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Owners' Equity Flashcards

1
Q

When are dividends in arrears recorded for cumulative preferred stock?

A

They are not accrued until declared

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2
Q

When are dividends in arrears included as a disclosure and not an accrual in the financial statements?

A

If a year passes and no Cumulative Preferred Stock is declared, then the dividends in arrears are included as a disclosure – not an accrual in the Financial Statements

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3
Q

What interest rate is used to discount stock options?

A

The risk-free interest rate

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4
Q

What are the three components of a corporation’s equity?

A

Contributed capital (stock + APIC)

Retained earnings

Accumulated balance of OCI

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5
Q

What are the four classifications of OCI?

A

Foreign currency items

Pension adjustments

Unrealized gains/losses on certain investments

Gains/losses on certain hedging activities

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6
Q

What differentiates capital stock from APIC?

A

Capital stock is the par value, APIC is the excess

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7
Q

What is legal capital?

A

The portion of contributed capital required by statute to stay with the business, for creditors’ sake

Usually the par value of issued stock, or the total amount received for stock without any par value

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8
Q

What are three rules related to legal capital?

A

Cannot be used as a basis for dividends

Acquisition of treasury stock can’t be more than retained earnings

Amount of legal capital can’t be arbitrarily reduced

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9
Q

What are the four basic rights for common stock?

A

Voting rights

Dividend rights

Preemptive rights

Rights to assets in liquidation

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10
Q

What would a JE for a conversion from preferred to common stock look like?

A

Debit: Preferred stock
Debit: APIC – Preferred
Credit: Common stock
Credit: APIC – Common (balance)

Preferred Stock and Common Stock entries will be for par value

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11
Q

What would a JE for a call/cancellation of preferred stock look like?

A 
Debit: Preferred Stock
Debit: APIC -- Preferred
Debit: Retained Earnings (if loss)
  Credit: Cash (call price)
  Credit: APIC -- Retirement of PS (if gain)
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12
Q

What is cumulative preferred stock?

A

If the corporation fails to pay dividends for a given year, cumulative PS holders are entitled to the dividends in future years

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13
Q

Are dividends in arrears considered a liability?

A

No, though they should be disclosed

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14
Q

What is participating preferred stock?

A

PS which entitles the holder to dividends paid to common stockholders in excess of a certain amount

E.g. owners of 4% fully participating PS will be entitled to 4% dividends yearly, but if common stockholders receive greater dividends, they will receive the same

Fully participating = entitled to all excess
Partially participating = limit on what the excess dividends can grow to

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15
Q

What are stock rights?

A

Rights to acquire more stock under certain conditions and in a given time period (e.g. for a new stock offering)

No JE is required when stock rights are issued (or expired) – they don’t affect common stock, APIC, or retained earnings

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16
Q

What are stock warrants?

A

Physical evidence of stock rights, specifying the terms of the rights

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17
Q

What disclosures are required for owner’s equity?

A

Rights of outstanding securities (e.g. dividend, liquidation, participation, call, conversion, voting, etc.) – in summary form

Number of shares issued

Liquidation preference for preferred stock

Redeemable stock

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18
Q

What, specifically, must be disclosed re: the liquidation preference for preferred stock?

A

If preference is very high in excess of par, disclosure is required in equity section (cannot be in notes)

Aggregate or per-share amounts at which PS may be called/redeemed, and aggregate or per-share amounts of cumulative dividends in arrears must be disclosed somewhere

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19
Q

What happens if a shareholder purchases stock for less than par value?

A

Incurs a contingent liability for the difference

But it’s mostly illegal to issue stock at a discount to par

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20
Q

What is a subscription?

A

Contract to purchase stock in the future

Stock is usually not issued until full subscription price is paid

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21
Q

What happens if a subscriber defaults on the subscription contract?

A

Corporation might:

  • return payments in full
  • issue an equivalent number of shares for the payments already made
  • retain payments to cover any losses on reselling stock to others, returning the rest
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22
Q

What is peculiar about JEs for subscriptions?

A

At the date of the contract, “Subscriptions Receivable” will be debited and “Common Stock Subscribed” credited. These are reversed when all cash is paid later.

Some cash might be paid at the date of contract, reducing the amount of the receivable

APIC – Common Stock is credited at the date of contract (there is no “subscribed” entry for it)

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23
Q

How do you record a transaction of a noncash asset for stock?

A

Determine FV of asset or market value of stock, whichever is more clearly determinable

Debit: Asset
Credit: Common Stock
Credit: APIC – Common Stock (balance)

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24
Q

How is a business incorporation recorded?

A
  • The corporation’s acquired assets are at FV
  • Current liabilities at face amount, noncurrent liabilities at PV
  • Issued stock given (in exchange for above) to incorporating persons is recorded at par value
  • APIC is the plug – no gain or loss is recorded

Debit: Assets
Credit: Liabilities
Credit: Common Stock (par)
Credit: APIC (balance)

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25
Q

How is a lump-sum purchase of different classes of stock accounted for?

A

Proportional method: allocated according to relative FV of classes of stock

Incremental method: one stock is given its FV, remainder to other security

Possibly combinations of these

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26
Q

How is retained earnings calculated?

A

Income
- dividends declared
- amounts transferred to PIC accounts
= RE

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27
Q

What is not included in retained earnings?

A
  • Gains from treasury stock transactions
  • Gifts of property
  • Additions to equity from property reappraisals
  • Accumulated balance of OCI
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28
Q

What is appropriated retained earnings?

A

The portion unavailable for dividends

Purpose might be to save for long-term asset, to pay off bonds, to provide a buffer for future losses, etc.

Often appropriated to cover total amount of treasury stock

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29
Q

What would be a JE for appropriated retained earnings?

A

At the end of the year, when closing out retained earnings…

Debit: Retained Earnings
Credit: Appropriated RE – Plant Construction [or whatever]

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30
Q

What is the format for a statement of retained earnings?

A 
BRE
\+/- cumulative effect of retroactive changes in accounting principles
\+/- prior period adjustments
= Adjusted RE
\+ net income
- dividends declared
= ERE
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31
Q

What is quasi-reorganization?

A

Shift in capital structure to eliminate a deficit in RE – as if the company had been legally reorganized

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32
Q

What are different means of quasi-reorganization?

A

Revalue assets at NRV, yet do not increase the assets, but apply any increase against the deficit (losses increase the deficit)

Donate stock or reduce par value of stock to offset deficit, with any excess increasing the APIC

Charge the deficit against PIC directly

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33
Q

How do stock dividends affect RE?

A

According to their size:

  • small (< 20-25%) decrease RE by the FV of the stock
  • large (> 25%) decrease RE by par value
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34
Q

How do stock splits affect RE?

A

No effect if par is reduced proportionally with the split – otherwise RE is decreased by the par value of the new shares

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35
Q

What is the effect on APIC from a stock split?

A

Stock splits only affect par value - APIC remains the same.

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36
Q

How does the acquisition of treasury stock affect RE?

A

No change if cost method

No change if par value method, so long as cost <= (par + APIC)
-Otherwise, RE is decreased by purchase price over par and pro rata APIC

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37
Q

How does the sale of treasury stock affect RE?

A

No change if par value method

No change if cost method, so long as sale price > cost
-Otherwise, RE is decreased by amount of cost over sale price, but offset first to APIC on TS transactions

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38
Q

What are the three significant dates for dividends?

A

Declaration date - Formally declared by board of directors, dividends become a liability (debit RE, credit dividends payable)

Record date - Establishes recipients of dividends, no JE required

Payment date - debit dividends payable, credit cash (or other asset)

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39
Q

Which of the three dividend dates affects RE?

A

Only the declaration date

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40
Q

How are property dividends recorded?

A

Recorded at FV at declaration date (NOT payment date)

-any gain or loss is recorded in income from continuing operations

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41
Q

What would the JEs be for a property dividend whose FV exceeded its carrying value?

A 
Declaration date:
Debit: RE
  Credit: Property Dividends Payable
Debit: Property
  Credit: Gain

Payment date:
Debit: Property dividends payable
Credit: Property

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42
Q

What are liquidating dividends?

A

Not distributions of RE, but returns of contributed capital

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43
Q

How do stock dividends affect equity?

A

Decrease RE and increase PIC by same amount, so no net effect

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44
Q

What are the JEs for small and large stock dividends?

A

Small:
Debit: RE (at FV)
Credit: Common Stock (at par)
Credit: APIC – Common Stock (balance)

Large:
Debit: RE (at par)
Credit: Common Stock (at par)

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45
Q

What are the necessary conditions for employee-share purchase plans to be considered noncompensatory?

A

Either (1) the offer is not more favorable than whatever’s available to all holders of the same kind of stock, or
(2) any discount from market price is less than 5%, or if greater than 5%, is less than the issuance costs per share that would have been incurred for a public offering

46
Q

What option features are noncompensatory employee-share purchase plans able to have?

A
  • Employees have a short time (at most 31 days) after the purchase price has been fixed to enroll in the plan
  • The purchase price is based on the shares’ market price at the purchase date, and employees can cancel participation before the purchase date and get a refund of anything previously paid

Any other option features make the plan compensatory

47
Q

What is the main difference about compensatory stock plans?

A

They account for a compensation cost accrued by the company: the cost of giving a (valuable) stock option to an employee

48
Q

For compensatory plans, how is the stock option valuated?

A

Valued at FV

Measurement date is the date when the option is granted

49
Q

What is an example of a valuation model to valuate stock-based compensation?

A

Black-Scholes model

50
Q

What are the important components when valuating stock-based compensation?

A 
Dividends expected on stock
Exercise price
Volatility of the stock
Interest rate (risk-free rate) for the expected term of the option
Life of the option
Stock current price
51
Q

How are exchanges of stock-based compensation with nonemployees accounted for?

A

Recorded at FV

FV of the assets received may be more easily determinable

52
Q

If the stock option is granted as compensation for past services, what is the relevant grant-date JE?

A

Debit: Compensation Expense

Credit: Stock Options Outstanding (at FV)

53
Q

If the stock option is granted as compensation for future services, what are the relevant JEs?

A

Grant date:
Debit: Deferred Compensation Cost
Credit: Stock Options Outstanding

Year-end (each year for life of option)
Debit: Compensation Expense
Credit: Deferred Compensation Cost

54
Q

Is deferred compensation cost an asset?

A

No: deferred compensation cost is a deduction to Stock Options Outstanding, with the “net” being what compensation the employee has earned to that point

55
Q

What is the JE for when the stock option is exercised?

A

Debit: Cash
Debit: Stock Options Outstanding (FV)
Credit: Common Stock (par value)
Credit: APIC – Common Stock (to balance)

56
Q

How is unearned stock compensation accounted for?

A

If stock is issued before the employee performs all his obligations, his compensation is unearned

USC shown as reduction to equity, recognized as expense over the years the obligations are performed

57
Q

How are unexercised stock options accounted for?

A

Nonvested employees = compensation expense from previous years is decreased in the year the option expires

Vested employees = expense is NOT reversed

58
Q

How is the compensation expense recorded for ESOPs?

A

The FV of the assets contributed (or committed to be contributed) by the company for the period

59
Q

How are employer obligations in ESOPs accounted for?

A

If the employer commits to make contributions, this is presented as a liability

Offsetting debit reduces equity

60
Q

What must be generally disclosed for stock-based employee compensation?

A

Prominent disclosures about the accounting method used, and its effects on the statements

Required in both annual and interim statements

61
Q

What is treasury stock?

A

Corporation’s stock that has been reacquired

Reacquisition reduces equity, reissuance increases it

Accounted for by cost method (more common) or par value method

62
Q

What is peculiar about treasury stock?

A
  • It is not an asset
  • No gains/losses on TS transactions
  • RE can be decreased but not increased by TS transactions
  • total SHE is the same under both methods
  • many states require RE to be appropriated to cover the cost of TS
63
Q

How does treasury stock affect total stockholders’ equity?

A

SHE decreases by the cost of TS acquired, increases by proceeds received from TS reissuance

64
Q

What is the cost method for treasury stock transactions?

A

TS is always recorded, carried, and reissued at acquisition cost

If reissuance of TS > cost, excess is credited to APIC – Treasury Stock

If reissuance of TS < cost, deficit is charged against APIC – TS, if any remains, and then charged against RE

65
Q

What is a typical JE for the acquisition of treasury stock under the cost method?

A

Debit: Treasury Stock
Credit: Cash

TS is treated like inventory (when it is reissued, it will be credited and subject to FIFO or LIFO, etc.)

66
Q

What is the main difference between the cost method and the par value method?

A

Just as the cost method uses the APIC – TS and RE accounts for differences in price with the reissuance, the par value method does the same for both reissuance and acquisition

67
Q

On the par value method, how is treasury stock recorded when initially acquired?

A

TS is listed at par, and APIC – Common Stock is debited too – as if the CS were being retired

If acquisition price < CS price, excess is credited to APIC – TS

If acquisition price > CS price, deficit charged to APIC – TS and then RE

68
Q

What is a JE for treasury stock that has been acquired at a price below the common stock, using the par value method?

A

Debit: Treasury Stock (par)
Debit: APIC – Common Stock (amount above par)
Credit: Cash (actual amount paid)
Credit: APIC – TS (balance)

69
Q

What is a JE for treasury stock that has been reissued at a price above the common stock, using the par value method?

A

Debit: Cash (actual amount received)
Credit: Treasury Stock (par)
Credit: APIC – TS (balance)

Notice that APIC – CS is not credited. It was “retired” when the TS was reacquired. Reissuance gains or losses, on the par value method, are always in relation to the par value of the TS.

70
Q

How is treasury stock retired under the cost method?

A

Common Stock (at par) and APIC – CS are both debited to retire them

Difference between acquisition cost and original issue cost will result in deficit or excess

Any deficits –> charged to APIC – TS and then RE
Any excesses –> credited to APIC – TS

71
Q

How is treasury stock retired under the par value method?

A

Since the APIC – CS is already effectively retired (and the APIC – TS and RE are offset), simply debit CS and credit TS at par value

Debit: Common Stock (par)
Credit: Treasury Stock (par)

72
Q

What are the criteria requiring equity instruments to be reclassified as liabilities?

A

Anything issued in the form of shares that must be redeemed – the company must redeem it for some date or certain event

Any instrument with the obligation to repurchase shares

Any instrument with the obligation to issue shares, so long as the value of the instrument is not predominantly directly correlated with the FV of the shares

73
Q

What kind of companies does equity reclassification affect?

A

Privately-held ones, since many require shares to be sold back to the company upon termination of the agreement or death of the owner (both of which are certain)

^^ This often removes equity entirely from their balance sheets

74
Q

How would shares that must be redeemed by the company be recorded?

A

Liability of “shares subject to mandatory redemption”

Footnote would detail how these shares are composed (e.g. common stock at par value + retained earnings attributable to those shares)

75
Q

How do you record the contribution of assets in a partnership formation?

A

Assets recorded at FV, liabilities at PV

If any assets are subject to a mortgage, that decreases the partner’s capital account

E.g. if Bob gives $100,000 and Jim gives $150,000 building with $30,000 mortgage...
Debit: Cash for $100,000
Debit: Building for $150,000
  Credit: Mortgage for $30,000
  Credit: Bob, Capital for $100,000
  Credit: Jim, Capital for $120,000
76
Q

What are the two methods for recording unidentifiable assets in a partnership formation?

A

Bonus method and Goodwill method

Example of unidentifiable asset = business reputation

77
Q

How does the bonus method record unidentifiable assets?

A

It doesn’t record any unidentifiable assets – any difference between a partner’s contribution and his capital (the bonus amount) is the implicit value of his unidentifiable asset

This method takes the total capital contributed and divides it between the partners according to some specified ratio (e.g. 50-50)

78
Q

How does the goodwill method record unidentifiable assets?

A

Debits Goodwill for the value of the unidentifiable assets

Bonus method decreases one partner’s capital and increases the other’s to give the latter a bonus – but Goodwill method simply increases the bonus-partner’s capital to achieve the same relative result (e.g. 50-50) and then debits Goodwill to offset it

79
Q

What is the account used to denote partner withdrawals?

A

Drawing

80
Q

How are profits and losses divided between partners?

A

Independently of ownership interest

If no arrangement, assumed to be equally shared

If arrangement only regards profit sharing or only regards loss sharing, then the same ratios are presumed to apply to the other

81
Q

What are different ways that profits/losses can be divided among partners?

A

According to the ratio of their capital balances (either at a given date, or weighted average over a period)

Guaranteed payments

Percentage distribution (either of all income, or of remaining amount after other subtractions)

82
Q

If a new partner purchases the interest of an existing partner, how is it recorded?

A

The transaction is private between the new and existing partners, so any amounts (and gains or losses) don’t matter. The capital accounts are simply renamed. If A purchases B’s interest…

Debit: B, Capital
Credit: A, Capital

If a partial partnership interest is purchased, then only that amount will be renamed

83
Q

If a new partner gains an interest by contributing new assets, how is it recorded?

A

Bonus method or Goodwill method

84
Q

What is the total capital of a partnership after a new partner contributes assets?

A

BV of old assets + FV of new assets

In other words, there is not a revaluation of the old assets

85
Q

Under the bonus method for the admission of a new partner, what are the JEs if the partner pays more than what his interest % requires?

A

Since his interest % will be lower than his % of contributed assets, he is paying a bonus to the other partner(s)

Debit: Asset (FV)
Credit: Other Partner, Capital (for bonus)
Credit: New Partner, Capital (for interest)

“Other Partner, Capital” is debited/decreased if the new partner pays less than his interest % requires

86
Q

In a partnership of 3 or more, if a new partner’s entrance requires a bonus to be paid (either to or from the new partner), how is it distributed among the other partners?

A

By the same ratio as their profit/loss allocation, unless specified otherwise in the agreement

87
Q

What is the implied capital of a partnership?

A

The total FV of it

Calculated in goodwill method whenever the contributed capital of a new partner < his partnership interest

Equal to contributed assets / ownership interest (e.g. contribution of $50,000 for interest of 33% = implied capital of $150,000)

88
Q

How are new partners added in the goodwill method, if their contributed assets exceed their partnership interest?

A

Goodwill is given to old partner(s)

The total FV (implied capital) of the partnership is recalculated

Difference between implied capital and actual capital is goodwill, attributable to other partner(s)

89
Q

In a partnership of 3 or more, if a new partner’s entrance requires goodwill to be distributed to the other partners, how is it distributed among them?

A

By the same ratio as their profit/loss allocation, unless specified otherwise in the agreement

90
Q

How are new partners added in the goodwill method, if their contributed assets are less than their partnership interest?

A

(New partner’s interest %) x (the actual capital) = new partner’s capital account

Difference between contributed assets and capital account is goodwill

Debit: Asset
Debit: Goodwill
Credit: New Partner, Capital

91
Q

What may a partnership decide to do upon a partner’s departure?

A

Revalue the assets (up or down) to FV

Any diff. between BV and FV is allocated according to partners’ capital accounts, according to profit/loss ratios

92
Q

How do you account for partner withdrawals through the bonus method?

A

Calculate difference between payment departing partner will receive and his capital account

If payment > capital account, then reduce other partners’ capital accounts (according to profit/loss ratio)

If payment < capital account, then increase other capital accounts

93
Q

How do you account for partner withdrawals through the goodwill method?

A

Calculate difference between payment departing partner will receive and his capital account

If payment > capital account, then use the difference to get the implied goodwill, and increase everyone’s capital accounts accordingly
-Capital account for departing partner will then equal his cash payment

If payment < capital account, then do the same but decrease the total partnership’s goodwill and capital accounts

94
Q

What is implied goodwill?

A

The amount of goodwill to be increased for the partnership as a whole, given one partner’s increase

E.g., if a partner’s capital balance should increase by $8,000 due to goodwill, and if he gets 20% of profits, then total goodwill should increase by $40,000 for the partnership

95
Q

What is an intuitive but incorrect way to account for partner withdrawals on the goodwill method?

A

Rather than calculate implied goodwill, directly add difference between departing partner’s payment and his capital account to goodwill (or charge it to goodwill)

^^This is wrong; implied goodwill must be calculated

96
Q

What is the basic rule for partnership liquidation?

A

Creditors are paid before partners receive distributions

97
Q

How do loans between partners affect their capital accounts at liquidation?

A

They increase or decrease the capital account

98
Q

What occurs if a partner is distributed cash but his capital account is later shown to be negative?

A

Whoever distributed the cash to him may be personally liable to pay for that partner’s deficit

99
Q

What are the two different ways a partnership can be liquidated?

A

Lump sum and installments

Liquidation can occur over several months

100
Q

What are the four steps of a partnership liquidation with a lump-sum distribution?

A
  1. Sell all noncash assets; gain/loss is applied to capital accounts according to profit/loss ratio
  2. Pay back creditors/liabilities
  3. Pay liabilities to partners besides capital and profits
  4. Distribute cash to partners for capital and for profits
101
Q

When calculating amounts for partnership distributions, how are partner deficits accounted for?

A

Solvent partner has to contribute cash to make up deficit

Otherwise, partners have to absorb it, according to profit/loss ratio

102
Q

What does a liquidation schedule generally look like?

A

Cash, Noncash Assets, Liabilities, and Partner Capital Accounts are column headings

Because there are assets, liabilities, and equity, any increase or decrease has to balance

103
Q

How is the final distribution of cash paid to the partners?

A

The cash is decreased to zero and the capital accounts are decreased to zero – so the cash is paid out to match whatever each partner’s capital account is

That is, it is not distributed according to a profit/loss ratio

104
Q

What is a schedule of safe payments?

A

Used when liquidation occurs in installments and when assets are sold at different points in time

Conservative approach to distribution – assumes total loss on noncash asset, then adds back amount for whatever the assets are sold for

105
Q

How are schedules of safe payments used in liquidation schedules?

A

With each sale, the asset is eliminated from the books and then cash added to the books. In the very next step of the schedule, whatever cash was added is then distributed, according to the SSP.

106
Q

How many asset sales will be accounted for in a schedule of safe distributions?

A

One less than the total asset sales

This is because the last asset sale involves the final cash distribution, which always equals the remaining capital accounts

107
Q

What occurs on a schedule of safe payments?

A

The balance of the capital accounts are decreased (according to profit/loss ratio) as if the entire asset were a loss (i.e. as if it were sold for nothing)

Any deficits are absorbed

The safe cash distribution are the remaining balances

108
Q

What is peculiar about a schedule of safe payments?

A

It takes the capital balances at a given point in time and then reduces them almost to nothing, simply in order to find out how much of a cash distribution each account will get

Then, in the liquidation schedule, the balances are not reduced to nothing at that point where the safe cash distribution is recorded – the distribution is simply subtracted from the capital accounts

109
Q

Is a stock dividend recorded as income by the investor?

A

No – not under either the cost method or the equity method

110
Q

What is the difference between the cost and equity method of accounting for stock dividends?

A

Cost method – calculate new cost basis per share

Equity method – calculate new carrying amount per share

111
Q

How does treasury stock relate to common stock on the two different methods?

A

Cost method = since TS is recorded at cost, it does not directly decrease CS until it is retired

Par value method = when TS is first acquired, it is treated as a retirement of the CS, so the net amount of CS is already decreased (by the par value)

FAR (26 decks)

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