14.6

Question 1

Pugh Co. reported the following in its statement of equity on January 1:
Common stock, $5 par value, authorized 200,000 shares, issued 100,000 shares: $500,000
Additional paid-in capital: 1,500,000
Retained earnings: 516,000
Contributed capital and retained earnings: $2,516,000
Minus treasury stock at cost (5,000 shares): 40,000
Total equity: $2,476,000
The following events occurred during the year:
May 1 - 1,000 shares of treasury stock were sold for: $10,000.
July 9 - 10,000 shares of previously unissued common stock sold for $12 per share.
October 1 - The distribution of a 2-for-1 stock split resulted in the common stock’s per-share par value being halved.
Pugh accounts for treasury stock under the cost method. Laws in the state of Pugh’s incorporation protect shares held in treasury from dilution when stock dividends or stock splits are declared.

The number of outstanding common shares at December 31 should be

Answer 1

$212,000

On January 1, 95,000 shares (100,000 issued – 5,000 treasury shares) were outstanding. The treasury stock sale and the issuance of previously unissued shares increased that amount to 106,000 shares (95,000 + 1,000 + 10,000). The stock split doubled the shares outstanding to 212,000 (106,000 shares × 2).

Question 2

Grand Corporation has 10,000,000 shares of $10 par-value stock authorized, of which 2,000,000 shares are issued and outstanding. The Board of Directors of Grand declared a 2-for-1 stock split on November 30 to be issued on December 30. The stock was selling for $30 per share on the date of declaration. In addition, the Board has amended the articles of incorporation to allow for a proportional increase in the number of authorized shares. The par-value information appearing in the shareholder’s equity section of Grand’s statement of financial position at December 31 will be

Answer 2

$5

As a result of the 2-for-1 stock split, the par value of Grand’s shares is halved to $5.

Question 3

Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30% stock dividend. The market value was $50 per share, the par value was $10, and the average issue price was $30 per share. By what amount will Universe decrease shareholders’ equity for the dividend?

Answer 3

$0

When a stock dividend is declared, a portion of retained earnings is reclassified as contributed capital. The net effect on total equity is thus $0.

Question 4

Which one of the following statements regarding treasury stock is correct?

Answer 4

It is reflected in shareholders’ equity as a contra account.

Treasury stock recorded at cost is a reduction of total equity. Treasury stock recorded at par is a direct reduction of the pertinent contributed capital balance, e.g., common stock or preferred stock.

Question 5

Day Corp. holds 10,000 shares of its $10 par value common stock as treasury stock reacquired in Year 2 for $120,000. On December 12, Year 4, Day reissued all 10,000 shares for $190,000. Under the cost method of accounting for treasury stock, the reissuance resulted in a credit to

Answer 5

Additional paid-in capital of $70,000.

When treasury stock accounted for under the cost method is acquired, the treasury stock account is debited for the amount of the purchase price. If it is subsequently reissued for a price greater than its carrying amount, the excess is credited to additional paid-in capital. For this transaction, the excess is $70,000 ($190,000 – $120,000).

Question 6

East Co. issued 1,000 shares of its $5 par-value common stock to Howe as compensation for 1,000 hours of legal services performed. Howe usually bills $160 per hour for legal services. On the date of issuance, the stock was trading on a public exchange at $140 per share. By what amount should the additional paid-in capital account increase as a result of this transaction?

Answer 6

$135,000

When stock is issued in exchange for property or services, the transaction is recorded at the more clearly determinable of the fair values of the stock issued or of the property or services received. In this case, the quoted price of the stock is used because it is based on trading in an active market (a level 1 input). The entry is to debit legal expense for $140,000 (1,000 shares × $140 market price), credit common stock for $5,000 (1,000 shares × $5 par value), and credit additional paid-in capital for the difference ($135,000).

Question 7

When collectibility is reasonably assured, the excess of the subscription price over the stated value of no-par common stock subscribed should be recorded as

Answer 7

Additional paid-in capital when the subscription is recorded.

The accounting for subscriptions of no-par stock with a stated value is the same as for par value stock. When stock is subscribed, the corporation recognizes an obligation to issue stock and the subscriber undertakes the legal obligation to pay for the shares subscribed. If collectibility of the subscription price is reasonably assured on the date the subscription is received, the issuing corporation should recognize the cash collected and a subscription receivable for the remainder. In addition, the common stock subscribed account should be credited for the stated value of the shares subscribed, with the excess of the subscription price over the stated value recognized as additional paid-in capital.

Question 8

On May 1, Rhud Corp. declared and issued a 10% common stock dividend. Prior to this dividend, Rhud had 100,000 shares of $1 par value common stock issued and outstanding. The fair value of Rhud’s common stock was $30 per share on May 1. As a result of the stock dividend, Rhud’s total equity

Answer 8

Did not change.

When a stock dividend is declared, a portion of retained earnings is reclassified as contributed capital. The net effect on total equity is thus $0.

Question 9

Porter Co. began its business last year and issued 10,000 shares of common stock at $3 per share. The par value of the stock is $1 per share. During January of the current year, Porter bought back 500 shares at $6 per share, which were reported by Porter as treasury stock. The treasury stock shares were reissued later in the current year at $10 per share. Porter used the cost method to account for its equity transactions. What amount should Porter report as paid-in capital related to its treasury stock transactions on its balance sheet for the current year?

Answer 9

$2,000

The purchase of treasury stock accounted for using the cost method resulted in a debit to treasury stock and a credit to cash for $3,000 (500 shares × $6). The reissuance entry was to debit cash for $5,000 (500 shares × $10), credit treasury stock for $3,000, and credit additional paid-in capital from treasury stock transactions for $2,000.

Question 10

At December 31, Year 3 and Year 4, Carr Corp. had outstanding 4,000 shares of $100 par value, 6% cumulative preferred stock and 20,000 shares of $10 par value common stock. At December 31, Year 3, dividends in arrears on the preferred stock were $12,000. Cash dividends declared in Year 4 totaled $44,000. What amounts were payable on each class of stock?

Preferred Stock:
Common Stock:

Answer 10

$36,000
$8,000

Given that the preferred stock is cumulative, preferred dividends in arrears and the dividends for the current period must be paid before common shareholders may receive any dividends. The preferred dividends for the year ending December 31, Year 4, are $24,000 (4,000 shares × $100 par value × 6%). Consequently, the preferred shareholders should receive $36,000 ($12,000 Year 3 dividends in arrears + $24,000 Year 4 dividends). The common shareholders will receive the remaining $8,000 ($44,000 – $36,000).

Question 11

On January 2, Year 5, Lake Mining Co.’s board of directors declared a cash dividend of $400,000 to shareholders of record on January 18, Year 5, payable on February 10, Year 5. The dividend is permissible under law in Lake’s state of incorporation. Selected data from Lake’s December 31, Year 4, balance sheet are as follows:

Accumulated depletion: $100,000
Capital stock: 500,000
Additional paid-in capital: 150,000
Retained earnings: 300,000

The $400,000 dividend includes a liquidating dividend of

Answer 11

$100,000

A common practice of companies whose major activity is the exploitation of depletable resources is to pay dividends in amounts up to the sum of retained earnings and accumulated depletion. However, any distribution by a corporation to its shareholders in excess of the dollar balance in the retained earnings account is considered a liquidating dividend and return of capital to the shareholders. Consequently, the liquidating dividend equals $100,000 ($400,000 dividend – $300,000 retained earnings).

Question 12

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

Answer 12

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.

Question 13

On December 1, Year 4, Pott Co. declared and distributed a property dividend when the fair value exceeded the carrying amount. As a consequence of the dividend declaration and distribution, what are the accounting effects?

Property Dividends Recorded at:
Retained Earnings:

Answer 13

Fair value
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 recognized as a decrease in (debit to) retained earnings and a corresponding increase in (credit to) a dividend payable. The distribution of the property dividend is recognized by a debit to property dividend payable and a credit to the property account.

Question 14

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 on retained earnings?

Acquisition of Treasury Stock:
Reissuance of Treasury Stock:

Answer 14

No effect
No effect

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. The amount of 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 amount (acquisition cost) of the treasury stock is credited to additional paid-in capital. Again, the amount of retained earnings is unaffected.

Question 15

On July 1, Alto Corp. split its common stock 5-for-1 when the market value was $100 per share. Prior to the split, Alto had 10,000 shares of $10 par value common stock issued and outstanding. After the split, the par value of the stock

Answer 15

Was reduced to $2

When a stock split is effected, the par value and total shares outstanding are adjusted to reflect the terms of the stock split. The 5-for-1 stock split will increase the number of shares to 50,000 (10,000 shares × 5). The par value will be reduced to $2 ($10 ÷ 5).

Question 16

Posy Corp. acquired treasury shares at an amount greater than their par value but less than their original issue price. Compared with the cost method of accounting for treasury stock, does the par-value method report a greater amount for additional paid-in capital and a greater amount for retained earnings?

Additional Paid-in Capital:
Retained earnings:

Answer 16

No
No

Under the cost method, the purchase of treasury stock (debit treasury stock, credit cash) has no effect on additional paid-in capital and retained earnings. Under the par-value method, given that the acquisition cost is greater than par but less than the original issue price, treasury stock is debited at par, and the additional paid-in capital associated with the original issue is also debited. Cash and paid-in capital from treasury stock transactions are credited. Hence, the par-value method does not report a greater amount for additional paid-in capital or retained earnings.

Question 17

For the last 10 years, Woody Co. has owned cumulative preferred stock issued by Hadley, Inc. During Year 2, Hadley declared and paid both the Year 2 dividend and the Year 1 dividend in arrears. How should Woody report the Year 1 dividend in arrears that was received in Year 2?

Answer 17

Include in Year 2 income from continuing operations.

Dividends, including those in arrears on preferred stock, are not liabilities of the investee or assets of the investor until the date of declaration. Thus, Woody should not recognize income from the dividends in arrears until Year 2. The amount received should be included under the income from continuing operations caption because dividends received are an operating item.

Question 18

A corporation declared a dividend, a portion of which was liquidating. How does this declaration affect each of the following?

Additional Paid-in Capital:
Retained Earnings:

Answer 18

Decrease
Decrease

The portion of a dividend that is liquidating results in a distribution in excess of the corporation’s retained earnings. The effect of a liquidating dividend is to decrease contributed capital. Additional paid-in capital is debited first to the extent available before other contributed capital accounts are charged. Thus, declaration of a cash dividend, a portion of which is liquidating, decreases both additional paid-in capital and retained earnings.

Question 19

On incorporation, Dee, Inc., issued common stock at a price in excess of its par value. No other stock transactions occurred except that treasury stock was acquired for an amount exceeding this issue price. If Dee uses the par value method of accounting for treasury stock appropriate for retired stock, what is the effect of the acquisition on the following?

Net Common Stock:
Additional Paid-in Capital:
Retained Earnings:

Answer 19

Decrease
Decrease
Decrease

Under the par value method, treasury stock is debited at par value, and the amount is reported as a reduction of common stock. The purchase also results in the removal of the additional paid-in capital associated with the original issue of the shares. Given that no other stock transactions occurred and that treasury stock was acquired for an amount exceeding the issue price, the balancing debit for the excess of the acquisition price over the issue price is to retained earnings. If paid-in capital from treasury stock had been previously recorded, the balancing debit would be to that account but only to the extent of its credit balance. Thus, retained earnings is also decreased.

Question 20

Clay Township owned an idle parcel of real estate consisting of land and a factory. Clay gave title to this realty to Wolf Co. as an incentive for Wolf to establish a factory in the Township. Wolf paid nothing for this realty, which had a fair value of $200,000 at the date of the grant. In accordance with traditional practice, Wolf may record this nonmonetary transaction as a

Answer 20

Credit Contributed Capital for $200,000

Contributions received from a nongovernmental entity are now recognized as revenues or gains in the period of receipt. However, this treatment is not required for transfers from a governmental unit to a business. In accordance with traditional practice, a contributed capital account is credited for the fair value of $200,000. Nevertheless, consistency suggests that a revenue or gain be recognized. Nothing in current guidance precludes use of this method.