Equity Flashcards
What is included in issued shares?
Issued shares include outstanding shares and treasury shares. Treasury shares are issued but not outstanding. Stock splits are applied to all outstanding and treasury shares because a split reduces the par value of each share of issued stock, and increases the number of shares in inverse proportion.
Which of the following errors could result in an overstatement of both current assets and stockholders’ equity?
A. An understatement of accrued sales expenses.
B. Noncurrent note receivable principal is misclassified as a current asset.
C. Annual depreciation on manufacturing machinery is understated.
D. Holiday pay expense for administrative employees is misclassified as manufacturing overhead.
D.
This error reduces expenses because part of the holiday pay will be held back in ending inventory, which is a current asset. Thus, net income, and therefore OE are overstated, as well as ending inventory, which is a current asset.
An individual contracts for the purchase of 200 shares of $10 par common stock at a subscription price of $15. After making payments totaling $1,200, the subscriber defaults. Shares are issued in proportion to the amount of cash paid by the investor. The summary journal entry to record the net effect of these two transactions includes:
The net effect of the transactions is to receive cash of $1,200 and issue stock for that amount at $15/share; $1,200/$15 = 80 shares fully paid. Required net changes in balances are (1) common stock, 80($10) = $800, (2) PIC-CS, 80($15 - $10) = $400, (3) cash $1,200. The share purchase contract receivable account is opened and then closed for the same amount. There is no ending balance in that account.
When collectability is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed should be recorded as…
APIC when the subscription is recorded. This is one of the few examples of a recognized executory contract. Given that collectability is not an issue, the recording of a stock subscription is essentially the same as the entry for issuing stock for cash, except that a receivable stands in place of cash, and common stock subscribed stands in place of common stock.
Common stock subscribed is an owners’ equity account that is replaced by common stock upon issuance. Any additional paid-in capital is recorded when the contract is signed or recorded, just as if cash were received at that point.
When preferred stock is called and retired, which account or aggregate category of accounts can be increased?
- Total S/H Equity
- Retained Earnings
When a firm retires preferred stock, cash is paid to the shareholders reducing total owners’ equity. Retained earnings can never be increased when shares are retired, redeemed, or converted into another class of stock.
How is the income statement affected by treasury stock transactions?
Income is not affected by treasury stock transactions. When a firm transacts with its owners acting as owners, it cannot profit or report a negative income.
On December 1, 2004, Line Corp. received a donation of 2,000 shares of its $5 par value common stock from a stockholder. On that date, the stock’s market value was $35 per share. The stock was originally issued for $25 per share.
By what amount would this donation cause total stockholders’ equity to decrease?
$0. The shares are considered donated treasury shares. Treasury stock and a gain or revenue account are increased by the market value of the stock received in donation (FAS 116). The increase in the treasury stock account decreases the owners’ equity, but the gain or revenue increases the owners’ equity by the same amount. Therefore, there is no net effect on the owners’ equity.
At its date of incorporation, Glean, Inc. issued 100,000 shares of its $10 par common stock at $11 per share. During the current year, Glean acquired 30,000 shares of its common stock at a price of $16 per share and accounted for them by the cost method. Subsequently, these shares were reissued at a price of $12 per share.
There have been no other issuances or acquisitions of its own common stock.
What effect does the reissue of the stock have on the Retained Earnings and APIC accounts?
Under the cost method, additional paid-in capital from treasury stock transactions is credited when treasury stock is reissued at a price in excess of cost. This account is to be debited before retained earnings when the opposite occurs: reissue treasury stock at less than cost (as happened in the question).
However, only one treasury stock reissuance has occurred. Therefore, there is no additional paid-in capital from previous treasury stock transactions to draw on so the difference between the purchase price and reissuance price is debited to retained earnings (a decrease). There is no effect on additional paid-in capital.
How does the retiring of Treasury Stock affect Common Stock Outstanding?
When treasury stock is cancelled (retired), the common stock account is reduced by the par value of the common stock cancelled.
Under the par value method, when treasury stock is purchased and retired at a price exceeding the original issue price, the following entry is made. No additional paid-in capital from treasury stock transactions exists. Therefore, retained earnings is debited. Common stock par Additional paid-in capital original issue price - par Retained earnings acquisition price - original issuance price Cash acquisition price. Thus, all three accounts listed in the question are decreased.
On incorporation, Dee Inc. issued common stock at a price in excess of its par value. No other stock transactions occurred except 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 Net Common Stock, APIC and Retained Earnings?
If a corporation sells some of its treasury stock at a price that exceeds its cost, this excess should be:
Credited to APIC. Under both the par and cost methods, sale of treasury stock at a price in excess of cost increases an additional paid-in capital account.
Effectively, the firm has obtained additional resources from the issuance of the stock a second time. Income is never increased or decreased by treasury stock transactions because such transactions are between the firm and its owners. A firm cannot profit from its owners.
Posy Corp. acquired treasury shares at an amount greater than their par value, but less than their original issue price.
Compared to 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?
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. Under the par 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.
On balance, additional paid-in capital decreases under the par method relative to the cost method, but there is no difference in the effect on retained earnings (neither method affects retained earnings under the conditions in the problem).
How does the acquisition of treasury stock affect common stock outstanding under the par method and cost method?
The acquisition of treasury stock reduces the number of shares of stock outstanding, regardless of the method used to account for the treasury stock.
Shares in the treasury are considered issued, but not outstanding.
Instead of the usual cash dividend, Evie Corp. declared and distributed a property dividend from its overstocked merchandise.
The excess of the merchandise’s carrying amount over its market value should be:
Reported as a reduction in income before extraordinary items. When the carrying value and market value of an asset distributed as a property dividend are different, the resulting gain or loss on disposal is recognized as ordinary income, just as the gain or loss from disposal is recognized for any other reason.
Had the asset been sold first, and the cash proceeds distributed in lieu of the property dividend, the same gain or loss would have resulted. The disposal loss or gain is recognized in income from continuing operations.
Bal Corp. declared a $25,000 cash dividend on May 8, 2005, to stockholders of record on May 23, 2005, payable on June 3, 2005. As a result of this cash dividend, working capital decreased on:
May 8th. It is at declaration that a dividend has its effect on the value of the firm and on working capital. Retained earnings are decreased (or a holding account called Dividends, which is closed to retained earnings, may be recorded), and dividends payable are increased. Dividends payable are a current liability, causing working capital to decrease.
Working capital equals current assets, less current liabilities. The payment of a dividend does not affect working capital, because both cash and the dividend payable are reduced. Both current assets and current liabilities are reduced by the same amount.
