Chapter 11: Stockholders' equity Flashcards
What are the two major components of stockholders’ equity? Which accounts generally appear in each component?
Stockholders’ equity has two major components: contributed capital and retained earnings. Contributed capital represents the amount the corporation received from the sale of stock to the stockholders. Retained earnings is the amount of net income over the life of the company not paid out as dividends. It represents an important link between the income statement and the balance sheet.
If a firm has a net income for the year, will the balance in the Retained Earnings account equal the net income? What is the meaning of the balance of the account?
The balance of the Retained Earnings account is not equal to the firm’s net income. The account indicates the amount of income for all previous years that has been earned but has not been paid out as dividends to the stockholders.
What is treasury stock? Where does it appear on a corporation’s financial statements?
Treasury stock is created when a company buys back (repurchases) its own stock sometime after issuing it. It represents the corporation’s own stock, previously issued to shareholders, repurchased from stockholders and not retired, but held for various purposes. Treasury Stock is a contra-equity account and is shown as a reduction of stockholders’ equity. When treasury stock is purchased, a debit to Treasury Stock, a contra-equity account is recorded.
What is a stock dividend? How should it be recorded?
A stock dividend occurs when a company issues shares of stock to its existing stockholders instead of paying cash as a dividend. Stock dividends should be recorded as a reduction of Retained Earnings and an increase in Stock Dividend Distributable. Therefore, stock dividends do not affect total stockholders’ equity. Normally, retained earnings is reduced by the market value of the stock distributed.
Would you rather receive a cash dividend or a stock dividend from a company? Explain.
It is better to receive a stock dividend when the company is using earnings to expand and reinvest in the business. A cash dividend is preferred by investors who need the cash to meet current needs.
What is the difference between stock dividends and stock splits? How should stock splits be recorded?
Stock dividends do not reduce the par value per share of the stock. Stock splits do reduce the par value per share. Splits do not require any journal entry but should be noted in the notes that accompany the balance sheet.
How is the book value per share calculated? Does the amount calculated as book value per share mean that stockholders will receive a dividend equal to the book value?
Book value per share is calculated as the total net assets of the corporation divided by the number of shares of common stock. It is a measure of the rights of the common stockholders to the assets of the firm in the event of liquidation. It does not mean that the common stockholders will receive a dividend equal to the book value per share.
Can the market value per share of stock be determined by the information on the income statement?
The market value per share of the stock is related to the income of the corporation, but many other factors also influence the market value. General economic factors such as inflation, factors related to the particular industry, tax consequences, and the mood of current and potential investors all have an impact on the market value of the stock.
What is the difference between a statement of stockholders’ equity and a retained earnings statement?
The statement of stockholders’ equity explains all reasons for the difference between the beginning and ending balances of each of the accounts in the Stockholders’ Equity category. The retained earnings statement details the changes in only one component of stockholders’ equity—retained earnings.
For each of the following items, indicate (a) in what category of the statement of cash flows the item will be reported and (b) whether it will appear as a cash inflow, cash outflow, or neither.
- Issuance of common stock for cash
- Purchase of treasury stock
- Issuance of a stock dividend
- Reissuance of treasury stock
- Issuance of common stock to acquire land
- Issuance of common stock for cash—Financing category as a cash inflow
- Purchase of treasury stock—Financing category as a cash outflow
- Issuance of a stock dividend—does not appear on the statement of cash flows
- Reissuance of treasury stock—Financing category as a cash inflow
- Issuance of common stock to acquire land—does not appear on the statement of cash flows but the company should provide a supplement indicating the transaction
