14.5

Question 1

Garland Corporation, a public company, has declared a property dividend of one share of its investment in Marlowe, Inc., for every 10 shares of its common stock outstanding. The Marlowe shares were originally purchased by Garland for $50 per share; on the date the dividend was declared, the market value was $75 per share. As a result of this declaration, Garland should recognize

Answer 1

A gain of $25 per share to be distributed.

When a property dividend is declared, the property is remeasured at its fair value as of the declaration date ($75 – $50 = $25).

Question 2

An entity issued rights to its existing shareholders without consideration. The rights allowed the recipients to purchase unissued common stock for an amount in excess of par value. When the rights are issued, which of the following accounts will be increased?

Common Stock:
Additional Paid-in Capital:

Answer 2

No
No

When rights are issued without consideration, only a memorandum entry is made. Common stock and additional paid-in capital are affected only if the rights are exercised.

Question 3

On December 1, Year 4, Line Corp. received a contribution of 2,000 shares of its $5 par value common stock from a shareholder. On that date, the stock’s fair value was $35 per share. The stock was originally issued for $25 per share. By what amount will this contribution cause total equity to decrease if Line accounts for treasury stock using the cost method?

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Answer 3

$0

Contributions received ordinarily are recorded as revenues or gains when received. However, adjustments or charges or credits resulting from transactions in the entity’s own stock are excluded from net income or the results of operations. Thus, the receipt of a contribution of a company’s own stock is recorded at fair value as increases in both contributed capital and treasury stock. Because these accounts offset, the net effect on equity is $0.

Question 4

A property dividend should be recorded in retained earnings at the property’s

Answer 4

Fair value at date of declaration.

When a property dividend is declared, the property to be distributed should be restated at fair value. Any gain or loss should be recognized. The declared dividend is then recorded as a debit to retained earnings and a credit to property dividends payable.

Question 5

Ten thousand shares of $10 par value common stock were issued initially at $15 per share. Subsequently, 1,000 of these shares were purchased as treasury stock at $13 per share. The cost method of accounting for treasury stock is used. What is the effect of the purchase of the treasury stock on the amount reported in the balance sheet on each of the following?

Additional Paid-in Capital:
Total Equity:

Answer 5

No effect
Decrease

Under the cost method, the acquisition of treasury stock is recorded as a debit to treasury stock and a credit to cash equal to the amount of the purchase price. This transaction results in a decrease in both total assets and total equity. Additional paid-in capital is unaffected by the treasury stock purchase.

Question 6

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?

Answer 6

$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.

Question 7

Band Co. uses the equity method to account for its investment in Guard, Inc., common stock. How should Band record a 2% stock dividend received from Guard?

Answer 7

As a memorandum entry reducing the unit cost of all Guard stock owned.

No entries are made to record the receipt of stock dividends. However, a memorandum entry should be made in the investment account to record additional shares owned. This treatment applies whether the investment is accounted for by the fair-value method or the equity method.

Question 8

The par-value method of accounting for treasury stock differs from the cost method because

Answer 8

It reverses the original entry to issue the common stock, with any difference between carrying amount and purchase price adjusted through paid-in capital or retained earnings. It treats a subsequent reissuance as a new issuance of common stock.

The par-value method treats the acquisition of treasury stock as a constructive retirement and the resale as a new issuance. Upon acquisition, the entry originally made to issue stock is reversed by offsetting the common stock account with treasury stock at par value and removing the paid-in capital recorded when the stock was originally issued. Any difference between the original issuance price and the reacquisition price is ordinarily adjusted through paid-in capital accounts and retained earnings. The subsequent reissuance removes the treasury stock at par value and reestablishes paid-in capital in excess of par for any excess of par value over the reissuance price. By contrast, the cost method does not treat the acquisition and reissuance of treasury stock as a constructive retirement and new issuance.

Question 9

Sanders Company effects self-insurance against loss from fire by appropriating an amount of retained earnings each year equal to the amount that would otherwise be paid out as fire insurance premiums. According to current accounting literature, the procedure used by Sanders is

Answer 9

Acceptable provided that fire losses are not charged against the appropriation.

An expense is not accrued prior to the occurrence of the event for which an entity self-insures. The fair value of the property diminishes only if the event actually occurs. But an appropriation of retained earnings is acceptable to disclose the self-insurance policy if, when a fire loss occurs, the entry appropriating retained earnings is reversed, and the loss is debited to income of the period of loss and not to retained earnings.

Question 10

How would a stock split affect the par value of the stock and the company’s shareholders’ equity?

Par Value:
Stockholder’s Equity:

Answer 10

Decrease
No change

A stock split reduces the par value of the stock and increases the number of shares outstanding, making it more attractive to investors. As with a stock dividend, each shareholder’s proportionate interest in the company and total book value remain unchanged.

Question 11

On January 15, Year 5, Rico Co. declared its annual cash dividend on common stock for the year ended January 31, Year 5. The dividend was paid on February 9, Year 5, to shareholders of record as of January 28, Year 5. On what date should Rico decrease retained earnings by the amount of the dividend?

Answer 11

January 15, Year 5.

On the date of declaration, a cash dividend becomes a legal liability of the corporation (unlike stock dividends, cash dividends cannot be rescinded). Thus, on January 15, a portion of retained earnings was reclassified as dividends payable.

Question 12

In September Year 1, Cal Corp. made a dividend distribution of one right for each of its 240,000 shares of outstanding common stock. Each right was exercisable for the purchase of 1/100 of a share of Cal’s $50 variable rate preferred stock at an exercise price of $80 per share. On March 20, Year 8, none of the rights had been exercised, and Cal redeemed them by paying each shareholder $0.10 per right. As a result of this redemption, Cal’s equity was reduced by

Answer 12

$24,000

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 the amount of their cost (240,000 × $.10 = $24,000).

Question 13

Earl was engaged by Farm Corp. to perform consulting services. Earl’s compensation for these services consisted of 1,000 shares of Farm’s $10 par value common stock, to be issued to Earl on completion of Earl’s services. On the execution date of Earl’s employment contract, Farm’s stock had a market value of $40 per share. Six months later, when Earl’s services were completed and the stock issued, the stock’s market value was $50 per share. Farm’s management estimated that Earl’s services were worth $100,000 in cost savings to the company. As a result of this transaction, additional paid-in capital should increase by

Answer 13

$30,000

When stock is issued in exchange for property or services, the transaction should be recorded at the fair value of the stock or of the property or services received, whichever is more clearly determinable. In this case, the value of the stock should be used to measure this transaction because it is more clearly determinable given market prices than the value of the services. The market price used to measure the transaction is that in effect at the date of the agreement. Accordingly, Farm debits consulting expense for $40,000 (1,000 shares × $40 market price), credits common stock for $10,000 (1,000 shares × $10 par value), and credits additional paid-in capital for the difference ($40,000 – $10,000 = $30,000).

Question 14

When an entity declares a cash dividend, retained earnings is decreased by the amount of the dividend on the date of

Answer 14

Declaration

Retained earnings is debited and dividends payable is credited on the date of declaration.

Question 15

Bertram Company had a balance of $100,000 in retained earnings at the beginning of the year and of $125,000 at the end of the year. Net income for this time period was $40,000. Bertram’s statement of financial position indicated that the dividends payable account had decreased by $5,000 throughout the year, despite the fact that both cash dividends and a stock dividend were declared. The amount of the stock dividend was $8,000. When preparing its statement of cash flows for the year, Bertram should show cash paid for dividends as

Answer 15

$12,000

The amount of total dividends declared during the year can be calculated as follows:
Beginning retained earnings: $100,000
Net income for the year: 40,000
Ending retained earnings: (125,000)
Dividends declared during the year: $15,000

Since $8,000 is the amount of stock dividends declared, the amount of cash dividends declared this year is $7,000 ($15,000 – $8,000). The amount of cash dividends paid during the year can be calculated as follows:
Decrease in the cash dividends payable account during the period: $5,000
Cash dividends declared during the year: 7,000
Cash paid for dividends during the year: $12,000

NOTE: Stock dividends declared does not affect the dividends payable account.

Question 16

Lem Co., which accounts for treasury stock under the par-value method, acquired 100 shares of its $6 par value common stock for $10 per share. The shares had originally been issued by Lem for $7 per share. By what amount would Lem’s additional paid-in capital from common stock decrease as a result of the acquisition?

Answer 16

$100

The entry for issuance of the stock was
Cash $700
Common stock ($6 per share) $600
Additional paid-in capital 100

The par-value method treats a treasury stock purchase as a constructive retirement. Assuming no balance in paid-in capital from treasury stock transactions, the entry for the treasury stock purchase using the par-value method is

Treasury stock $600
Additional paid-in capital 100
Retained earnings 300
Cash $1,000

Question 17

Cyan Corp. issued 20,000 shares of $5 par common stock at $10 per share. On December 31, Year 3, Cyan’s retained earnings were $300,000. In March Year 4, Cyan reacquired 5,000 shares of its common stock at $20 per share. In June Year 4, Cyan sold 1,000 of these shares to its corporate officers for $25 per share. Cyan uses the cost method to record treasury stock. Net income for the year ended December 31, Year 4 was $60,000. At December 31, Year 4, what amount should Cyan report as retained earnings?

Answer 17

$360,000

Under the cost method, the treasury stock account should be debited for the purchase price. When this stock is subsequently reissued for an amount greater than the acquisition cost, the excess should be credited to additional paid-in capital, not the retained earnings account. Thus, retained earnings is $360,000 ($300,000 + $60,000).

Question 18

Beck Corp. issued 200,000 shares of common stock when it began operations in Year 1 and issued an additional 100,000 shares in Year 2. Beck also issued preferred stock convertible to 100,000 shares of common stock. In Year 3, Beck purchased 75,000 shares of its common stock and held it in treasury. At the end of Year 3, how many shares of Beck’s common stock were outstanding?

Answer 18

225,000

Beck issued 200,000 shares of common stock in Year 1 and 100,000 shares in Year 2. The purchase of 75,000 shares of treasury stock decreased the number of shares of common stock outstanding in Year 3 to 225,000 (200,000 + 100,000 – 75,000). The convertible preferred stock is not considered common stock.

Question 19

Anand Co. reported the following in its statement of equity on January 1:

Common stock, $5 par value, authorized
400,000 shares, issued 300,000 shares: $1,500,000
Additional paid-in capital: 1,000,000
Retained earnings: 516,000
Total:$3,016,000
Minus treasury stock, at cost, 6,000 shares: 50,000
Total equity: $2,966,000

The following events occurred during the year:
May 1 - 2,000 shares of treasury stock were sold for: $10,000.
July 9 - 8,000 shares of previously unissued common stock sold for $12 per share.
October 1 - A 3-for-1 stock split took effect

Anand accounts for treasury stock under the cost method. Laws in the state of Anand’s incorporation protect shares held in treasury from dilution when stock dividends or stock splits are declared. The number of issued common shares at December 31 should be

Answer 19

924,000

On January 1, 300,000 shares were issued. The issuance of previously unissued shares increased that amount to 308,000 shares (300,000 + 8,000). The stock split tripled the shares issued to 924,000 (308,000 × 3).

Question 20

On July 1, Year 4, Cove Corp., a closely held corporation, issued 6% bonds with a maturity value of $60,000 together with 1,000 shares of its $5 par value common stock for a combined cash amount of $110,000. The market value of Cove’s stock cannot be ascertained. If the bonds were issued separately, they would have sold for $40,000 on an 8% yield to maturity basis. What amount should Cove record for additional paid-in capital on the issuance of the stock?

Answer 20

$65,000

The proceeds of the combined issuance of different classes of securities should be allocated based on the relative fair values of the securities. Since the fair value of the stock is not known, the bonds should be recorded at their fair value ($40,000), with the remainder of the proceeds ($110,000 – $40,000 = $70,000) credited to common stock at par value (1,000 shares × $5 = $5,000) and additional paid-in capital ($70,000 – $5,000 par = $65,000).