Module 4

Question 1

Durango Inc. had net income for 2017 of $2,120,000 and earnings per share on common stock of $5. Included in the net income was $300,000 of bond interest expense related to its long-term debt. The income tax rate for 2017 was 30%. Dividends on preferred stock were $400,000. The payout ratio on common stock was 25%. What were the dividends for common stock in 2017?

Answer 1

$430,000
Correct. The Common Stock Payout Ratio is calculated as Common Stock Cash Dividends divided by Net Income (less preferred dividends, if applicable). Net income already accounts for bond interest and income taxes. Therefore, Common Stock Cash Dividends = Common Stock Payout Ratio x Net Income (less preferred dividends). [25% x ($2,120,000 - $400,000)] = $430,000.

Question 2

At the date of declaration of a large common stock dividend, what should the entry include?

Answer 2

A debit to Retained Earnings
Correct. A large stock dividend (greater than 20% - 25%) more closely resembles a stock split. The corporation uses the par value instead of the fair value when calculating the transfer from Retained Earnings to Common Stock. On the declaration date, a large stock dividend is recorded using the following journal entry: Debit to Retained Earnings (at par), Credit to Common Stock Dividend Distributable (at par).

Question 3

Common stockholders of a business enterprise are said to be the residual owners. What does the term residual owner mean?

Answer 3

The stockholders bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership.
Correct. Common stockholders bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership.

Question 4

Long Co. issued 100,000 shares of $10 par common stock for $1,200,000. A year later Long acquired 16,000 shares of its own common stock at $15 per share. Three months later Long sold 8,000 of these shares at $19 per share.

If the cost method is used to record treasury stock transactions, what is the credit side of the journal entry to record the sale of the 8,000 treasury shares?

Answer 4

Treasury Stock for $120,000 and Paid-in Capital from Treasury Stock for $32,000
Correct. Sales of treasury stock above and below cost of treasury stock are only recorded in the Paid-in Capital from Treasury Stock account. The treasury stock balance for the 16,000 shares purchased is $240,000 (16,000 shares x $15/share). The cost of 8,000 shares, therefore is $120,000. The credit to treasury stock is limited to that cost. The journal entry to record the sale of 8,000 shares of treasury stock is: Debit Cash $152,000 (8,000 shares x $19/share); Credit Treasury Stock $120,000, Credit Paid-in Capital from Treasury Stock $32,000.