978-0078025549 Chapter 10 Solution Manual Part 1

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Question 10-1 (LO 10-1)

Most corporations first raise money by selling stock to the founders of the business and their

friends and family. As the equity financing needs of the corporation grow, companies prepare a

business plan and seek outside investment from “angel” investors and venture capital firms.

Angel investors are wealthy individuals in the business community willing to risk investment

Question 10-2 (LO 10-1)

The stock of a publicly held corporation trades on the New York Stock Exchange (NYSE),

National Association of Securities Dealers Automated Quotations (NASDAQ), or by

A privately held corporation does not allow investment by the general public and normally

Question 10-3 (LO 10-1)

The basic ownership rights of common stockholders are (1) the right to vote, (2) the right to

Question 10-4 (LO 10-1)

Sole proprietorships are the most common form of business. However, corporations are

Question 10-5 (LO 10-1)

A corporation offers two primary advantages over sole proprietorships and partnerships.

These are (1) limited liability, (2) ability to raise capital and transfer ownership. Because of

limited liability, even in the event of bankruptcy, stockholders in a corporation can lose no more

Chapter 10

Stockholders’ EquityREVIEW Questions

A corporation has two primary disadvantages relative to sole proprietorships and

partnerships. These are (1) additional taxes and (2) more paperwork. Corporations have double

Question 10-6 (LO 10-1)

An LLC or an S Corporation allows a company to enjoy limited liability as a corporation, but

Question 10-7 (LO 10-2)

Authorized stock is the total number of shares available to sell, stated in the company’s

articles of incorporation. Issued stock is the number of shares that have been sold to investors. A

company usually does not issue all its authorized stock. Outstanding stock is the number of

Question 10-8 (LO 10-2)

1 million shares are authorized, 100,000 shares are issued, and 90,000 shares are outstanding.

Question 10-9 (LO 10-2)

Par value is the legal capital per share of stock that’s assigned when the corporation is first

established. Par value has no relationship to the market value of the common stock. We credit the

Question 10-10 (LO 10-3)

The three potential features of preferred stock are convertible, redeemable, and cumulative.

Question 10-11 (LO 10-3)

Investors in common stock are the owners of the corporation. Investors in bonds are creditors

who have loaned money to the corporation. Preferred stock fits somewhere between common

stock and bonds. For example, the risk and expected return are greatest for investments in

Question 10-12 (LO 10-4)

A company may buy back its own stock to boost under-priced stock. When a company’s

management feels the market price of its stock is too low, it may attempt to support the price by

Question 10-13 (LO 10-4)

When a corporation repurchases its own stock, it increases, or debits treasury stock reported

in the balance sheet as a reduction in stockholders’ equity. When a corporation purchases stock in

Question 10-14 (LO 10-5)

Some companies are unprofitable and therefore unable to pay cash dividends. However,

many profitable companies choose not to pay cash dividends. Companies with large expansion

Investors purchase stock in companies that do not pay dividends because they expect share

Question 10-15 (LO 10-5)

The declaration date is when the board of directors declares the cash dividend to be paid. The

Question 10-16 (LO 10-6)

Total assets, total liabilities, and total stockholders’ equity do not change as a result of a

Question 10-17 (LO 10-6)

Declaration and payment of a cash dividend reduces total assets and total stockholders’

Question 10-18 (LO 10-6)

In a 2-for-1 stock split the number of shares outstanding doubles, while the par value and

Question 10-19 (LO 10-7)

The correct order in the stockholders’ equity section of the balance sheet is preferred stock,

Question 10-20 (LO 10-7)

The stockholders’ equity section of the balance sheet shows the balance in each equity

Question 10-21 (LO 10-8)

Total stockholders’ equity is equal to assets minus liabilities. An asset usually equals its

market value on the date it’s purchased. However, the two aren’t necessarily the same after that.

For instance, many buildings increase in value over time, but continue to be reported in the

Question 10-22 (LO 10-8)

The return on equity tends to be larger. The return on equity is net income divided by average

stockholders’ equity. The return on the market value of equity is net income divided by the

Question 10-23 (LO 10-8)

PE stands for price-earnings. Investors use the PE ratio to evaluate the price of a stock in

relation to the current earnings generated. A high PE ratio indicates that the market has high

hopes for a company’s stock and has bid up the price. They are priced high in relationship to

BRIEF Exercises

Brief Exercise 10-1 (LO 10-1)

ADVANTAGES OF A CORPORATION

• Limited Liability– Even in the event of bankruptcy, stockholders in a

corporation can lose no more than the amount they invested in the company.

• Raising Capital– A corporation is better suited to raising capital than is a

DISADVANTAGES OF A CORPORATION

• Additional Taxes– Owners of sole-proprietorships and partnerships are

• More Paperwork– To protect the rights of those who buy a corporation’s

Brief Exercise 10-2 (LO 10-1)

An S Corporation allows a company to enjoy limited liability as a corporation,

but tax treatment as a partnership. Because of these benefit, many companies

Brief Exercise 10-3 (LO 10-2)

Cash (3,000 shares x $11) 33,000

Common Stock (3,000 shares x $0.01) 30

Brief Exercise 10-4 (LO 10-2)

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

Common Stock (1,000 shares x $1.00) 1,000

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

Brief Exercise 10-5 (LO 10-3)

Cash (1,000 shares x $32) 32,000

Preferred Stock (1,000 shares x $0.01) 10

Brief Exercise 10-6 (LO 10-3)

Preferred Stock Features Description

__c___ 1. Convertible a. Prior unpaid dividends receive

__b___ 2. Redeemable b. Shares can be sold at a

__a___ 3. Cumulative c. Shares can be exchanged for

Brief Exercise 10-7 (LO 10-3)

Preferred dividends in arrears for 2013 and 2014 ($7,000 x 2 years) $14,000

Preferred dividends for 2015 (2,000 shares x 7% x $50 par value) 7,000

Remaining dividends to common stockholders 2,000

Brief Exercise 10-8 (LO 10-4)

Treasury Stock (100 shares x $38) 3,800

Brief Exercise 10-9 (LO 10-4)

Cash (100 shares x $40) 4,000

Treasury Stock (100 shares x $38) 3,800

Brief Exercise 10-10 (LO 10-5)

October 1

Dividends (4,000 shares x $0.75) 3,000

October 15

No Entry

October 31

Dividends Payable (4,000 shares x $0.75) 3,000

Brief Exercise 10-11 (LO 10-6)

June 30

Stock Dividends (30,000 shares x $1.00) 30,000

Brief Exercise 10-12 (LO 10-6)

• No entry is recorded for a 2-for-1 stock split, because the balance in all of the

accounts remain the same before and a?er a stock split.

• Number of shares: 30,000 x 2 = 60,000

Brief Exercise 10-13 (LO 10-7)

Transaction

Total

Assets Total Liabilities

Total

Stockholders’

Equity

Issue common stock + NE +

Issue preferred stock + NE +

Purchase treasury stock − NE −

Sale of treasury stock + NE +

Brief Exercise 10-14 (LO 10-7)

Summit Apparel

Balance Sheet

(Stockholders’ Equity Section)

December 31

Stockholders’ equity:

Common stock, $1.00 par value $ 2,000,000

Additional paid-in capital 18,000,000

Total paid-in capital 20,000,000

Retained earnings 11,000,000

Brief Exercise 10-15 (LO 10-8)

($ in millions) Net

Income ÷

Average

Stockholders’

Equity

=Return on

Equity

Exercise 10-1 (LO 10-1)

Terms

__f___ 1. Publicly held corporation.

__d___ 2. Organization chart.

__h___ 3. Articles of incorporation.

__a___ 4. Limited liability.

Definitions

Exercises

a. Shareholders can lose no more than the amount they invested in the

b. Corporate earnings are taxed twice – at the corporate level and individual

c. Like an S corporation, but there are no limitations on the number of owners

d. Traces the line of authority within the corporation.

e. Allows for legal treatment as a corporation, but tax treatment as a

f. Has stock traded on a stock exchange such as the New York Stock Exchange

g. The first time a corporation issues stock to the public.

h. Describe (a) the nature of the firm’s business activities, (b) the shares to be

Exercise 10-2 (LO 10-2, 10-3, 10-4)

Authorized stock is the number of shares the company is authorized to sell, stated

Issued stock is the number of shares that have been sold to investors.

Outstanding stock is the number of shares held by investors. Issued and

Preferred stock is “preferred” over common stock in two ways. Preferred

stockholders usually have first rights to a specified amount of dividend and receive

Treasury stock is the corporation’s own stock that it reacquired.

Authorized stock,

Issued stock

Outstanding stock

Preferred stock

Treasury stock

Exercise 10-3 (LO 10-2)

Requirement 1

January 1

Cash (700 shares x $50) 35,000

April 1

Cash (110 shares x $54) 5,940

Requirement 2

January 1

Cash (700 shares x $50) 35,000

Common Stock (700 shares x $1.00) 700

April 1

Cash (110 shares x $54) 5,940

Common Stock (110 shares x $1.00) 110

Exercise 10-4 (LO 10-3)

Requirement 1

Preferred dividends in arrears for 2014 $10,000

Preferred dividends for 2015 (2,000 shares x 5% x $100 par value) 10,000

Requirement 2

Preferred dividends in arrears for 2014 $ 0

Preferred dividends for 2015 (2,000 shares x 5% x $100 par value) 10,000

Exercise 10-5 (LO 10-2, 10-3, 10-5)

February 1 Debit Credit

Cash (6,000 x $16) 96,000

May 15

Cash (700 x $13) 9,100

Preferred Stock (700 x $10) 7,000

October 1

Dividends (6,700 shares x $1.25) 8,375

October 15

No Entry

October 31

Dividends Payable (6,700 shares x $1.25) 8,375