14.1 Flashcards
At its date of incorporation, Glean, Inc., issued 100,000 shares of its $10 par common stock at $11 per share. During the current year, Glean acquired 30,000 shares of its common stock at a price of $16 per share and accounted for them by the cost method. Subsequently, these shares were reissued at a price of $12 per share. Glean had made no other issuances or acquisitions of its own common stock. What effect does the reissuance of the stock have on the following accounts?
Retained earnings:
Additional paid-in capital:
Decrease
No effect
When shares are issued for an amount greater than their par value, the difference is credited to additional paid-in capital. Under the cost method, the treasury stock account should be debited for the price of reacquired shares. If the treasury stock is reissued for an amount less than its acquisition cost, the difference between the acquisition cost and the reissuance price should be debited to additional paid-in capital from treasury stock transactions to the extent it has a credit balance from previous transactions. However, Glean has not previously reissued treasury stock. Thus, it has a zero balance in this account. Thus, Glean must debit cash for $360,000 (30,000 shares × $12 reissuance price per share), debit retained earnings for $120,000 [30,000 shares × ($16 cost per share – $12)], and credit treasury stock for $480,000 (30,000 shares × $16 cost per share).
Effective April 27, the shareholders of Dorr Corp. approved a 2-for-1 split of its common stock and an increase in authorized common shares from 100,000 shares (par value $20 per share) to 200,000 shares (par value $10 per share). Dorr’s equity accounts immediately before issuance of the stock-split shares were as follows:
Common stock, par value $20; 100,000 shares authorized; 50,000 shares outstanding: $1,000,000
Additional paid-in capital ($3 per share on issuance of common stock): 150,000
Retained earnings: 1,350,000
The stock-split shares were issued on June 30. In Dorr’s June 30 statement of equity, the balances of additional paid-in capital and retained earnings are
Additional paid-in capital:
Retained earnings:
$150,000
$1,350,000
A 2-for-1 stock split is a nonreciprocal transfer of an entity’s own shares to its common shareholders for the purpose of reducing the unit market price of the shares. The goal is to increase their marketability and broaden their distribution. The transaction described will increase the number of shares outstanding to 100,000 (50,000 shares × 2). The par value will be reduced to $10 ($20 ÷ 2), but the capital accounts will be unaffected. To effect a stock split, no formal entry is necessary because no capitalization of retained earnings occurs. Thus, additional paid-in capital ($150,000) and retained earnings ($1,350,000) will not change.
On May 18, Sol Corp.’s board of directors declared a 10% stock dividend. The market price of Sol’s 3,000 outstanding shares of $2 par value common stock was $9 per share on that date. The stock dividend was distributed on July 21, when the stock’s market price was $10 per share. What amount should Sol credit to additional paid-in capital for this stock dividend?
$2,100
A stock dividend in which the number of shares issued is fewer than 20 to 25% of those outstanding should be accounted for by debiting retained earnings for the fair value of the stock and crediting a capital stock account for the par value. Any excess of fair value over the par value is credited to an additional paid-in capital account. Sol thus records the dividend with the following entry:
Retained earnings [(3,000 shares × 10%) × $9] $2,700
Common stock dividend distributable [(3,000 shares ×10%) ×$2] $600
Additional paid-in capital – common (difference) 2,100
The following accounts were among those reported on Luna Corp.’s year-end balance sheet:
Securities (market value $140,000): $80,000
Preferred stock, $20 par value 20,000 shares issued and outstanding: 400,000
Additional paid-in capital on preferred stock: 30,000
Retained earnings: 900,000
On January 20, Luna exchanged all of the securities for 5,000 shares of Luna’s preferred stock, which were not mandatorily redeemable. Market values at the date of the exchange were $150,000 for the securities and $30 per share for the preferred stock. The 5,000 shares were retired immediately. Which of the following journal entries should Luna record in connection with this transaction?
Preferred stock $100,000
Additional paid-in capital 7,500
Retained earnings 42,500
Securities $80,000
Gain 70,000
The reacquisition and retirement of the preferred stock result in debits to preferred stock at par (5,000 shares × $20 = $100,000) and additional paid-in capital [(5,000 ÷ 20,000 shares) × $30,000 = $7,500]. The transfer of the nonmonetary asset to a shareholder should be recorded at the fair value of the asset transferred, and a gain should be recognized (credit securities at their $80,000 carrying amount and credit a gain for the $70,000 excess of fair value over the carrying amount). The balancing debit is to retained earnings for $42,500.
Ray Corp. declared a 5% stock dividend on its 10,000 issued and outstanding shares of $2 par value common stock, which had a fair value of $5 per share before the stock dividend was declared. This stock dividend was distributed 60 days after the declaration date. By what amount did Ray’s current liabilities increase as a result of the stock dividend declaration?
$0
Declaration of a stock dividend is not accounted for as a liability but as a reclassification of equity. For a stock dividend that is smaller than 20 to 25% of the shares outstanding, the entry is to debit retained earnings for the fair value of the stock (10,000 shares × $5 fair value × 5% = $2,500), credit stock dividend distributable at par (10,000 shares × $2 × 5% = $1,000), and credit additional paid-in capital for the excess of fair over par value ($2,500 – $1,000 = $1,500).
The following information pertains to Meg Corp.:
- Dividends on its 1,000 shares of 6%, $10 par value cumulative preferred stock have not been declared or paid for 3 years.
- Treasury stock that cost $15,000 was reissued for $8,000.
What amount of retained earnings should be appropriated as a result of these items?
$0
An appropriation is a discretionary reclassification of retained earnings. Its purpose is to restrict the amount of retained earnings available for dividends. Undeclared cumulative preferred dividends are not recognized in the accounts. The loss on the sale of treasury stock is charged to additional paid-in capital from treasury stock transactions to the extent it has a credit balance, or to retained earnings. Hence, these transactions do not result in appropriated retained earnings. However, state law may have required an appropriation of the cost of the treasury stock.
Munn Corp.’s records included the following equity accounts:
Preferred stock, par value $15, authorized 20,000 shares: $255,000
Additional paid-in capital, preferred stock: 15,000
Common stock, no par, $5 stated value, 100,000 shares authorized: 300,000
In Munn’s statement of equity, the number of issued and outstanding shares for each class of stock is
Common Stock:
Preferred Stock:
60,000
17,000
If an entity does not hold any stock as treasury stock, the number of shares of each type of stock may be determined by dividing the amount allocated to each stock account by the related par value. The number of shares of preferred stock issued and outstanding is therefore 17,000 ($255,000 ÷ $15 par value), and the number of shares of common stock issued and outstanding is 60,000 ($300,000 ÷ $5 stated value).
An entity declared a cash dividend on its common stock on December 15, Year 1, payable on January 12, Year 2. How would this dividend affect equity on the following dates?
December 15, Year 1:
December 31, Year 1:
January 12, Year 2:
Decrease
No effect
No effect
When cash dividends are declared, a liability to the shareholders is created because the dividends must be paid once they are declared. At the declaration date, retained earnings must be debited, resulting in a decrease in retained earnings. The effect is to decrease total equity (assets – liabilities) because liabilities are increased with no corresponding increase in assets. At the balance sheet date, no entry is made, and there is no effect on equity. When the cash dividends are subsequently paid, dividends payable is debited and cash is credited. Thus, at the payment date, equity is also not affected.
On December 1, Year 4, Nilo Corp. declared a property dividend to be distributed on December 31, Year 4, to shareholders of record on December 15, Year 4. On December 1, Year 4, the property to be transferred had a carrying amount of $60,000 and a fair value of $78,000. What is the effect of this property dividend on Nilo’s Year 4 retained earnings, after all nominal accounts are closed?
$60,000 decrease.
When a corporation declares a dividend consisting of tangible property, the property is first remeasured to fair value as of the date of declaration. The dividend should then be debited to retained earnings and credited to a dividend payable. The distribution is recognized by a debit to property dividend payable and a credit to the property. The net effect of recognition of the gain and the declaration of the dividend is a $60,000 decrease in retained earnings ($78,000 fair value of the property dividend – $18,000 gain).
Murphy Co. had 200,000 shares outstanding of $10 par common stock on March 30 of the current year. Murphy reacquired 30,000 of those shares at a cost of $15 per share and recorded the transaction using the cost method on April 15. Murphy reissued the 30,000 shares at $20 per share and recognized a $50,000 gain on its income statement on May 20. Which of the following statements is correct?
Murphy’s net income for the current year is overstated.
The cost method debits cash and credits treasury stock and paid-in capital from treasury stock transactions when a reissuance of shares is made for an amount in excess of cost. The credit to treasury stock is $450,000 (30,000 shares × $15), and the credit to paid-in capital from treasury stock transactions is $150,000 [$600,000 cash (debit) – $450,000 treasury stock (credit)]. The reason for the latter credit (an equity account) instead of a gain is that the effects of transactions in the entity’s own stock are always excluded from net income or the results of operations. Thus, recognizing a gain on the reissuance of treasury stock overstates current net income.
Treasury stock was acquired for cash at a price in excess of its par value. The treasury stock was subsequently reissued for cash at a price in excess of its acquisition price. Assuming that the cost method of accounting for treasury stock transactions is used, what is the effect of the subsequent reissuance of the treasury stock on each of the following?
Additional paid-in capital:
Retained earnings:
Total equity:
Increase
No effect
Increase
When the cost method of accounting for treasury stock transactions is used, the acquisition of treasury stock is recorded as a debit to a treasury stock account and a credit to cash. Retained earnings is unaffected. When the treasury stock is subsequently reissued for cash at a price in excess of its acquisition cost, the difference between the cash received and the carrying value (acquisition cost) of the treasury stock is credited to additional paid-in capital. Again, retained earnings is unaffected. Thus, the transactions increase additional paid-in capital and total equity but have no effect on retained earnings.
Cross Corp. had 2,000 outstanding shares of 11% preferred stock, $50 par. These shares were not mandatorily redeemable. On August 8, Cross redeemed and retired 25% of these shares for $22,500. On that date, Cross’s additional paid-in capital from preferred stock totaled $30,000. To record this transaction, Cross should debit (credit) its capital accounts as follows:
Preferred stock:
Additional paid-in capital:
Retained earnings:
$25,000
$(2,500)
$0
Under the cost method, the entry to record a treasury stock purchase is to debit treasury stock at cost ($22,500) and credit cash. The entry to retire this stock is to debit preferred stock at par [(2,000 shares × 25%) × $50 = $25,000], debit additional paid-in capital from the original issuance ($30,000 × 25% = $7,500), credit treasury stock at cost ($22,500), and credit additional paid-in capital from stock retirement ($10,000). Thus, the net effect on additional paid-in capital is a $2,500 credit ($10,000 credit – $7,500 debit). No entry to retained earnings is necessary.
Bal Corp. declared a $25,000 cash dividend on May 8 to shareholders of record on May 23, payable on June 3. As a result of this cash dividend, working capital
Decreased on May 8
On May 8, the date of declaration, retained earnings is debited, and dividends payable is credited. The declaration decreases working capital because a current liability is increased. On May 23, the date of record, no entry is made, and there is no effect on working capital. On June 3, when payment is made, both a current liability (dividends payable) and a current asset (cash) are decreased, which has no net effect on working capital. Thus, the only net effect to working capital took place on May 8.
On November 2, Year 3, Finsbury, Inc., issued warrants to its shareholders giving them the right to purchase additional $20 par value common shares at a price of $30. The shareholders exercised all rights on March 1, Year 4. The shares had market prices of $33, $35, and $40 on November 2, Year 3, December 31, Year 3, and March 1, Year 4, respectively. What were the effects of the warrants on Finsbury’s additional paid-in capital and net income?
Additional paid-in capital:
Net Income
Increased in Year 4
No effect
When stock rights are issued for no consideration, only a memorandum entry is made. Common stock and additional paid-in capital are not affected. However, when rights are exercised and stock is issued, the issuing company will reflect the proceeds as an increase in common stock and additional paid-in capital. Consequently, Finsbury will increase additional paid-in capital in Year 4 when stock is issued, and net income will not be affected.
In September Year 1, West Corp. made a dividend distribution of one right for each of its 120,000 shares of outstanding common stock. Each right was exercisable for the purchase of 1/100 of a share of West’s $50 variable rate preferred stock at an exercise price of $80 per share. On March 20, Year 5, none of the rights had been exercised, and West redeemed them by paying each shareholder $0.10 per right. As a result of this redemption, West’s equity was reduced by
$12,000
When rights are issued for no consideration, only a memorandum entry is made. Consequently, neither common stock nor additional paid-in capital is affected by the issuance of rights in a nonreciprocal transfer. The redemption of the rights reduces equity by their $12,000 cost (120,000 × $0.10).
