FAR-F7-M1/M2-Stockholder's Equity Part 1 and 2

Question 1

What is the biggest difference between common stock and preferred stock?

Answer 1

Common stock usually has voting rights and preferred stock doesn’t. Preferred stock usually has dividends and dividend priority and common stock MIGHT not receive dividends

Question 2

Either with the cost method or the pav method, when a company issues stock, what are the three accounts hit?

Answer 2

Dr. Cash Received XXX
Cr. Common stock (# of shares * par value) (XXX)
Cr. APIC (whatever is above par value) (XXX)

Question 3

What are the main components of stockholder’s equity?

Answer 3

Stockholder’s equity =
Capital Stock (common stock and preferred stock)
PLUS Additional paid in capital (capital in excess of par)
PLUS Retained Earnings (appropriated and unappropriated retained earnings)
PLUS AOCI
LESS Cost of Shares in Treasury
EQUALS Total Stockholder’s equity of corporation
PLUS Noncontrolling Interest
EQUALS Total Stockholder’s Equity of corporation

Question 4

Is the following statement true or false? Preferred stock may include preference to dividends, which may be cumulative, noncumulative and participating or nonparticipating.

Answer 4

TRUE. Preferred stock may include preference to dividends, which may be cumulative, noncumulative and participating or nonparticipating.

Question 5

What are cumulative preferred stock?

Answer 5

Cumulative preferred stock provides that all or part of the preferred dividend not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders. The accumulated amount is referred to as Dividends in Arrears.

Question 6

Is the amount held in Dividends in arrears for cumulative preferred stock considered a liability? Should it be disclosed?

Answer 6

The amount withheld in dividends in arrears for cumulative preferred stock is not a liability but it must be disclosed in the total and as a pre share basis in the footnotes.

Question 7

What are noncumulative preferred stock?

Answer 7

Noncumulative preferred stock: Dividends not paid in any year DO NOT ACCUMULATE. The preferred sthareholders lose the right to receive dividends that are not declared.

Question 8

How are dividends shared with participating cumulative preferred stock?

Answer 8

Participating preferred stock basically share dividends equally THEN pro-rata. The principle applied is that with participating cumulative preferred stock, before any pro-ration of dividends exist, the common shareholders must receive an equal % as the preferred shareholders. Then the remaining balance is distributed to preferred stockholders and common stockholders based on the par values of ownership held relative to total capitalization.

Question 9

How are dividends shared with nonparticipating preferred stock?

Answer 9

When preferred stock is nonparticipating, preferred shareholders are limited to the dividends provided by their preference. They do not share in excess dividends.

Question 10

Should mandatorily redeemable preferred stock be considered a liability by the issuing company?

Answer 10

Yes. Common stock that contains an unconditional redemption feature should be reported on the issuer’s books as liability on the date of issuance because there is an obligation of a cash outflow in the future that the company has no ability to prevent.

Question 11

Is the following statement true or false? 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 are paid.

Answer 11

TRUE. 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 are paid.

Question 12

Can preferred stock be callable, redeemable or convertible?

Answer 12

Yes, preferred stock can be callable, redeemable and convertible.

Question 13

What are convertible preferred stock?

Answer 13

Convertible preferred stock may be exchanged for common stock (at the option of the stockholder) at a specified conversion rate.

Question 14

Is the following statement true or false in relation to convertible preferred stock? Allocate ISSUE PROCEEDS of a basket purchase or sale of convertible preferred stock based on relative fair market values.

Answer 14

TRUE. Allocate ISSUE PROCEEDS of a basket purchase or sale of convertible preferred stock based on relative fair market values.

Question 15

How is retained earnings generally calculated?

Answer 15

Retained earnings =
Net Income or Loss
LESS dividends declared
PLUS or LESS prior period adjustments (correction of error)
PLUS or LESS accounting principle change
EQUALS retained earnings

Question 16

Is the following statement true or false. Retained earnings may be classified as appropriated (restricted) or unappropriated. The purpose of appropriating Retained Earnings is to disclose to shareholders that some of the retained earnings are not available to pay dividends because they have been restricted for legal and contractual reasons.

Answer 16

TRUE. Retained earnings may be classified as appropriated (restricted) or unappropriated. The purpose of appropriating Retained Earnings is to disclose to shareholders that some of the retained earnings are not available to pay dividends because they have been restricted for legal and contractual reasons.

Question 17

Can appropriation of retained earnings be used to absorb costs or losses or to smooth periodic income?

Answer 17

NO. Appropriation of retained earnings cannot be used to absorb costs or losses or to smooth periodic income.

Question 18

What is the JE to record appropriation of retained earnings.

Answer 18

Dr. Retained earnings (unappropriated) XXX
Cr. Retained earnings (appropriated) (XXX)

Total retained earnings remains unchanged though. It does not affect the income statement.

Question 19

Is appropriation of retained earnings required?

Answer 19

No, retained earnings is not a requirement. It can be set aside but its at the discretion of the board of directors.

Question 20

What is treasury stock?

Answer 20

Treasury stock is a corporation’s own stock that has been issued to shareholders and subsequently reacquired.

Question 21

The 2 different methods of accounting for treasury stock are the cost method and the par value method. How are gains and losses recorded under both?

Answer 21

With the cost method, the gain or loss is recorded UPON REISSUE

With the par value method, the gain or loss is recorded UPON REPURCHASE.

Question 22

Regardless of whether the cost method or the par value method is used to account for treasury stock, are the gains and losses recorded on the income statement?

Answer 22

No, under both methods, the gains and losses are recorded as a direct adjustment to stockholder’s equity and are not included in the income statement.

Question 23

With the cost method of accounting for treasury stock, the treasury shares are recorded and carried at their reacquistion cost. Does this reacquisition cost become the new par value of the treasury stock?

Answer 23

Yes, the reacquisition cost becomes the new par value of the treasury stock. With the cost method, gains and losses are only recorded when the treasury stock is reissued or retired.

Original Entry to record issuance of common stock
Dr. Cash Received XXX
Cr. Common stock (par value) (XXX)
Cr. APIC - C/S (@ excess of selling price over par) (XXX)

If buy back @ above issue price
Dr. Treasury Stock (@ repurchase price)
Cr. Cash (XXX)

If reissued at above cost (Gain)
Dr. Cash (@ selling price)
Cr. Treasury Stock (@new par aka the repurchase price)
Cr. APIC - Treasury Stock (@excess of selling price over new par) (XXX)

If reissued at below cost (loss)
Dr. Cash (@selling price) XXX
Dr. APIC - Treasury Stock (whatever balance is in this account is withdrawn first) XXX
Dr. Retained Earnings (if APIC - T/S is completely withdrawn, then debit R/E) XXX
Cr. Treasury Stock (@ new par)

Question 24

Is the following statement true or false? The account APIC - T/S is credited for gains and debited for losses when treasury stock is reissued at prices that differ from the reacquisition cost (the new par value). Losses may also decrease retained earnings IF the APIC - T/S does not have a balance large enough to absorb the loss.

Answer 24

TRUE. The account APIC - T/S is credited for gains and debited for losses when treasury stock is reissued at prices that differ from the reacquisition cost (the new par value). Losses may also decrease retained earnings IF the APIC - T/S does not have a balance large enough to absorb the loss.

Original Entry to record issuance of common stock
Dr. Cash Received XXX
Cr. Common stock (par value) (XXX)
Cr. APIC - C/S (@ excess of selling price over par) (XXX)

If buy back @ above issue price
Dr. Treasury Stock (@ repurchase price)
Cr. Cash (XXX)

If reissued at above cost (Gain)
Dr. Cash (@ selling price)
Cr. Treasury Stock (@new par aka the repurchase price)
Cr. APIC - Treasury Stock (@excess of selling price over new par) (XXX)

If reissued at below cost (loss)
Dr. Cash (@selling price) XXX
Dr. APIC - Treasury Stock (whatever balance is in this account is withdrawn first) XXX
Dr. Retained Earnings (if APIC - T/S is completely withdrawn, then debit R/E) XXX
Cr. Treasury Stock (@ new par)

Question 25

Using the par value method to account for treasury stock, when are gains and losses recognized?

Answer 25

With the par value method, gains and losses are calculated upon repurchase, as opposed to reissuance.

Question 26

Is the following statement true or false. Under the par value method to account for treasury stock, the resale of stock significantly below par results in recording a loss in retained earnings to the extent the loss exceeds the previously recorded APIC - T/S account.

Answer 26

TRUE. Under the par value method to account for treasury stock, the resale of stock significantly below par results in recording a loss in retained earnings to the extent the loss exceeds the previously recorded APIC - T/S account.

Question 27

Regardless of the cost method or par value method used, how will retained earnings and net income be affected with treasury stock transactions?

Answer 27

Regardless of the method used, Net income or retained earnings will NEVER BE INCREASED through treasury stock transactions. Retained earnings may be decreased however.

Question 28

What is donated stock?

Answer 28

Donated stock is a company's own stock received as a donation from a shareholder. There is no change in total stockholder's equity, but the number of shares outstanding decreases resulting in higher book value per common share.

Question 29

Is donated stock recorded at fair value by the company?

Answer 29

Yes, donated stock is recorded at fair value.

Question 30

What is the JE to record the sale of capital stock using the subscription method?

Answer 30

Dr. Subscription Receivable XXX Cr. Common Stock "subscribed" (XXX) Cr. APIC (XXX) Once fully paid, then Dr. Common stock "subscribed" XXX Cr. Common stock (issued) (XXX)

Question 31

What are stock subscriptions?

Answer 31

Frequently a corporation sells its capital stock by subscription. This means that a contractual agreement to sell a specified number of shares at a agreed upon price on credit is entered into and upon full payment of the subscription, a stock certificate evidencing ownership in the corporation is issued.

Question 32

Is the following statement true or false? The issuance of stock rights requires a memorandum entry only.

Answer 32

TRUE. The issuance of stock rights requires a memorandum entry only.

Question 33

If the stock rights are issued without consideration, should there be an entry or a disclosure?

Answer 33

If the stock rights are issued without consideration (not exercised) then no entry is required. Only disclosure.

Question 34

Is the following statement true or false. Stock issued for outside services should be recorded at the fair value of the stock.

Answer 34

True. Stock issued for outside services should be recorded at the fair value of the stock.

Question 35

When should a liability for dividends payable be recorded?

Answer 35

The date the board of directors formally approves a dividend. On the date of declaration Dr. Retained Earnings XXX Cr. Dividends Payable (XXX)

Question 36

Is the following statement true or false? Liquidating dividends occurs when dividends to shareholders exceed retained earnings. Dividends in excess of retained earnings would be charged (debited) first to APIC and then to common stock and preferred stock.

Answer 36

TRUE. Liquidating dividends occurs when dividends to shareholders exceed retained earnings. Dividends in excess of retained earnings would be charged (debited) first to APIC and then to common stock and preferred stock

Question 37

Is the following statement true or false? On the date of declaration, the property to be distributed should be restated to fair value and any gain or loss should be recognized in come. The dividend liability and related debit to retained earnings should be recorded at fair value of the assets transferred.

Answer 37

TRUE. On the date of declaration, the property to be distributed should be restated to fair value and any gain or loss should be recognized in come. The dividend liability and related debit to retained earnings should be recorded at fair value of the assets transferred.

Question 38

What are scrip dividends and how are they recorded?

Answer 38

With scrip dividends, a corporation commits to paying a dividend at some later date. On the date of declaration, retained earnings is debited and notes payable (instead of dividends payable is credited). Some scrip dividends even bear interest from the declaration date of the payment and thus require accrual.

Question 39

Is the following statement true or false? When a small stock dividend (less than 20 to 25% of the shares previously outstanding) is distributed, the fair market value of the stock dividend at the date of declaration is transferred from R/E to capital stock and APIC. There is no affect on total S/E

Answer 39

TRUE. When a small stock dividend (less than 20 to 25% of the shares previously outstanding) is distributed, the fair market value of the stock dividend at the date of declaration is transferred from R/E to capital stock and APIC. There is no affect on total S/E Dr. Retained Earnings (@ FMV) XXX Cr. Common Stock (@ par) (XXX) Cr. APIC (@ excess of par) (XXX)

Question 40

Is the following statement true or false. If a stock dividend is more than 20 to 25% of the previously issued stock, then it is considered a large stock dividend and therefore the par value of the stock dividend is transferred from R/E to capital stock.

Answer 40

True. If a stock dividend is more than 20 to 25% of the previously issued stock, then it is considered a large stock dividend and therefore the par value of the stock dividend is transferred from R/E to capital stock. JE to record declaration Dr. Retained Earnings (par) XXX Cr. Common stock distributable (@ par) (XXX) JE to record distribution Dr. Common Stock Distributable XXX Cr. Capital Stock (XXX)

Question 41

What are stock splits?

Answer 41

Stock splits occur when a corporation issues additional shares of its own stock (without charge) to current shareholders and reduces the par value per share proportionately. There is no change in the total book value of the shares outstanding.

Question 42

Does a stock split affect Retained earnings or stockholder's equity?

Answer 42

No. Stock splits do not affect retained earnings or stockholder's equity.

Question 43

How is the book value per share calculated?

Answer 43

Total shareholder's equity LESS preferred stock outstanding LESS cumulative preferred dividends in arrears EQUALS common shareholder's equity Common shareholders equity / # of common shares outstanding.