F1 - M3 Stockholders' Equity, Pt. I Flashcards
What are some of the rules of appropriated retained earnings?
- When the purpose of the appropriation has been achieved, it should be restored to unappropriated retained earnings.
- Sinking fund cash typically reduces regular cash and does not affect retained earnings. If there is a corresponding appropriation, this would have to be specifically mentioned.
What are the two methods of accounting for treasury stock?
- Cost method - the treasury shares are recorded and carried at their reacquisition cost. The account “additional paid-in capital from treasury stock” is credited for gains and debited for losses when treasury stock is reissued at prices that differ from the acquisition cost. Net income or retained earnings will never be increased through treasury stock transactions.
- Legal (or Par-Stated Value) Method (Used by Entities Approx. 5% of the Time) - the treasury shares are recorded by reducing the amounts of par (or stated) value and additional paid-in capital received at the time of the original sale.
NOTE: Be sure to calculate APIC-CS per share for future calculations under the Legal/Par/State Value Method.
What are the rules with respect to paying preferred stock dividends?
- Cumulative preferred stock dividends are paid on par value (not sales price) of preferred stock and have a “preference” over common stock dividends until all past preferred stock dividends are paid.
- Dividends are not reported as a liability until the dividends are declared.
How does it work to allocate “issue proceeds” in a basket purchase?
Allocated “issue proceeds” of a basket purchase or sale of convertible preferred stock based on relative fair market values (e.g. add the fair values of the respective stock classes and, on a weighted average basis, apply the relative percentage to the total amount received).
When are dividends reported as a liability?
Dividends are not reported as a liability until the dividends are declared. Until then, cumulative preferred dividends are reported as a disclosure in the notes.
Does the sale of treasury stock at less than cost have increase or decrease stockholders’ equity?
The sale of treasury stock at less than cost will INCREASE stockholders’ equity. The original cost of the treasury stock is credited; any additional paid-in-capital-treasury stock is debited; and any excess over the additional paid-in-capital would REDUCE RETAINED EARNINGS. However, the net impact to stockholders’ equity would still be positive as long as cash is received from the sale of the treasury stock.
How are gains and losses on Treasury Stock treated under the cost method?
Gains and losses on treasury stock transactions are never recorded on the income statement. Gains are recorded by increasing Additional Paid-in Capital―Treasury Stock. Losses are recorded by first eliminating any balance in Additional Paid-in Capital―Treasury Stock and then decreasing retained earnings.
How are gains and losses on Treasury Stock treated under the legal (or Par Value/Stated) method?
Under the legal (or Par Value/Stated) method, the additional paid-in capital account is debited for losses when the treasury stock is repurchased; however, when the Additional Paid-in Capital-Treasury Stock account (not to be confused with the APIC-Common Stock Account) does not have enough of a balance to absorb a loss, retained earnings is further reduced.
For all transaction gains, the additional paid-in capital account (not retained earnings) is credited.
What is the primary difference between the cost and legal (par/stated value) methods of accounting for treasury stock transactions?
A primary difference between the cost method and legal method is the timing of the recognition of gains or losses on treasury stock transactions.
Do paid dividends effect retained earnings?
Yes. They are an expense.
What type of equity is treasury stock?
Treasury stock is recognized as contra-equity.
What is the impact of acquiring treasury stock at a price less than its book value?
- Decrease stockholders’ equity in total. All treasury stock transactions decrease total equity.
- Increase book value per share. Book value per share is based on the number of outstanding common shares, which is reduced by the acquisition of treasury stock (the denominator is reduced). The numerator (book value) is also reduced by the cost to purchase the shares, but the overall effect on the ratio is an increase in book value per share. For example, if book value were $1,000 and there were 100 common shares, the book value per common share would be $10. If 10 shares were repurchased for $8 (which is less than the original book value per share), the new book value would be $920 and the reduced number of shares would be 90, thus, resulting in a new book value per common share of $10.22, which is larger than the original $10.
What is the affect of a stock dividend on APIC and Retained Earnings?
The fair market value of the stock dividend at declaration date is capitalized (transferred) from retained earnings (DECREASE) to capital stock and paid-in capital (INCREASE).
How do dividend distributions work when they are split between preferred and common stock holders?
Participating preferred stock splits dividend distributions with common shareholders only after the common shareholders have received percentage dividends equivalent to preferred shareholders. The remaining dividend is shared in relation to relative capitalization.
Are preferred dividends based on par value or market value?
Par Value
