Stockholders' Equity

Question 1

Describe the differences between the following terms for an entity’s stock

Authorized

Issued

Outstanding

Answer 1

Authorized - the max # of shares the entity is allowed to sell

Issued - The # of shares that have been sold

Outstanding - the # of shares that are currently held by the public

Question 2

What is treasury stock?

Answer 2

treasury stock are issued shares of an entity’s own stock that the entity buys back.

Question 3

One share of an entity’s $10 par value common stock is issued for $14. How is the transaction recorded?

Answer 3

Cash 14
C-stock 10
APIC 4

Question 4

One share of an entity’s stock is issued for a piece of equipment. The stock has a par value of $10 and a FV of $78. How is this transaction recorded?

Answer 4

Equipment $78
C-stock 10
APIC 68

Question 5

An entity offers to issue a share of its $10 par value common stock for $18. One person pays $3 now with the agreement that the subscription will be fully paid before the stock is actually issued. A few weeks later, this person pays the other $15 and receives a share of stock. How are these transactions recorded?

Answer 5

Initial recording

Cash 3
stock sub. rec 15
common stock sub 10
APIC 8

When cash is received

Cash 15
common stock sub 10
Common stock 10
stock sub. rec 15

Question 6

Preferred stock often is quoted as being a cumulative preferred stock. What is the nature of such stock?

Answer 6

with cumulative preferred stock all dividends must be paid to preferred stock holders before common stock holders. this includes dividends in arrears.

Question 7

An entity has one share of preferred stock outstanding that specifies a $4 per year cumulative dividend. In year 1, no dividend is paid or declared. What liability is shown by the entity at the end of year 1?

Answer 7

no liability is recognized until dividends are declared

Question 8

An entity has assets of $800,000, liabilities of $300,000, contributed capital of $300,000, and R/E of $200,000. The entity borrows money and, as part of the contract, agrees that it will limit dividends to $30,000 for the next few years. How is this limitation reported on the F/S?

Answer 8

Because the entity can pay a max dividend of only $30,000, the R/E balance should be separated into 2 figures within stockholders’ equity for disclosure purposes.

R/E appropriated for bond agreement $170,000
R/E unappropriated $30,000

This allows the reader to see the total R/E and that the company can only pay a max dividend of $30,000.

Question 9

What are the three methods of accounting for treasury stock?

Answer 9

cost method

par value method

retirement method

Question 10

What type of account is a treasury stock account?

Answer 10

contra stockholders’ equity account

Question 11

B issues 2 shares of its $10 par value common stock for $12 each. Later both shares are reacquired for $15. Subsequently, one is resold for $16 and then the other is resold for $12.

What entries are made for the treasury shares if the cost method is used?

Answer 11

Treasury stock 30
Cash 30

Cash 16
Treasury stock 15
APIC - Treasury 1

Cash 12
APIC - Treasury 1
R/E 2
Treasury stock 15

Question 12

How are retained earnings impacted by stock transactions, such as treasury shares?

Answer 12

R/E can’t be increased due to stock transactions. however it can be decreased if no appropriate APIC accounts can be reduced.

Question 13

B issues 2 shares of its $10 par value common stock for $12 each. Later both shares are reacquired for $15. Subsequently, one is resold for $16 and then the other is resold for $12.

What entries are made for the treasury shares if the par value method is used?

Answer 13

Treasury stock 20
APIC common 4
R/E 6
Cash 30

Cash 16
Treasury stock 10
APIC - treasury 6

Cash 12
Treasury stock 10
APIC - treasury 2

Question 14

B issues 2 shares of its $10 par value common stock for $12 each. Later both shares are reacquired for $15. These shares are retired so no further issuance occurs.

What entries are made for the retirement?

Answer 14

Common stock 20
APIC - common 4
R/E 6
Cash 30

Question 15

When is a quasi-reorganization applicable?

Answer 15

when an entity is near bankruptcy and the entity and its creditors agree to restate the F/S

Question 16

Following a quasi-reorganization, what appears on the balance sheet of the entity?

Answer 16

assets are stated at FV

liabilities are frequently reduced through agreement with creditors

R/E is zero

Par value of common stock is normally reduced

any remaining figure to balances is recorded to APIC

Question 17

A sole proprietorship or a partnership is going to be incorporated. What balances appear on the balance sheet for this corporation?

Answer 17

all assets and liabilities are initially stated at FV

R/E is zero because it is the beginning of a new corp.

Stock is issued to owners based on initially stated FV

Question 18

An entity declares a $1 dividend on Monday to owners of record as of Wednesday, with checks to be mailed on Friday. What journal entries should the entity make for this dividend?

Answer 18

Monday

R/E 1
Dividends payable 1

Friday

Dividends payable 1
Cash 1

Question 19

An entity declares a $1 dividend on Monday to owners of record as of Wednesday, with checks to be mailed on Friday. What journal entries should the owner of the stock make for this dividend?

Answer 19

Wednesday

Dividend receivable 1
Dividend revenue 1

Friday

Cash 1
Dividend receivable 1

Question 20

An entity has an acre of land that had a cost of $10,000 and has a FV of $12,000. The land is distributed to an owner as a dividend. The dividend is declared and distributed at the same time. How does the entity record the dividend?

Answer 20

to mark up the asset to FV

land 2,000
Gain on value of land 2,000

R/E 2,000
land 2,000

Question 21

What is a liquidating dividend and how is it recorded by an entity?

Answer 21

a distribution to an owner exceeding the balance in R/E. this reduces APIC

Question 22

An entity has 100 shares of common stock outstanding. The entity declares a 10% stock dividend so that 10 news shares are issued to its owners. The stock has a $10 per share par value but a $30 per share FV. By what abount is R/E reduced?

Answer 22

stock dividends below 20-25% are recorded at FV

so $30 x 10 shares or $300

Question 23

An entity has 100 shares of common stock outstanding. The entity declares a 40% stock dividend so that 40 news shares are issued to its owners. The stock has a $10 per share par value but a $30 per share FV. By what abount is R/E reduced?

Answer 23

stock dividends above 20-25% are recorded at PV

so $10 x 40 or $400

Question 24

An entity has 1,000 shares of common stock O/S with a $40 per share par value. The entity distributes 1,000 new shares of stock to its owners as a stock split. These shares are worth $43 per share. By how much should the entity reduce its R/E?

Answer 24

no formal recording of stock split is done.

R/E will not be reduced.

Question 25

On Jan 1, year 1, the price of an entity’s stock is $20 per share. The entity gives the president, 1,000 stock appreciation rights. At the end of three years, if the president is still employed by the entity, a cash bonus equal to 1,000 times the increase in the price of stock over $20 will be paid. At the end of year 1, the price of the stock has risen to $25 per share.

How does the entity determine the amount of expense to be recognized for year 1?

Answer 25

at the end of year 1, the value of the rights must be determined using an appropriate valuation pricing model. That figure is multiplied by the 1,000 rights to get the anticipated expense.

Because 3 years are required to vest this compensation it is multiplied by .33 to recognize the expense for this period.

Question 26

On Jan 1, year 1, the price of an entity’s stock is $20 per share. The entity gives the president, 1,000 stock appreciation rights. At the end of three years, if the president is still employed by the entity, a cash bonus equal to 1,000 times the increase in the price of stock over $20 will be paid. At the end of year 1, the price of the stock has risen to $25 per share. At the end of year 2, the price of the stock has risen further to $28 per share.

How does the entity determine the amount of expense to be recognized for year 2?

Answer 26

at the end of year 2, the value of the rights must be determined using an appropriate valuation pricing model. That figure is multiplied by the 1,000 rights to get the anticipated expense.

Because 3 years are required to vest this compensation it is multiplied by .66 to recognize the total liability for this period. The change in the liability from the prior period is the expense.

Question 27

On Jan 1, year 1, the price of an entity’s stock is $20 per share. The entity gives the president, 1,000 stock appreciation rights. At the end of three years, if the president is still employed by the entity, a cash bonus equal to 1,000 times the increase in the price of stock over $20 will be paid. At the end of year 1, the price of the stock has risen to $25 per share. An appropriation valuation pricing model is used to determine a value of $6 for each right.

How much expense does the entity recognize for year 1?

Answer 27

6 x 1000 = 6000

6000 x .33 = 2000 expense

Question 28

On Jan 1, year 1, the price of an entity’s stock is $20 per share. The entity gives the president, 1,000 stock appreciation rights. At the end of three years, if the president is still employed by the entity, a cash bonus equal to 1,000 times the increase in the price of stock over $20 will be paid. At the end of year 1, the price of the stock has risen to $25 per share. An appropriation valuation pricing model is used to determine a value of $6 for each right. At the end of year 2, the stock is $29 per share and the same model determines a value of $12 for each right.

How much expense does the entity recognize for year 2?

Answer 28

12 x 1000 = 12,000

12,000 x .66 = 8,000

8000 - 2000 = 6,000 expense

Question 29

For $3 cash, and entity sells the right to buy a share of its common stock for $21 per share. The stock has a par value of $10 per share. Several weeks later, the owner of this right converts it into a share of common stock. What two entries should the entity record?

Answer 29

sale of stock right

cash 3
APIC - stock right 3

converted stock right

cash 21
APIC- stock right 3
Common stock 10
APIC - Common 14

Question 30

An entity issues noncompensatory stock options to its employees. How does the distribution of stock options qualify as noncompensatory?

Answer 30

they are given to virtually all employees in some equitable manner

the option price is reasonably close to the FV (under 5%)

the option prices is a set amount

the employee has only a short period of time to convert the options into stock

Question 31

How does an entity record a noncompensatory stock option plan when given to employees? What entry is made when one of the options is converted to stock?

Answer 31

no recording is made when noncompensatory stock options are awarded to employees

entry is made in the normal fashion with a debit to he cash and a credit to common stock for par value and a credit to APIC for the difference

Question 32

Which method does an entity use to determine the amount of expense associated with a compensatory stock option?

Answer 32

only FV may be use to determine expense. this requires the use of a option pricing model at the grant date to determine the value of the rights and the amount of expense to be recognized

however if similar options are being sold on an exchange, the sales price at the grant date is used to determine the expense instead of an option pricing model

Question 33

Which option pricing model must be used for a compensatory option?

Answer 33

no single pricing model is required. The most common selections are Black-Scholes-Merton or a binomial model.

Question 34

Pricing models for compensatory stock options are based on several variables. What are some of these variables?

Answer 34

option price

current value of stock

historical dividend rate

expected term of the option

expected volatility of the stock price

risk free rate of interest

Question 35

An entity can record compensatory stock options using the FV method. Once the expense is determined, when is it recognized?

Answer 35

the expense is recognized evenly over the period that the employee must work to be entitled to the options. typically the grant date to the date the employee’s options vest

Question 36

On Jan 1, year 1, an entity gives its president the right to buy 10,000 shares of its stock for $24 per share, if the president works four additional years. After that date, the president has two additional years in which to convert. The price of the stock on the grant date was $20 per share.

A computer pricing model is used on the grant date to determine that the value of each option is $8. On the last day of year 1, the value is determined to be $10.

What amount of expense should the entity recognize for year 1?

Answer 36

the expense is determined on the grant date

$8 x 10,000 = 80,000

80,000 x .25 = 20,000 expense for year 1

Question 37

On Jan 1, year 1, an entity gives its president the right to buy 10,000 shares of its stock for $24 per share, if the president works four additional years. After that date, the president has two additional years in which to convert. The price of the stock on the grant date was $20 per share.

A computer pricing model is used on the grant date to determine that the value of each option is $8. On the last day of year 1, the value is determined to be $10. On the last day of year 2, the model determines the value to be $14.

What amount of expense should the entity recognize for year 2?

Answer 37

the expense is determined on the grant date

$8 x 10,000 = 80,000

80,000 x .25 = 20,000 expense for year 1 through year 4 when the options are fully vested

Question 38

An entity gives stock options to some employees. These options are viewed as compensatory. In determining the amount of expense, what impact will the following have on the value of the options?

the expected term of the option is exceptionally long.

the stock price of the entity’s shares has a high degree of volatility.

Answer 38

if the term is exceptionally long there is significant time for the stock price to rise. therefore the value of the option will be higher than it would be otherwise

if the stock is especially volatile, there is a better chance that the employees will be able to wait until the price is high before converting. therefore the value of the option will be higher than it would be otherwise.