978-0078025549 Chapter 10 Lecture Note Part 1

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shares to the general public. The reporting of common stock, preferred stock, and treasury stock

are illustrated using one example company, Canadian Falcon. Many competing texts develop a

new company example with all new information to separately illustrate common stock, preferred

stock, and treasury stock making it more difficult to show how the accounts in stockholders’

equity are integrated.

Part B is entitled “Earned Capital,” and examines transactions related to retained earnings.

The recording of cash dividends is covered first including a discussion as to why many profitable

companies pay little or no dividends. Stock dividends and stock splits are covered in a little more

depth using the continuing example of Canadian Falcon. It’s important to emphasize the reason

for most large stock dividends and stock splits. The primary reason is to lower the trading price

of the stock to a more acceptable trading range, making it attractive to a larger number of

potential investors (see the decision maker’s perspective in this section).

Part C analyzes the stockholders’ equity section for American Eagle, Inc. It also demonstrates

how a separate statement of stockholders’ equity differs from the stockholders’ equity section

reported in the balance sheet. The stockholders’ equity section reported in the balance sheet

shows the balance in each equity account at a point in time. In contrast, the statement of

stockholders’ equity summarizes the changes in the balance in each equity account over a

period of time.

The chapter ends with the calculation of financial ratios for Deckers Outdoor (makers of

Teva sandals and Ugg boots) and Wolverine World Wide (makers of Chacos and Patagonia).

Ratios include the return on equity, return on the market value of equity, earnings per share, and

the price-earnings ratio. The decision maker’s perspective in this section is designed to help

students understand why stockholders’ equity reported on the balance sheet doesn’t usually equal

the true market value of equity.

Assignment Charts

Questions Learning

Objective(s) Topic

Time

(Min.)

1 LO10-1 Describe stages of equity financing 5

2 LO10-1 Provide examples of public and private corporations 5

3 LO10-1 Describe the four basic ownership rights of common

stockholders

4 LO10-1 Compare forms of business 5

5 LO10-1 Describe the primary advantages and disadvantages

of a corporation

6 LO10-1 Explain the benefits of an LLC or an S corporation 5

7 LO10-2 Explain the difference between authorized, issued,

and outstanding shares

8 LO10-2 Identify how many shares are authorized, issued,

and outstanding

9 LO10-2 Describe par value and how it used in recording the

issuance of stock

10 LO10-3 Discuss the three potential features of preferred

stock

11 LO10-3 Explain why preferred stock is a mixture of

attributes between common stock and bonds

12 LO10-4 Discuss what would motivate a company to buy

back its own stock

13 LO10-4 Describe how treasury stock differs from the

purchase of stock in another corporation

14 LO10-5 Explain why some companies choose not to pay

dividends

15 LO10-5 Describe the declaration date, record date, and

payment date for a cash dividend

16 LO10-6 Explain the effects of a 100% stock dividend or a

2-for-1 stock split

17 LO10-6 Contrast the effects of a cash dividend with a stock

dividend

18 LO10-6 Describe the effects of a 2-for-1 stock split on par

value, share price, and shares outstanding

19 LO10-7 Indicate the correct order to report accounts within

stockholders’ equity

20 LO10-7 Contrast the stockholders’ equity section of the

balance sheet with the statement of stockholders’

equity

21 LO10-8 Discuss why stockholders’ equity doesn’t equal the

value of the firm

22 LO10-8 Explain the difference between return on equity and

the return on the market value of equity

23 LO10-8 Explain how investors use the PE ratio 5

Brief

Exercises Learning

Objective(s) Topic

Time

(Min.)

BE10-1 LO10-1 Cite advantages and disadvantages of a corporation 10

BE10-2 LO10-1 Understand an S corporation 10

BE10-3 LO10-2 Record issuance of common stock 5

BE10-4 LO10-2 Record issuance of common stock 5

BE10-5 LO10-3 Record issuance of preferred stock 5

BE10-6 LO10-3 Recognize preferred stock features 5

BE10-7

BE10-8

LO10-3

LO10-4

Determine the amount of preferred stock dividends

Record purchase of treasury stock

BE10-9 LO10-4 Record sale of treasury stock 5

BE10-10 LO10-5 Record cash dividends 5

BE10-11 LO10-6 Record stock dividends 5

BE10-12 LO10-6 Analyze a stock split 5

BE10-13 LO10-7 Indicate effects on total stockholders’ equity 5

BE10-14 LO10-7 Prepare the stockholders’ equity section 10

BE10-15 LO10-8 Calculate the return on equity 5

Exerc

ises Learning

Objective(s) Topic

Time

(Min.)

E10-1 LO10-1 Match terms with their definitions 10

E10-2 LO10-2,10-3,1

0-4

Explain the meaning of terms used in stockholders’

equity

E10-3 LO10-2 Record the issuance of common stock 25

E10-4 LO10-3 Determine the amount of preferred stock dividends 15

E10-5 LO10-2,10-3,1

0-5

Record common stock, preferred stock, and

dividend transactions

E10-6 LO10-2,10-3,1

0-4

Record issuance of stock and treasury stock

transactions

E10-7 LO10-7 Prepare the stockholders’ equity section 20

E10-8 LO10-5 Record cash dividends 10

E10-9 LO10-2,10-4,1

0-5

Record common stock, treasury stock, and cash

dividends

E10-10 LO10-6 Record stock dividends and stock splits 20

E10-11 LO10-7 Prepare the stockholders’ equity section 20

E10-12 LO10-7 Prepare a statement of stockholders’ equity 20

E10-13 LO10-7 Indicate effects on total stockholders’ equity 15

E10-14 LO10-7 Prepare the stockholders’ equity section 20

E10-15 LO10-8 Calculate and analyze ratios 15

E10-16 LO10-8 Calculate and analyze ratios 15

Problems Learning

Objective(s) Topic

Time

(Min.)

P10-1A LO10-1 Match terms with their definitions 15

P10-2A LO10-2 to 10-5 Record equity transactions and indicate the effect on

the balance sheet equation

P10-3A LO10-6 Indicate effect of stock dividends and stock splits 10

P10-4A LO10-7 Analyze the stockholders’ equity section 15

P10-5A LO10-7 Understand stockholders’ equity and the statement

of stockholders’ equity

P10-6A LO10-2,10-3,1

0-4,10-5,10-7

Record equity transactions and prepare the

stockholders’ equity section

P10-7A LO10-8 Calculate and analyze ratios 20

P10-1B LO10-1 to

LO10-8

Match terms with their definitions 15

P10-2B LO10-2 to 10-5 Record equity transactions and indicate the effect on

the balance sheet equation

P10-3B LO10-6 Indicate effect of stock dividends and stock splits 10

P10-4B LO10-7 Analyze the stockholders’ equity section 15

P10-5B LO10-7 Understand stockholders’ equity and the statement

of stockholders’ equity

P10-6B LO10-2,10-3,1

0-4,10-5,10-7

Record equity transactions and prepare the

stockholders’ equity section

P10-7B LO10-8 Calculate and analyze ratios 20

Additional

Perspectives Topic

Time

(Min.)

AP10-1 Continuing Problem: Great Adventures 35

AP10-2 Financial Analysis: American Eagle Outfitters, Inc. 15

AP10-3 Financial Analysis: The Buckle, Inc. 15

AP10-4 Comparative Analysis: American Eagle Outfitters, Inc., vs. The

Buckle, Inc.

AP10-5 Ethics 20

AP10-6 Internet Research 20

AP10-7 Written Communication 20

AP10-8 Earnings Management 30

Chapter Quiz Questions

The following multiple-choice questions are 10 unique quiz questions that correspond to the 10

questions at the end of each chapter. Each question covers the same learning objective but with a

little different twist. The correct answer is highlighted in bold for each item.

LO10-1

1. Common shareholders usually have all of the following rights except:

a. To participate in the day-to-day operations.

b. To share in the distribution of assets.

c. To elect board of directors.

d. To receive dividends when declared.

LO10-1

2. The advantages of owning a corporation include all of the following except:

a. Ability to transfer ownership.

b. Ability to raise capital.

c. Limited liability.

d. Additional taxes.

LO10-2

3. The correct order from the largest number of shares to the smallest number of shares is:

a. Authorized, issued, and outstanding.

b. Outstanding, issued, and authorized.

c. Issued, outstanding, and authorized.

d. Issued, authorized, and outstanding.

LO10-3

4. Which of the following is not a potential feature of preferred stock?

a. Convertible.

b. Redeemable.

c. Cumulative.

d. Secured.

LO10-4

5. When treasury stock is purchased, what is the effect on total shareholders’ equity?

a. Increase

b. Decrease

c. No effect

d. Cannot tell from the given information.

LO10-5

6. Retained earnings:

a. Is increased by debits.

b. Decreases stockholders’ equity.

c. Is backed by an equivalent amount of cash.

d. Increases stockholders’ equity.

LO10-5

7. Entries for cash dividends are recorded on all of the following dates except:

a. Declaration date.

b. Record date.

c. Payment date.

d. Entries are made on all of these dates.

LO10-6

8. What effect does a stock dividend have on total stockholders’ equity?

a. No effect on total stockholders’ equity.

b. Increases total stockholders’ equity.

c. Decreases total stockholders’ equity.

d. Can either increase or decrease total stockholders’ equity depending on the situation.

LO10-7

9. Which of the following summarizes the changes in the balance in each stockholders’ equity

account over a period of time?

a. The stockholders’ equity section reported on the balance sheet.

b. The statement of stockholders’ equity.

c. Both the stockholders’ equity section reported on the balance sheet and the statement of

stockholders’ equity.

d. Neither the stockholders’ equity section reported on the balance sheet or the statement of

stockholders’ equity.

LO10-8

10. Return on equity is calculated as:

a. Net income divided by ending stockholders’ equity.

b. Net income divided by average stockholders’ equity.

c. Net income divided by ending market value of equity.

d. Net income divided by average market value of equity.

Alternate Let’s Review

Problem #1

Forever Young has two classes of stock authorized: $100 par preferred and $1 par common. As

of the beginning of the year, 5,000 shares of common stock and no preferred shares have been

issued. The following transactions affect stockholders’ equity during the year:

January 10 Issue 1,000 additional shares of common stock for $30 per share.

March 1 Issue 1,000 shares of preferred stock for $105 per share.

July 1 Declare a cash dividend of $5 per share on preferred stock and $1.25 per share on

common stock to all stockholders of record on July 15.

July 31 Pay the cash dividend declared on July 1.

October 10 Purchase 500 shares of treasury stock for $28 per share.

November 1 Reissue 200 shares of the treasury stock purchased on October 10 for $26 per

share.

Forever Young has the following beginning balances in its stockholders’ equity accounts:

Preferred stock, $0, common stock, $5,000; additional paid-in capital, $20,000; and retained

earnings, $10,000.

Required:

1. Record each of these transactions.

2. Indicate whether each of these transactions increases (+), decreases (−), or has no effect

(NE), on total assets, total liabilities, and total stockholders’ equity.

Solution:

January 10 Debit Credit

Cash (1,000 x $30) 30,000

Common Stock (1,000 x $1) 1,000

Additional Paid-in Capital (difference) 29,000

(Issue common stock above par)

March 1

Cash (1,000 x $105) 105,000

Preferred Stock (1,000 x $100) 100,000

Additional Paid-in Capital (difference) 5,000

(Issue preferred stock above par)

July 1

Dividends* 12,500

Dividends Payable 12,500

(Declare cash dividends)

* 1,000 preferred shares x $5 + 6,000 common shares x $1.25

July 31

Dividends Payable 12,500

Cash 12,500

(Pay cash dividends)

October 10

Treasury Stock (500 shares x $28) 14,000

Cash 14,000

(Purchase treasury stock)

November 1

Cash (200 shares x $26) 5,200

Additional Paid-in Capital (200 x $2) 400

Treasury Stock (200 shares x $28) 5,600

(Reissue treasury stock below cost)

Transaction

Total

Assets

Total

Liabilities

Total

Stockholders’

Equity

Issue common stock + NE +

Issue preferred stock + NE +

Declare cash dividends NE + –

Pay cash dividends – – NE

Purchase treasury stock – NE –

Reissue treasury stock + NE +

Problem #2

This is a continuation of problem #1. Forever Young has two classes of stock authorized: $100

par preferred and $1 par value common. As of the beginning of 2015, no preferred stock has

been issued and 5,000 shares of common stock have been issued. The following transactions

affect stockholders’ equity during 2015:

January 10 Issue 1,000 additional shares of common stock for $30 per share.

March 1 Issue 1,000 shares of preferred stock for $105 per share.

July 1 Declare a cash dividend of $5 per share on preferred stock and $1.25 per share on

common stock to all stockholders of record on July 15.

July 31 Pay the cash dividend declared on July 1.

October 10 Repurchase 500 shares of treasury stock for $25 per share.