Solution Manual
Book Title
Financial Accounting Fundamentals 5th Edition

978-0078025754 Chapter 11 Lecture Note Part 1

March 26, 2020
Related Assignment Materials
Student Learning Objectives
Beyond the
Conceptual objectives:
C1. Identify characteristics of
corporations and their
1, 2, 3, 4
C2. Explain characteristics of, and
distribute dividends between
common and preferred stock.
5, 6, 7,8, 9,
20, 21, 22
11-9, 11-10
11-7, 11-8,
11-1, 11-5
11-1, 11-7
C3. Explain the items reported in
retained earnings.
11-11, 11-17,
11-2, 11-4
11-3, 11-5
Analytical objectives:
A1 Compute earnings per share
and describe its use.
11-14, 11-15
11-12, 11-13
11-1, 11-2,
11-4, 11-8,
A2. Compute price-earnings ratio
and describe its use in analysis.
11-2, 11-4,
A3. Compute dividend yield and
explain its use in analysis.
11-2, 11-8
A4. Compute book value and
explain its use in analysis.
11-1, 11-2
Procedural objectives:
P1. Record the issuance of
corporate stock.
11-2, 11-3,
11-4, 11-5,
11-2, 11-3,
11-4, 11-17
P2. Record transactions
involving cash dividends, stock
dividends and stock splits.
10, 11, 12,
13, 14, 18
11-6, 11-7,
11-8, 11-12
11-5, 11-6,
11-2, 11-3,
P3. Record purchases and sales
of treasury stock and the
retirement of stock.
15, 16, 23
11-11, 11-12
11-10, 11-18
11-2, 11-4
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
Synopsis of Chapter Revisions
Alibaba Group: NEW opener with new entrepreneurial assignment
New dividend taxation information
New learning notes for computations
Updated PE and dividend yield ratios for Amazon and Altria
Chapter Outline
I. Corporate Form of OrganizationAn entity created by law that is
separate from its owners. Owners are called stockholders. A publicly
held corporation offers its stock for public sale (organized stock
market) whereas a privately held (closely held) corporation does not.
A. Characteristics of a CorporationAdvantages
1. Separate legal entitya corporation, through its agents
(officers and managers), may conduct business affairs with the
same rights, duties, and responsibilities of a person.
2. Limited liability of stockholdersstockholders are not liable
for corporate debt or corporate acts.
3. Transferable ownership rightstransfer of shares generally
has no effect on corporation operation.
4. Continuous lifelife is indefinite because it is not tied to
physical life of owners.
5. Lack of mutual agency for stockholdersstockholders do not
have the power to bind the corporation to contracts.
6. Ease of capital accumulationBuying stock is attractive to
investors and enables a corporation to accumulate large
amounts of capital.
B. Characteristics of a CorporationDisadvantages
1. Governmental regulation—must meet requirements of a state’s
incorporation laws.
2. Corporate taxationcorporate income is taxed; and when
income is distributed to shareholders as dividends, it is taxed a
second time as personal income (double taxation).
C. Corporate Organization and Management
1. IncorporationA corporation is created by obtaining a charter
from a state government. A charter application, signed by
prospective stockholders (incorporators or promoters) must
be filed with the state and fees must be paid.
2. Organization Expenses (organization costs)include legal
fees, promoters’ fees, and amounts paid to obtain a charter.
Expensed as incurred.
3. Management of a Corporation
a. Stockholders have ultimate control through vote to elect
board of directors.
b. Board of directors (BOD) has final managing authority,
but it usually limits its actions to setting broad policy.
Chapter Outline
c. Executive officers (appointed by the BOD) manage the
day-to-day direction of corporation. President is often the
chief executive officer (CEO) unless one person has the
dual role of chairperson of the BOD and CEO, then the
president is the chief operation officer (COO).
D. Stockholders of Corporations
1. Rights of StockholdersSpecific rights are granted by the
charter and general rights by state laws. State laws vary but
common stockholders general rights usually include right to:
a. Vote at stockholders’ meeting.
b. Sell or otherwise dispose of their stock.
c. Purchase their proportional shares of any common stock
later issued. (called preemptive right).
d. Receive the same dividend, if any, on each common share
of the corporation.
e. Share equally, on a per share basis, in any assets
remaining after creditors and preferred stockholders are
paid when and if in liquidation.
f. Receive timely financial reports.
2. Stock Certificates and Transfer
a. Stock certificate is sometimes received as proof of share
b. Certificates show the company name, stockholder name,
number of shares and other crucial information.
c. Issuances of stock certificates is becoming less common.
3. Registrar and Transfer Agentsif stock is traded on a major
exchange, the corporation must have both a registrar and
transfer agent (usually large banks or financial institutions).
a. Registrarkeeps stockholder records and prepares
official lists of stockholders for stockholders’ meetings
and dividend payments.
b. Transfer agentassists with purchases and sales of shares
by receiving and issuing certificates as necessary.
E. Basics of Capital Stockshares issued to obtain capital (owner
1. Authorized stockthe total amount of stock that the charter
authorizes for sale.
a. Outstanding stock refers to issued stock held by
b. Corporation must apply for a change in its charter if it
wishes to issue more shares than previously authorized.
2. Issuing stockcan be sold directly/indirectly to stockholders.
Chapter Outline
3. Market value of stockthe price at which a stock is bought
and sold.
a. Influenced by expected future earnings, dividends,
growth, and other company and economic events.
b. Current market value of previously issued shares does not
impact that corporation's stockholders' equity accounts.
4. Classes of stock
a. Commonthe name of stock when all classes have same
rights and privileges.
b. Preferred stockgives its owners a priority status over
common stockholders in one or more ways.
c. Additional classescorporation may issue more than one
class of common and/or preferred stock.
5. Par value stocka class of stock that is assigned a value per
share by the corporation in its charter.
a. Printed on the stock certificate.
b. In many states, used to establish minimum legal capital.
6. No-par value stocknot assigned a value per share by the
corporate charter.
7. Stated value stockno-par stock that is assigned a “stated”
value per share by the directors. This stated value becomes
legal capital.
8. Stockholders’ (Shareholders’) Equityhas two parts:
a. Paid-in capital (contributed capital)the total amount of
cash and other assets received by the corporation from its
stockholders in exchange for stock.
b. Retained earningsthe cumulative net income and losses
not distributed as dividends to stockholders..
II. Common StockIssuance of stock affects only paid-in capital
accounts, not retained earnings accounts.
A. Issuing Par Value Stock
1. At par for cashdebit Cash for # shares issued x market price
and credit Common Stock for # shares issued x par value
2. Issuing par value stock at a premium. (Premium on stock is an
amount paid in excess of par by the purchasers of newly
issued stock.)
a. Debit Cash (# shares issued x market price).
b. Credit Common Stock (# shares issued x par value).
c. Credit Paid-In Capital in Excess of Par Value, Common
Stock (for the amount of the premium).
Chapter Outline
3. Issuing par value stock at a discount Discount occurs when
a corporation sells its stock for less than its par value
(prohibited by most states).
a. Debit Cash (# shares issued x market price).
b. Credit Common Stock (# shares issued x par value).
c. Debit Discount on Common Stock, a contra to the
common stock account (for the amount of the discount).
d. When allowed, the purchasers usually become
contingently liable to the corporation’s creditors for the
amount of the discount.
B. Issuing No Par Value Stock
When no-par stock is not assigned a stated value, the entire
amount received becomes legal capital and is recorded as
Common Stock.
C. Issuing Stated Value Stock
Stated value becomes legal capital and is credited to a no-par stock
account. If stock is issued at an amount in excess of stated value,
this excess is credited to Paid-In Capital in Excess of Stated Value,
Common Stock.
D. Issuing Stock for Noncash Assets
1. Issuing par value stock for other assets
a. Record the transaction at the market value of the noncash
asset as of the date of the transaction.
b. Record par value or stated value of stock issued in stock
c. Record the amount that market value exceeds par value or
stated value of stock in the Paid-In Capital in Excess
2. Issuing par value stock for organizational costsstock is
issued in exchange for services (from promoters, lawyers,
accountants) in organizing the corporation
a. Record the transaction at the market value of the services
received debiting this amount to Organization Expense.
b. Record par or stated value of shares issued in stock
account and any value received above this in Paid-In
Capital in Excess account.
III. Dividends
A. Cash Dividendsdecision to pay these dividends rest with board
of directors and is based on evaluating the amounts of retained
earning and cash as well as many other factors.
1. Accounting for cash dividends involves three important dates.
a. Date of Declarationdate the directors vote to pay a
dividend (legal liability created).
Chapter Outline
b. Date of Recorddate specified for identifying
stockholders (owners on this date will receive dividend).
c. Date of Paymentdate corporation makes payment.
2. Cash Dividend Entriesreduce in equal amounts both cash
and the retained earnings component of stockholders' equity.
a. At declarationDebit Retained Earnings and credit
Dividends Payable.
b. At date of record no entry ndded
b. At paymentDebit Dividends Payable and credit Cash.
3. Deficit and Cash Dividendsa debit (abnormal) balance in
retained earnings is called a deficit
a. Arises when cumulative losses and/or dividends are
greater than total profits earned in prior years.
b. Deducted on the balance sheet.
c. In cases of deficit, some states allow a liquidating cash
dividend where paid-in capital accounts are debited
instead of retained earnings because this is returning part
of original investment back to investors.
B. Stock DividendsDistribution of additional shares of stock to
stockholders without receipt of any payment in return. They do not
reduce assets or total equity, just the components of equity.
1. Reasons for a stock dividend
a. To keep the market price of stock affordable.
b. To provide evidence of management's confidence that the
company is doing well.
2. Accounting for stock dividendstransfers a portion of equity
from retained earnings to contributed capital (called
capitalizing retained earnings)
a. Small stock dividend is 25% or less of the issuing
corporation's previously outstanding shares; the market
value of the shares to be distributed is capitalized.
b. Large stock dividend is more than 25% of the shares
outstanding before the dividend; only the legally required
minimum amount (par or stated value of shares) must be
c. Declaration entryDebit Retained Earnings (full
capitalized amount), credit Common Stock Dividend
Distributable (par value of dividend shares) and credit
Paid-in Capital in Excess of Par (any capitalization above
d. Payment entryDebit Common Stock Dividend
Distributable and credit Common Stock (to transfer par).
Chapter Outline
C. Stock Splits
The distribution of additional shares of stock to stockholders
according to their percent of ownership. Involves “calling in” the
outstanding shares of stock and replacing them with a larger
number of shares that have a lower par value.
1. Reason for stock splits is similar to those for stock dividends..
2. Only a memorandum entry is required.
3. Splits do not affect any equity account balances or any
individual stockholder’s percentage of ownership.
4. Reverse stock splits reduce number of shares and increase par
IV. Preferred StockHas special rights that give it priority over common
stock in one or more areas such as preference for receiving dividends
and for the distribution of assets if the corporation is liquidated.
Usually does not have right to vote.
A. Issuance of Preferred Stock
Usually has a par value; can be sold at a price different from par.
1. Separate contributed capital accounts are used to record
preferred stock.
2. Preferred Stock account is used to record the par value of
shares issued.
3. Paid-in in Excess of Par Value, Preferred Stock is used to
record any value received above the par value.
B. Dividend Preference of Preferred Stock
Preferred stockholders are allocated their dividends before any
dividends are allocated to common stockholders. The dividends
allocated per share is usually expressed as a set dollar amount per
share or a percent applied to the par value.
1. Cumulative or Noncumulative Dividend
a. Cumulative preferred stock has a right to be paid both
current and all prior periods' unpaid dividends before any
dividend is paid to common stockholders. These unpaid
dividends are referred to as dividends in arrears.
b. Most preferred stock carries a cumulative dividend right.
c. Noncumulative preferred stock confers no right to prior
periods' unpaid dividends if they were not declared.
d. Full-disclosure principle requires that the amount of
preferred dividends in arrears be reported as of the balance
sheet date, normally in a note to the financial statements.
Undeclared dividends are not a liability.
Chapter Outline
2. Participating or Nonparticipating Dividend
a. Nonparticipatingdividends are limited each year to a
maximum amount determined by applying the preferred
percentage to the par value. Any remaining declared
dividend amounts are received by common stockholders.
b. Participatinggives its owners the right to share in
dividends in excess of the stated percentage or amount
after common stockholders have received the same rate.
C. Convertible Preferred Stock
1. Gives holders the option of exchanging their preferred shares
into common shares at a specified rate.
2. Offers investors a higher potential return.
D. Callable Preferred Stock
1. Gives the issuing corporation the right to purchase (retire) this
stock from its holders at specified future prices and dates.
2. Amount paid to call and retire a preferred share is its call
price, or redemption value, and is set when stock is issued.
3. Dividends in arrears must be paid when stock is called.
E. Reasons for Issuing Preferred Stock
1. To raise capital without sacrificing control of the corporation.
2. To boost the return earned by common stockholders on
corporate assets. Called financial leverage or trading on
V. Treasury StockA corporation acquires their own shares for several
reasons such as to acquire another company, or to avoid a hostile
takeover, or to use for employee compensation, or to maintain a strong
market for their stock.
A. Purchasing Treasury StockCost Method
1. Reduces the corporation's assets and stockholders' equity by
equal amounts.
2. Debit Treasury Stock (contra-equity) and credit Cash for full
cost. (Reduces total assets and total equity).
3. The equity reduction is reported by subtracting Treasury Stock
account balance from the total of Paid-in Capital accounts and
Retained Earnings on the Balance Sheet.
4. Places a restriction on retained earnings.

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