Equity

Question 1

What is owners equity?

Answer 1

The owners’ equity (OE) accounts represent the residual interest in the net assets of an entity that remain after deducting its liabilities.

Question 2

What are the two main OE categories?

Answer 2

Earned and contributed

Question 3

What is Par?

Answer 3

the minimum legal issue price for capital stock in most states and appears on the stock certificate.

Question 4

What happens when a stock has no par value?

Answer 4

The firm may designate a stated value which serves the same function as par value except that it does not appear on the certificate.
The firm may not use a par value at all, in which case the stock is referred to as no par stock.

Question 5

How is no par stock categorized?

Answer 5

If the stock is no-par stock, then the entire issuance proceeds is credited to the capital stock account and there is no additional paid-in capital account (contributed capital in excess of par).

Question 6

What is the legal capital?

Answer 6

The legal capital or minimum capital of a corporation is usually the par value of the stock or the stated value of the stock issued

Question 7

What are the rights for Preferred Stockholders?

Answer 7

Nonvoting, dividend preference, cumulative preferred stock and participating preferred stock, dividends in arrears, liquidation preference

Question 8

What is an authorized share?

Answer 8

the total number of shares that can be issued

Question 9

what is the number of stock shares issued?

Answer 9

The number of shares ever issued by the firm but not retired

Question 10

What is the number of stock shares outstanding?

Answer 10

The number of shares currently held by stockholders

Question 11

What is the common stock equation?

Answer 11

Issued shares = # Outstanding shares + # Treasury shares

Question 12

What information is required for the sale of stock on a subscription basis?

Answer 12

Specifying the share price;
Number of shares;
And the payment dates.

Question 13

When is stock issued when sold on a subscription basis?

Answer 13

once the full amount is received

Question 14

What type of account is common stock subscribed?

Answer 14

Owners Equity

Question 15

What is convertible preferred stock?

Answer 15

It allows the preferred shareholder to convert the preferred shares to common shares. The journal entry for issuance of convertible preferred stock does not allocate any of the proceeds to the conversion feature

Question 16

What happens when a company calls and redeems preferred stock?

Answer 16

Any debit difference is recorded in retained earnings;
Any credit difference is recorded in a contributed capital account.
Any dividends in arrears must be paid when the shares are acquired (retained earnings is debited).
No gain or loss is recognized for these events because the transactions are between the firm and its owners.

Question 17

What happens when preferred stock is converted?

Answer 17

When convertible preferred stock is converted into common stock, the preferred stock accounts are transferred to the common stock accounts. Again, there is no gain or loss.

Question 18

What methods are available to account for treasury stock?

Answer 18

Cost Method which records the treasury stock account at the cost of shares reacquired;
Par Value Method which records the treasury stock account at the par value of shares reacquired.

• Owners’ equity is reduced by the same amount, regardless of which method is used, but the balances of certain OE accounts are different under the two methods.

Question 19

Explain the cost method for accounting for treasury stock.

Answer 19

At purchase, treasury stock is debited for cost. The contributed capital in excess of par account that was credited when the stock was issued is not affected. Reissuances credit the treasury stock account at cost, and the difference between the purchase price and reissue price is recorded in contributed capital from treasury stock.

Question 20

Explain the par method for accounting for treasury stock.

Answer 20

At purchase, the treasury stock account is debited for par value, and the contributed capital in excess of par account that was credited when the stock was issued is debited for the original amount recorded. Reissuances are treated as a regular issuance of stock except that treasury stock is credited, rather than common stock

Question 21

When treasury shares are purchased at a cost greater than par but less than original issue price, what is the relative impact of the cost and the par value methods on additional paid-in capital and retained earnings?

Answer 21

a. Cost Method – Under the cost method, when treasury stock is purchased for an amount less than original price, the treasury stock account is debited. This is a contra OE account. Additional paid-in capital and retained earnings are unaffected.
b. Par Value Method – Under the par value method, the treasury stock account is debited for par value, and additional paid-in capital is debited for the amount in proportion to the original issue price. Because less was paid for the treasury stock than was received on original issuance, retained earnings is unaffected. Rather, additional paid-in capital from treasury stock is credited for the difference, but not by as much as the debit to the original issuance additional paid-in capital account.

Question 22

What happens to increase the contributed capital from treasury stock account?

Answer 22

Cost method = Reissue at a price exceeding cost

Par Value = Purchase at a price less than original issue price

Question 23

What happens to decrease the contributed capital from treasury stock account?

Answer 23

cost method - reissue at a price less than cost

par value method - purchase at a price exceeding original issue price

Question 24

What happens when a firm retires shares?

Answer 24

Retired shares are placed back into the authorized but unissued category.

If the purchase price is less than the original issue price, then contributed capital from stock retirement is credited.

If the purchase price is greater than the original issue price, then contributed capital from stock retirement is debited until exhausted, and retained earnings is debited for the remainder, if any.

Question 25

When is a liability recorded for dividends?

Answer 25

A liability is recognized for these liabilities on the date of declaration

Question 26

What is a declaration date for dividends?

Answer 26

declaration date is the date the board of directors formally declares the dividend. This is the most important date in terms of the effect on the firm’s resources and therefore its balance sheet. At this date, the firm recognizes a liability and a reduction in retained earnings

Question 27

What is the date of record for dividends?

Answer 27

the date of record is simply a cut-off date. The shareholders of record on this date will be the recipients of the dividend payments

Question 28

What is the payment date for dividends?

Answer 28

the payment date is the date the dividends are actually distributed to the shareholders.

Question 29

What are dividends in arrears?

Answer 29

Unpaid dividends for a particular year on cumulative preferred stock. Dividends are not required to be paid but are said to accumulate if unpaid

Question 30

Do dividends in arrears create a liability?

Answer 30

no liability is recognized for dividends in arrears until there has been a dividend declaration.

Question 31

What happens with other property is distributed as a dividend?

Answer 31

In this type of dividend, the distribution of earnings will take the form of a non-cash distribution. In other words, a non-cash asset will be distributed to the shareholders. The most common type of asset distributed in a property dividend is an investment in securities of other firms.

The related liability and the gain or loss on disposal of the asset will be recognized on the date of declaration. The dividend is recorded at the market value at declaration date.

Question 32

What is a scrip dividend?

Answer 32

A scrip dividend is first distributed in note payable (scrip) form because the firm does not have the cash at the date of declaration to pay the dividend but wants to assure the shareholders that the dividend is forthcoming

Question 33

is interest paid on a scrip dividend?

Answer 33

Yes, it is paid on the note until cash is paid

Question 34

What happens when a partial payment is made on a scrip dividend?

Answer 34

If a partial payment is made after declaration (to shareholders of record), then the interest expense is computed from the date of that partial payment to the date the final payment is made. The principal amount on which interest is computed is the amount of the final payment.

Question 35

What is a liquidating dividend?

Answer 35

A liquidating dividend is a return of capital, rather than a return on capital. It is a return of contributed capital – an amount invested by the shareholder

Question 36

Does a liquidating dividend affect the contributed capital account?

Answer 36

The liquidating portion of a dividend reduces a contributed capital account, rather than retained earnings, and must be disclosed as a liquidating dividend.

Question 37

What is a stock dividend?

Answer 37

A stock dividend is a distribution by a firm of its stock to its shareholders in proportion to their existing holdings. The shareholder does not pay for these shares. Stock dividends do not involve a future transfer of assets or a future provision of services

Question 38

Do stock dividends create a liability?

Answer 38

no liability is recorded. Each investor simply holds more shares, but each share is worth proportionately less than before the dividend

Question 39

What do stock dividends do?

Answer 39

Increase the number of shares issued and outstanding

Decrease earnings per share

reduce the market price of the stock and demand for cash dividends

Question 40

How do you account for a small stock dividend (% less than 25%)

Answer 40

Capitalize at market price
Market price is used on the assumption that the market price of the stock will not change given the small size of the dividend

Question 41

How do you account for a large stock dividend (% more than 25%)

Answer 41

Capitalize at par value

In this case, the assumption cannot be made that the market price of the stock will remain unchanged because of the large dilution in the number of shares outstanding.
Thus, only the par value of shares issued is permanently capitalized. Subsequent changes in market price do not affect the accounting

Question 42

Do stock dividends change OE?

Answer 42

Neither type of stock dividend causes a change in total OE, but retained earnings is reduced and contributed capital is increased

Question 43

What happens with a 2 for 1 stock dividend?

Answer 43

A 2-for-1 split halves the par value and doubles the number of shares. The reason firms split their shares is to reduce the market price and make the shares available to a larger number of shareholders

No change in OE

Question 44

What effect on other accounts does 100% stock dividend have

Answer 44

Effect on total OE	None
Effect on retained earnings	Decrease
Effect on par value	None
Effect on shares outstanding	Double
Effect on contributed capital	Increase
Effect on common stock account	Increase

Question 45

What effect on other accounts does a 2 for 1 stock split have

Answer 45

2-for-1
	stock split
Effect on total OE	None
Effect on retained earnings	None
Effect on par value	Cut in half
Effect on shares outstanding	Double
Effect on contributed capital	None
Effect on common stock account	None

Question 46

Do treasury shares receive stock dividends?

Answer 46

No

Question 47

In what order are dividends allocated when the preferred stock does not participate?

Answer 47

1. Preferred: Any dividends in arrears (only if preferred stock is cumulative);
2. Preferred: Current period dividend;
3. Common: Remainder.

Question 48

In what order are dividends allocated when the preferred stock is fully participating?

Answer 48

1. After any dividends in arrears are allocated, the remaining dividends are allocated based on the total par value of the preferred and common stock outstanding.
2. If total dividends are not sufficient to provide common with a matching amount equal to the preferred percentage times total par value of common, then there is no participation and common receives all the dividends after the current year preferred dividend requirement and any dividends in arrears are allocated.

Question 49

In what order are dividends allocated when the preferred stock is partially participating?

Answer 49

a. Preferred: Any dividends in arrears;
b. Preferred: Current period dividend;
c. Common: Matching amount: preferred percentage x total par of common outstanding;
d. Preferred: Additional percentage;
e. Common: Remainder.

Question 50

What is a stock right?

Answer 50

Gives the holder the option to purchase a certain number of shares of the issuing firm at a specified price during a specified time period.
Stock rights are often used to convey preemptive rights.
The existing shareholders are given rights (via a stock warrant) to purchase their pro rata number of shares to keep their current percentage in the firm.

Question 51

What happens with a stock right when the rights are first issued?

Answer 51

No journal entry is made. No resources have been transferred

Question 52

What happens with stock rights when they are exercised?

Answer 52

The usual entry to record the issuance of stock is made. The issue price is the exercise price as specified in the stock warrant, not the market price on the date of exercise.

Question 53

What happens with stock rights when they lapse?

Answer 53

No entry is made if the shareholder does not exercise the rights.

Question 54

What happens when stock rights are issued to outside parties for services?

Answer 54

At issuance of rights: Record an expense and owners’ equity account equal to the difference between the market price and exercise price, times the number of shares under option.

At exercise of rights: Record the stock issuance at the exercise price and remove the OE account credited at issuance of the rights.

Question 55

What is unappropriated retained earnings?

Answer 55

This portion of retained earnings is available for dividend declaration. In other words, the future use of this amount of retained earnings has not been determined.

Question 56

What are appropriated retained earnings?

Answer 56

This amount of retained earnings has been declared off-limits for dividends so that funds may be conserved for a specific purpose or objective

This is often used for financial planning, legal requirement, contractual obligation,

Question 57

What is a restriction on retained earnings?

Answer 57

A constraint placed on a certain portion of retained earnings by an external party.

Question 58

What is the book value per share ratio equal to?

Answer 58

common stockholders equity per share of outstanding common stock at the end of a period

Question 59

what is common stockholders equity?

Answer 59

Common stockholders’ equity is total OE after preferred dividend claims are removed.

Question 60

Equation for Book value per share oustanding

Answer 60

= Common stockholders’ equity/ending common shares of common stock outstanding

Question 61

Equation for common stock holders equity

Answer 61

= Total OE - liquidation preference of preferred stock- preferred stock dividends in arrears

Question 62

What is quasi-reorganization?

Answer 62

An alternative to bankruptcy in some cases, quasi-reorganization allows a firm a fresh start and new, more conservative asset values.

Question 63

What are the requirements for a Quasi reorganization?

Answer 63

1. Approval – Shareholder and creditor approval.
2. Balance Becomes Zero – The retained earnings balance must be zero immediately after the quasi-reorganization.
3. No Negative Balance After – No contributed capital account can have a negative balance after the quasi-reorganization.
4. Assets Down to Market – Assets must be written down to market value (asset write-ups are possible but would be rare).
5. Dated Years After – Retained earnings must be dated for a period of 3 - 10 years after the quasi-reorganization to indicate that the balance reflects income earned after the quasi-reorganization.

Question 64

What are the accounting steps for a quasi reorganization?

Answer 64

1. Write assets down to market value, further reducing retained earnings (increasing the deficit).
2. Reduce contributed capital to absorb the retained earnings deficit.
3. Change Value/Number Shares – If needed, change par value or the number of shares of common stock to absorb the remaining deficit.