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Chapter 11—Equity Financing

MULTIPLE CHOICE

1. Which of the following shareholder rights is most commonly enhanced in an issue of preferred
stock?
a. The right to vote for the board of directors.
b. The right to maintain one's proportional interest in the corporation.
c. The right to receive a full cash dividend before dividends are paid to other classes of
stock.
d. The right to vote on major corporate issues.
ANS: C OBJ: LO 1

2. Which of the following features of preferred stock would most likely be opposed by common
shareholders?
a. Par or stated value.
b. Callable.
c. Redeemable.
d. Participating.
ANS: D OBJ: LO 1

3. Which of the following is not one of the basic shareholders rights?


a. The right to participate in earnings.
b. The right to maintain one's proportional interest in the corporation.
c. The right to participate in the proceeds of the sale of corporate assets upon liquidation of
the corporation.
d. The right to inspect the accounting records of the corporation.
ANS: D OBJ: LO 1

4. The full amount of compensation expense incurred in a compensatory stock option plan under the
intrinsic value method is known at
a. the grant date.
b. the measurement date.
c. the plan adoption date.
d. the date the options expire.
ANS: B OBJ: LO 5

5. The exercise price and market price of stock under a fixed compensatory stock option plan are
equal on the grant date. The fair value of the options is greater than the option price. Under the
fair value method
a. Compensation expense will be recognized in connection with the option plan.
b. No compensation expense will be recognized in connection with the option plan.
c. Deferred compensation will be recognized.
d. No paid-in capital from stock options will be recognized.
ANS: A OBJ: LO 5

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6. The exercise price and market price of stock under a fixed compensatory stock option plan are
equal on the grant date. The fair value of the options is greater than the option price. Under the
intrinsic value method
a. Compensation expense will be recognized in connection with the option plan.
b. No compensation expense will be recognized in connection with the option plan.
c. Deferred compensation will be recognized.
d. Paid-in capital from stock options will be recognized.
ANS: B OBJ: LO 5

7. Current financial accounting standards require


a. the use of the fair value method, but not the intrinsic value method.
b. the use of the fair value method and the intrinsic value method to account for each plan.
c. disclosure in the notes to the financial statements of compensation expense under the fair
value method if the intrinsic value method is used.
d. disclosure in the notes to the financial statements of compensation expense under the
intrinsic value method if the fair value method is used.
ANS: C OBJ: LO 5

8. An adjustment to retained earnings as a result of a conversion of preferred stock to common stock


most likely would occur when
a. par value of the preferred stock is high relative to fair value of the common stock.
b. par value of the common stock is less than the book value of the preferred stock.
c. par value of the common stock exceeds the book value of the preferred stock.
d. par value of the preferred stock is low relative to fair value of the common.
ANS: C OBJ: LO 6

9. Which of the following is least likely to affect the retained earnings balance?
a. Conversion of preferred stock into common stock.
b. Stock splits.
c. Treasury stock transactions.
d. Stock dividends.
ANS: B OBJ: LO 7

10. Which of the following is most likely to be found in state laws regarding payment of dividends?
a. Dividends may be paid from legal capital.
b. Retained earnings are available for dividends unless restricted by contract or by statute.
c. Unrealized capital is available for any type of dividend.
d. Capital from donated assets is available for dividends.
ANS: B OBJ: LO 7

11. Which of the following is not a component of comprehensive income?


a. Asset revaluation reserve.
b. Net income.
c. Foreign currency translation adjustment.
d. Minimum pension liability adjustment.
ANS: A OBJ: LO 9

12. The use of equity reserves under international accounting standards


a. is strictly voluntary on the part of the management of a company.
b. is based on whether a reserve is part of distributable or nondistributable equity.

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c. is primarily for the benefit of shareholders rather than creditors.
d. results in the elimination of the retained earnings category from the total equity of a
company.
ANS: B OBJ: LO 9

13. The par value of common stock represents


a. the liquidation value of the stock.
b. the book value of the stock.
c. the legal nominal value assigned to the stock.
d. the amount received by the corporation when the stock was originally issued.
ANS: C OBJ: LO 2

14. The entry to record the issuance of common stock for fully paid stock subscriptions is
a. a memorandum entry.
b. Common Stock Subscribed Common Stock Additional Paid-In Capital
c. Common Stock Subscribed Subscriptions Receivable
d. Common Stock Subscribed Common Stock
ANS: D OBJ: LO 2

15. Farnon Company has not declared or paid dividends on its cumulative preferred stock in the last
three years. These dividends should be reported
a. in a note to the financial statements.
b. as a reduction in stockholders' equity.
c. as a current liability.
d. as a noncurrent liability.
ANS: A OBJ: LO 8

16. Which of the following is an appropriate presentation of treasury stock?


a. As a marketable security
b. As a deduction at cost from total stockholders' equity
c. As a deduction at cost from total contingent liabilities
d. As a deduction at par from total stockholders' equity
ANS: B OBJ: LO 3

17. Gains and losses on the purchase and resale of treasury stock may be reflected only in
a. paid-in capital accounts.
b. paid-in capital and retained earnings accounts.
c. income, paid-in capital, and retaining earnings accounts.
d. income and paid-in capital accounts.
ANS: B OBJ: LO 3

18. A company issued rights to its existing shareholders to acquire, at $15 per share, 5,000 unissued
shares of common stock with a par value of $10 per share. Common Stock will be credited at
a. $15 per share when the rights are exercised.
b. $15 per share when the rights are issued.
c. $10 per share when the rights are exercised.
d. $10 per share when the rights are issued.
ANS: C OBJ: LO 4

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19. A company issued rights to its existing shareholders to purchase for par unissued shares of
common stock with a par value of $10 per share. When the market value of the common stock
was $12 per share, the rights were exercised. Common Stock should be credited at $10 per share
and
a. Paid-In Capital from Stock Rights credited at $2 per share.
b. Additional Paid-In Capital credited at $2 per share.
c. Retained Earnings credited at $2 per share.
d. no credit made to Additional Paid-In Capital or Retained Earnings.
ANS: D OBJ: LO 4

20. The issuance of shares of preferred stock to shareholders


a. increases preferred stock outstanding.
b. has no effect on preferred stock outstanding.
c. increases preferred stock authorized.
d. decreases preferred stock authorized.
ANS: A OBJ: LO 2

21. How would a stock split affect each of the following?

Total
Stockholders' Additional
Assets Equity Paid-In Capital

a. Increase Increase No effect


b. No effect No effect No effect
c. No effect No effect Increase
d. Decrease Decrease Decrease

ANS: B OBJ: LO 8

22. On February 1, authorized common stock was sold on a subscription basis at a price in excess of
par value, and 20 percent of the subscription price was collected. On May 1, the remaining 80
percent of the subscription price was collected. Additional Paid-In Capital would increase on

February 1 May 1

a. No Yes
b. No No
c. Yes No
d. Yes Yes

ANS: C OBJ: LO 2

23. Stock warrants outstanding should be classified as


a. liabilities.
b. reductions of capital contributed in excess of par value.
c. capital stock.
d. additions to contributed capital.
ANS: D OBJ: LO 4

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24. At the date of the financial statements, common stock shares issued would exceed common stock
shares outstanding as a result of the
a. declaration of a stock split.
b. declaration of a stock dividend.
c. purchase of treasury stock.
d. payment in full of subscribed stock.
ANS: C OBJ: LO 2

25. When treasury stock is purchased for more than its par value, Treasury Stock is debited for the
purchase price under which of the following methods?

Cost Method Par Value Method

a. No No
b. No Yes
c. Yes No
d. Yes Yes

ANS: C OBJ: LO 3

26. When treasury stock is purchased for cash at more than its par value, what is the effect on total
stockholders' equity under each of the following methods?

Cost Method Par Value Method

a. No effect Decrease
b. Decrease No effect
c. Increase Increase
d. Decrease Decrease

ANS: D OBJ: LO 3

27. Treasury stock was acquired for cash at a price in excess of its par value. The treasury stock was
subsequently reissued for cash at a price in excess of its acquisition price. Assuming that the cost
method of accounting for treasury stock transactions is used, what is the effect on retained
earnings?

Acquisition of Reissuance of
Treasury Stock Treasury Stock

a. No effect Increase
b. Increase No effect
c. No effect No effect
d. Increase Decrease

ANS: C OBJ: LO 3

28. Five thousand shares of common stock with a par value of $10 per share were issued initially at
$12 per share. Subsequently, 1,000 of these shares were acquired as treasury stock at $15 per
share. Assuming that the par value method of accounting for treasury stock transactions is used,
what is the effect of the acquisition of the treasury stock on each of the following?

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Additional Retained
Paid-In Capital Earnings

a. Increase No effect
b. Increase Decrease
c. Decrease Increase
d. Decrease Decrease

ANS: D OBJ: LO 3

29. Which of the following is issued to shareholders by a corporation as evidence of the ownership of
rights to acquire its unissued or treasury stock?
a. Stock options
b. Stock rights
c. Stock dividends
d. Stock subscriptions
ANS: B OBJ: LO 4

30. A company issued rights to its existing shareholders to purchase, for $30 per share, unissued
shares of $15 par value common stock. When the rights lapse,
a. Additional Paid-In Capital will be credited.
b. Stock Rights Outstanding will be debited.
c. Gain on Lapse of Stock Rights will be credited.
d. no entry will be made.
ANS: D OBJ: LO 4

31. Select the statement that is incorrect concerning the appropriations of retained earnings.
a. Appropriations of retained earnings do not change the total amount of stockholders' equity.
b. Appropriations of retained earnings reflect funds set aside for a designated purpose, such
as plant expansion.
c. Appropriations of retained earnings can be made as a result of contractual requirements.
d. Appropriations of retained earnings can be made at the discretion of the board of directors.
ANS: B OBJ: LO 7

32. When a property dividend is declared and the book value of the property exceeds its market
value, the dividend is recorded at the
a. market value of the property at the date of distribution.
b. book value of the property at the date of declaration.
c. book value of the property at the date of distribution if it still exceeds the market value of
the property at the date of declaration.
d. market value of the property at the date of declaration.
ANS: D OBJ: LO 8

33. On July 31, 2004, Lakers Corporation purchased 500,000 shares of Celtic Corporation. On
December 31, 2005, Lakers distributed 250,000 shares of Celtic stock as a dividend to Lakers'
stockholders. This is an example of a
a. liquidating dividend.
b. investment dividend.
c. property dividend.
d. stock dividend.
ANS: C OBJ: LO 8

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34. When a portion of stockholders' original investment is returned in the form of a dividend, it is
called a
a. compensating dividend.
b. liquidating dividend.
c. property dividend.
d. equity dividend.
ANS: B OBJ: LO 8

35. When a property dividend is declared and the market value of the property exceeds its book
value, the excess is credited to
a. Gain on Distribution of Property Dividends.
b. Retained Earnings.
c. Additional Paid-In Capital.
d. the related asset account.
ANS: A OBJ: LO 8

36. How would the declaration of a 20 percent stock dividend by Jets Corporation affect each of the
following accounts on Jets' balance sheet?

Retained Total Stock-


Earnings holders' Equity

a. Decrease Decrease
b. Decrease No effect
c. No effect Decrease
d. No effect No effect

ANS: B OBJ: LO 8

37. When a dividend is declared and paid in stock,


a. stockholders' equity does not change.
b. total stockholders' equity decreases.
c. the current ratio increases.
d. the amount of working capital decreases.
ANS: A OBJ: LO 8

38. Which of the following actions or events does not result in an addition to retained earnings?
a. A change from the double-declining-balance method to the straight-line method of
depreciation.
b. Earning of net income for the period
c. Correction of an error in which ending inventory was understated in a previous year
d. Issuance of a 3-for-1 stock split
ANS: D OBJ: LO 7

39. Undistributed stock dividends should be reported as


a. a current liability.
b. an addition to capital stock outstanding.
c. a reduction in total stockholders' equity.
d. a note to the financial statements.
ANS: B OBJ: LO 8

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40. A restriction of retained earnings is most likely to be required by
a. incurring a net loss in the current year.
b. incurring a net loss in the prior year.
c. purchasing treasury stock.
d. reissuing treasury stock.
ANS: C OBJ: LO 7

41. The Securities and Exchange Commission requires that mandatorily redeemable preferred stock
be presented on the balance sheet
a. as a liability.
b. between liabilities and stockholders' equity.
c. as a component of stockholders' equity.
d. as a deduction from total stockholders' equity.
ANS: B OBJ: LO 1

42. Under international accounting requirements, which of the following equity reserves is part of
distributable equity?

a. Par value of shares


b. Capital redemption reserve
c. Asset revaluation reserve
d. Retained earnings

ANS: D OBJ: LO 9

43. If 40 percent of the recent dividend paid by Packers Corporation was correctly considered to be a
liquidating dividend, how would this distribution affect each of the following accounts?

Additional Retained
Paid-In Capital Earnings

a. No effect Decrease
b. No effect No effect
c. Decrease No effect
d. Decrease Decrease

ANS: D OBJ: LO 8

44. Unlike a stock split, a stock dividend requires a formal journal entry in the financial accounting
records because
a. stock dividends increase the relative book value of an individual's stock holdings.
b. stock dividends increase the stockholders' equity in the issuing firm.
c. stock dividends are payable on the date they are declared.
d. stock dividends represent a transfer from Retained Earnings to Capital Stock.
ANS: D OBJ: LO 8

45. A company declared a cash dividend on its common stock in December 2004, payable in January
2005. Retained Earnings would
a. increase on the date of declaration.
b. not be affected on the date of declaration.
c. not be affected on the date of payment.
d. decrease on the date of payment.

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ANS: C OBJ: LO 8
46. How would the declaration of a liquidating dividend by a corporation affect each of the
following?

Contributed Total Stock-


Capital holders' Equity

a. No effect Decrease
b. Decrease No effect
c. No effect No effect
d. Decrease Decrease

ANS: D OBJ: LO 8

47. An investment in marketable securities was accounted for by the cost method. These securities
were distributed to stockholders as a property dividend in a nonreciprocal transfer. The dividend
should be reported at the
a. fair value of the asset transferred.
b. fair value of the asset transferred or the recorded amount of the asset transferred,
whichever is higher.
c. fair value of the asset transferred or the recorded amount of the asset transferred,
whichever is lower.
d. recorded amount of the asset transferred.
ANS: A OBJ: LO 8

48. How would retained earnings be affected by the declaration of each of the following?

Stock Dividend Stock Split

a. Decrease Decrease
b. No effect Decrease
c. No effect No effect
d. Decrease No effect

ANS: D OBJ: LO 8

49. How would the declaration of a 10 percent stock dividend by a corporation affect each of the
following on its books?

Retained Total Stock-


Earnings holders' Equity

a. Decrease No effect
b. Decrease Decrease
c. No effect Decrease
d. No effect No effect

ANS: A OBJ: LO 8

50. The Amelia Corporation was incorporated on January 1, 2005, with the following authorized
capitalization:

• 40,000 shares of common stock, no par value, stated value $40 per share
• 10,000 shares of 5 percent cumulative preferred stock, par value $10 per share

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During 2005, Amelia issued 24,000 shares of common stock for a total of $1,200,000 and 6,000
shares of preferred stock at $16 per share. In addition, on December 20, 2005, subscriptions for
2,000 shares of preferred stock were taken at a purchase price of $17. These subscribed shares
were paid for on January 2, 2006. What should Amelia report as total contributed capital on its
December 31, 2005, balance sheet?
a. $1,040,000
b. $1,262,000
c. $1,296,000
d. $1,330,000
ANS: D OBJ: LO 2

51. On June 1, Mason Company issued 8,000 shares of its $10 par common stock to Dixon for a tract
of land. The stock had a fair market value of $18 per share on this date. On Dixon's last property
tax bill, the land was assessed at $96,000. Mason should record an increase in Additional Paid-In
Capital of
a. $96,000.
b. $64,000.
c. $40,000.
d. $16,000.
ANS: B OBJ: LO 2

52. On August 1, 2005, B. Doran Company reacquired 4,000 shares of its $15 par value common
stock for $18 per share. Doran uses the cost method to account for treasury stock. What journal
entry should Doran make to record the acquisition of treasury stock?
a. Treasury Stock ............................. 60,000
Additional Paid-In Capital ................. 12,000
Cash ..................................... 72,000
b. Treasury Stock ............................. 60,000
Retained Earnings .......................... 12,000
Cash ..................................... 72,000
c. Retained Earnings .......................... 72,000
Cash ..................................... 72,000
d. Treasury Stock ............................. 72,000
Cash ..................................... 72,000

ANS: D OBJ: LO 3

53. Harbottle Corporation was organized on January 3, 2005, with authorized capital of 100,000
shares of $10 par common stock. During 2005, Harbottle had the following transactions affecting
stockholders' equity:

• January 7--Issued 40,000 shares at $12 per share


• December 2--Purchased 6,000 shares of treasury stock at $13 per share

The cost method was used to record the treasury stock transaction. Harbottle's net income for
2005 is $300,000. What is the amount of stockholders' equity at December 31, 2005?
a. $640,000
b. $702,000
c. $708,000
d. $720,000
ANS: B OBJ: LO 3

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54. Thorpe Corporation holds 10,000 shares of its $10 par common stock as treasury stock, which
was purchased in 2004 at a cost of $120,000. On December 10, 2005, Thorpe sold all 10,000
shares for $210,000. Assuming that Thorpe used the cost method of accounting for treasury stock,
this sale would result in a credit to
a. Paid-In Capital from Treasury Stock of $90,000.
b. Paid-In Capital from Treasury Stock of $110,000.
c. Gain on Sale of Treasury Stock of $90,000.
d. Retained Earnings of $90,000.
ANS: A OBJ: LO 3

55. On March 2, 2005, Ross Corporation issued 4,000 shares of 6 percent cumulative $100 par value
preferred stock for $434,000. Each preferred share carried one nondetachable stock warrant
which entitled the holder to acquire, at $17, one share of Ross $10 par common stock. On March
2, 2005, the market price of the preferred stock (without warrants) was $90 per share and the
market price of the stock warrants was $15 per warrant. The amount credited to Paid-In Capital in
Excess of Par-Preferred by Ross on the issuance of the stock was
a. $0.
b. $8,000.
c. $34,000.
d. $62,000.
ANS: C OBJ: LO 4

56. On January 2, 2005, Stoner Corporation granted stock options to key employees for the purchase
of 60,000 shares of the company's common stock at $25 per share. The options are intended to
compensate employees for the next two years. The options are exercisable within a four-year
period beginning January 1, 2007, by grantees still in the employ of the company. The market
price of Stoner's common stock was $32 per share at the date of grant. Stoner plans to distribute
up to 60,000 shares of treasury stock when options are exercised. The treasury stock was acquired
by Stoner at a cost of $28 per share and was recorded under the cost method. Assume that no
stock options were terminated during the year. How much should Stoner charge to Compensation
Expense for the year ended December 31, 2005?
a. $420,000
b. $210,000
c. $180,000
d. $90,000
ANS: B OBJ: LO 5

57. On December 10, Daniel Co. split its stock 5-for-2 when the market value was $65 per share.
Prior to the split, Daniel had 200,000 shares of $15 par value stock. After the split, the par value
of the stock was
a. $3.00.
b. $6.00.
c. $15.00.
d. $26.00.
ANS: B OBJ: LO 8

58. On December 10, Daniel Co. split its stock 5-for-2 when the market value was $65 per share.
Prior to the split, Daniel had 200,000 shares of $15 par value stock. After the split, Daniel's
outstanding shares would be
a. 1,000,000.
b. 200,000.

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c. 300,000.
d. 500,000.
ANS: D OBJ: LO 8

59. On July 1, Rainbow Corporation issued 2,000 shares of its $10 par common and 4,000 shares of
its $10 par preferred stock for a lump sum of $80,000. At this date, Rainbow's common stock was
selling for $18 per share and the preferred stock for $13.50 per share. The amount of proceeds
allocated to Rainbow's preferred stock should be
a. $40,000.
b. $48,000.
c. $54,000.
d. $60,000.
ANS: B OBJ: LO 2

60. Victor Corporation was organized on January 2 with 100,000 authorized shares of $10 par value
common stock. During the year, Victor had the following capital transactions:

• January 5 -- issued 75,000 shares at $14 per share


• December 27 -- purchased 5,000 shares at $11 per share

Victor used the par value method to record the purchase of the treasury shares.

What would be the balance in the paid-in capital from treasury stock account at December 31?
a. $0
b. $5,000
c. $15,000
d. $20,000
ANS: C OBJ: LO 3

61. The stockholders' equity section of Hall Corporation's balance sheet at December 31, 2005, was
as follows:

Common stock ($10 par value, authorized 1,000,000


shares, issued and outstanding 900,000 shares) ..... $ 9,000,000
Paid-In capital in excess of par ..................... 2,700,000
Retained earnings .................................... 1,300,000
Total stockholders' equity ........................... $13,000,000

On January 2, 2006, Hall purchased and retired 100,000 shares of its stock for $1,800,000. Hall
records treasury stock using the par value method. Immediately after retirement of these 100,000
shares, the balances in the additional paid-in capital and retained earnings accounts should be

Paid-In Capital Retained


in Excess of Par Earnings

a. $900,000 $1,300,000
b. $1,400,000 $800,000
c. $1,900,000 $1,300,000
d. $2,400,000 $800,000

ANS: D OBJ: LO 3

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62. In 2005, Wyatt Corporation issued for $110 per share, 15,000 shares of $100 par value
convertible preferred stock. One share of preferred stock may be converted into three shares of
Wyatt's $25 par value common stock at the option of the preferred shareholder. On December 31,
2006, all of the preferred stock was converted into common stock. The market value of the
common stock at the conversion date was $40 per share. What amount should be credited to the
common stock account on December 31, 2006?
a. $1,125,000
b. $1,500,000
c. $1,650,000
d. $1,800,000
ANS: A OBJ: LO 6

63. Cox Corporation was organized on January 1, 2004, at which date it issued 100,000 shares of $10
par common stock at $15 per share. During the period January 1, 2004, through December 31,
2006, Cox reported net income of $450,000 and paid cash dividends of $230,000. On January 10,
2006, Cox purchased 6,000 shares of its common stock at $12 per share. On December 31, 2006,
Cox sold 4,000 treasury shares at $8 per share. Cox uses the cost method of accounting for
treasury shares. What is Cox's total stockholders' equity on December 31, 2006?
a. $1,720,000
b. $1,704,000
c. $1,688,000
d. $1,680,000
ANS: D OBJ: LO 3

64. On February 24, BMC Company purchased 4,000 shares of Winn Corp.'s newly issued 6 percent
cumulative $75 par preferred stock for $304,000. Each share carried one detachable stock warrant
entitling the holder to acquire at $10 one share of Winn no-par common stock. On February 25,
the market price of the preferred stock ex-warrants was $72 per share, and the market price of the
stock warrants was $8 per warrant. On December 29, BMC sold all the stock warrants for
$41,000. The gain on the sale of the stock warrants was
a. $0.
b. $1,000.
c. $9,000.
d. $10,600.
ANS: D OBJ: LO 4

65. On July 1, Black Corporation had 200,000 shares of $10 par common stock outstanding. The
market price of the stock was $12 per share. On the same date, Black declared a 1-for-2 reverse
stock split. The par value of the stock was increased from $10 to $20, and one new $20 par share
was issued for each two $10 par shares outstanding. Immediately before the 1-for-2 reverse stock
split, Black's additional paid-in capital was $650,000. What should be the balance in Black's
additional paid-in capital account immediately after the reverse stock split?
a. $450,000
b. $650,000
c. $850,000
d. $1,050,000
ANS: B OBJ: LO 8

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66. Clayton Co. owned 30,000 common shares of Dayton Corporation purchased in 2002 for
$540,000. On September 20, 2005, Clayton declared a property dividend of 1 share of Dayton for
every 5 shares of Clayton stock held by a stockholder. On that date, there were 50,000 common
shares of Clayton outstanding, and the market value of Dayton shares was $30 per share. The
entry to record the declaration of the property dividend would include a debit to Retained
Earnings of
a. $0.
b. $300,000.
c. $360,000.
d. $540,000.
ANS: B OBJ: LO 8

67. Beldon Co. was organized on January 2, 2005, with the following capital structure:

10 percent cumulative preferred stock, par value $100,


and liquidation value $105; issued and outstanding
2,000 shares ........................................ $200,000
Common stock, par value $25; authorized 100,000 shares;
issued and outstanding 20,000 shares ................ 500,000

Beldon's net income for the year ended December 31, 2005, was $900,000, but no dividends were
declared. Beldon's balance sheet would report Dividends Payable at December 31, 2005, of
a. $90,000.
b. $20,000.
c. $2,000.
d. $0.
ANS: D OBJ: LO 8

68. On September 20, 2005, Nozzle Corporation declared the distribution of the following dividend
to its stockholders of record as of September 30, 2005:

• Investment in 100,000 shares of Astro Corporation stock, carrying value $600,000;


fair market value on September 20, $1,450,000; fair market value on September 30,
$1,575,000.

The entry to record the declaration of the property dividend would include a debit to Retained
Earnings of
a. $1,575,000.
b. $1,450,000.
c. $850,000.
d. $600,000.
ANS: B OBJ: LO 8

69. Thomas Company reported the following for the year ended December 31, 2005 (all items are net
of income taxes):

Income from continuing operations $1,300


Income (loss) from discontinued operations (200)
Unrealized gain (loss) on available-for-sale securities 30
(Increase)Decrease in minimum pension liability (72)
Unrealized gain (loss) on derivative instruments (12)
Foreign currency translation adjustment,increase
(decrease)in stockholders' equity 180

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Comprehensive income (loss) for the year ended December 31, 2005, would be
a. ($74).
b. $1,226.
c. $1,426.
d. $126.
ANS: B OBJ: LO 9

70. On June 1, 2005, Patriot Corporation declared a stock dividend entitling its stockholders to one
additional share for each share held. At the time the dividend was declared, the market value of
the stock was $10 per share and the par value was $5 per share. On this date Patriot had
1,000,000 shares of common stock authorized of which 600,000 shares were outstanding.
Assuming the par value of the stock was not changed, what entry should Patriot make to record
this transaction?
a. Retained Earnings .................. 6,000,000
Common Stock Dividend Distributable. 3,000,000
Capital in Excess of Par............ 3,000,000
b. Stock Dividend Payable ............. 6,000,000
Common Stock Dividend Distributable. 3,000,000
Capital in Excess of Par............ 3,000,000
c. Retained Earnings................... 3,000,000
Common Stock Dividend Distributable. 3,000,000
d. No entry
ANS: C OBJ: LO 8

71. The stockholders' equity section of Dolphin Corporation as of December 31, 2005, contained the
following accounts:

Common stock, 25,000 shares authorized; 10,000 shares


issued and outstanding .............................. $ 30,000
Capital contributed in excess of par .................. 40,000
Retained earnings ..................................... 80,000
$150,000

Dolphin's board of directors declared a 10 percent stock dividend on April 1, 2006, when the
market value of the stock was $7 per share. Accordingly, 1,000 new shares were issued. All of
Dolphin's stock has a par value of $3 per share. Assuming Dolphin sustained a net loss of
$12,000 for the quarter ended March 31, 2006, what amount should Dolphin report as retained
earnings as of April 1, 2006?
a. $61,000
b. $64,000
c. $68,000
d. $73,000
ANS: A OBJ: LO 8

72. The Gradison Corporation had the following classes of stock outstanding as of December 31,
2005:
Common stock, $20 par value, 20,000 shares outstanding
Preferred stock, 6 percent, $100 par value, cumulative, 2,000 shares outstanding

15
No dividends were paid on preferred stock for 2003 and 2004. On December 31, 2005, a total
cash dividend of $200,000 was declared. What are the amounts of dividends payable on both the
common and preferred stock, respectively?
a. $0 and $200,000
b. $164,000 and $36,000
c. $176,000 and $24,000
d. $188,000 and $12,000
ANS: B OBJ: LO 8

73. On June 30, 2005, O'Hara Co. declared and issued a 10 percent stock dividend. Prior to this
dividend, O'Hara had 60,000 shares of $10 par value common stock issued and outstanding. The
market value of O'Hara Co.'s common stock on June 30, 2005, was $24 per share. As a result of
this stock dividend, by what amount would O'Hara's total stockholders' equity increase
(decrease)?
a. $0
b. $60,000
c. $84,000
d. $(84,000)
ANS: A OBJ: LO 8

74. On January 2, 2005, the board of directors of Gimli Mining Corporation declared a cash dividend
of $1,200,000 to stockholders of record on January 18, 2005, and payable on February 10, 2005.
The dividend is permissible by law in Gimli's state of incorporation. Selected data from Gimli's
December 31, 2004, balance sheet follow:

Accumulated depletion ................................. $ 200,000


Capital stock ......................................... 1,100,000
Additional paid-in capital ............................ 800,000
Retained earnings ..................................... 500,000

The $1,200,000 dividend includes a liquidating dividend of


a. $800,000.
b. $700,000.
c. $600,000.
d. $200,000.
ANS: B OBJ: LO 8

75. Which of the following presentation formats is permitted by Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income,"?
I. A single statement of income and comprehensive income.

II. Two statements of income, a traditional income statement ending with net income, and a
second statement beginning with net income, all the elements of comprehensive income,
and a total of comprehensive income.

III. Within the statement of changes in stockholders' equity.


a. Only I.
b. I and III.
c. I and II.
d. I, II, and III.
ANS: D OBJ: LO 9

16
76. On December 31, 2005, the stockholders' equity section of Addyson Co. was as follows:

Common stock, par value $10; authorized, 60,000 shares;


issued and outstanding, 18,000 shares ............... $180,000
Additional paid-in capital ............................ 232,000
Retained earnings ..................................... 192,000
Total stockholders' equity ............................ $604,000

On March 31, 2006, Addyson declared a 10 percent stock dividend, and accordingly 1,800
additional shares were issued, when the fair market value of the stock was $16 per share. For the
three months ended March 31, 2006, Addyson sustained a net loss of $64,000. The balance of
Addyson's Retained Earnings as of March 31, 2006, should be
a. $99,200.
b. $110,000.
c. $112,000.
d. $128,000.
ANS: A OBJ: LO 8

77. Cash dividends on the $10 par value common stock of Sackville Company were as follows:
1st quarter of 2005 $400,000
2nd quarter of 2005 450,000
3rd quarter of 2005 500,000
4th quarter of 2005 550,000
• The 4th quarter cash dividend was declared on December 20, 2005, to stockholders
of record on December 31, 2005. Payment of the 4th quarter dividend was made on
January 9, 2006.
• In addition, Sackville declared a 5 percent stock dividend on its $10 par value
common stock on December 1, 2005, when there were 150,000 shares issued and
outstanding and the market value of the common stock was $20 per share. The shares
were issued on December 1, 2005.

What was the effect on Sackville's stockholders' equity accounts as a result of the 2005 dividend
transactions?
Additional
Common Stock Paid-In Capital Retained Earnings
a. $75,000 credit $0 $1,975,000 debit
b. $75,000 credit $75,000 credit $2,050,000 debit
c. $150,000 credit $150,000 credit $1,900,000 debit
d. $150,000 credit $75,000 credit $2,050,000 debit

ANS: B OBJ: LO 8

78. On September 1, 2005, Steelers Corporation declared and issued a 20 percent common stock
dividend. Prior to this date, Steelers had 20,000 shares of $2 par value common stock that were
both issued and outstanding. The market value of Steelers' stock was $20 per share at the time the
dividend was issued. As a result of this stock dividend, Steelers' total stockholders' equity
a. decreased by $40,000.
b. decreased by $400,000.
c. increased by $400,000.
d. did not change.
ANS: D OBJ: LO 8

17
79. Ellis Company has 1,000,000 shares of common stock authorized with a par value of $3 per share
of which 600,000 shares are outstanding. Ellis authorized a stock dividend when the market value
was $8 per share, entitling its stockholders to one additional share for each share held. The par
value of the stock was not changed. Assuming the declaration is not recorded separately, what
entry, if any, should Ellis make to record distribution of the stock dividend?
a. Retained Earnings............... 4,800,000
Common Stock.................. 1,800,000
Gain on Stock Dividends....... 3,000,000
b. Retained Earnings............... 1,800,000
Common Stock.................. 1,800,000
c. Retained Earnings............... 4,800,000
Common Stock.................. 1,800,000
Paid-In Capital from Stock Dividends 3,000,000
d. Memorandum entry noting the number of additional shares issued as
a dividend

ANS: B OBJ: LO 8

80. The following data are extracted from the stockholders' equity section of the balance sheet of
Guthrie Corporation:

12/31/04 12/31/05
Common stock ($1 par value) ............... $50,000 $51,000
Paid-In capital in excess of par .......... 25,000 29,000
Retained earnings ......................... 50,000 52,300

During 2005, the corporation declared and paid cash dividends of $7,500 and also declared and
issued a stock dividend. There were no other changes in stock issued and outstanding during
2005. Net income for 2005 was
a. $2,300.
b. $9,800.
c. $10,800.
d. $14,800.
ANS: D OBJ: LO 8

81. Cohen Corporation owns 1,000 shares of common stock of Berg, Inc., a large publicly traded
company listed on a major stock exchange. If Berg issues a 20 percent stock dividend when the
par value is $10 per share and the market value is $70 per share, how much and what type of
income should Cohen report?
a. $0
b. $2,000 ordinary income
c. $14,000 ordinary income
d. $2,000 ordinary income and $12,000 extraordinary income
ANS: A OBJ: LO 8

82. The following was abstracted from the accounts of the Oak Corp. at year-end:

Total income since incorporation ...................... $420,000


Total cash dividends paid ............................. 130,000
Proceeds from sale of donated stock ................... 45,000
Total value of stock dividends distributed ............ 30,000
Excess of proceeds over cost of treasury stock sold ... 70,000

18
What should be the current balance of Retained Earnings?
a. $260,000
b. $290,000
c. $305,000
d. $335,000
ANS: A OBJ: LO 6

PROBLEMS

1. Barker Corp. received a charter authorizing 120,000 shares of common stock at $15 par value per
share. During the first year of operations, 40,000 shares were sold at $28 per share. 600 shares
were issued in payment of a current operating debt of $18,600. In the first year, the net income
was $142,000.

During the year, dividends of $36,000 were paid to stockholders. At the end of the year, total
liabilities were $82,000. Use the given data to compute the following items at the end of the first
year (show all computations):

(1) Total liabilities and stockholders' equity


(2) Stockholders' equity
(3) Contributed capital
(4) Issued capital stock (par)
(5) Outstanding capital stock (par)
(6) Unissued capital stock (number of shares)
(7) Paid-In capital in excess of par value

ANS:
(1)
Shares sold (40,000 ´ $28) ........................... $1,120,000
Shares issued in payment of debt (600 ´ $31) ......... 18,600
Net income ........................................... 142,000
Total liabilities .................................... 82,000
$1,362,600
Less dividends ....................................... 36,000
Total liabilities & stockholders' equity ............. $1,326,600

(2)
$1,326,600 - $82,000 = $1,244,600

(3)
$1,120,000 + $18,600 = $1,138,600

(4)
40,600 shares ´ $15 = $609,000

(5)
40,600 shares ´ $15 = $609,000

(6)
120,000 - 40,600 = 79,400 shares

(7)
$1,138,600 - $609,000 = $529,600

OBJ: LO 2

19
2. The following transactions relate to the stockholders' equity transactions of Lindsay Corporation
for its initial year of existence.

(a) Jan. 7 Articles of incorporation are filed with the state. The state authorized the
issuance of 10,000 shares of $50 par value preferred stock and 200,000
shares of $10 par value common stock.
(b) Jan. 28 40,000 shares of common stock are issued for $14 per share.
(c) Feb. 3 80,000 shares of common stock are issued in exchange for land and
buildings that have an appraised value of $250,000 and $1,000,000,
respectively. The stock traded at $15 per share on that date on the over-the-
counter market.
(d) Feb. 24 2,000 shares of common stock are issued to Shane and Winston, Attorneys-
at-Law, in payment for legal services rendered in connection with
incorporation. The company charged the amount to organization costs. The
market value of the stock was $16 per share.
(e) Sep. 12 Received subscriptions for 10,000 shares of preferred stock at $53 per share.
A 40 percent down payment accompanied the subscriptions. The balance is
due on October 1.
(f) Oct. 1 Received the final payment for 10,000 shares.

Prepare journal entries to record the foregoing transactions. Identify the entries by letter (a - f).

ANS:
* Note to the instructor: Problem 2 can be shortened by eliminating the subscription of preferred
shares (entries e - f).

(a)
No entry is required for the authorization of shares.

(b)

Cash (40,000 ´ $14) ......................... 560,000


Common Stock (40,000 ´ $10) ................. 400,000
Paid-In Capital in Excess of Par--Common .... 160,000

(c)

Land ........................................ 240,000


Buildings ................................... 960,000
Common Stock (80,000 ´ $10) ................. 800,000
Paid-In Capital in Excess of Par--Common .... 400,000

Note: The fair market value of the stock is more readily determinable
than the value of the real property because it was traded on
the over-the-counter market on the transaction date. The value
of the stock should be assigned to the land and buildings in
proportion to their appraised values.

Cost of Land = $250,000/($250,000 + $1,000,000) _ $1,200,000 = $240,000


Cost of Building = $1,000,000/($250,000 + $1,000,000) _ $1,200,000 = $960,000

20
(d)

21
Organization Costs (2,000 ´ $16)............. 32,000
Common Stock (2,000 ´ $10)................... 20,000
Paid-In Capital in Excess of Par--Common 12,000

(e)
Cash (10,000 ´ $53 ´ 40%).................... 212,000
Subscriptions Receivable .................... 318,000
Preferred Stock Subscribed (10,000 ´ $50) ... 500,000
Paid-In Capital in Excess of Par--Preferred . 30,000

(f)
Cash (10,000 ´ $53 ´ 60%).................... 318,000
Subscriptions Receivable .................... 318,000

Preferred Stock Subscribed .................. 500,000


Preferred Stock ............................. 500,000

OBJ: LO 2

3. On August 10, Jameson Corporation reacquired 8,000 shares of its $100 par value common stock
at $134. The stock was originally issued at $110. The shares were resold on November 21 at
$145.

Provide the entries required to record the reacquisition and the subsequent resale of the stock
using the:

(1) Par value method of accounting for treasury stock.


(2) Cost method of accounting for treasury stock.

ANS:
(1)

Aug. 10 Treasury Stock (8,000 ´ $100) ...... 800,000


Paid-In Capital in Excess of Par
(8,000 ´ $10) .................... 80,000
Retained Earnings (8,000 ´ $24) .... 192,000
Cash (8,000 ´ $134) ............. 1,072,000

Nov. 21 Cash (8,000 ´ $145) ................ 1,160,000


Treasury Stock ................... 800,000
Paid-In Capital in Excess of Par . 360,000

(2)

Aug. 10 Treasury Stock ..................... 1,072,000


Cash ............................. 1,072,000
Nov. 21 Cash (8,000 ´ $145) ................ 1,160,000
Treasury Stock ..................... 1,072,000
Paid-In Capital from Sale of
Treasury Stock (8,000 ´ $11) ... 88,000

OBJ: LO 3

4. The data below are from the December 31, 2005, balance sheet of the Handi Corner Corporation:

22
Common stock, $50 par, 3,000 shares issued and
outstanding ......................................... $150,000
Paid-in capital in excess of par ...................... 45,000
Retained earnings ..................................... 75,000

During 2006, the following transactions affecting corporate capital were recorded:

Aug. 16 Purchased 400 shares of treasury stock at $78 per share.


Oct. 23 Purchased 225 shares of stock at $71 per share and
immediately retired the stock.
Nov. 3 Sold 150 shares of the treasury stock purchased on Aug. 16
at $81 per share.

Assuming the cost method is used for treasury stock and that retained earnings are to be reduced
minimally in stock reacquisition transactions, provide the entries required to record the above
transactions.

ANS:

Aug. 16 Treasury Stock ..................... 31,200


Cash (400 ´ $78) ................. 31,200

Oct. 23 Common Stock (225 ´ $50) ........... 11,250


Paid-In Capital in Excess of Par
(225 ´ $15) ...................... 3,375
Retained Earnings (225 x $6) ....... 1,350
Cash (225 ´ $71) ................. 15,975

Nov. 3 Cash (150 ´ $81) ................... 12,150


Treasury Stock (150 ´ $78) ......... 11,700
Paid-In Capital from Sale of 450
Treasury Stock (150 ´ $3) ........

OBJ: LO 3

5. The Perry Company wants to raise additional equity capital. The company decides to issue 5,000
shares of $25 par preferred stock with detachable warrants. The package of the stock and
warrants sells for $105. Each warrant enables the holder to purchase two shares of $10 par
common stock at $30 per share. Immediately following the issuance of the stock, the stock
warrants are selling at $14 each. The market value of the preferred stock without the warrants is
$96.

(1) Prepare a journal entry for Perry Company to record the issuance of the preferred
stock and the detachable warrants.
(2) Assuming that all the warrants are exercised, prepare a journal entry for Perry to
record the exercise of the warrants.
(3) Assuming that only 70 percent of the warrants are exercised, prepare a journal entry
for Perry to record the exercise and expiration of the warrants.

23
ANS:

(1)
Cash (5,000 ´ $105) ......................... 525,000
Common Stock Warrants ..................... 66,818
Preferred Stock (5,000 ´ $25) ............. 125,000
Paid-In Capital in Excess of Par-Preferred 333,182
Stock ...................................

Value assigned to warrants:


14/110 ´ $105 ´ 5,000 = $ 66,818

Value assigned to preferred stock:


96/110 ´ $105 ´ 5,000 = $458,182

(2)
Common Stock Warrants ....................... 66,818
Cash (10,000 ´ $30) ......................... 300,000
Common Stock (10,000 ´ $10) ............... 100,000
Paid-In Capital in Excess of Par-Common 266,818
Stock ....................................

(3)
Common Stock Warrants (70% ´ $66,818) ....... 46,773
Cash (7,000 ´ $30) .......................... 210,000
Common Stock (7,000 ´ $10) ................ 70,000
Paid-In Capital in Excess of Par-Common
Stock .................................... 186,773

Common Stock Warrants (30% ´ $66,818) ....... 20,045


Paid-In Capital from Expired Stock Warrants 20,045

OBJ: LO 4

6. Bennett Company paid cash dividends totaling $150,000 in 2003 and $75,000 in 2004. In 2005,
Bennett intends to pay cash dividends of $800,000. Compute the amount of cash dividends per
share to be received by common stockholders in 2005 under each of the following assumptions.
Treat each case independently. There were no dividends in arrears as of January 1, 2003.

(1) 25,000 shares of common; 100,000 shares of 6 percent, $50 par cumulative
preferred.
(2) 25,000 shares of common; 50,000 shares of 6 percent, $50 par noncumulative
preferred.
(3) 25,000 shares of common; 70,000 shares of 6 percent, $100 par cumulative
preferred.

ANS:
(1)

Cumulative preferred
Preferred dividends per year: 100,000 shares ´ $3 = $300,000
Paid In Arrears
Preferred dividends in 2003 $150,000 $150,000

24
Preferred dividends in 2004:
Arrearage from 2003 $ 75,000 (75,000)
Arrearage from 2004 $300,000
Total in arrears at $375,000
12/31/2004
Dividends for 2005:
Arrearage from years 2003 and 2004 $375,000
Current year preferred dividend 300,000
Total preferred dividends paid in 2005 $675,000
Remainder to common: $800,000 - $675,000 = $125,000
Common dividends per share: $125,000/25,000 shares = $5.00 per share

(2)

Noncumulative preferred
Preferred dividends per year: 50,000 shares ´ $3 = $150,000
Dividends in arrears for 2000: $ 0
Dividends in arrears for 2001: 0
Dividends for 2005: 150,000
Total preferred dividends $150,000

Remainder to common: $800,000 - $150,000 = $650,000


Common dividends per share: $650,000/25,000 shares = $26.00 per
share

(3)

Cumulative preferred
Preferred dividends per year: 70,000 shares ´ $6 = $420,000
Paid In Arrears
Preferred dividends in 2003 $150,000 $270,000
Preferred dividends in 2004:
Arrearage from 2003 $ 75,000 (75,000)
Arrearage from 2004 420,000
Total in arrears at 12/31/2004 $615,000
Dividends for 2005:
Total dividends paid in 2005 $800,000
Arrearage from years 2003 and 2004 615,000
Amount available for preferred dividend in 2005 $185,000
Total preferred dividends $800,000

Remainder to common: $0
Common dividends per share: $0

OBJ: LO 8

7. On January 1, 2005, the records of the Gerrard Corporation showed these balances:

Common stock--authorized 78,000 shares at $100 par;


issued 30,800 shares ................................ $3,080,000
Paid-In capital in excess of par ...................... 264,800
Retained earnings ..................................... 2,960,000

25
During 2005 and 2006, these transactions occurred:

July 1, 2005 Declared stock dividend (from unissued stock) of 1 share for each 2 shares
outstanding, issued September 1. (Prior to the declaration, the market value of
the unissued stock was $115 per share.)
June 1, 2006 Declared stock dividend (from unissued stock) of 1 share for each 10 shares
outstanding, issued August 1. (Prior to the declaration, the market value of the
unissued stock was $120 per share.)

Provide the entries to record the declaration and payment of the stock dividends during 2005 and
2006.

ANS:

2005
July 1 Retained Earnings ................. 1,540,000
Stock Dividends Distributable ... 1,540,000
[(30,800/2) ´ $100] .............

Sep. 1 Stock Dividends Distributable ..... 1,540,000


Common Stock ($100 par) ......... 1,540,000

2006
June 1 Retained Earnings ................... 554,400
Stock Dividends Distributable ..... 462,000
Paid-In Capital from Stock
Dividends ........................ 92,400
30,800 + 15,400 = 46,200
outstanding shares .............
46,200 ´ 10% = 4,620 shares .....
4,620 shares ´ $120 = $554,400 ..

Aug. 1 Stock Dividends Distributed ......... 462,000


Common Stock ($100 par) ........... 462,000

OBJ: LO 8

8. Upon organization on January 1, 2005, Okra Inc. was authorized to issue 200,000 shares of $10
par common stock in multiples of 100 shares. During 2005, 110,000 shares were sold at $65 per
share; 6,000 shares were later reacquired as treasury stock at $72 per share. A stock split of 2-for-
1 on all issued shares was approved on December 31, 2005.

During 2006, these dividend and treasury stock transactions occurred:


April 12 Declared and paid a 10 percent stock dividend on all
outstanding shares.

Oct. 17 All treasury stock was sold at $81 per share.

Dec. 4 Declared and paid these dividends:


• $1 cash dividend per share for common stock outstanding
• Property dividend of 1 share of Hall Co. common stock for each 10 shares
of Okra stock held. The cost to the company for 1 share of Hall Co.
common stock was $25 with a current market value
of $30.

26
Provide the entries to record the declaration and payment of the dividends on December 4, 2006.

ANS:

Common Stock Description Shares


Issued during 2005 ...................... 110,000
Reacquired during 2005 .................. (6,000)
Outstanding on December 31, 2005 ........ 104,000

Outstanding after 2-for-1 stock split,


December 31, 2005 (104,000 ´ 2) ....... 208,000

10% stock dividend, April 12


(10% ´ 208,000) ....................... 20,800
Resale of treasury stock, Oct. 17
(6,000 ´ 2) ........................... 12,000
Outstanding December 4, 2006 ............ 240,800

2006
Dec. 4 Retained Earnings ................... 240,800
Cash Dividends Payable
(240,800 ´ $1) .................... 240,800

Cash Dividends Payable .............. 240,800


Cash .............................. 240,800

Dec. 4 Retained Earnings (24,080 ´ $30) .... 722,400


Property Dividends Payable
(24,080 ´ $25) .................... 602,000
Gain on Distribution of Property
Dividends (24,080 ´ $5) ......... 120,400

Property Dividends Payable .......... 602,000


Investment in Hall Co. Stock ...... 602,000

OBJ: LO 8

9. During 2005, the following transactions related to the capital stock of the Buffet-Line Corp.
occurred:

Jan. 7 Declared a $.75 cash dividend on 150,000 shares of preferred stock.


Feb. 7 Paid dividends on preferred stock.
March 4 Declared a $.50 cash dividend on 200,000 shares of common stock with a $20 par
value.
March 18 Paid dividends on common stock.
June 30 Split common stock 4-for-1.
July 9 Purchased 12,000 shares of Buffet-Line's own common stock at $32 per share;
acquisition recorded at cost.
Sept. 10 Declared a cash dividend of $.40 per share on common stock outstanding.
Sept. 18 Paid dividends on common stock.

Provide the entries to record the above transactions.

27
ANS:

Jan. 7 Retained Earnings (150,000 ´ $.75) .. 112,500


Cash Dividends Payable--Preferred
Stock ............................ 112,500

Feb. 7 Cash Dividends Payable--Preferred


Stock .............................. 112,500
Cash .............................. 112,500

Mar. 4 Retained Earnings (200,000 ´ $.50) .. 100,000


Cash Dividends Payable--Common
Stock ............................. 100,000

Mar. 18 Cash Dividends Payable--Common Stock 100,000


Cash .............................. 100,000

June 30 Memorandum entry ....................

July 9 Treasury Stock--Common .............. 384,000


Cash .............................. 384,000

Sept. 10 Retained Earnings ................... 315,200


Cash Dividends Payable--Common
Stock [(800,000 - 12,000) ´ $.40] . 315,200

Sept. 18 Cash Dividends Payable--Common Stock 315,200


Cash .............................. 315,200

OBJ: LO 8

10. The stockholders' equity section of Jessie Corp. is presented below.

Common stock, $20 par value, authorized 1,000,000 $ 8,000,000


shares, issued and outstanding 400,000 shares .......
Additional paid-in capital ............................ 2,400,000
Retained earnings ..................................... 10,800,000
Total stockholders' equity ............................ $21,200,000

Complete the following table to depict the number of shares of stock and balances in the
stockholders' equity accounts after each of the following transactions. Each situation is to be
considered independently of the others.

(a) 15 percent stock dividend, market value $25 per share


(b) 2-for-1 stock split
(c) 100 percent stock dividend, market value $25 per share

Additional Total Total


Outstanding Common Paid-In Retained Stockholders'
Shares Stock Capital Earnings Equity
(a)
(b)
(c)

28
ANS:

Additional Total Total


Outstanding Common Paid-In Retained Stockholders'
Shares Stock Capital Earnings Equity
(a) 460,000 $ 9,200,000 $2,700,000 $ 9,300,000 $21,200,000
(b) 800,000 $ 8,000,000 $2,400,000 $10,800,000 $21,200,000
(c) 800,000 $16,000,000 $2,400,000 $ 2,800,000 $21,200,000

OBJ: LO 8

11. The following information pertains to Rondo Corp. for the year ended September 30, 2005:

Net income ............................................. $ 75,000


Retained earnings, Oct. 1, 2004 ........................ 860,000
Cash dividends declared ................................ 16,400
Stock dividends declared ............................... 41,000
Overstatement of depreciation expense of 2001 and 2002— 62,000
pretax ...............................................
Tax rate ............................................... 30%

Prepare a statement of retained earnings for Rondo Corp. for the year ended September 30, 2005.

ANS:

Rondo Corp.
Statement of Retained Earnings
For Year Ended September 30, 2005

Retained earnings, October 1, 2004, as $860,000


originally reported ....................
Prior period adjustment--overstatement 43,400
of depreciation, net of income taxes of
$18,600 ...............................

Retained earnings, October 1, 2004, as $903,400


restated ..............................
Add: Net income ..................... 75,000
Less: Cash dividends declared ........ $16,400
Stock dividends declared ..... 41,000 (57,400)
Retained earnings, September 30, 2005 ... $921,000

OBJ: LO 6

12. On July 23, Tinbabe Company declared a cash dividend totaling $80,000. Stockholders were
notified that $15,000 of this dividend represented a liquidating dividend. At the time, the balance
in Paid-In Capital in Excess of Par was $113,000.

Make the journal entries to record (1) the declaration and (2) the payment of this dividend.

ANS:

(1)
Dividends (or Retained Earnings) ............ 65,000
Paid-In Capital in Excess of Par ............ 15,000

29
Dividends Payable ......................... 80,000
(2)
Dividends Payable ........................... 80,000
Cash ...................................... 80,000

OBJ: LO 8

13. Indicate how each of the following transactions would be reflected in a statement of cash flows:

(1) Cash dividends declared and paid during the year.


(2) A 10 percent stock dividend declared and distributed during the year.
(3) A 50 percent stock dividend declared and distributed during the year.
(4) A property dividend declared and distributed during the year.
(5) A retained earnings appropriation made during the year.

ANS:

(1) Cash outflow in the financing activities section.


(2) Not reflected in the statement of cash flows.
(3) Not reflected in the statement of cash flows.
(4) Not reflected in the statement of cash flows. Supplemental disclosure.
(5) Not reflected in the statement of cash flows.

OBJ: LO 8

14. On January 1, 2005, Thomas Company granted its 20 top executives stock options to acquire
6,000 shares of $10 par value common stock for $15 per share in the year commencing January 1,
2008. The market price of Thomas stock is $20 on the date of the grant. The executives must
remain in the employ of the company only until December 31, 2006, to retain their options.

The market price of the stock is $20, $25, and $26 on December 31, 2005, 2006, and 2008,
respectively. On January 1, 2008, options equivalent to 5,200 shares are exercised, with no other
exercises of options during the year.

Prepare the journal entries necessary under APB Opinion No. 25 on January 1, 2005, December
31, 2005, December 31, 2006, and during the year beginning January 1, 2008.

ANS:
Jan. 1, 2005 No entry required.

Dec. 31, 2005 Salary Expense ..................... 15,000


Paid-in Capital-Stock Options .... 15,000

Dec. 31, 2006 Salary Expense ..................... 15,000


Paid-in Capital-Stock Options .... 15,000
Jan. 1, 2008 Cash (5,200 shares ´ %15) .......... 78,000
Paid-in Capital-Stock Options ...... 26,000
5,200 shares ´ ($20 - $15)
Common Stock ..................... 52,000
Paid-in Capital in Excess of Par . 52,000
(5,200 shares ´ ($20 - $10)

Dec. 31, 2008 Paid-in Capital-Stock Options ...... 4,000


Paid-in Capital from Expired
Options ........................ 4,000

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OBJ: LO 5
15. The accounts from the stockholders' equity section of the balance sheet of Western Company
showed the following at December 31, 2004:

Common Stock .......................................... $ 475,000


Paid-in Capital in Excess of Par ...................... 6,650,000
Retained Earnings ..................................... 787,500

Western issued 475,000 shares of the $1 par value common stock on January 1, 2004.

The company also is authorized to issue 500,000 shares of $5 par value, 6% preferred stock.

During 2005, Western had the following transactions:

Jan. 10 Issued an additional 90,000 shares of common stock at $17 per share.
Apr. 1 Issued 100,000 shares of preferred stock at $8 per share.
July 19 The board of directors authorized the appropriation of $295,000 of retained earnings
for the purchase of equipment.
Oct. 23 Sold an additional 60,000 shares of preferred stock at $9 per share.
Dec. 31 Net income for the year was $1,200,000. The board of directors declared a dividend
of $623,000 to stockholders of record on January 15, 2006, to be paid on February
1, 2006.

Prepare a statement of changes in stockholders' equity for 2005 using the


information given above.

ANS:

Western Company
Statement of Changes in Stockholders' Equity
For the Year Ended December 31, 2005

Paid-in Paid-in
Capital Capita
Preferred In Excess Common In Excess Retained
Stock of Par Stock of Par Earnings Total
Balances,
Dec. 31, 2004 $ -0- $ -0- $475,000 $6,650,000 $ 787,500 $7,912,000
Jan. 10:
Issued 90,000
common at $17 90,000 1,440,000 1,530,000
Apr. 23:
Issued 100,000
preferred at $8 500,000 300,000 800,000
Oct 23:
Issued 60,000
preferred at $9 300,000 240,000 540,000
Dec. 31:
Net income for
2005 1,200,000 1,200,000
Cash dividends:
Preferred:
$.30 x 160,000 (48,000) (48,000)
Common:
$1.00 x 575,000 (575,000) (575,000)
Balances,
Dec. 31, 2005 $800,000 $540,000 $565,000 $8,090,000 $1,364,500 $11,359,500

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OBJ: LO 10

16. A major conclusion of the FASB's standard on accounting for stock options is that fixed option
plans for which the option price is equal to the market price of the stock at the date of grant will
result in compensation cost. Under APB Opinion No. 25, such plans generated no such
compensation cost if the exercise price was greater than or equal to the market price at the grant
date. Under the FASB standard, compensation expense would be measured by the value of the
option rather than the spread between the option price and the market price of the stock at the
grant date.

One means of measuring the value of the option itself is the use of a mathematical model, such as
the Black-Scholes option pricing model. This model considers both the minimum value and
volatility values in measuring the fair value of an option. The minimum value is the current price
of the stock minus both the present value of the exercise price and the present value of expected
dividends on the stock during the term of the option, both discounted at the risk-free rate of
return. The volatility value is a measure of the amount by which the price of the stock has
fluctuated or is expected to fluctuate during a period. Volatility is measured by the standard
deviation of a probability distribution. The larger the standard deviation in relation to average
price level, the more variable the price.

Identify the objections that might be raised to the use of the Black-Scholes mathematical option
pricing model in valuing options issued as part of a stock compensation plan.

ANS:
The following may be cited as objections to the use of the Black-Scholes model:

(1) The estimation of stock-price volatility may prove to be difficult and


timeconsuming and estimates too imprecise.

(2) The model was developed for third-party, traded options and is not applicable to
employee stock options which, unlike third-party, traded options, are forfeitable
and nontransferable.

(3) The model was developed primarily for shorter-term options rather than for the
long-term employee stock options to which the model is to be applied under the
FASB standard.

(4) The model is not appropriate for emerging entities whose stock is not publicly
offered and for which an estimation of volatility would be difficult if not
impossible.

OBJ: LO 5

17. The following amounts were taken from the income statement of LFM Company for the year
ending December 31, 2005:
Revenues $1,800,000
Expenses 1,000,000
Income before taxes $ 800,000
Income tax expense 200,000
Net income $ 600,000
Income from discontinued operations:
Income from operations $ 50,000
Loss on disposal (200,000)

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Loss from discontinued operations (150,000)
Net income $ 450,000
In addition, LFM reported the following items (all items are before taxes):

Unrealized gain (loss) on available-for-sale securities $100,000


(Increase) Decrease in minimum pension liability (60,000)
Unrealized gain (loss) on derivative instruments (20,000)
Foreign currency translation adjustment, increase (decrease)
in stockholders' equity 300,000

The tax rate on all items is 40%.

Prepare a statement of comprehensive income in a one-statement format.

ANS:
LFM Company
Statement of Income and Comprehensive Income
For the Year Ending December 31, 2005

Revenues $1,800,000
Expenses 1,000,000
Income before taxes $ 800,000
Income tax expense 200,000
Net income $ 600,000
Income from discontinued operations:
Income from operations $ 50,000
Loss on disposal (200,000)
Loss from discontinued operations (150,000)
Net income $ 450,000
Other comprehensive income, net of income tax:

Unrealized gain on available-for-sale securities $ 60,0001


Increase in minimum pension liability (36,000)2
Unrealized loss on derivative instruments (12,000) 3
Foreign currency translation adjustment 180,0004 192,000
Comprehensive income $ 642,000
1
$ 100,000 x (1 - 0.40)
2
$ 60,000 x (1 - 0.40)
3
$ 20,000 x (1 - 0.40)
4
$300,000 x (1 - 0.40)

OBJ: LO 9

18. The following amounts were taken from the income statement of LFM Company for the year
ending December 31, 2005:

Revenues $1,800,000
Expenses 1,000,000
Income before taxes $ 800,000
Income tax expense 200,000
Net income $ 600,000
Income from discontinued operations:
Income from operations $ 50,000
Loss on disposal (200,000)

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Loss from discontinued operations (150,000)
Net income $ 450,000
In addition, LFM reported the following items (all items are before taxes):

Unrealized gain (loss) on available-for-sale securities $100,000


(Increase) Decrease in minimum pension liability (60,000)
Unrealized gain (loss) on derivative instruments (20,000)
Foreign currency translation adjustment, increase (decrease)
in stockholders' equity 300,000

The tax rate on all items is 40%.

Prepare a statement of comprehensive income in a two-statement format.

ANS:

LFM Company
Statement of Income
For the Year Ending December 31, 2005

Revenues $1,800,000
Expenses 1,000,000
Income before taxes $ 800,000
Income tax expense 200,000
Net income $ 600,000
Income from discontinued operations:
Income from operations $ 50,000
Loss on disposal (200,000)
Loss from discontinued operations (150,000)
Net income $ 450,000

LFM Company
Statement of Comprehensive Income
For the Year Ending December 31, 2005

Net income $ 450,000


Other comprehensive income, net of income tax:

Unrealized gain on available-for-sale securities $ 60,0001


Increase in minimum pension liability (36,000)2
Unrealized loss on derivative instruments (12,000) 3
Foreign currency translation adjustment 180,0004 192,000
Comprehensive income $ 642,000
1
$ 100,000 x (1 - 0.40)
2
$ 60,000 x (1 - 0.40)
3
$ 20,000 x (1 - 0.40)
4
$300,000 x (1 - 0.40)

OBJ: LO 9

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