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Chapter 11: Stockholders' Equity
217. [APPENDIX] Fowler Company opened business as a sole proprietorship on January 1, 2016. The owner contributed
$525,000 cash on that date. During the year, the company had a net income of $20,000. The company purchased
equipment of $120,000 during the year. The owner also withdrew $75,000 to pay for personal expenses during 2016.
Required:
Determine the company’s owner’s equity at December 31, 2016.
ANSWER:
Initial investment
$525,000
Plus: Net income
20,000
Less: Withdrawal
(75,000)
Owner’s equity, December 31, 2016
$470,000
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-11 - LO: 11-11
KEYWORDS:
Bloom's: Analyzing
218. [APPENDIX] Body Sports is a surf shop owned by Chris, Nicole, and Dan in partnership. On January 1, 2016, their
capital balances were as follows:
Chris, Capital
$30,000
Nicole, Capital
60,000
Dan, Capital
40,000
During 2016, Chris withdrew $10,000; Nicole, $20,000; and Dan, $15,000. Income for the partnership for 2016 was
$75,000.
Required:
If the partners agreed to allocate income equally, what was the ending balance in each of their capital accounts on
December 31, 2016?
ANSWER:
Chris
Nicole
Dan
Beginning balance
$30,000
$60,000
$40,000
Add: Allocation of net
income
25,000*
25,000
25,000
$55,000
$85,000
$65,000
Less: Withdrawals
(10,000)
(20,000)
(15,000)
Ending balance
$45,000
$65,000
$50,000
*$75,000/3 = $25,000
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-11 - LO: 11-11
KEYWORDS:
Bloom's: Analyzing
219. Stella Gregson received a windfall from one of her investments. She would like to invest $100,000 of the money in
Shoreline Industries, which is offering common stock, preferred stock, and bonds on the open market. The common stock
has paid $8 per share in dividends for the past three years, and the company expects to be able to perform as well in the
current year. The current market price of the common stock is $100 per share. The preferred stock has an 8% dividend
rate, cumulative and nonparticipating. The bonds are selling at par with an 8% stated rate.
Required:
1. What are the advantages and disadvantages of each type of investment?
2. Recommend one type of investment over the others to Stella and justify your reason.
ANSWER:
1. Common stock has ownership privileges. The residual of the company belongs to the
common shareholders. Preferred stock has preference over common stockholders in dividend
payouts. Bonds earn interest that is a legal obligation of the company.
2. The return on the preferred stock depends upon its issue price. If it is assumed that the
stock is issued at par value, the return is 8%. Since all three instruments yield the same rate of
return, 8%, Stella should choose to invest in the bonds because they carry the lowest risk. As
risk increases, the expected rate of return on an investment should increase.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-02 - LO: 11-02
KEYWORDS:
Bloom's: Applying
220. On May 1, 2016, Xiu Inc. had common stock of $345,000, additional paid-in capital of $1,298,000, and retained
earnings of $3,013,000. Xiu did not purchase or sell any common stock during the year. The company reported net
income of $556,000 and declared dividends in the amount of $78,000 during the year ended April 30, 2017.
Required:
Prepare a financial statement that explains the differences between the beginning and ending balances for the accounts in
the Stockholders’ Equity category of the balance sheet.
ANSWER:
Xiu Inc.
Statement of Stockholder’s Equity
for the Year Ended April 30, 2017
Common
Stock
Add. Pd-in
Cap.
Retained
Earnings
Total
Stockholders'
Equity
Balance May 1,
2016
$345,000
$1,298,000
$3,013,000
$4,656,000
Net Income
556,000
556,000
Dividends
(78,000)
(78,000)
221. Assume that Cosmo Company’s Stockholders’ Equity category of the balance sheet appears as follows as of
December 31, 2016:
Common stock, $10 par, 60,000 shares issued and outstanding
$ 600,000
Additional paid-in capital—Common
480,000
Retained earnings
1,240,000
Total stockholders’ equity
$2,320,000
On May 1, 2017, Cosmo declared and issued a 15% stock dividend, when the stock was selling for $20 per share. Then on
November 1, it declared and issued a 2-for-1 stock split.
Required:
1. How many shares of stock are outstanding at year-end?
2. What is the par value per share of these shares?
3. Develop the Stockholders’ Equity category of Cosmo’s balance sheet as of December 31, 2017.
ANSWER:
1. Jan. 1 Balance........................................ 60,000 shares
May 1 60,000 × 15%............................... 9,000
69,000
Nov. 1 .................................................... × 2
Total shares outstanding............................ 138,000 shares
2. $10/2 = $5 per share
3. Stockholders’ Equity:
Common stock, $5 par value, 138,000 shares
issued and outstanding.................................. $ 690,000
Additional paid-in capital.................................. 570,000*
Retained earnings [$1,240,000 – (9,000 × $20)].. 1,060,000
Total stockholders’ equity............................ $2,320,000
*9,000 shares × ($20 – $10) = $90,000 from May 1
$90,000 + $480,000 = $570,000
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-07 - LO: 11-07
KEYWORDS:
Bloom's: Analyzing
222. Falcon Company has 1,000 shares of $100 par value, 9% preferred stock and 10,000 shares of $10 par value common
stock outstanding. The preferred stock is cumulative and nonparticipating. Dividends were paid in 2014. Since 2014,
Falcon has declared and paid dividends as follows:
2015
$ 0
2016
10,000
2017
20,000
2018
25,000
Required:
1. Determine the amount of the dividends to be allocated to preferred and common stockholders for each year 2016 to
2018.
2. If the preferred stock had been noncumulative, how much would have been allocated to the preferred and common
stockholders each year?
ANSWER:
1. Preferred Dividends per Year = 1,000 × $100 × 9% = $9,000
Year Preferred Dividends Common Dividends
2015 $ 0 $ 0
2016 10,000* 0
2017 17,000** 3,000
2018 9,000 16,000
*$9,000 (from 2015) + $1,000 (for 2016) = $10,000.
**$8,000 (from 2016) + $9,000 (for 2017) = $17,000.
2. Year Preferred Dividends Common Dividends
2015 $ 0 $ 0
2016 9,000 1,000
2017 9,000 11,000
2018 9,000 16,000
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-05 - LO: 11-05
KEYWORDS:
Bloom's: Analyzing
223. At December 31, 2016, Forgione Company has the following:
Common Stock, $10 par, 10,000 shares authorized, 8,000 issued, 7,000 outstanding
Preferred Stock, $100 par, 7%, cumulative, 1,000 shares authorized, issued, and outstanding
The company did not pay any dividend during 2015 or 2014.
Required:
1. Compute the amount of dividend to be received by the common and preferred stockholders in 2016 if the company
declared a dividend of $50,000.
2. How many shares of treasury stock does Forgione have?
3. What are the dividends per share of common stock as a result of this distribution?
4. What are the dividends per share of Preferred stock as a result of this distribution?
ANSWER:
1. Preferred dividend in arrears ($100,000 × 7% × 2 years) $14,000
Preferred dividend for current year ($100,000 × 7%)...... 7,000
Total............................................................................ $21,000
Common stock ($50,000 – $21,000 = $29,000)
2. 8,000 – 7,000 = 1,000 shares of treasury stock
3. $29,000 / 7,000 = $4.14 / share of common stock
4. $21,000 / 1,000 = $21 / share of preferred stock (including cumulative
amounts)
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-05 - LO: 11-05
KEYWORDS:
Bloom's: Analyzing
224. At December 31, 2016, Marley Company has the following:
Common Stock, $10 par, 10,000 shares authorized, 9,000 issued, 8,000 outstanding
Required:
Indicate whether the following would increase, decrease, or have no effect on (a) assets, (b) retained earnings, and (c) total
stockholders’ equity.
1. A company declares and pays a cash dividend of $25,000.
2. A company declares and issues a 10% stock dividend.
ANSWER:
1. Decrease assets
Decrease retained earnings
Decrease total stockholders’ equity
2. No change in assets
Decrease retained earnings
No change in total stockholders’ equity
DIFFICULTY:
Moderate
225. At December 31, 2016, North Company and South Company have identical amounts of common stock and retained
earnings as follows:
Common Stock, $10 par, 50,000 shares authorized, 9,000 issued, 9,000 outstanding
Retained Earnings, $500,000
At December 31, 2016, North Company declares and issues a 100% stock dividend, while South Company declares and
issues a 2-for-1 stock split.
Required:
Determine for each company the following amounts as of January 1, 2017:
_______ Number of shares of common stock outstanding
_______ Par value per share of the common stock
_______ Total amount reported in Common Stock account
_______ Retained earnings
ANSWER:
North Company:
Number of shares outstanding
18,000
Par value per share
$10
Common Stock account
$180,000
Retained earnings
$410,000
South Company:
Number of shares outstanding
18,000
Par value per share
$5
Common Stock account
$90,000
Retained earnings
$500,000
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-07 - LO: 11-07
KEYWORDS:
Bloom's: Analyzing
226. At December 31, 2016, Corning Company has the following:
Common Stock, $10 par, 10,000 shares authorized, 9,000 issued, 8,000 outstanding
Preferred Stock, $100 par, 8%, cumulative, 1,000 shares authorized, issued, and outstanding
The company did not pay any dividend during 2015 or 2014.
Required:
Compute the amount of dividend to be received by the common and preferred stockholders in 2016 if the company
declared a dividend of $24,000.
ANSWER:
Preferred dividend in arrears ($100,000 × 8% × 2 years)........ $16,000
Preferred dividend for current year ($100,000 × 8%).... 8,000
Total.................................................................... $24,000
Common stock (0)
227. At December 31, 2016, Corning Company has the following:
Common Stock, $10 par, 10,000 shares authorized, 9,000 issued, 8,000 outstanding
Preferred Stock, $100 par, 8%, cumulative, 1,000 shares authorized, issued, and outstanding
The company did not pay any dividend during 2015 or 2014.
Required:
Compute the amount of dividend to be received by the common and preferred stockholders in 2016 if the company
declared a dividend of $60,000.
ANSWER:
Preferred dividend in arrears ($100,000 × 8% × 2 years)...... $16,000
Preferred dividend for current year ($100,000 × 8%).. 8,000
Total................................................................... $24,000
Common stock ($60,000 – $24,000 = $36,000)
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-05 - LO: 11-05
KEYWORDS:
Bloom's: Analyzing
228. Use the comparative financial statements of Penny Company for the year ended December 31, 2016 to answer the
following question(s).
Penny Company
Statement of Stockholder’s Equity
for the Year Ended December 31, 2016
in thousands, except share data
Common Stock
Retained
Treasury Stock
Shares
Amount
Earnings
Shares
Amount
Total
Balance, Jan. 1, 2016
57,936,988
$ 89,861
$20,037
$109,898
Exercise of stock options
including tax benefit of
$4,754
945,780
7,911
7,911
Sale of common stock
12,050,000
163,873
163,873
Stock subscription notes
repayments
3,671
3,671
Conversion of convertible
debentures, net
6,798
100
100
Sale of common stock under
employee stock purchase
plan
17,424
263
263
Net earnings
26,102
26,102
Unrealized holding gains,
net
141
141
Translation adjustment
272
272
Balance Dec. 31, 2016
70,956,990
$265,679
$46,552
0
$ 0
$312,231
See notes to consolidated financial statements.
Required:
Prepare a statement of retained earnings for the year ended December 31, 2016.
ANSWER:
Penny Company
Statement of Retained Earnings
for the Year Ended December 31, 2016
(in thousands)
Beginning retained earnings, January 1, 2016
$20,037
Net earnings
26,102
Ending retained earnings, December 31, 2016
$46,139
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-08 - LO: 11-08
KEYWORDS:
Bloom's: Analyzing
234. Explain the difference between authorized, issued, and outstanding shares.
ANSWER:
The corporation charter specifies a number of shares that are said to be authorized. This is the
maximum number of shares that can be issued. If the corporation wishes to issue shares in
excess of this number, the charter must be amended. Issued shares are those which have been
sold or transferred to stockholders. Outstanding shares are those which have been issued and
are still in the hands of stockholders.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-01 - LO: 11-01
KEYWORDS:
Bloom's: Applying
235. What is the difference between par value and market value? Which is the better indicator of the true worth of the
stock?
ANSWER:
Par value is an arbitrary amount stated on the face of the stock certificate and is needed to
satisfy legal requirements. Market value is the amount that each share of stock is selling for
on the market. Market value is the better indicator since par value is chosen only to establish
a minimum legal liability.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-01 - LO: 11-01
FACC.PONO.13.11-09 - LO: 11-09
KEYWORDS:
Bloom's: Applying
236. What is meant by the balance in the retained earnings account?
ANSWER:
Retained earnings represents the net income that the firm has earned but not paid out as
dividends. It is accumulated over the life of the corporation.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-01 - LO: 11-01
KEYWORDS:
Bloom's: Applying
237. What is substance over form and how does this concept relate to the presentation of preferred stock?
ANSWER:
Substance over form means that a company must look not only at the legal form but also at
the economic substance of the security to decide whether it is debt or equity. When preferred
stock carries certain provisions, the stock is very similar to bonds and notes payable. Using
this concept, management must evaluate whether such securities represent debt and should be
presented in the Liability category of the balance sheet or whether they represent equity and
should be presented in the Equity category.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-02 - LO: 11-02
KEYWORDS:
Bloom's: Applying
238. Explain the two ways that a dividend rate on preferred stock may be stated by giving examples.
ANSWER:
The examples in student answers may vary but can include something similar to the
following:
1. It may be stated as a percentage of the stock’s par value. For example, if a stock is
presented on the balance sheet as $100 par, 7% preferred stock, its dividend rate is $7 per
share ($100 × 7%).
2. The dividend may be stated as a per-share amount. For example, a stock may appear on the
balance sheet as $100 par, $7 preferred stock, meaning that the dividend rate is $7 per share.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-02 - LO: 11-02
KEYWORDS:
Bloom's: Applying
239. Gemini Company has the following accounts in the Stockholders’ Equity category of the balance sheet:
Common Stock, $10 no par, 10,000 shares authorized, 9,000 issued, 8,000 outstanding
Preferred Stock, $100 par, 8%, cumulative, participating, 1,000 shares authorized, issued, and outstanding
Required:
1. Explain how the issuance of stock affects the financial statements when the stock has no par value.
2. Why would preferred stockholders want to have a cumulative feature in preferred stock?
3. When a participating feature is present in preferred stock, how does it affect the amount of dividends that preferred
stockholders can expect to receive?
ANSWER:
1. When no par stock is issued, the entire amount of the issuance is in the stock account.
There is no distinction between the stock amount and the additional paid-in capital amount.
2. The cumulative feature gives the stockholders some assurance that a dividend will
eventually be received. If the dividends on preferred stock are cumulative, then the dividends
that are not paid are considered to be in arrears. Before a dividend on common stock can be
declared in a subsequent period, the dividends in arrears as well as the current year’s
dividend must be paid to the preferred stockholders.
3. If a participating feature is present in preferred stock, then it allows the preferred
stockholders to receive a dividend in excess of the regular rate when the firm has been
particularly profitable and declares an abnormally large dividend.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-02 - LO: 11-02
KEYWORDS:
Bloom's: Applying
240. Name two different examples of items that can be received (in addition to cash) in exchange for issuing stock.
Describe how the value of each item affects additional paid-in capital.
ANSWER:
Some examples are land, a machine, equipment, or a building. The best indicator of the value
241. Chad Darrow, CFO of your company is considering constructing a deal with Extreme Industries, whereby stock is
issued in exchange for an asset (custom extrusion equipment valued at $400,000 by an outside appraiser). The stock to be
exchanged is a new class of preferred stock that has not yet been traded in the open market. He has asked that you draft a
memo to Marc Lyon, CEO about the valuation of the asset to be used in the exchange. In your memo address the reporting
amount for the asset and how fair market value could be determined.
ANSWER:
INTERNAL MEMORANDUM
TO: Marc Lyon, CEO
FROM: Chad Darrow, CFO
I have determined that the best way to construct the deal with Extreme Industries is by
issuing our stock in exchange for the custom extrusion equipment. The asset should be
recorded at the fair market value of the consideration given (the stock) or the fair market
value of the consideration received (the asset), whichever is more readily determinable. Fair
market value may be determined by reference to sales of the stock on the stock exchange or,
in some cases, by an appraisal of the asset. In this case, since the new class of preferred stock
does not have a readily determinable market value, we will be recording the custom extrusion
equipment at $400,000, which was the value determined by an independent appraiser.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-03 - LO: 11-03
KEYWORDS:
Bloom's: Applying
242. What is treasury stock? How is it reported on the financial statements?
ANSWER:
Treasury stock is issued stock that is repurchased by a company. It is reported as a deduction
from total stockholders' equity on the balance sheet.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-04 - LO: 11-04
KEYWORDS:
Bloom's: Applying
243. a. Explain what the dividend payout ratio is and which firms typically have a high ratio and which firms may have
the lowest.
b. Many firms operate at a dividend payout ratio of less than 50%. Why do many firms not pay a larger percentage of
income as dividends?
ANSWER:
a. The dividend payout ratio is calculated as the annual dividend amount divided by the
annual net income. Typically, utilities pay a high proportion of their earnings as dividends. In
contrast, fast-growing companies in technology often pay nothing to stockholders.
b. Many firms do not pay out all of their income as dividends because there are other
alternative uses of the income. Management’s objective should be to maximize the wealth of
the stockholders. Sometimes that can be achieved by paying dividends; other times it can be
achieved by retaining the income and reinvesting it in alternatives such as purchasing
replacement fixed assets or equipment which could be vital to the continuing operations of
the company.
244. Contrast stock dividends and stock splits.
ANSWER:
Stock dividends involve the issuance of additional shares of stock. The dividend normally
reflects the fair market value of the additional shares. A stock split is similar to a stock
dividend except that stock splits reduce the par value per share of the stock. No accounting
transaction is necessary for a stock split.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-06 - LO: 11-06
FACC.PONO.13.11-07 - LO: 11-07
KEYWORDS:
Bloom's: Applying
245. What is comprehensive income and what is contained in a statement of comprehensive income?
ANSWER:
Comprehensive income is the total change in net assets from all sources except investments
by or distributions to the owners. These include “income-type” items that escape the income
statement. In other words, the statement of comprehensive income includes all of the
revenues and expenses that are presented on the income statement to calculate net income
and includes items that are not presented on the income statement but that affect total
stockholders’ equity. For example, these include transactions such as unrealized gains that
affect stockholders’ equity.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-08 - LO: 11-08
KEYWORDS:
Bloom's: Applying
246. What is the difference between book value and market value of stock?
ANSWER:
Market value is the amount that each share of stock is selling for on the market. Market value
is the best indicator of true value since par value is chosen only to establish a minimum legal
liability. Book value is calculated as net assets divided by the number of shares of common
stock outstanding. It indicates the rights that stockholders have, based on recorded values, to
the net assets in the event of liquidation. It is therefore not a measure of the market value of
the stock.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-09 - LO: 11-09
KEYWORDS:
Bloom's: Applying
247. What section of the statement of cash flows is related to the Stockholders' Equity section of the balance sheet? Name
four different transactions that are reported in that section that relate to the statement of cash flows.
ANSWER:
The section of the statement of cash flows that is related to the statement of stockholders'
equity is the Financing Activities section. Some transactions are: payments of dividends, sale
of common or preferred stock for cash, cash paid for the retirement of stock, sale of treasury
stock, and purchase of treasury stock.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-10 - LO: 11-10
KEYWORDS:
Bloom's: Applying
248. [APPENDIX] Explain the differences between a partnership and sole proprietorship. Include in your discussion
whether either is considered a separate legal entity.
ANSWER:
A partnership is a company owned by two or more persons. A proprietorship is owned by
only one person. Neither is considered a separate legal entity.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.11-11 - LO: 11-11
KEYWORDS:
Bloom's: Applying
249. [APPENDIX] What are the advantages of organizing a company as a corporation instead of a partnership or sole
proprietorship?
ANSWER:
Sole proprietorships and partnerships are not considered separate entities for legal or tax
purposes. Owners of corporations are not liable for debts of the corporation, whereas owners
of sole proprietorships and partnerships are. The owners of sole proprietorships and
partnerships pay their individual share of the business's income taxes, while stockholders of
corporations do not. This may or may not be an advantage.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-11 - LO: 11-11
KEYWORDS:
Bloom's: Applying
250. [APPENDIX] Which accounts are used by a sole proprietorship that are not used by a corporation?
ANSWER:
A sole proprietorship uses a capital account instead of the common stock, additional paid-in
capital, and retained earnings accounts, which are used by corporations. It also utilizes a
withdrawals account instead of a dividends account.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.11-11 - LO: 11-11
KEYWORDS:
Bloom's: Applying
