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Intermediate Accounting Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield Chapter 15. Stockholders’ Equity Solution Manual
Typology: Exercises
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Topics Questions
Brief Exercises Exercises Problems
Concepts for Analysis
*12. Dividend preferences and book value.
*This material is covered in an Appendix to the chapter.
Learning Objectives Questions
Brief Exercises Exercises Problems
Concepts for Analysis
*5. Explain the different types of preferred stock dividends and their effect on book value per share.
ANSWERS TO QUESTIONS
1. The basic rights of each stockholder (unless otherwise restricted) are to share proportionately: (1) in profits, (2) in management (the right to vote for directors), (3) in corporate assets upon liquidation, and (4) in any new issues of stock of the same class (preemptive right).
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
2. The preemptive right protects existing shareholders from dilution of their ownership share in the event the corporation issues new shares.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
3. Preferred stock commonly has preference to dividends in the form of a fixed dividend rate and a preference over common stock to remaining corporate assets in the event of liquidation. Preferred stock usually does not give the holder the right to share in the management of the company. Common stock is the residual security possessing the greater risk of loss and the greater potential for gain; it is guaranteed neither dividends nor assets upon dissolution but it generally controls the management.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
4. The distinction between paid-in capital and retained earnings is important for both legal and economic points of view. Legally, dividends can be declared out of retained earnings in all states, but in many states dividends cannot be declared out of paid-in capital. Economically, management, stockholders, and others look to earnings for the continued existence and growth of the corporation.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
5. Authorized capital stock—the total number of shares authorized by the state of incorporation for issuance. Unissued capital stock—the total number of shares authorized but not issued. Issued capital stock—the total number of shares issued (distributed to stockholders). Outstanding capital stock—the total number of shares issued and still in the hands of stockhold- ers (issued less treasury stock). Treasury stock—shares of stock issued and repurchased by the issuing corporation but not retired.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
6. Par value is an arbitrary, fixed per share amount assigned to a stock by the incorporators. It is recognized by the state of incorporation as the amount that must be paid in for each share if the stock is to be fully paid when issued. If not fully paid, the shareholder has a contingent liability for the discount that results.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
7. The issuance for cash of no-par value common stock at a price in excess of the stated value of the common stock is accounted for as follows: (1) Cash is debited for the proceeds from the issuance of the common stock. (2) Common Stock is credited for the stated value of the common stock. (3) Paid-in Capital in Excess of Stated Value Common Stock is credited for the excess of the proceeds from the issuance of the common stock over its stated value.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 15 (Continued)
8. The proportional method is used to allocate the lump sum received on sales of two or more classes of securities when the fair value or other sound basis for determining relative value is available for each class of security. In instances where the fair value of all classes of securities is not determinable in a lump-sum sale, the incremental method must be used. The value of the securities is used for those classes that are known and the remainder is allocated to the class for which the value is not known.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
9. The general rule to be applied when stock is issued for services or property other than cash is that the property or services be recorded at either their fair value or the fair value of the stock issued, whichever is more clearly determinable. If neither is readily determinable, the value to be assigned is generally established by the board of directors.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
10. The direct costs of issuing stock, such as underwriting costs, accounting and legal fees, printing costs, and taxes, should be reported as a reduction of the amounts paid in. Issue costs are there- fore debited to Paid-in Capital in Excess of Par—Common Stock because they are unrelated to corporate operations.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
11. The character of preferred stock can be altered by being cumulative or noncumulative, partici- pating or nonparticipating, convertible or nonconvertible, callable or noncallable, or redeemable.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
12. Nonparticipating means the security holder is entitled to no more than the specified fixed dividend. If the security is partially participating, it means that in addition to the specified fixed dividend the security may participate with the common stock in dividends up to a certain stated rate or amount. A fully participating security shares pro rata with the common stock dividends declared without limitation. In this case, Dagwood Inc. has a fully participating preferred stock. Cumulative means dividends not paid in any year must be made up in a later year before any profits can be distributed to common stockholders. Any dividends not paid on cumulative preferred stock constitute a dividend in arrears. A dividend in arrears is not a liability until the board of directors declares a dividend.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
13. Preferred stock is generally reported at par value as the first item in the stockholders’ equity section of a company’s balance sheet. Any excess over par value is reported as part of additional paid-in capital.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
14. The major reasons for purchasing its own shares are: (1) to provide tax-efficient distributions of excess cash to shareholders, (2) to increase earnings per share and return on equity, (3) to provide stock for employee stock compensation contracts or to meet potential merger needs, (4) to thwart takeover attempts or to reduce the number of stockholders, and (5) to make a market in the stock.
LO: 1, 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 15 (Continued)
20. In declaring a dividend, the board of directors must consider the condition of the corporation such that a dividend is (1) legally permissible and (2) economically sound.
In general, directors should give consideration to the following factors in determining the legality of a dividend declaration: (1) Retained earnings, unless legally encumbered in some manner, is usually the correct basis for dividend distribution. (2) In some states, additional paid-in capital may be used for dividends, although such dividends may be limited to preferred stock. (3) Deficits in retained earnings and debits in paid-in capital accounts must be restored before payment of any dividends. (4) Dividends in some states may not reduce retained earnings below the cost of treasury stock held.
In order that dividends be economically sound, the board of directors should consider: (1) the availability (liquidity) of assets for distribution; (2) agreements with creditors; (3) the effect of a dividend on investor perceptions (e.g. maintaining an expected “payout ratio”); and (4) the size of the dividend with respect to the possibility of paying dividends in future bad years. In addition, the ability to expand or replace existing facilities should be considered.
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
21. Cash dividends are paid out of cash. A balance must exist in retained earnings to permit a legal distribution of profits, but having a balance in retained earnings does not ensure the ability to pay a dividend if the cash situation does not permit it.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
22. A cash dividend is a distribution in cash while a property dividend is a distribution in assets other than cash. Any dividend not based on retained earnings is a liquidating dividend. A stock dividend is the issuance of additional shares of the corporation’s stock in a nonreciprocal exchange involving existing stockholders with no change in the par or stated value.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
23. A stock dividend results in the transfer from retained earnings to paid-in capital of an amount equal to the fair value of each share (if the dividend is less than 20–25%) or the par value of each share (if the dividend is greater than 20–25%). No formal journal entries are required for a stock split, but a notation in the ledger accounts would be appropriate to show that the par value of the shares has changed.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
24. (a) A stock split effected in the form of a dividend is a distribution of corporate stock to present stockholders in proportion to each stockholder’s current holdings and can be expected to cause a material decrease in the market price per share of the stock. GAAP specifies that a distribution in excess of 20% to 25% of the number of shares previously outstanding would cause a material decrease in the market price. This is a characteristic of a stock split as opposed to a stock dividend, but, for legal reasons, the term “dividend” must be used for this distribution. From an accounting viewpoint, it should be disclosed as a stock split effected in the form of a dividend because it meets the accounting definition of a stock split as explained above.
Questions Chapter 15 (Continued)
(b) The stock split effected in the form of a dividend differs from an ordinary stock dividend in the amount of other paid-in capital or retained earnings to be capitalized. An ordinary stock dividend involves capitalizing (charging) retained earnings for an amount equal to the fair value of the stock distributed. A stock split effected in the form of a dividend involves charging retained earnings for the par (stated) value of the additional shares issued.
Another distinction between a stock dividend and a stock split is that a stock dividend usually involves distributing additional shares of the same class of stock with the same par or stated value. A stock split usually involves distributing additional shares of the same class of stock but with a proportionate reduction in par or stated value. The aggregate par or stated value would then be the same before and after the stock split.
(c) A declared but unissued stock dividend should be classified as part of paid-in capital rather than as a liability in a balance sheet. A stock dividend affects only capital accounts; that is, retained earnings is decreased and paid-in capital is increased. Thus, there is no debt to be paid, and, consequently, there is no severance of corporate assets when a stock dividend is issued. Furthermore, stock dividends declared can be revoked by a corporation’s board of directors any time prior to issuance. Finally, the corporation usually will formally announce its intent to issue a specific number of additional shares, and these shares must be reserved for this purpose.
LO: 3, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
25. A partially liquidating dividend will be debited both to Retained Earnings and Paid-in Capital in Excess of Par. The portion of dividends that is a return of capital should be debited to Paid-in Capital in Excess of Par.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
26. A property dividend is a nonreciprocal transfer of nonmonetary assets between company and its owners. A transfer of a nonmonetary asset to a stockholder or to another entity in a non- reciprocal transfer should be recorded at the fair value of the asset transferred, and a gain or loss should be recognized on the disposition of the asset.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
27. Retained earnings are restricted because of legal or contractual restrictions, or the necessity to protect the working capital position.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
28. Restrictions of retained earnings are best disclosed in a note to the financial statements. This allows a more complete explanation of the restriction.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
SOLUTIONS TO BRIEF EXERCISES
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
SOLUTIONS TO EXERCISES
LO: 1, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication