Chapter 10
Stockholders’ Equity
REVIEW QUESTIONS
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 funds on a
promising business venture. Venture capital firms provide additional financing, often in the millions,
for a percentage ownership in the company. Many venture capital firms look to invest in promising
companies to which they can add value through business contacts, financial expertise, or marketing
channels. Most corporations do not consider issuing stock to the general public (going public) until
their equity financing needs exceed $20 million dollars.
Question 10-2 (LO 10-1)
The stock of a publicly held corporation trades on the New York Stock Exchange (NYSE),
Question 10-3 (LO 10-1)
Question 10-4 (LO 10-1)
Question 10-5 (LO 10-1)
A corporation offers two primary advantages over sole proprietorships and partnerships. These
are (1) limited liability and (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 than the
amount they invested in the company. Because corporations sell ownership interest in the form of
Question 10-6 (LO 10-1)
Question 10-7 (LO 10-2)
Authorized stock is the total number of shares available to sell, stated in the company’s articles
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
Question 10-10 (LO 10-3)
Question 10-11 (LO 10-3)
Investors in common stock are the owners of the corporation. Investors in bonds are creditors
Question 10-12 (LO 10-4)
A company may buy back its own stock to boost under-priced stock. When a company’s
Question 10-13 (LO 10-4)
When a corporation repurchases its own stock, it increases, or debits treasury stock reported in
Question 10-14 (LO 10-5)
Some companies are unprofitable and therefore unable to pay cash dividends. However, many
Question 10-15 (LO 10-5)
Question 10-16 (LO 10-6)
Question 10-17 (LO 10-6)
Question 10-18 (LO 10-6)
Question 10-19 (LO 10-7)
Question 10-20 (LO 10-7)
Question 10-21 (LO 10-7)
Total stockholders’ equity is equal to assets minus liabilities. An asset usually equals its market
Question 10-22 (LO 10-8)
Earnings per share is not comparable between companies because companies do not have 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
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. In
contrast, owners in a sole proprietorship or a partnership can be held personally
DISADVANTAGES OF A CORPORATION
• Additional Taxes-- Owners of sole-proprietorships and partnerships are taxed
once, when they include their share of earnings in their personal income tax
returns. However, corporations have double taxation.
• More Paperwork-- To protect the rights of those who buy a corporation’s stock
or who loan money to a corporation, the state and federal governments impose
extensive reporting requirements on the company.
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 benefits, many companies that
Brief Exercise 10-3 (LO 10-2)
Cash (3,000 shares x $11)
33,000
Brief Exercise 10-4 (LO 10-2)
Cash (1,000 shares x $30)
30,000
Brief Exercise 10-5 (LO 10-3)
Cash (1,000 shares x $32)
32,000
Brief Exercise 10-6 (LO 10-3)
Preferred Stock Features
Description
__c___ 1. Convertible
a. Prior unpaid dividends receive
priority.
Brief Exercise 10-7 (LO 10-3)
Preferred dividends in arrears for 2016 and 2017 ($7,000 x 2 years)
$14,000
Brief Exercise 10-8 (LO 10-4)
Brief Exercise 10-9 (LO 10-4)
Cash (100 shares x $40)
4,000
Brief Exercise 10-10 (LO 10-5)
October 1
October 15
No Entry
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 after a stock split.
• Market price per share: $35.00 ÷ 2 = $17.50
Brief Exercise 10-13 (LO 10-7)
Transaction
Total
Assets
Total Liabilities
Total
Stockholders’
Equity
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
Brief Exercise 10-15 (LO 10-8)
($ in millions)
Net
Income
÷
Average
Stockholders’
Equity
=
Return on
Equity
EXERCISES
Exercise 10-1 (LO 10-1)
Terms
__f___ 1. Publicly held corporation.
__d___ 2. Organization chart.
Definitions
a. Shareholders can lose no more than the amount they invested in the company.
b. Corporate earnings are taxed twice - at the corporate level and individual
shareholder level.
Exercise 10-2 (LO 10-2, 10-3, 10-4)
Authorized stock is the number of shares the company is authorized to sell, stated in
the company’s articles of incorporation.
Issued stock is the number of shares that have been sold to investors.
Exercise 10-3 (LO 10-2)
Requirement 1
January 1
Cash (700 shares x $50)
35,000
Common Stock
35,000
Requirement 2
January 1
Cash (700 shares x $50)
35,000
Common Stock (700 shares x $1.00)
700
Exercise 10-4 (LO 10-3)
Requirement 1
Preferred dividends in arrears for 2017
$10,000
Requirement 2
Preferred dividends in arrears for 2017
$ 0
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
Exercise 10-6 (LO 10-2, 10-3, 10-4)
January 2, 2018
Debit
Credit
Cash (100,000 x $35)
3,500,000
Common Stock (100,000 x $1)
100,000
February 6, 2018
Cash (3,000 x $11)
33,000
Preferred Stock (3,000 x $10)
30,000
September 10, 2018
Treasury Stock (11,000 shares x $40)
440,000
December 15, 2018
Cash (5,500 shares x $45)
247,500
Exercise 10-7 (LO 10-7)
Finishing Touches
Balance Sheet
(Stockholders’ Equity Section)
December 31, 2018
Stockholders’ equity:
Preferred stock, $10 par value
$ 30,000
Common stock, $1.00 par value
100,000
Exercise 10-8 (LO 10-5)
March 15
Debit
Credit
Dividends (210 million shares x $0.125)
26,250,000
March 30
No Entry
April 13
Exercise 10-9 (LO 10-2, 10-4, 10-5)
March 1, 2018
Debit
Credit
Cash (65,000 x $62)
4,030,000
Common Stock (65,000 x $1)
65,000
Exercise 10-10 (LO 10-6)
Requirement 1
September 1
Stock Dividends (10,000 x 10% x $30)
30,000
Requirement 2
September 1
Requirement 3
• No entry is recorded for a 2-for-1 stock split, because the balance in all of the
Exercise 10-11 (LO 10-7)
Power Drive Corporation
Balance Sheet
(Stockholders’ Equity Section)
December 31, 2018
Stockholders’ equity:
Common stock, $1.00 par value
$ 165,000
Additional paid-in capital
9,480,000
Exercise 10-12 (LO 10-7)
Power Drive Corporation
Statement of Stockholders’ Equity
For the Year Ended December 31, 2018
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Treasury
Stock
Total
Stockholders’
Equity
Balance, January 1
$100,000
5,500,000
3,000,000
-0-
$ 8,600,000
Exercise 10-13 (LO 10-7)
Transaction
Total
Assets
Total
Liabilities
Total
Stockholders’
Equity
Issue common stock
+
NE
+
Exercise 10-14 (LO 10-7)
United Apparel
Balance Sheet
(Stockholders’ Equity Section)
December 31, 2018
Stockholders’ equity:
Preferred stock
$ 3,600,000
Common stock
600,000
