Becker - Module 7

Question 1

Define common stock and list the basic properties

Answer 1

Common stock: Residual ownership interest

Basic rights include:

• voting rights
• dividend rights
• rights to share in distribution of assets if corporation is liquidated, after satisfaction of creditor and preferred stockholders’ claims

Question 2

List some common properties of preferred stock

Answer 2

• convertible, callable
• redeemable
• dividends can be cumulative and/or participating

Question 3

Describe the adjustments of a quasi-reorganization

Answer 3

• Assets are restated at fair value (no increase in asset value is permitted, write-downs are charged directly to retained earnings)
• Liabilities are restated at present values
• Retained earnings brought to zero balance by closing additional paid-in capital or other capital accounts
• Remember to continue to show the date of the adjustment to retained earnings for 3-10 years, as this is a departure from cost principle
• No negative balance in any capital account

Question 4

What are the two alternative methods of accounting for treasury stock?

Answer 4

Cost method: Unallocated reduction in stockholders’ equity

Par value method: deducted from capital stock

Remember, no gains/losses are recognized on the income statement; income and retained earnings may never increase by the transaction; additional paid-in capital - treasury stock account used to record “gains” and absorb “losses”

Treasury stock is not an asset; cash and property dividends are not paid on treasury stock; stock dividends may be paid on treasury stock.

Question 5

Summarize the cost method of accounting for treasury stock

Answer 5

• Recorded, carried, and reissued at reacquisition cost
• Any “gain” is credited to Paid-in Capital - Treasury Stock
• Any “loss” is charged against previous “gains,” then retained earnings
• Reported as a deduction from total stockholders’ equity

Question 6

Summarize the par value method of accounting for treasury stock

Answer 6

• Recorded at par value with excess to Paid-in Capital - Treasury Stock or deducted from retained earnings after charged to any Paid-in Capital - Treasury Stock
• Reported as a deduction from capital stock

Question 7

List the significant dates with respect to cash dividends

Answer 7

• Date of Declaration: becomes a liability and reduces retained earnings
• Date of Record: no journal entry, memorandum entry only
• Date of Payment: actually paid

Question 8

List five types of dividends

Answer 8

1) Cash
2) Liquidating: return of investment
3) Property: FMV of assets given up, with gain/loss recognized
4) Scrip: promise to pay a dividend in future
5) Stock: results in capitalizing part of retained earnings, increasing legal capital. Remember, if 20-25%, record at par value.

Question 9

What is the threshold for treating stock dividends as large vs. small stock dividends?

Answer 9

Small stock dividend: 20-25%

The treatment of stock dividends depends on the percentage of the dividend in proportion to the total shares outstanding prior to the declaration of the dividend

Question 10

What is the accounting treatment of small stock dividends?

Answer 10

Fair value of additional shares issued at the date of declaration is transferred from retained earnings to capital stock and additional paid-in capital

Question 11

What is the accounting treatment of large stock dividends?

Answer 11

Par value of additional shares issued is transferred from retained earnings to capital stock.

Question 12

Identify the disclosure requirements about capital structure

Answer 12

• rights and privileges of various securities outstanding
• number of shares issued upon conversion, exercise, or satisfaction of required conditions during at least the most recent annual fiscal period and any subsequent interim period presented
• liquidation preference of preferred stock
• redemption requirements related to redeemable stock

Question 13

Identify two types of stock options

Answer 13

1) Noncompensatory: Under US GAAP, substantially all full-time employees may participate; offered equally or as a percentage of salary; reasonable exercise period; and discount is no greater than that offered to stockholders.
2) Compensatory: Compensation cost is determined on the grant date, using an option pricing model

Note: Under IFRS, stock options are generally considered to be compensatory

Question 14

Describe the computation and allocation of compensation expense under compensatory stock option plans

Answer 14

Compensation cost is based on the fair value of the equity instrument awarded, determined by an option pricing model. This cost is expensed and allocated over the service period.

Question 15

Describe the accounting for unexercised, expiring stock options

Answer 15

Any balance in “additional paid-in capital - stock options” is reclassified to “additional paid-in capital - expired stock options.” Previously recognized compensation expense is not adjusted.

Question 16

What is the basic formula used for calculating EPS?

Answer 16

income available to common shareholders / weighted-average # of common shares outstanding

Question 17

Compare basic and diluted EPS

Answer 17

Basic: simple capital structure (only common stock outstanding):
income available to common shareholders / weighted-average common shares outstanding

Diluted: complex capital structure:
income available to common shareholders assuming conversion of all dilutive securities / weighted-average common shares outstanding after conversion of all dilutive shares

Question 18

Name the potentially dilutive securities or instruments

Answer 18

• stock options and warrants and their equivalents
• convertible securities (bonds or preferred stock)
• contracts that may be settled in stock or cash
• contingent issuable shares

Question 19

What is the antidilution rule?

Answer 19

Any conversion, exercise, or contingent issuance that has an antidilutive effect (increases EPS or decreases loss per share) is not included in the calculation unless the shares have actually been converted, exercised, or satisfaction of the contingency met.

Each potential common share is considered separately in sequence from most to least dilutive, with in the money options and warrants generally included first.

Question 20

List the reporting requirements for EPS

Answer 20

Face of income statement, with equal prominence for basic and diluted per-share amounts, for both income from continuing operations and net income.

Per-share amounts for discontinued operations and extraordinary items can be reported on the face of the income statement or in the notes to the financial statements.

Question 21

What are the three sections of the statement of cash flows? What cash flows are included in each section?

Answer 21

• Operating activities - cash flows from income statement transactions and current assets/liabilities
• Investing activities - cash flows from noncurrent assets
• Financing activities - cash flows from debt and equity

Question 22

Define cash equivalents

Answer 22

Cash equivalents: cash equivalents are highly liquid investments with maturities of three months or less that are readily convertible into cash with insignificant risk of changes in value.

Note: “Maturities of three months or less” is of original instrument or from purchase date of instrument.

Question 23

Name the two methods of presentation of cash flows from operating activities. Which method is preferred?

Answer 23

• Direct and Indirect methods

- Direct method is preferred

Question 24

If using the direct method of presenting cash flows from operating activities, what additional item needs to be included in the statement of cash flows under US GAAP?

Answer 24

A reconciliation of net income to net cash provided by operations needs to be provided by operations needs to be provided as a supplemental schedule (not required under IFRS)

Question 25

Name the common adjustments made to cash flows from operating activities using the indirect method.
[CLAD]

Answer 25

Current assets and liabilities
Losses and gains
Amortization and depreciation
Deferred items

Question 26

Name the most common classes of cash receipts and disbursements included in cash flows from operating activities using the direct method.

Answer 26

• Cash received from customers
• Cash paid to suppliers and employees
• Interest received and paid
• Dividends received
• Purchases and sales of trading securities, if appropriate, based on the nature and purpose for which the securities were acquired
• Income taxes paid