I. EQUITY

Question 1

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Common vs Preferred Stock

Answer 1

Common vs Preferred Stock

The biggest difference in common stock vs preferred is that

• common stock usually has voting rights and
• preferred doesn’t, and
• preferred stock usually has dividends and dividend priority when common stock might not receive dividends

Question 2

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Stock Issuance

Answer 2

When a company issues stock, there are usually 3 accounts hit:

• ‘Cash’ for the amount of the stock issued (cash received)
• ‘Common stock’ (#shares * par value)
• ‘Paid-in capital excess of par’- whatever is above the par value

If you issued 10 shares of $1 par value stock for $100, you would receive $100 in cash, credit ‘common stock’ for $10, and credit ‘additional paid in capital’ for $90.

If the stock is “no par” stock, then the entry would just be a debit to cash of $100 and a credit to ‘common stock’ of $100.

Question 3

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Preferred stock can be:

Answer 3

Preferred stock can be:

• callable
• redeemable
• convertible

If redeemable preferred stock has a specified date at a specified price, it is usually classified as debt and associated cash dividends are reported as interest expense.

When callable or redeemable stock is called or redeemed, any dividends in arrears are paid first.

Question 4

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Treasury Stock

Answer 4

Treasury Stock

Treasury stock is when a company purchases its own stock. It does not represent ownership and it lowers cash and owners’ equity.

Treasury stock is a contra- owners’ equity account.

It is not an asset or an investment, income is never affected, earnings per share is increased, and retained earnings can be decreased but not increased by treasury stock.

There are two methods of accounting for treasury stock:

Cost method: this debits the treasury stock account at cost.

Par method: this debits the treasury stock account at par.

When treasury stock is purchased, common stock is reduced pro-rata for the # of treasury shares purchased.

Question 5

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accounting for treasury stock:

Cost method: example

Answer 5

Cost method: this debits the treasury stock account at cost.

When treasury stock is purchased, cash is credited and ‘treasury stock’ is credited for the same amount.

Example:

ABC purchases 100 of its own shares for $20 per share. The entry would be:

Treasury stock $2,000

Cash $2,000

Notice there’s no mention of par value - the treasury stock account is simply debited for the amount spent.

If ABC later reissued 20 of these shares at $30 per share:

Cash $600

Contributed capital from treasury stock $200

Treasury stock $400

The original purchase of treasury assigns a value of $20 to each share of treasury stock, and this acts like a “par value” for the treasury stock in subsequent reissues of the treasury stock.

Question 6

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accounting for treasury stock:

Par method: example

Answer 6

Par method: this debits the treasury stock account at par.

When treasury stock is purchased, common stock is reduced pro-rata for the # of treasury shares purchased.

Example:

ABC purchases 100 shares at $30/share of its own $10 par stock that was originally issued at $20 per share.

The entry would be:

Treasury stock $1,000

Contributed capital excess of par $1,000

Contributed capital from treasury stock $1,000

Cash $3,000

If the treasury stock was purchased for $15 per share it would be:

Treasury stock $1,000

Contributed capital in excess of par $1,000

Contributed capital from treasury stock $500

Cash $1,500

Under the par method, treasury stock is debited for the par amount of shares purchased, and then “contributed capital excess of par” is debited up to the amount of the original issue price. The remainder is either debited or credited to “contributed capital from treasury stock” depending on whether the treasury stock purchase price was more or less than the original price.

Question 7

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Dividends (7)

Answer 7

• Dividends are a distribution of cash or other property from a firm to its owners.
• They are a distribution of earnings, so they are not an expense.
• The liability for dividends is recognized at the declaration date.
• The ‘date of record’ is the cutoff date for the owners who will receive dividends. If you bought stock in the company after the date of record, no dividends for you.
• Payment date is the date the dividends are actually paid out.
• Dividends in arrears are dividends that accumulate because they weren’t actually paid out during a period. However, no liability is recorded on dividends in arrears until dividends are declared.
• Dividends reduce the owners’ equity account when paid.