Test Bank – Chapter 12 – Shareholders’ Equity 12–33
18. Cullen Distribution Corporation’s contributed capital section of its balance sheet follows:
Preferred stock: $10 par, 4%
$650,000
Common stock: $8 par
400,000
During the last two years, Cullen Distribution Corporation did not declare any dividends
to its shareholders. This year, Cullen declares and pays total dividends of $100,000.
Calculate separately the dividends paid to preferred and common shareholders if the
preferred stock is cumulative.
19. A 10% stock dividend was declared and distributed to shareholders of 60,000
outstanding shares of Meadville Company’s $10 par value common stock; at that time
the common stock’s market price was $32. Prepare the journal entry required by the
stock dividend.
20. A sequence of events affecting the shareholders’ equity section of Malabar Corporation
follows:
A. On January 21, 8,000 shares of $10 par value common stock were issued for
$160,000.
B. On May 16, a 3-for-1 stock split was distributed.
C. On December 23, $8,000 of cash dividends on outstanding common stock were
declared. The dividends will be paid in 30 days.
For each entry, state how the event changed assets, liabilities, and shareholders’ equity.
21. Immediately before a 15% stock dividend was declared and distributed on 20,000 shares
of par $8 stock, the market price of the Coolidge Corporation’s stock was $18. Coolidge
has total liabilities of $150,000 and total shareholders’ equity of $450,000. Prior to the
stock dividend, current assets were $250,000, and there were no long-term liabilities.
Required:
(1) Give the journal entry to record the declaration and distribution of the stock dividend.
(2) Calculate Coolidge’s current ratio immediately after the stock dividend and comment.
22. Immediately before a 3-for-1 stock split was declared and distributed on 20,000 shares
of par $80 stock, Mikah Company has total liabilities of $260,000 and total shareholders’
equity of $320,000. Calculate Mikah Company’s debt/equity ratio immediately after the
stock split.
23. Immediately before a $4,000 cash dividend was declared on 20,000 shares of par $80
stock, Sea Breeze Corporation has total liabilities of $220,000 and total shareholders’
equity of $180,000. Calculate Sea Breeze’s debt/equity ratio before and after the
declaration of the cash dividend and indicate the effect the declaration had on this ratio.
Test Bank – Chapter 12 – Shareholders’ Equity 12–35
24. Tropical Corporation has the following amounts as other revenue and expenses on its
income statement.
$21,000
4,200
18,000
(1,000)
(11,000)
(6,000)
$25,200
List the items that do not belong on the income statement and indicate where each
should be reported.
25. If a corporation distributes a 4-for-3 stock split on its $5 common stock, how much is the
par value after the split?
12–36 Test Bank – Chapter 12 – Shareholders’ Equity
26. Gomer Paper Corporation has the following balance sheet accounts immediately
preceding an investing and financing decision:
Current assets
$67,000
Long-lived assets
73,500
Current liabilities
28,500
Long-term liabilities
22,000
Contributed capital
60,000
Retained earnings
30,000
A long-term debt covenant specifies that Gomer Paper’s debt/equity ratio cannot be
greater than 1.0 and its current ratio must be at least 2.0.
Gomer Paper is going to invest $70,000 in new equipment. It is considering two methods
of financing the investment. It can use $10,000 of its own money and obtain $60,000
from the issue of long-term debt. Alternatively, Gomer Paper can use $15,000 of its own
money and obtain the remaining financing from the issue of stock.
A. Recalculate the balance sheet amounts given above for each of the two financing
alternatives immediately after financing is achieved and the investment is
undertaken.
B. Use numerical calculations to determine if the debt covenants are respected under
each of the two financing alternatives. If the covenants are broken for each
alternative, suggest financing options that Gomer Paper might use to finance the
$70,000 investment in equipment.
Test Bank – Chapter 12 – Shareholders’ Equity 12–37
SHORT ESSAY QUESTIONS
1. Seneca Corporation has the following balance sheet accounts immediately preceding an
investing and financing decision:
Current assets
$ 430,000
Long-lived assets
1,070,000
Current liabilities
120,000
Long-term liabilities
630,000
Contributed capital
100,000
Retained earnings
650,000
A long-term debt covenant specifies that Seneca’s debt/equity ratio cannot be greater
than 1.0 and current ratio cannot be less than 2.0.
Seneca is going to invest $600,000 in a new machine that will keep Seneca Corporation
in an excellent competitive position in a very competitive industry. In order to finance this
investment, Seneca will use its cash, issue long-term debt, and issue common stock.
However, besides having to adhere to the debt covenants, Mr. Seneca, the sole owner
of Seneca Corporation, will not issue more than $100,000 of common stock so that he
can retain at least a 50% ownership in his corporation.
Can Seneca Corporation finance the $600,000 investment and still adhere to the debt
covenants and allow Seneca to retain at least 50% ownership? If Seneca cannot finance
the machine within the parameters given, suggest possible means for Seneca to finance
the needed acquisition of the machine.
12–38 Test Bank – Chapter 12 – Shareholders’ Equity
2. For what reasons might a company purchase treasury stock?
Solution:
Test Bank – Chapter 12 – Shareholders’ Equity 12–39
3. What rights do preferred shareholders have that common shareholders do not?
4. Identify the two components of shareholders’ equity. How do they differ?
5. Explain par value.
12–40 Test Bank – Chapter 12 – Shareholders’ Equity
6. Which characteristics make equity financing more advantageous than debt financing?
7. What factors influence corporate dividend strategies?
8. How does the behavior of stock prices relate to the riskiness of equity securities?
Test Bank – Chapter 12 – Shareholders’ Equity 12–41
9. Why is debt financing considered less expensive than equity financing?
10. How do the book value and market value of stock compare?
11. How is the excess of cash receipts over the original cost of treasury stock accounted for
and reported in financial statements?
12–42 Test Bank – Chapter 12 – Shareholders’ Equity
12. What makes preferred stock questionable in classification?
13. What is the purpose of the date of record?
Solution:
14. How does an appropriation of retained earnings affect the income statement and assets
of a company?
15. What is the purpose of a prior period adjustment?
Test Bank – Chapter 12 – Shareholders’ Equity 12–43
16. From a business perspective, how does a stock split differ from a small stock dividend?
How are they similar?
IFRS Question
1. Under US GAAP, companies must provide a description of the changes in
comprehensive income as either a separate statement or as a part of the statement of
changes in stockholders’ equity. Under IFRS, companies must also provide a description
of the changes in comprehensive income in a:
A. Statement of Recognized Income and Expense
B. Statement of Unrecognized Income and Expense
C. Statement of Retained Earnings
D. Income Statement