ANSWERS TO QUESTIONS – CHAPTER 8
1. The three major forms of business organizations are the sole proprietorship, the
partnership, and the corporation.
The sole proprietorship is a business owned by one individual.
The partnership is a business that is owned by two or more persons with the intent
2. The sole proprietorship is formed when an individual decides to engage in some
activity that provides goods or services, with the intent of making a profit.
3. The partnership agreement is a legal agreement that defines the responsibilities of
4. The phrase separate legal entity simply means that the business organization
5. The articles of incorporation constitute a legal document that is filed with the
appropriate state agency requesting the official formation of a corporation. The
6. The stock certificate is issued as evidence of ownership in a corporation and
represents a certain proportionate share of the business ownership.
7. The stock market crash of 1929 and the subsequent economic depression led to the
passage of the Securities and Exchange Acts of 1933 and 1934. These acts were
8. The corporate form of business has both advantages and disadvantages.
Advantages:
(1) Limited liability. Owners are not held personally responsible for the actions of
the corporation. Generally, the maximum amount an owner can lose is limited to
his/her amount of the investment.
business.
Disadvantages:
(1) Regulation. Corporations are subject to considerably more regulation, both
state and federal, than are sole proprietorships and partnerships. Corporations are
required to file separate income tax returns and public corporations are required to
9. The limited liability company is a relatively new organizational form in the United
States and operates similar to a partnership in that income is taxed at the owner
10. The term double taxation as it applies to a corporation means that earnings are
taxed both at the corporate level and the shareholder level when earnings are
11. Contributed capital is the capital that is acquired by the corporation from owners of
the corporation. For example, the sale of stock to an investor is a type of
contributed capital.
12. For both sole proprietorships and partnerships, contributed capital and retained
earnings are combined in one capital account for financial statement reporting.
13. Because corporations can be owned by millions of individuals, they are able to pool
14. a. Legal capital: Par value multiplied by the number of shares issued.
This represents the minimum amount of assets that should be
maintained as a protection for creditors.
b. Par value of stock: An arbitrary value that is assigned to a share of
stock.
e. Book value of stock: The amount of equity of one share of stock, i.e., (assets
− liabilities) divided by the number of shares of stock outstanding.
f. Authorized shares of stock: The number of shares that a corporation has
been authorized by the state to issue.
j. Common stock: A class of stock that possesses certain rights usually not
given to other classes of stock. These rights include the right to share in the
distribution of profits, the right to share in the distribution of corporate
assets upon liquidation, the right to vote on certain matters that affect the
l. Dividends: Distributions of corporate profits to shareholders.
15. Cumulative preferred stock: A class of preferred stock for which the stipulated
dividend, if not paid, accumulates from one year to the next. If a corporation does
not pay dividends one year, the unpaid dividend amount is carried forward and
16. No-par stock is stock for which a par value has not been established by the
corporation. No-par stock may have a stated value. If so, issuance of the stock is
17. Dividend per share: $100 par x 10% = $10 per share. The total dividends per year
18. The amount added to the common stock account is equal to par value times the
19. Par value and stated value are similar in meaning in the sense that they are
20. A company will repurchase its own stock for a number of reasons. Some of the most
common reasons include: (1) to reduce the number of shares outstanding and thus
21. The purchase of treasury stock decreases total equity by increasing the treasury
stock account which is a contra-equity account.
22. Even though the stock was purchased for $30 per share and resold for $35 per
23. The declaration date is the date the dividend is officially declared by the
corporation’s board of directors. The declaration of the dividend creates a legal
24. A stock dividend may be declared to give the shareholders some reward when the
corporation does not have sufficient cash to distribute. The stock dividend will give
each shareholder additional shares in proportion to their stock ownership. After
25. A stock dividend is declared either to compensate shareholders when cash is not
available or to lower the market price of a share of stock.
26. The primary reason for declaring a stock split is to reduce the market value of stock
stock more affordable and may, therefore, increase demand for the stock.
27. In a stock split, the number of shares is increased according to the amount of the
28. When retained earnings are appropriated, an equal amount of cash is not
29. Equity financing (i.e., capital acquired from owners) is the largest source of
financing for most U.S. businesses.
30. Equity financing refers to capital acquired from owners; usually the term refers to
issuance of stock.
31. A widely held corporation is one in which the stock is held by a large number of
investors.
32. In deciding whether to declare dividends, the board of directors must consider
whether the corporation has sufficient cash to cover operating requirements and
SOLUTIONS TO EXERCISES – CHAPTER 8
EXERCISE 8-1
Transactions
Cash Acquired from Owner
Revenues
Expenses
Withdrawals
Alex Ard Sole Proprietorship
Financial Statements
For the Year Ended December 31, 2014
Income Statement
Revenues
$50,000
Expenses
(22,300)
Net Income
$27,700
Capital Statement
Beginning Capital Balance
$ -0-
Plus: Capital Acquired from Owner
30,000
Plus: Net Income
27,700
Less: Withdrawal by Owner
(10,000)
Ending Capital Balance
$47,700
EXERCISE 8-1 (cont.)
Alex Ard Sole Proprietorship
Financial Statements
Balance Sheet
As of December 31, 2014
Assets
Cash
$47,700
Total Assets
$47,700
Liabilities
$ -0-
Equity
Ard, Capital
47,700
Total Liabilities and Equity
$47,700
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash Flows From Operating Activities:
Inflow from Revenues
$50,000
Outflow for Expenses
(22,300)
Net Cash Flow from Operating Activities
$27,700
Cash Flows From Investing Activities
-0-
Cash Flows From Financing Activities:
Inflow from Owner
$30,000
Outflow for Owner Withdrawals
(10,000)
Net Cash Flow from Financing Activities
20,000
Net Change in Cash
47,700
Plus: Beginning Cash Balance
-0-
Ending Cash Balance
$47,700
EXERCISE 8-2
Transactions:
Cash Contributions
D. Cushing
$ 70,000
33.33%
S. Tadlock
140,000
66.67%
Total
$210,000
100.00%
Revenues
$ 75,000
Expenses
39,000
Cushing Withdrawal
2,000
Tadlock Withdrawal
4,000
CT Partnership
Financial Statements
For the Year Ended December 31, 2014
Income Statement
Revenues
$75,000
Expenses
(39,000)
Net Income
$36,000
Capital Statement
Beginning Capital Balance
$ -0-
Plus: Capital Acquired from Owners
210,000
Plus: Net Income
36,000
Less: Withdrawals by Owners
(6,000)
Ending Capital Balance
$240,000
EXERCISE 8-2 (cont.)
Prepared for the instructor’s use:
Analysis of Capital Accounts:
Cushing
Tadlock
Total
Beginning Capital Balance
$ -0-
$ -0-
$ -0-
Investments
70,000
140,000
210,000
Net Income
36,000
D. Cushing 33.33%
12,000
S. Tadlock 66.67%
24,000
Withdrawals
(2,000)
(4,000)
(6,000)
Ending Capital Balances
$80,000
$160,000
$240,000
EXERCISE 8-2 (cont.)
CT Partnership
Financial Statements
Balance Sheet
As of December 31, 2014
Assets
Cash
$240,000
Total Assets
$240,000
Liabilities
$ -0-
Equity
D Cushing, Capital
$ 80,000
S. Tadlock, Capital
160,000
Total Equity
240,000
Total Liabilities and Equity
$240,000
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash Flows From Operating Activities:
Inflow from Revenues
$ 75,000
Outflow for Expenses
(39,000)
Net Cash Flow from Operating Activities
$36,000
Cash Flows From Investing Activities
-0-
Cash Flows From Financing Activities:
Inflow from Partners
$210,000
Outflow for Partners’ Withdrawals
(6,000)
Net Cash Flow from Financing Activities
204,000
Net Change in Cash
240,000
Plus: Beginning Cash Balance
-0-
Ending Cash Balance
$240,000
EXERCISE 8-3
Transactions:
Issued 10,000 shares of $10 par stock @ $16
$160,000
Revenues
71,000
Expenses
46,500
Dividends Paid
5,000
Bozeman Corporation
Financial Statements
For the Year Ended December 31, 2014
Income Statement
Revenues
$71,000
Expenses
(46,500)
Net Income
$24,500
Statement of Changes in Stockholders’ Equity
Beginning Common Stock
$ -0-
Plus: Issuance of Common Stock
160,000
Ending Common Stock
$160,000
Beginning Retained Earnings
$ -0-
Plus: Net Income
24,500
Less: Dividends
(5,000)
Ending Retained Earnings
19,500
Total Stockholders’ Equity
$179,500
EXERCISE 8-3 (cont.)
Bozeman Corporation
Financial Statements
Balance Sheet
As of December 31, 2014
Assets
Cash
$179,500
Total Assets
$179,500
Liabilities
$ -0-