Chapter 15
Financial Reporting for Owners’ Equity
True-False
1. Net income or loss generally arises from transactions with owners who provide net capital to
the firm.
2. If a company purchases treasury stock its earnings per share will increase.
3. A reason prompting a firm to purchase treasury stock is that management believes the stock is
undervalued in the marketplace and therefore represents a good investment opportunity.
4. Corporations that issue preferred stock do so because preferred stock is less risky than debt.
5. Mandatorily redeemable preferred stock dividends are reported as interest expense on the
income statement.
6. The Revised Model Business Corporation Act defines solvency as a situation where the fair
value of assets exceeds the fair value of liabilities after a distribution to shareholders.
7. The Revised Model Business Corporation Act would potentially allow a corporation to have
negative book value of net assets after an asset distribution occurred.
8. When a loan agreement restricts a company from distributing its entire balance of retained
earnings as dividends to shareholders, restricted retained earnings must be reported separately
from unrestricted retained earnings on the face of the balance sheet.
9. When a company repurchases its own shares, the transaction may not result in treasury stock
being reported on the balance sheet.
10. Under IFRS a company may report either a statement of financial position or a statement of
changes in shareholders’ equity but it need not provide both statements.
11. The comparability of earnings per share across firms is influenced by the relative amount of
capital raised by the various firms and by the ability of the firms to manage their reported
earnings per share.
12. Current GAAP requires that share-based compensation be expensed at the grant date of the
stock options award.
13. Current GAAP requires the allocation of total share-based compensation cost to expense on a
straight-line basis over the vesting period.
CHAPTER 15 Financial Reporting for Owners’ Equity
14. By using the book value method to record the conversion of convertible bonds, managers are
able to protect themselves from recording conversion losses.
15. Two companies, Company A and Company B, issue convertible bonds at par. If Company A
uses IFRS and Company B follows U.S. GAAP, the amount Company A records for the debt
will be greater than the amount Company B records for the debt.
Multiple-Choice Questions
16. Which of the following does not accurately describe the “ownership” perspective of the
firm?
a. Its focus is on the firm’s net capital deployed.
b. It is the prevailing view of GAAP.
c. Its focus is on owners’ capital.
d. It requires that financing transactions generate income or loss.
17. Cash dividends paid by a corporation
a. are an expense of the corporation that declared the dividend.
b. reduce the net income of the corporation that declared the dividend.
c. reduce the retained earnings of the corporation that declared the dividend
d. reduce the retained earnings of the corporation that declared the dividend because net
income is reduced by the amount of the dividend.
18. Which item goes not properly describe the par value of common stock?
a. The par value of common stock is set by the state government.
b. A stock’s par value does not necessarily have any relationship with a stock’s market value.
c. Par value refers to the nominal value or face value of a security.
d. Par value is an assigned amount (such as $1 per share) used to compute the dollar accounting
value of the common shares on the company’s balance sheet.
19. Which of the following statements is correct if treasury stock costing $25,000 was sold for
$27,500?
a. Total owners’ equity increases $2,500.
b. Total owners’ equity increases $27,500.
c. Net income increases $2,500.
d. Total owners’ equity increases $25,000.
20. Treasury stock is reported within the balance sheet as
a. a long-term investment.
b. a short-term investment.
c. an account contra to retained earnings.
d. an account contra to owners’ equity.
Use the following to answer questions 21 – 23:
REFERENCE: Ref. 15_01
The Vernon Corporation was formed on January 2, 2018. The company sold 20,000 shares of
$8.00 par value stock for $20.00 per share. On July 1, 2018, Vernon bought back 4,000 shares of
stock for $24.00 per share. The treasury stock was resold on September 1, 2018 for $32.00 per
share.
[QUESTION]
REFER TO: Ref. 15_01
21. Which one of the following is the entry to record the original sale of the stock?
a. DR Cash 400,000
CR Common stock 160,000
CR Paid-in capital in excess of par 240,000
b. DR Cash 400,000
CR Common stock 240,000
CR Paid-in capital in excess of par 160,000
c. DR Common stock 240,000
DR Paid-in capital in excess of par 160,000
CR Cash 400,000
d. DR Common stock 160,000
DR Paid-in capital in excess of par 240,000
CR Cash 400,000
22. Which one of the following is the correct entry to record when Vernon acquires its shares to
hold as treasury stock?
a. DR Treasury stock 96,000
CR Cash 96,000
b. DR Investments 96,000
CR Cash 96,000
c. DR Common stock 96,000
CR Cash 96,000
d. DR Retained earnings 96,000
CR Cash 96,000
23. Which one of the following is the correct entry to record the resale of treasury stock?
a. DR Cash 128,000
CR Common stock 128,000
b. DR Cash 128,000
CR Treasury stock 96,000
CR Paid-in capital from treasury stock 32,000
c. DR Cash 128,000
CR Treasury stock 96,000
CR Gain on sale of treasury stock 32,000
d. DR Cash 128,000
CR Treasury stock 96,000
CR Retained earnings 32,000
24. A corporation reported the following during 2018:
• Net income $175,250
• Sale of 10,000 shares of $5 par value common stock for $8.75 per share
• A repurchase of shares as treasury stock, costing $24,750
CHAPTER 15 Financial Reporting for Owners’ Equity
• A resale of treasury stock for $14,695; the shares cost $15,500 when repurchased.
• A declaration and distribution of a $39,000 cash dividend
• A declaration and distribution of a “small” stock dividend of 5,000 shares of $5 par value
common stock at a total market value of $50,000.
What was the increase in shareholders’ equity during 2018?
a. $213,695
b. $188,695
c. $198,195
d. $173,195
25. Shareholders who sell their shares back to the company under a share repurchase program are
a. not taxed.
b. taxed at ordinary rates.
c. taxed at capital gains rates.
d. subject to tax penalties.
26. Financial analysts should always review stock repurchase plans carefully because
a. the plans always produce above-market returns.
b. the plans usually produce above-market returns.
c. it is important to determine the reasons for the buyback.
d. the plans are always beneficial to the shareholders.
27. Companies with surplus cash will consider the needs of cash for
a. buying back shares of their company stock.
b. acquiring another company.
c. issuing a special dividend to shareholders.
d. all of these answer choices are considerations for using surplus cash.
28. Which of the following is not typically disclosed in the financial statements regarding share
repurchase programs?
a. The dollar amount of the board-approved share buyback.
b. The time period the repurchase program will be effective.
c. The dollar amount remaining under the share repurchase program.
d. The reason for the share repurchase program.
Use the following to answer questions 29 and 30:
REFERENCE: Ref. 15_02
A company’s retained earnings on December 31, 2018 was $2,190,000 and its shareholders’
equity was $8,760,000. During 2019 the company reported the following:
• Net income $225,000
• A sale of treasury stock costing $75,000 for $79,750
• A treasury stock purchase costing $125,700
• A cash dividend declaration of $73,200
• A 10,000 share “small” common stock ($10 par value) dividend was declared and
distributed when the market value was $12.75 per share.
[QUESTION]
REFER TO: Ref. 15_02
29. What is the retained earnings balance on December 31, 2019?
a. $1,994,050
b. $2,219,050
c. $2,216,100
d. $2,246,550
30. What is the shareholders’ equity balance on December 31, 2019?
a. $8,663,350
b. $8,738,350
c. $8,865,850
d. $8,934,300
31. Which of the following is not a reason why a company would purchase its own stock?
a. The company needs shares in order to meet employee stock option plans.
b. The company’s management may have concluded that the company’s stock is undervalued
at the prevailing market price.
c. The company wants to increase its earnings per share.
d. The company wants to manipulate its net income.
32. When a dividend is not declared on preferred stock, and the common shareholders cannot
receive a dividend until all past and current dividends are paid to the preferred shareholders, the
preferred stock is
a. cumulative.
b. noncumulative
c. participating.
d. nonparticipating.
33. Companies with a history of net operating losses are prone to issue which one of the
following to raise money?
a. Debenture bonds
b. Serial bonds
c. Preferred stock
d. Notes payable
34. Mandatorily redeemable preferred stock is reported on the balance sheet as
a. a liability.
b. an equity item.
c. a temporary investment.
d. a separate line between liabilities and shareholders’ equity.
35. Which of the following statements pertaining to preferred stock is not correct?
a. Preferred stock may have an adjustable rate which pays a dividend that is adjusted, usually
on a quarterly basis.
b. Preferred stock dividends are contractual obligations that must be paid in profitable years.
c. Most preferred stock issues are nonparticipating, meaning that the shareholders are entitled
to receive only dividends based on the stated dividend rate.
d. Preferred shareholders are given preference with respect to both dividend distributions and
in liquidation of the company.
36. When a publicly traded company issues both common stock and preferred stock, the SEC
requires that
a. preferred and common stock be combined in the equity section.
b. preferred and common stock be clearly differentiated on the balance sheet.
c. all preferred stock be shown as a liability.
d. mandatorily redeemable preferred stock be shown as a liability.
37. The Revised Model Business Corporation Act defines solvency as a situation where the fair
value of
a. assets exceeds the book value of liabilities after a distribution to shareholders.
b. assets exceeds the fair value of liabilities after a distribution to shareholders.
c. liabilities exceeds the fair value of assets.
d. liabilities exceeds the fair value of assets after a distribution to shareholders.
38. As a result of the Revised Model Business Corporation Act, it may be fair to state that
a. the book value of owners’ equity may not give an accurate picture of potentially legal
distributions.
b. the book value of owners’ equity gives an accurate picture of potentially legal distributions.
c. the book value of owners’ equity never gives an accurate picture of potentially legal
distributions.
d. the book value of assets gives an accurate picture of potentially legal distributions.
Use the following to answer questions 39 and 40:
REFERENCE: Ref. 15_03
Ace Industries has the following shareholders’ equity accounts at December 31, 2018:
Preferred stock, $100 par value, 10% dividend, 50,000 shares issued and
outstanding
$5,000,000
Common stock, $6 par value, 1 million shares issued and outstanding
6,000,000
Paid-in capital in excess of par
119,000,000
Unrestricted retained earnings
7,500,000
Retained earnings restricted for plant expansion
2,500,000
[QUESTION]
REFER TO: Ref. 15_03
39. Assuming that the preferred stock is cumulative, and that there are no dividends in arrears,
what is the maximum dividend that may be distributed to common shareholders at December 31,
2018?
a. $9,500,000
b. $7,000,000
c. $7,500,000
d. $2,000,000
40. On December 15, 2018 Ace Industries repurchased 200,000 shares of its common stock for
$10 per share. Based on its shareholders’ equity accounts, what can be inferred about this
purchase?
a. Ace is holding $2,000,000 of treasury stock which is being disclosed in the notes to the
financial statements.
b. Ace retired the shares by reducing the common stock and paid-in capital accounts.
c. Ace is reporting the shares as a $2,000,000 investment on the asset side of the balance
sheet.
d. Not enough information is provided to determine how Ace recorded the purchase.
41. By examining the statement of shareholders’ equity an investor can determine all of the
following except:
a. shares issued to employees for share-based compensation.
b. unrealized losses on available-for-sale securities.
c. the amount of convertible bonds issued during the year.
d. dividends declared on common stock.
42. A 3-for-1 stock split will reduce the per share par value and will
a. decrease the number of shares proportionately.
b. decrease earnings per share.
c. increase owners’ equity.
d. increase the total par value of the common stock.
43. In discussing book value of common stock, which statement below is not correct?
a. Book value is also referred to as total equity of the firm.
b. The terms “issued” and “outstanding” are synonymous when discussing the number of
common shares.
c. Book value per share is computed by dividing common equity by the number of common
shares outstanding.
d. If any preferred stock were outstanding, its carrying amount would be deducted from the
total equity to obtain the common equity.
44. When a company does not have any convertible securities or options or warrants outstanding,
the company has
a. a complex capital structure.
b. a simple capital structure.
c. to report only diluted earnings per share.
d. to report both basic and diluted EPS.
45. The denominator used in the calculation of basic earnings per share is the
a. number of common shares outstanding at the end of the year.
b. number of preferred shares outstanding at the end of the year.
c. weighted average number of common shares outstanding during the year.
d. weighted average number of common shares and preferred shares outstanding during the
year.
46. Which of the following is not indicative of a complex capital structure?
a. Outstanding convertible bonds.
b. Outstanding convertible preferred stock.
c. Outstanding cumulative preferred stock.
d. Outstanding stock options.
47. Which of the following statements is correct when a company has a complex capital structure?
a. Diluted earnings per share must be shown on the income statement.
b. Diluted earnings per share and basic earnings per share must both be shown on the income
statement.
c. The company might have convertible bonds outstanding.
d. The company must have participating preferred stock outstanding.
48. Earnings per share (EPS) data are prominent in corporate annual reports, but EPS suffers as a
financial performance measure because EPS ignores the amount of
a. revenue required to generate reported earnings.
b. capital required to generate reported earnings.
c. liabilities required to generate reported earnings.
d. expenses required to generate reported earnings.
49. A company that has earnings in Year 2 equal to the earnings of Year 1 can improve its Year
2 reported earnings per share by
a. selling additional common stock.
b. selling additional preferred stock.
c. selling shares of treasury stock at a price exceeding what was paid for the treasury stock.
d. purchasing shares of treasury stock.
Use the following to answer questions 50 – 52:
REFERENCE: Ref. 15_04
The Heath Corporation reported net income for 2018 of $177,500. Heath began the year with
100,000 shares of $5 par value common shares outstanding and 2,500 shares of $100 par value
8% preferred shares outstanding. On October 1, Heath sold 10,000 shares of common stock for
$6 per share. Heath paid dividends to the common shareholders in December.
[QUESTION]
REFER TO: Ref. 15_04
50. The weighted average number of common shares used to compute earnings per share for
2018 is
a. 100,000.
b. 102,500.
c. 105,000.
d. 110,000.
51. The basic earnings per share for 2018 is
a. $1.43 per share.
b. $1.50 per share.
c. $1.54 per share.
d. $1.73 per share.
52. If each share of preferred stock is convertible into 8 shares of common stock, the diluted
earnings per share for 2018 is (rounded)
a. $1.29 per share.
b. $1.45 per share.
c. $1.54 per share.
d. $1.73 per share.
Use the following to answer questions 53 – 55:
REFERENCE: Ref. 15_05
Vent, Inc. reported net income of $770,000 for 2018. Vent sold 15,000 shares of treasury stock
acquired in a previous year on July 1 and 15,000 new shares on November 1. At year-end,
180,000 shares were outstanding. Vent had 20,000 shares of $100 par value 7% preferred stock
outstanding all year. Vent paid dividends to the preferred shareholders.
53. The weighted average number of common shares used to compute earnings per share for
2018 is
a. 150,000.
b. 160,000.
c. 165,000.
d. 180,000.
54. The basic earnings per share for 2018 is (rounded)
a. $3.50 per share.
b. $3.94 per share.
c. $4.81 per share.
d. $6.10 per share.
55. If each share of preferred stock is convertible into 2 shares of common stock, the diluted
earnings per share for 2018 is
CHAPTER 15 Financial Reporting for Owners’ Equity
a. $3.85 per share.
b. $3.94 per share.
c. $4.81 per share.
d. $6.10 per share.
56. The following information has been obtained from the Massena Corporation:
• 100,000 shares of common stock were outstanding on January 1, 2018.
• 30,000 shares of common stock were issued on March 1, 2018.
• A 2-for-1 stock split was declared on April 1, 2018.
• The 2-for-1 stock split was distributed on May 1, 2018.
• 10,000 shares of common stock were purchased on October 1, 2018.
What is the weighted average number of shares to be used in the calculation of basic earnings per
share for 2018?
a. 247,500
b. 216,250
c. 230,833
d. 209,167
57. The following information has been obtained from the Brewster Corporation:
• 250,000 shares of common stock were outstanding on January 1, 2018.
• 30,000 shares of preferred stock were issued on March 1, 2018.
• 12,000 shares of common stock were purchased on April 1, 2018.
• 10,000 shares of common stock were issued on October 1, 2018.