 $ 90,000 $ 0.90 $130,000 552

Chapter 11, P 7. (Continued) 3. The 2012 and 2013 dividends yield for common stock calculated Dividends Yield Dividends per Share Market Price per Share $0.54 $7.25 $0.90 $8.00 2012 7.4% 2013 11.3% 4. User Insight: Preferred stock compared to long-term bonds Both cumulative and noncumulative preferred stock have a fixed level of dividends and are thus similar in this way to long-term bonds, which have a fixed level of interest. However, cumulative preferred stock would be more similar to long-term bonds in the sense that if dividends are declared in any given year, past dividends not paid must be made up. Likewise, any past interest missed on long-term bonds would have to be made up. The difference is that with noncumulative preferred stock, if no dividends are ever declared, then the past dividends do not need to be made up; however, any past interest on bonds becomes a liability of the company and is not under the control of the board of directors. Also, missing the payment of interest on long-term bonds will usually result in a default and possible bankruptcy of the company, whereas skipping a preferred dividend in any one year does not have this result. 553

Chapter 11, P 8. 1. Journal entries prepared July Aug. 1 Cash 110,000 Additional Paid-In Capital Issued 10,000 shares of $5 stated value common stock at $11 per share 1 Start-up and Organization Costs 5,500 Additional Paid-In Capital Issued 500 shares of $5 stated value common stock at $11 per share for legal services to organize the corporation 2 Cash 100,000 Preferred Stock Issued 1,000 shares of $100 par value preferred stock at par 10 Land 30,000 Additional Paid-In Capital Issued 2,500 shares of $5 stated value common stock with a market value of $12 per share for land 2 Treasury Stock, Common 19,500 Cash Purchased 1,500 shares of common stock for the treasury at $13 per share 10 Dividends 980 Dividends Payable Declaration of preferred and common stock dividends $100,000 0.09 1 / 12 $750 11,500 shares $0.02 230 Total $980 12 No entry required 22 Dividends Payable 980 Cash Payment of preferred and common stock cash dividends 50,000 60,000 2,500 3,000 100,000 12,500 17,500 19,500 980 980 554

Chapter 11, P 8. (Continued) 2. Stockholders equity section of the balance sheet prepared Contributed capital Preferred stock, $100 par value, 9 percent, 5,000 shares Common stock, no-par $5 stated value, 50,000 shares authorized, 13,000 shares issued, and 11,500 shares outstanding Additional paid-in capital Total contributed capital Retained earnings* Total contributed capital and retained earnings Less: Treasury stock, common (1,500 shares, at cost) Total stockholders equity Java, Inc. Balance Sheet August 31, 2011 Stockholders Equity authorized, 1,000 shares issued and outstanding $100,000 $65,000 80,500 145,500 $245,500 10,520 $256,020 19,500 $236,520 * $11,500 $980 $10,520 555

Chapter 11, P 8. (Continued) 3. User Insight: Performance ratios computed Dividends Yield Dividends per Share Market Price per Share $0.02 $20.00 0.1% Price/Earnings (P/E) Ratio Market Price per Share Earnings per Share $20.00 $1.00 20.0 Times Return on Equity Net Income Average Stockholders Equity $11,500 ( $236,520 + $245,500* ) 2 $11,500 $241,010 4.8% * $110,000 + $5,500 + $100,000 + $30,000 $245,500 4. User Insight: Investors return discussed Java s dividends yield is only 0.1 percent, which means that investors must also consider changes in the price of the company s stock. A return on equity of only 4.8 percent is low and will not encourage a rise in the company s stock or an expansion of the company s price/earnings ratio of 20 times net income. 556

Chapter 11, P 9. 1. Journal entries prepared 2012 Jan. 4 No entry required 14 Cash 960,000 Preferred Stock 960,000 Sold 24,000 shares of $40 par value preferred stock at $40 14 Building 160,000 Preferred Stock 160,000 Issued 4,000 shares of preferred stock in exchange for a building valued at $160,000 Mar. 8 Memo: The 120,000 shares of $8 par value common stock that are issued and outstanding were split 2 for 1, resulting in 240,000 shares of $4 par value common stock issued and outstanding. Apr. 20 Treasury Stock, Common 72,000 Cash 72,000 Purchased 6,000 shares of common stock for the treasury at $12 per share May 4 Cash 32,000 Treasury Stock, Common Paid-In Capital, Treasury Stock 24,000 8,000 Sold 2,000 shares of treasury stock for $16 per share; originally purchased for $12 per share July 15 Dividends 206,400 Dividends Payable Declared a cash dividend of $4 per share on 28,000 shares of preferred stock and $0.40 per share on 236,000 shares of common stock $112,000 + $94,400 $206,400 25 No entry required 206,400 557

Chapter 11, P 9. (Continued) 2012 Aug. 15 Dividends Payable 206,400 Cash Paid cash dividends to preferred and common stockholders Nov. 28 Stock Dividends 708,000 Distributable Additional Paid-In Capital Declared a 15 percent stock dividend on 236,000 shares of common stock; market value was $20 per share; par value is $4 per share 35,400 shares $20 $708,000 Dec. 15 No entry required 206,400 141,600 566,400 558

Chapter 11, P 9. (Continued) T accounts for stockholders equity Preferred Stock 1/14/12 960,000 Bal. 960,000 1/14/12 160,000 Bal. 1,120,000 Distributable Additional Paid-In Capital 11/28/12 141,600 Bal. 2,560,000 11/28/12 566,400 Bal. 3,126,400 Paid-In Capital, Treasury Stock Retained Earnings 5/4/12 8,000 7/15/12 206,400 * Bal. 1,648,000 11/28/12 708,000* 12/31/12 436,000 Bal. 297,600 Treasury Stock, Common 4/20/12 72,000 5/4/12 24,000 Bal. 48,000 *Cash dividends declared and stock dividends declared reduce Retained Earnings. 559

Chapter 11, P 9. (Continued) 2. Stockholders equity section of the balance sheet prepared Stockholders Equity Contributed capital Preferred stock, $40 par value, $4 dividend, 40,000 shares authorized, 28,000 shares issued and outstanding Common stock, $4 par value, 400,000 shares authorized, 240,000 shares issued, 236,000 shares outstanding Common stock distributable, 35,400 shares Additional paid-in capital Paid-in capital, treasury stock Sophia Company Balance Sheet December 31, 2012 Total contributed capital Retained earnings Total contributed capital and retained earnings Less: Treasury stock, common (4,000 shares, at cost) Total stockholders equity $1,120,000 960,000 141,600 3,126,400 8,000 $5,356,000 297,600 $5,653,600 48,000 $5,605,600 3. User Insight: Book value per share computed December 31, 2011 Common stock: $5,168,000* 120,000 shares $43.07** per share December 31, 2012 Preferred stock: Call price of $42 equals book value per share Common stock: ( $5,605,600 $1,176,000 ) ( 236,000 shares + 35,400 $4,429,600 271,400 shares $16.32** per share shares) Book value per share usually does not affect market price, which is affected by many other factors. * ** 28,000 shares of preferred stock $42 per share Rounded. 560

Chapter 11, P 10. 1. Journal entries prepared 2012 Mar. Apr. June Aug. Oct. Dec. 5 Dividends 400,000 Dividends Payable Declaration of a cash dividend 1,000,000 shares $0.40 $400,000 20 No entry required 400,000 6 Dividends Payable 400,000 Cash 400,000 Payment of cash dividend declared on March 5 17 Stock Dividends 1,400,000 Distributable Additional Paid-In Capital 200,000 1,200,000 Declaration of a stock dividend of 100,000 shares (1,000,000 shares 0.10) on $2 par value common stock, to be distributed on August 17 at the market value of the stock of 100,000 shares $14 $1,400,000 5 No entry required 17 Distributable 200,000 200,000 Distribution of stock dividend of 100,000 shares declared on June 17 2 Memo: The 1,100,000 shares of $2 par value common stock that are issued and outstanding were split 2 for 1, resulting in 2,200,000 shares of $1 par value common stock issued and outstanding. 27 Dividends 440,000 Dividends Payable 440,000 Declaration of a cash dividend 2,200,000 shares $0.20 $440,000 561

Chapter 11, P 10. (Continued) 2. Stockholders equity section of the balance sheet prepared Jet Moving Company Balance Sheet December 31, 2012 Stockholders Equity Contributed capital Common stock, $1 par value, 6,000,000 shares authorized, 2,200,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings* Total stockholders equity $2,200,000 2,000,000 $4,200,000 720,000 $4,920,000 * $2,160,000 $400,000 $1,400,000 $440,000 + $720,000 $800,000 3. User Insight: Effect of stock transactions on share price If you owned shares in Jet, you would expect the total value of your shares to remain about the same, although the price per share would be less because there are more shares outstanding. An intangible that might cause the total value to increase is that it is usually considered a positive sign to the market when a company declares stock dividends or stock splits. These actions often accompany positive views on the part of management about the future of the company. 562

Chapter 11, C 1. An advantage of issuing common stock is that it improves the company s debt to equity ratio by increasing the amount of common stock outstanding in relation to long-term debt. Another advantage is that issuing stock is less risky than issuing bonds because dividends do not have to be paid on stock and there is no debt to be repaid. These are effects that could improve DreamWorks bond rating and lower the interest it might pay on future bond issues. A disadvantage of issuing stock is that it dilutes the share of the company owned by the current stockholders unless they buy more shares. In addition, when the company is profitable, it reduces the company s ability to use financial leverage to increase the return on equity over the return on assets. Also, the interest paid on bonds is tax-deduct- ible, whereas dividends paid on common stock are not. Chapter 11, C 2. Even though preferred stocks have some characteristics of bonds, such as a fixed dividend rate, they are classified on the balance sheet as equity. This is very important to companies that have suffered losses resulting in decreased stockholdstock and retire it. If a company does not have the cash to redeem the shares, it ers equity and to banks, which must maintain minimum ratios of capital to total assets. From the investor s standpoint, the dividend is fixed, like bond interest. The value of the preferred stock varies with changes in the market rate of interest, also like bond prices. If the preferred stock is convertible and the price of the comthen rise with the common price (in which case the investor has a capital gain). mon stock rises above the conversion price, the price of the preferred stock will PERCs are popular with companies because they provide great flexibility. If the in- terest rates decline and a company wishes to refinance the stock, it can call the can simply wait; they will be converted into common stock after three years. From the investor s viewpoint, PERCs pay a high fixed rate and may result in a capital gain if the shares are converted into common stock. 563

Chapter 11, C 3. A company may have several reasons for buying back its own shares. One reason is that it may have uses for the shares for employee stock purchase plans or employee pension plan contributions. A second reason would be to increase the value of the company s stock. A third reason is to increase earnings per share: with fewer shares outstanding, earnings per share should be higher. When the economy has been growing slowly, this is a way to accelerate the growth in earnings per share. A fourth reason would be to reduce the cash that will have to be paid in the future for cash dividends. With fewer shares outstanding, less cash will have to be paid. A fifth reason is that management feels that investing in the company s own stock is a sound idea because it is a good value. Sometimes a company is so successful that it has no better investment opportunity at the time. A sixth reason is to have sufficient shares to purchase other companies. The effects of buybacks are as follows: Favorable or Ratio Effect Unfavorable Earnings per share Increase Favorable Return on equity Increase Favorable Return on assets Increase Favorable Debt to equity Increase Unfavorable Current ratio Decrease Unfavorable Chapter 11, C 4. A stock split is an increase in the number of outstanding shares accompanied by a proportionate reduction in the par or stated value. Thus, a stock split does not affect amounts in the stockholders equity section. The stock split will cause the market value of the stock to drop. A stock split often occurs after the price of a company s stock has risen and thus is a positive signal to the market that management is confident about the company s future. 564

Chapter 11, C 5. 1. Stock issue recorded as journal entry Cash Additional Paid-In Capital Issued 22,500,000 shares of $0.001 par value common stock at net proceeds of $1,800,000,000 1,800,000,000 22,500 1,799,977,500 2. Stockholders equity section of the balance sheet prepared Contributed capital Google, Inc. Balance Sheet After Stock Offering Stockholders Equity (in thousands) Common stock, $0.001 par value, 700,000,000 shares authorized, 183,500,000 shares issued and outstanding Additional paid-in capital Total contributed capital Retained earnings Total stockholders equity $ 184 2,525,197 $2,525,381 191,352 $2,716,733 3. Google s need to increase the authorized shares discussed Google did not have to increase its authorized shares because management knew the 700,000,000 previously authorized shares and the 161,000,000 previously issued shares left a sufficient number of authorized but unissued shares to cover the new issue. 4. Underwriters fee discussed The total proceeds were $1,912,500,000 ($85 22,500,000 shares). Google received $80 ($1,800,000,000 22,500,000 shares) per share. The underwriters received a total of $112,500,000 ($1,912,500,000 $1,800,000,000), or $5 ($85 $80) per share, to assist in issuing the shares. The underwriters find investors to buy the stock at the offering price. 565

Chapter 11, C 6. 1. Explanations of transactions (1) To transfer 2011 net income of $18,753,000 to retained earnings (2) To adjust available-for-sale securities to market: $12,000,000 (3) To redeem and retire 27,560 shares of preferred stock at par value of $100 for $2,756,000 (4) Purchase of 89,000 shares of $1 par value common stock at an average price of $10.52 for a total of $936,000 (including additional paid-in capital of $847,000 by employees under stock option plan) (5) Purchase of 501,412 shares of common stock at an average price of $25.03 per share ($12,552,000 501,412 shares) for the treasury (6) Conversion of convertible debentures into 148,000 shares of common stock at an exchange rate of $25.56 per share ($3,783,000 148,000 shares) (7) Issuance of 715,000 shares of common stock for cash at $35.31 per share ($25,250,000 715,000 shares) (8) Exchange of 500,000 shares of common stock for shares in Miti Company as an investment; the value of the transaction is $35.53 per share ($17,763,000 500,000 shares) (9) To transfer 2011 cash dividends to retained earnings in the amount of $3,086,000 2. Comprehensive income discussed Comprehensive income is the change in a company s equity during a period from sources other than owners and includes net income, change in unrealized investment gains and losses, and other items affecting equity. Thus, Spencer s comprehensive income is net income of $18,753,000 plus the unrealized gain on availablefor-sale securities of $12,000,000, or a total of $30,753,000. 566

Chapter 11, C 7. 1. 2. CVS has preferred stock, preference stock, and common stock. The preferred stock ($0.01 par value) has 0.1 million authorized but none issued or outstanding. It is available if management wants to use it for some purpose. The preference stock ($1.00 par value) has 50 million shares authorized but none issued or outstanding at the end of fiscal 2009. The common stock has a par value of $0.01 per share. There are 3.2 billion authorized shares, of which 1.612 billion shares have been issued and 1.391 billion shares are outstanding; 219 million shares are in the treasury. The dividends yield for 2009 is as follows: Dividends Yield Dividends per Share Market Price $0.305 $32.83* 0.9% * Stock prices from Note 15. ( $38.27 + $27.38 ) 2 $32.83 This yield is less than 1 percent. As a result, the stockholders total return is dependent on share price changes. Since retained earnings makes up about 46 percent of stockholders equity, the company relies more on earnings than stock for its stockholders equity. 3. 4. CVS has an employee stock ownership plan (ESOP) described in Note 8, which applies to full-time employees with at least one year of service. This plan relates to the preference stock. In addition, the company has a stock option plan (called a stock incentive plan) described in Note 10. These options apply to executive officers and other officers and employees of the company and its subsidiaries. The options are exercisable at an average price of $29.14. With fourth-quarter shares ranging from $27.38 to $38.27, only some of the holders have gains, but holders of the options have an incentive to keep their options and help the company to succeed in order to make significant profits from the options (Note 15). Aside from net earnings and dividends on preference and common stock, several items appear on each of the three years of CVS s statement of shareholders equity. These items include conversion of preference stock to common stock, conversion of preference stock to treasury stock, common stock issued, employee stock purchases, reduction of guaranteed ESOP obligation, stock option activity and awards (and related tax effects), treasury stock purchases, and a minimum pension liability adjustment. 567

Chapter 11, C 8. 1. Return on equity computed (dollars in millions) CVS s Return on Equity Ratio: Return on Equity 2009 Net Income Average Stockholders Equity $3,696 ( $35,768 + $34,574 ) 2 $3,696 $35,171 2008 10.5% $3,212 ( $34,574 + $31,322 ) 2 $3,212 $32,948 9.7% Southwest s Return on Equity Ratio: Net Income Return on Equity Average Stockholders Equity 2009 2008 $99 ( $5,466 + $4,953 ) 2 $99 $5,210 1.9% $178 ( $4,953 + $6,941 ) 2 $178 $5,947 3.0% 568

Chapter 11, C 8. (Continued) 2. Treasury stock purchases discussed According to the statement of cash flows, CVS purchased treasury stock of $2.477 billion in 2009, but about $7.87 billion over the past three years. In contrast, Southwest repurchased no treasury stock in 2009, but a total of approximately $1.055 billion over three years. The purchases of treasury shares will have the effect of increasing return on equity (because the cost of the treasury shares will reduce stockof shares holders equity) and earnings per share (because treasury shares reduce the number outstanding). 3. Stock issues discussed From their income statements, statements of cash flows, and statements of stock- holders equity, it may be seen that both companies pay cash dividends, but the amounts are small ($0.305 per share for CVS and $0.018 per share for Southwest). Thus, stockholders for both companies must get most of their return from increases in the stock price. Neither company raised significant funds through stock issues. It may be seen in the statement of cash flows that the only types of stock issued by both companies during the three-year period were those associated with employee stock plans. The proceeds from these issues were greater in the case of CVS ($250 million in 2009). The proceeds for Southwest were lower than CVS s, at $20 million in 2009. 4. Dividend policies discussed 569

Chapter 11, C 8. (Continued) 5. Book values per share computed CVS s Book Value per Share (in millions except per share): Total stockholders equity Less equity allocated to preference shareholders Stockholders equity related to common stock Common stock outstanding Book value per common share Average stock price per share* 2009 2008 $35,768 $34,574 191 $35,768 $34,383 1,391 1,436 $25.71 $23.94 $32.83 $29.05 * ( $38.27 + $27.38 ) 2 ( $34.90 + $23.19 ) 2 $32.83 $29.05 Southwest s Book Value per Share (in millions except per share): Stockholders equity related to common stock Common stock outstanding Book value per common share Average stock price per share 2009 2008 $5,466 $4,953 808 808 $6.76 $ 6.13 $9.94 $11.01 6. Book values per share and their relationship to market prices discussed In both cases, book value per share bears little relationship to market value per share. If a company is successful, as both CVS and Southwest are, market price will usually far exceed book value as it does in these cases. Although CVS s 2009 stockholders equity is roughly 6.5 times as much as Southwest s, its book value is only about 3.8 times that of Southwest. Book value per share is a function of the number of shares outstanding. CVS has roughly two times as many shares outstanding as Southwest does. 570

Chapter 11, C 9. Some may argue that if management were not prohibited from taking such action, then its actions might be judged as acceptable. Others will clearly see that owners are harmed by this action in at least two ways. Buying treasury stock is not unethical in and of itself. It is the borrowing to do it that is questionable. First, cash bonuses were paid as a result of borrowing to buy back shares, not because mannot carefully selected, management can actually destroy shareholder value. If yearagement improved the operating success of the firm. Second, the risk of stock ownership increased because debt to equity is now higher. In this case, the share buyback increased management s wealth but not the owners wealth. Conflicts of interest between owners and managers often arise. If compensation measures are end bonuses were based on measures adjusted as if the borrowing and share re- purchase had not occurred, then management would not be rewarded for actions that are not in the best interests of shareholders. 571