F7 - Stock Owners' Equity, Cash Flows and Ratio Analysis

Question 1

Define common stock and list the basic properties.

Answer 1

Common Stock: Residual ownership interest

Basic rights include:
~Voting rights

~Divident rights

~Rights to share 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 retain earnings).

~Liabilities are restated at present value.

~Retained earnings brought to zero balance by closing to 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 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

Cash

Liquidating: Return of investment

Property: FMV of assets given up, with gain/loss recognized

Scrip: Promise to pay a dividend in future

Stock: Results in capitalizing part of retained earnings, increasing legal capital. Remember, if < 20-20%, record at market value; 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%

Large 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 recenet 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

Noncompensatory: Under U.S. GAAP, substantially all full-time employees may participate; offered equally or as a percentage of salary; reasonable exercise period; and discount is no greater tahn that offered to stockholders.

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 # of common shares outstanding

Diluted: Complex capital structure:
Income available to common shareholders assuming conversion of all dilutive securities/Weighted-average of 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 securitites (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 issurance that has an antidutive 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 ar 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 or 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. What 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 U.S. GAAP?

Answer 24

A reconciliation of net income to net cash 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

Loss 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
~Divdends received
~Purchases and sales of trading securities, if appropriate, based on the nature and purpose for which the securities were acquired
~Income taxes paid

Question 27

What is the calculation for the Indirect Method?

Answer 27

Net income per I/S
\+ Depreciation Expense
\+ Losses and amortization (discounts)
- Gains and amortization (premiums)
- Equity Earnings Affliate
\+ Decrease in OA (sell - inflow)
- Increase in OA (buy - outflow)
\+ Increase in OL (borrow - inflow)
- Decrease in OL (repay - outflow)

**Remember change in OA and OL for this are INFLOW ACTIVITIES. (Inflow +) and (Outflow). Or OA opposite sign, OL same sign.

Question 28

Explain a way to remember going from Accrual to Cash.

Mainly in Cash Flow Statement Preparation.

Opposite of Cash to Accrual.

Answer 28

INFLOW Activities usually involve Revenues and Receivables. It’s used in the cash received from customers (direct method) and in the indirect method.

INFLOW: Inflow + and Outflow -
INFLOW: OA opposite sign, OL same sign

OUTFLOW Activities usually involve Expenses and Payables. It’s used in the cash paid to suppliers and employees and cash paid for other expenses (direct method).

OUTFLOW: Outflow + and Inflow -
OUTFLOW: OA same sign, OL opposite sign

Question 29

Explain a way to remember going from Cash to Accrual.

Opposite of Accrual to Cash.

Answer 29

INFLOW Activities usually involve Revenues and Receivables.

INFLOW: Inflow - and Outflow +
INFLOW: OA same sign, OL opposite sign

OUTFLOW Activities usually involve Expenses and Payables.

OUTFLOW: Outflow - and Inflow +
OUTFLOW: OA opposite sign, OL same sign