FAR 2I - Equity

Question 1

How does buying treasury stock at greater than book value affect equity and EPS?

Answer 1

Buying treasury stock at greater than book value reduces equity and the number of shares outstanding, which increases EPS due to fewer shares being available.

Question 2

What are the two methods for accounting for treasury stock?

Answer 2

Cost Method: Treasury stock is carried at cost until reissued or retired.
Par Value Method: Reacquired shares are treated as if retired, and subsequent sales are treated as if the shares were unissued.

Question 3

Do treasury stock transactions result in a gain or loss?

Answer 3

No, treasury stock transactions do not result in a gain or loss. They affect additional paid-in capital (APIC) and retained earnings, as they are treated as equity transactions.

Question 4

When is a liability for dividends payable recorded?

Answer 4

A liability for dividends payable is recorded when the board of directors declares the dividend. Prior to declaration, there is no legal obligation to pay.

Question 5

What are liquidating dividends, and how are they recorded?

Answer 5

Liquidating dividends are a return of capital, not a return on investment. They occur when dividends exceed retained earnings and are debited to other equity accounts.

Question 6

What factors are commonly considered in a partnership’s income or loss distribution agreement?

Answer 6

Salaries for partners.
Interest on capital balances.
Bonuses to managing partners.
Residual distributed by a fixed ratio.

Question 7

How are initial partnership capital accounts determined?

Answer 7

Initial partnership capital accounts are based on the net fair value invested by each partner into the partnership.

Question 8

What happens to a subscriber’s rights when stock is sold on a subscription basis?

Answer 8

The subscriber usually has all the rights and privileges of a stockholder, unless specified otherwise in the subscription contract, even before the full subscription price is paid.

Question 9

How are quasi-endowments classified in Not-for-Profit (NFP) organizations?

Answer 9

Quasi-endowments in NFPs are classified as net assets without donor restrictions because future governing boards can undo the designation.

Question 10

What are warrants, and what rights do they give the holder?

Answer 10

Warrants give the holder the right to purchase a set number of shares at a fixed price on or before the expiration date. They provide potential for future equity ownership.

Question 11

How are partnership capital balances treated during liquidation?

Answer 11

During liquidation, combine the partner’s loans to the partnership with their capital balances. After paying debts and accounting for losses, distribute any remaining cash based on the final capital account balances.

Question 12

How does the bonus-to-new-partner method work in partnerships?

Answer 12

Under the bonus-to-new-partner method, the new partner’s capital is based on their percentage ownership of the total revalued partnership capital, computed by adding the new partner’s investment.

Question 13

When issuing additional shares less than 20-25%, what amount is transferred from retained earnings?

Answer 13

When issuing additional shares less than 20-25%, transfer an amount equal to the fair value of the additional shares from retained earnings.

Question 14

How are warrants recorded?

Answer 14

Warrants are recorded when issued, typically under equity. They provide the holder the option to purchase shares at a fixed price before expiration.

Question 15

What is the difference between cost method and par value method for treasury stock?

Answer 15

Cost Method: Reacquired shares are carried at cost until sold or retired.
Par Value Method: Reacquired shares are treated as if they were retired immediately.

Question 16

How are treasury stock sales treated under the par value method?

Answer 16

Under the par value method, the reacquisition and subsequent sale are treated as separate transactions. The sale is accounted for as if the shares were newly issued.

Question 17

How are liquidating dividends accounted for?

Answer 17

Liquidating dividends are recorded by debiting equity accounts when the dividend amount exceeds retained earnings, as they represent a return of investment rather than income.

Question 18

What happens if a partnership agreement does not specify profit or loss distribution?

Answer 18

If there is no specific agreement, profits and losses are shared equally among all partners, regardless of their capital contributions.

Question 19

What are the major factors considered in determining a partnership’s profit-sharing agreement?

Answer 19

Asset investment by partners.
Time (service) investment of partners.
Experience, expertise, and education of partners.

Question 20

What is the treatment of unpaid dividends before the declaration date?

Answer 20

Before the declaration date, there is no liability for dividends payable, as the company has no legal obligation to distribute them until they are declared by the board.

Question 21

What rights do subscribers of stock on a subscription basis have?

Answer 21

Subscribers typically have all stockholder rights unless the subscription contract specifies otherwise, even before the full payment for the shares is received.

Question 22

How are quasi-endowments treated in NFPs?

Answer 22

Quasi-endowments in NFPs are classified as net assets without donor restrictions, as future governing boards can change or revoke the designation.

Question 23

What is a liquidating dividend, and when does it occur?

Answer 23

A liquidating dividend is a return of capital to investors, and it occurs when the dividend exceeds retained earnings, requiring debits to other equity accounts. No dividend income is booked

Question 24

How are treasury stock transactions treated in financial reporting?

Answer 24

Treasury stock transactions affect equity accounts like additional paid-in capital (APIC) and retained earnings. They do not result in gains or losses in the income statement.

Question 25

When must a company accrue for dividends?

Answer 25

A company must accrue for dividends only after they are declared by the board of directors, creating a legal obligation to pay.

Question 26

What is the role of a sinking fund related to treasury stock?

Answer 26

A sinking fund is not typically involved with treasury stock but is used in bond payments, where funds are set aside to ensure repayment of debt. Treasury stock is an equity transaction.

Question 27

What are dividends in arrear?

Answer 27

Unpaid dividends on cumulative preferred stock that have accumulated because the company has not paid them on their scheduled payment dates

Question 28

When to accrue for dividends in arrear?

Answer 28

When actually declared

Question 29

What is the bonus method in a partnership?

Answer 29

Adjusts partners’ capital balances without recognizing goodwill. Any excess or shortfall in payments to a retiring partner or contributions by a new partner is allocated to the remaining partners based on their profit-sharing ratios

Question 30

What are dividends in arrears?

Answer 30

Any preferred dividend not paid out, so cumulative preferred stock

Must be disclosed in total and on a per share basis

Question 31

What are liquidating dividends?

Answer 31

Non-dividend distribution made during a partial or full liquidation. Retained earnings is used up and APIC is debited which is the portion that is not taxable for shareholders

Question 32

2 Types of partnership admissions are?

Answer 32

1) Bonus method
2) Goodwill method

Question 33

How does the bonus method in a partnership admission work?

Answer 33

New partner contributes cash and identifiable assets at FV (no intangible recognition).
Total partner contributions are carrying amount of existing net assets + FV of contributed new assets
Any difference between assets contributed and interest granted to new partner is the bonus recognized

Question 34

How does the goodwill method in a partnership admission work?

Answer 34

Same as Bonus method, but intangible contribution (e.g. expertise) IS recognized
Difference FV of partnership and interest granted is recognized as goodwill (if FV>interest received, excess goodwill goes to old partners and vice versa)

Question 35

Steps of partnership liquidation?

Answer 35

1) Sell off assets; Recognize any gain/loss in partners’ capital accounts
2) Pay off liabilities
3) Any negative partner’s account is either absorbed by other partners or an additional contribution is made by that partner
4) Final distribution to partners

Question 36

Accumulated other comprehensive income examples? (BS)

Answer 36

a) Unrealized holding gains/losses on available-for-sale investments
b) Foreign currency translation gains/losses
c) Pension plan gains/losses
d) Pension prior service costs or credits

AOCI represents the sume of unrealized ganis/losses from OCI on the income statement

Question 37

Components of statement of retained earnings?

Answer 37

a) BB RE
b) + Net income of the year
c) - dividends paid
d) - appropreated RE for e.g. contruction
e) +- Net unrealized gain/loss on AOCI
f) = EB RE

Question 38

Stock dividend bookings at FV or par value?

Answer 38

a) less than 20-25% record at FV (difference between FV and par is credited as APIC)
b) more than 20-25% record at par value (like a stock split, no APIC used, credit is fully in Common stock dividend distributable at par)

Retained earnings is debited at either FV or par at date of declaration.

Question 39

Stock dividend booking at a) Date of declaration and b) disctribution?

Answer 39

a) Debit RE (FV or Par), Credit Common Stock Dividend Distributable, Credit APIC for difference (if below 20-25% and FV method is used)
b) Debit Common Stock Dividend Distributable, Credit Common Stock

Question 40

When is APIC credited when treasury stock is reissued under the cost method?

Answer 40

When reissued at excess of bought back previously. A loss does not touch APIC, but Retained Earnings

Question 41

When issuing a stock dividend, at what timing is the APIC calculated? Date of declaration or distribution?

Answer 41

Date of declaration, ignore date of distribution

Question 42

What happens if a company redeems preferred stock above par value and the Additional Paid-In Capital (APIC) from preferred stock is insufficient to absorb the excess over par?

Answer 42

The shortfall is debited to Retained Earnings, reducing the company’s overall equity.

Redeem=Retires=Buys back=repurchases

Question 42

When issuing a stock dividend, what is key to look at and what are the implications on the journal entries?

Answer 42

Above or below 20-25%.
a) If above, then RE is only lowered by the par value of the issued shares and the credit entry is common stock (no APIC is recorded, no FV is used).
b) if below, RE is debited by FV, common stock Par value credited, and APIC for difference credited

Question 43

What happens if a company redeems preferred stock below par value?

Answer 43

The difference between the par value and the redemption price is credited to Additional Paid-In Capital (APIC), and Retained Earnings is not affected.

Redeem=Retires=Buys back=repurchases

Question 44

Are APIC and APIC TS 2 different FSLI?

Answer 44

Yes, so if the cost method of treasury stock is applied and treasury stock transaction resulted in a loss and there is no APIC TS balance available (although there would be APIC on common stock), then RE is debited and not APIC (TS)