A corporation has been defined as an entity separate and distinct from its owners. In what ways is a corporation a separate legal entity?

WileyPLUS

Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.


Questions

Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

1. Joe, a student, asks your help in understanding some characteristics of a corporation. Explain each of these to Joe.

a. Separate legal existence.

b. Limited liability of stockholders.

c. Transferable ownership rights.

2. a. Your friend G. C. Jones cannot understand how the characteristic of corporate management is both an advantage and a disadvantage. Clarify this problem for G. C.

b. Identify and explain two other disadvantages of a corporation.

3. Nona Jaymes believes a corporation must be incorporated in the state in which its headquarters office is located. Is Nona correct? Explain.

4. What are the basic ownership rights of common stockholders in the absence of restrictive provisions?

5. A corporation has been defined as an entity separate and distinct from its owners. In what ways is a corporation a separate legal entity?

6. What are the two principal components of stockholders’ equity?

7. The corporate charter of Gage Corporation allows the issuance of a maximum of 100,000 shares of common stock. During its first 2 years of operation, Gage sold 70,000 shares to shareholders and reacquired 4,000 of these shares. After these transactions, how many shares are authorized, issued, and outstanding?

8. Which is the better investment—common stock with a par value of $5 per share or common stock with a par value of $20 per share?

9. For what reasons might a company like IBM repurchase some of its stock (treasury stock)?

10. Monet, Inc. purchases 1,000 shares of its own previously issued $5 par common stock for $11,000. Assuming the shares are held in the treasury, what effect does this transaction have on (a) net income, (b) total assets, (c) total paid-in capital, and (d) total stockholders’ equity?

11. a. What are the principal differences between common stock and preferred stock?

b. Preferred stock may be cumulative. Discuss this feature.

c. How are dividends in arrears presented in the financial statements?

12. Identify the events that result in credits and debits to retained earnings.

13. Indicate how each of these accounts should be classified in the stockholders’ equity section of the balance sheet.

a. Common Stock.

b. Paid-in Capital in Excess of Par Value.

c. Retained Earnings.

d. Treasury Stock.

e. Paid-in Capital in Excess of Stated Value.

f. Preferred Stock.

14. What three conditions must be met before a cash dividend is paid?

15. Three dates associated with Petrie Company’s cash dividend are May 1, May 15, and May 31. Discuss the significance of each date and give the entry at each date.

16. Contrast the effects of a cash dividend and a stock dividend on a corporation’s balance sheet.

17. Doris Angel asks, “Since stock dividends don’t change anything, why declare them?” What is your answer to Doris?

18. Jayne Corporation has 10,000 shares of $15 par value common stock outstanding when it announces a 3-for-1 split. Before the split, the stock had a market price of $120 per share. After the split, how many shares of stock will be outstanding, and what will be the approximate market price per share?

19. The board of directors is considering a stock split or a stock dividend. They understand that total stockholders’ equity will remain the same under either action. However, they are not sure of the different effects of the two actions on other aspects of stockholders’ equity. Explain the differences to the directors.

20. What was the total cost of Apple‘s treasury stock acquired in fiscal year 2017? (Hint: Refer to Apple’s statement of cash flows.)

21. a. What is the purpose of a retained earnings restriction?

b. Identify the possible causes of retained earnings restrictions.

22. Thom Inc.’s common stock has a par value of $1 and a current market price of $15. Explain why these amounts are different.

23. What is the formula for the payout ratio? What does it indicate?

24. Explain the circumstances under which debt financing will increase the return on common stockholders’ equity.

25. Under what circumstances will the return on assets and the return on common stockholders’ equity be equal?

26. Sauer Corp. has a return on assets of 12%. It plans to issue bonds at 8% and use the cash to repurchase stock. What effect will this have on its debt to assets ratio and on its return on common stockholders’ equity?


Brief Exercises

BE11.1 (LO 1), K Hana Ascot is planning to start a business. Identify for Hana the advantages and disadvantages of the corporate form of business organization.

BE11.2 (LO 2), AP On May 10, Pilar Corporation issues 2,500 shares of $5 par value common stock for cash at $13 per share. Journalize the issuance of the stock.

BE11.3 (LO 2), AP On June 1, Forest Inc. issues 3,000 shares of no-par common stock at a cash price of $7 per share. Journalize the issuance of the shares.

BE11.4 (LO 2), AP Layes Inc. issues 8,000 shares of $100 par value preferred stock for cash at $106 per share. Journalize the issuance of the preferred stock.

BE11.5 (LO 2), AP On July 1, Raney Corporation purchases 500 shares of its $5 par value common stock for the treasury at a cash price of $9 per share. Journalize the treasury stock transaction.

BE11.6 (LO 3), AP Basse Corporation has 7,000 shares of common stock outstanding. It declares a $1 per share cash dividend on November 1 to stockholders of record on December 1. The dividend is paid on December 31. Prepare the entries on the appropriate dates to record the declaration and payment of the cash dividend.

BE11.7 (LO 3), AP M. Bot Corporation has 10,000 shares of 8%, $100 par value, cumulative preferred stock outstanding at December 31, 2022. No dividends were declared in 2020 or 2021. If M. Bot wants to pay $375,000 of dividends in 2022, what amount of dividends will common stockholders receive?

BE11.8 (LO 3), AP The stockholders’ equity section of Mabry Corporation’s balance sheet consists of common stock ($8 par) $1,000,000 and retained earnings $300,000. A 10% stock dividend (12,500 shares) is declared when the market price per share is $19. Show the before-and-after effects of the dividend on (a) the components of stockholders’ equity and (b) the shares outstanding.

BE11.9 (LO 3), K Indicate whether each of the following transactions would increase (+), decrease (−), or not affect (N/A) total assets, total liabilities, and total stockholders’ equity.

Transaction Assets Liabilities Stockholders’ Equity
a. Declared cash dividend.
b. Paid cash dividend declared in (a).
c. Declared stock dividend.
d. Distributed stock dividend declared in (c).
e. Split stock 3-for-1.

BE11.10 (LO 4), AP Sudz Corporation has these accounts at December 31: Common Stock, $10 par, 5,000 shares issued, $50,000; Paid-in Capital in Excess of Par Value $22,000; Retained Earnings $42,000; and Treasury Stock, 500 shares, $11,000. Prepare the stockholders’ equity section of the balance sheet.

BE11.11 (LO 4), C Hans Miken, president of Miken Corporation, believes that it is a good practice for a company to maintain a constant payout of dividends relative to its earnings. Last year, net income was $600,000, and the corporation paid $120,000 in dividends. This year, due to some unusual circumstances, the corporation had income of $1,600,000. Hans expects next year’s net income to be about $700,000. What was Miken Corporation’s payout ratio last year? If it is to maintain the same payout ratio, what amount of dividends would it pay this year? Is this necessarily a good idea—that is, what are the pros and cons of maintaining a constant payout ratio in this scenario?

BE11.12 (LO 4), AP SUPERVALU, one of the largest grocery retailers in the United States, is headquartered in Minneapolis. Suppose the following financial information (in millions) was taken from the company’s 2022 annual report: net sales $44,597, net income $393, beginning stockholders’ equity $2,581, and ending stockholders’ equity $2,887. There were no dividends paid on preferred stock. Compute the return on common stockholders’ equity. Provide a brief interpretation of your findings.

BE11.13 (LO 4), AP Emron Inc. is considering these two alternatives to finance its construction of a new $2 million plant:

  • 1. Issuance of 200,000 shares of common stock at the market price of $10 per share.
  • 2. Issuance of $2 million, 6% bonds at face value.

Complete the table and indicate which alternative is preferable.

Issue Stock Issue Bond
Income before interest and taxes $1,500,000 $1,500,000
Interest expense from bonds                
Income before income taxes
Income tax expense (30%)                
Net income $        $       
Outstanding shares           700,000
Earnings per share $        $       

*BE11.14 (LO 5), AP Stossel Corporation has 200,000 shares of $10 par value common stock outstanding. It declares a 12% stock dividend on December 1 when the market price per share is $17. The dividend shares are issued on December 31. Prepare the entries for the declaration and distribution of the stock dividend.


DO IT! Exercises

DO IT! 11.1a (LO 1), C Indicate whether each of the following statements is true or false. If false, indicate how to correct the statement.

__________ 1. The corporation is an entity separate and distinct from its owners.

__________ 2. The liability of stockholders is normally limited to their investment in the corporation.

__________ 3. The relatively low amount of government regulation of corporations is an advantage of the corporate form of business.

__________ 4. There is no journal entry to record the authorization of capital stock.

__________ 5. No-par value stock is quite rare today.

DO IT! 11.1b (LO 1), AP At the end of its first year of operation, Goss Corporation has $1,000,000 of common stock and net income of $236,000. Prepare (a) the closing entry for net income and (b) the stockholders’ equity section at year-end.

DO IT! 11.2a (LO 2), AP Beauty Island Corporation began operations on April 1 by issuing 55,000 shares of $5 par value common stock for cash at $13 per share. In addition, Beauty Island issued 1,000 shares of $1 par value preferred stock for $6 per share. Journalize the issuance of the common and preferred shares.

DO IT! 11.2b (LO 2), AP Dinosso Corporation purchased 2,000 shares of its $10 par value common stock for $76,000 on August 1. It will hold these in the treasury until resold. Journalize the treasury stock transaction.

DO IT! 11.3a (LO 3), AP Sparks Corporation has 3,000 shares of 8%, $100 par value preferred stock outstanding at December 31, 2022. At December 31, 2022, the company declared a $105,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios.

  • 1. The preferred stock is noncumulative, and the company has not missed any dividends in previous years.
  • 2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years.
  • 3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years.

DO IT! 11.3b (LO 3), AP Spears Company has had 4 years of record earnings. Due to this success, the market price of its 400,000 shares of $2 par value common stock has increased from $6 per share to $50. During this period, paid-in capital remained the same at $2,400,000. Retained earnings increased from $1,800,000 to $12,000,000. CEO Don Ames is considering either (1) a 15% stock dividend or (2) a 2-for-1 stock split. He asks you to show the before-and-after effects of each option on (a) retained earnings, (b) total stockholders’ equity, and (c) par value per share.

DO IT! 11.4a (LO 4), AP Hoyle Corporation has issued 100,000 shares of $5 par value common stock. It was authorized 500,000 shares. The paid-in capital in excess of par value on the common stock is $263,000. The corporation has reacquired 7,000 shares at a cost of $46,000 and is currently holding those shares. It also had accumulated other comprehensive income of $67,000.

The corporation also has 2,000 shares issued and outstanding of 9%, $100 par value preferred stock. It was authorized 10,000 shares. The paid-in capital in excess of par value on the preferred stock is $23,000. Retained earnings is $372,000. Prepare the stockholders’ equity section of the balance sheet.

DO IT! 11.4b (LO 4), AP On January 1, 2022, Vahsholtz Corporation purchased 5,000 shares of treasury stock. Other information regarding Vahsholtz Corporation is provided as follows.

2022 2021
Net income $110,000 $100,000
Dividends on preferred stock $ 30,000 $ 30,000
Dividends on common stock $ 25,000 $ 20,000
Weighted-average number of common shares outstanding 45,000 50,000
Common stockholders’ equity beginning of year $750,000 $600,000
Common stockholders’ equity end of year $830,000 $750,000

Compute (a) return on common stockholders’ equity for each year, and (b) discuss the changes in each.


Exercises

E11.1 (LO 1), C Andrea has prepared the following list of statements about corporations.

  • 1. A corporation is an entity separate and distinct from its owners.
  • 2. As a legal entity, a corporation has most of the rights and privileges of a person.
  • 3. Most of the largest U.S. corporations are privately held corporations.
  • 4. Corporations may buy, own, and sell property; borrow money; enter into legally binding contracts; and sue and be sued.
  • 5. The net income of a corporation is not taxed as a separate entity.
  • 6. Creditors have a legal claim on the personal assets of the owners of a corporation if the corporation does not pay its debts.
  • 7. The transfer of stock from one owner to another requires the approval of either the corporation or other stockholders.
  • 8. The board of directors of a corporation legally owns the corporation.
  • 9. The chief accounting officer of a corporation is the controller.
  • 10. Corporations are subject to fewer state and federal regulations than partnerships or proprietorships.

Instructions

Identify each statement as true or false. If false, indicate how to correct the statement.

E11.2 (LO 1), C Andrea (see E11.1) has studied the information you gave her in that exercise and has come to you with more statements about corporations.

  • 1. Corporation management is both an advantage and a disadvantage of a corporation compared to a proprietorship or a partnership.
  • 2. Limited liability of stockholders, government regulations, and additional taxes are the major disadvantages of a corporation.
  • 3. When a corporation is formed, organization costs are recorded as an asset.
  • 4. Each share of common stock gives the stockholder the ownership rights to vote at stockholder meetings, share in corporate earnings, keep the same percentage ownership when new shares of stock are issued, and share in assets upon liquidation.
  • 5. The number of issued shares is always greater than or equal to the number of authorized shares.
  • 6. A journal entry is required for the authorization of capital stock.
  • 7. Publicly held corporations usually issue stock directly to investors.
  • 8. The trading of capital stock on a securities exchange involves the transfer of already issued shares from an existing stockholder to another investor.
  • 9. The market price of common stock is usually the same as its par value.
  • 10. Retained earnings is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock.

Instructions

Identify each statement as true or false. If false, indicate how to correct the statement.

E11.3 (LO 2), AP During its first year of operations, Mona Corporation had these transactions pertaining to its common stock.

Jan. 10 Issued 30,000 shares for cash at $5 per share.
July  1 Issued 60,000 shares for cash at $7 per share.

Instructions

a. Journalize the transactions, assuming that the common stock has a par value of $5 per share.

b. Journalize the transactions, assuming that the common stock is no-par with a stated value of $1 per share.

E11.4 (LO 2), AP Sagan Co. had these transactions during the current period.

June 12 Issued 80,000 shares of $1 par value common stock for cash of $300,000.
July  11 Issued 3,000 shares of $100 par value preferred stock for cash at $106 per share.
Nov. 28 Purchased 2,000 shares of treasury stock for $9,000.

Instructions

Prepare the journal entries for the Sagan Co. transactions.

E11.5 (LO 2), AP Quay Co. had the following transactions during the current period.

Mar. 2 Issued 5,000 shares of $5 par value common stock to attorneys in payment of a bill for $30,000 for services performed in helping the company to incorporate.
June 12 Issued 60,000 shares of $5 par value common stock for cash of $375,000.
July 11 Issued 1,000 shares of $100 par value preferred stock for cash at $110 per share.
Nov. 28 Purchased 2,000 shares of treasury stock for $80,000.

Instructions

Journalize the transactions.

E11.6 (LO 2, 4), AP Penland Corporation is authorized to issue both preferred and common stock. The par value of the preferred is $50. During the first year of operations, the company had the following events and transactions pertaining to its preferred stock.

Feb. 1 Issued 40,000 shares for cash at $51 per share.
July 1 Issued 60,000 shares for cash at $56 per share.

Instructions

a. Journalize the transactions.

b. Post to the stockholders’ equity accounts. (Use T-accounts.)

c. Discuss the statement presentation of the accounts.

E11.7 (LO 2, 4), C The stockholders’ equity section of Lachlin Corporation’s balance sheet at December 31 is presented here.

Lachlin Corporation
Balance Sheet (partial)
Stockholders’ equity
 Paid-in capital
  Preferred stock, cumulative, 10,000 shares authorized, 6,000 shares issued and outstanding $  600,000
  Common stock, no par, 750,000 shares authorized, 580,000 shares issued 2,900,000
   Total paid-in capital 3,500,000
 Retained earnings 1,158,000
 Total paid-in capital and retained earnings 4,658,000
 Less: Treasury stock (6,000 common shares) 32,000
Total stockholders’ equity $4,626,000

Instructions

From a review of the stockholders’ equity section, answer the following questions.

a. How many shares of common stock are outstanding?

b. Assuming there is a stated value, what is the stated value of the common stock?

c. What is the par value of the preferred stock?

d. If the annual dividend on preferred stock is $36,000, what is the dividend rate on preferred stock?

e. If dividends of $72,000 were in arrears on preferred stock, what would be the balance reported for retained earnings?

E11.8 (LO 2), AN Mesa Corporation recently hired a new accountant with extensive experience in accounting for partnerships. Because of the pressure of the new job, the accountant was unable to review what he had learned earlier about corporation accounting. During the first month, he made the following entries for the corporation’s capital stock.

May  2 Cash 104,000
 Capital Stock 104,000
  (Issued 8,000 shares of $10 par value common stock at $13 per share)
10 Cash 530,000
 Capital Stock 530,000
  (Issued 10,000 shares of $20 par value preferred stock at $53 per share)
15 Capital Stock 7,200
 Cash 7,200
  (Purchased 600 shares of common stock for the treasury at $12 per share)

Instructions

On the basis of the explanation for each entry, prepare the entries that should have been made for the capital stock transactions.

E11.9 (LO 3), AP On January 1, Graves Corporation had 60,000 shares of no-par common stock issued and outstanding. The stock has a stated value of $4 per share. During the year, the following transactions occurred.

Apr.   1 Issued 9,000 additional shares of common stock for $11 per share.
June 15 Declared a cash dividend of $1.50 per share to stockholders of record on June 30.
July  10 Paid the $1.50 cash dividend.
Dec.  1 Issued 4,000 additional shares of common stock for $12 per share.
15 Declared a cash dividend on outstanding shares of $1.60 per share to stockholders of record on December 31.

Instructions

a. Prepare the entries, if any, on each of the three dates that involved dividends.

b. How are dividends and dividends payable reported in the financial statements prepared at December 31?

E11.10 (LO 3), AP Knudsen Corporation was organized on January 1, 2021. During its first year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock. At December 31, the company declared the following cash dividends: 2021, $5,000; 2022, $12,000; and 2023, $28,000.

Instructions

a. Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 6% and noncumulative.

b. Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 7% and cumulative.

c. Journalize the declaration of the cash dividend at December 31, 2023, under part (b).

E11.11 (LO 3), AP On October 31, the stockholders’ equity section of Manolo Company’s balance sheet consists of common stock $648,000 and retained earnings $400,000. Manolo is considering the following two courses of action: (1) declaring a 5% stock dividend on the 81,000 $8 par value shares outstanding or (2) effecting a 2-for-1 stock split that will reduce par value to $4 per share. The current market price is $17 per share.

Instructions

Prepare a tabular summary of the effects of the alternative actions on the company’s stockholders’ equity and outstanding shares. Use these column headings: Before ActionAfter Stock Dividend, and After Stock Split.

E11.12 (LO 2, 3), AP The stockholders’ equity accounts of Ripley Corporation on January 1, 2022, were as follows.

Preferred Stock (8%, $100 par noncumulative, 5,000 shares authorized) $  400,000
Common Stock ($10 stated value, 800,000 shares authorized) 1,500,000
Paid-in Capital in Excess of Par Value—Preferred Stock 55,000
Paid-in Capital in Excess of Stated Value—Common Stock 880,000
Retained Earnings 760,000
Treasury Stock (8,000 common shares) 64,000

During 2022, the corporation had the following transactions and events pertaining to its stockholders’ equity.

Mar  1 Issued 6,000 shares of common stock for $85 per share.
June 22 Purchased 1,000 additional shares of common treasury stock at $11 per share.
Sept.  1 Declared a 8% cash dividend on preferred stock, payable October 1.
Oct.  1 Paid the dividend declared on September 1.
Dec.  1 Declared a $0.70 per share cash dividend to common stockholders of record on December 15, payable December 31, 2022.
31 Determined that net income for the year was $110,000. Paid the dividend declared on December 1.

Instructions

Journalize the transactions for the dates shown. Include entries to close net income and dividends to Retained Earnings.

E11.13 (LO 4), AP Wells Fargo & Company, headquartered in San Francisco, is one of the nation’s largest financial institutions. Suppose it reported the following selected accounts (in millions) as of December 31, 2022.

Retained Earnings $41,563 
Preferred Stock 8,485 
Common Stock—$123; par value, authorized 6,000,000,000 shares; issued 5,245,971,422 shares 8,743 
Treasury Stock—67,346,829 common shares (2,450)
Paid-in Capital in Excess of Par Value—Common Stock 52,878 
Accumulated Other Comprehensive Income 8,327 

Instructions

Prepare the stockholders’ equity section of the balance sheet for Wells Fargo as of December 31, 2022.

E11.14 (LO 4), AP The following stockholders’ equity accounts, arranged alphabetically, are in the ledger of Ryder Corporation at December 31, 2022.

Common Stock ($2 stated value) $1,600,000
Paid-in Capital in Excess of Par Value—Preferred Stock 45,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,050,000
Preferred Stock (8%, $100 par, noncumulative) 600,000
Retained Earnings 1,334,000
Treasury Stock (12,000 common shares) 72,000

Instructions

Prepare the stockholders’ equity section of the balance sheet at December 31, 2022.

E11.15 (LO 4), AP The following accounts appear in the ledger of Paisan Inc. after the books are closed at December 31, 2022.

Common Stock (no-par, $1 stated value, 400,000 shares authorized, 250,000 shares issued) $  250,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,200,000
Preferred Stock ($50 par value, 8%, 40,000 shares authorized, 14,000 shares issued) 700,000
Retained Earnings 920,000
Treasury Stock (9,000 common shares) 64,000
Paid-in Capital in Excess of Par Value—Preferred Stock 24,000
Accumulated Other Comprehensive Loss 31,000

Instructions

Prepare the stockholders’ equity section at December 31, assuming $100,000 of retained earnings is restricted for plant expansion. (Use Note R.)

E11.16 (LO 4), AP The following financial information is available for Flintlock Corporation.

(in millions) 2022 2021
Average common stockholders’ equity $2,532 $2,591
Dividends declared for common stockholders 298 611
Dividends declared for preferred stockholders 40 40
Net income 504 555

Instructions

Calculate the payout ratio and return on common stockholders’ equity for 2022 and 2021. Comment on your findings.

E11.17 (LO 4), AP Suppose the following financial information is available for Walgreen Company.

(in millions) 2022 2021
Average common stockholders’ equity $13,622.5 $11,986.5
Dividends declared for common stockholders 471 394
Dividends declared for preferred stockholders 0 0
Net income 2,006 2,157

Instructions

Calculate the payout ratio and return on common stockholders’ equity for 2022 and 2021. Comment on your findings.

E11.18 (LO 4), AN Kojak Corporation decided to issue common stock and used the $300,000 proceeds to redeem all of its outstanding bonds on January 1, 2022. The following informa tion is available for the company for 2022 and 2021.

2022 2021
Net income $  182,000 $  150,000
Dividends declared for preferred stockholders 8,000 8,000
Average common stockholders’ equity 1,000,000 700,000
Total assets 1,200,000 1,200,000
Current liabilities 100,000 100,000
Total liabilities 200,000 500,000

Instructions

a. Compute the return on common stockholders’ equity for both years.

b. Explain how it is possible that net income increased but the return on common stockholders’ equity decreased.

c. Compute the debt to assets ratio for both years, and comment on the implications of this change in the company’s solvency.

E11.19 (LO 4), AN Baja Airlines is considering these two alternatives for financing the purchase of a fleet of airplanes:

  • 1. Issue 50,000 shares of common stock at $40 per share. (Cash dividends have not been paid nor is the payment of any contemplated.)
  • 2. Issue 12%, 10-year bonds at face value for $2,000,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90,000 shares of common stock outstanding prior to the new financing.

Instructions

Determine the effect on net income and earnings per share for (a) issuing stock and (b) issuing bonds. Assume the new shares or new bonds will be outstanding for the entire year.

E11.20 (LO 4), AN Cabo Company has $1,000,000 in assets and $1,000,000 in stockholders’ equity, with 40,000 shares outstanding the entire year. It has a return on assets of 10%. During 2021, it had net income of $100,000. On January 1, 2022, it issued $400,000 in debt at 4% and immediately repurchased 20,000 shares for $400,000. Management expected that, had it not issued the debt, it would have had net income of $100,000 in 2022.

Instructions

a. Determine the company’s net income and earnings per share for 2021 and 2022. (Ignore taxes in your computations.)

b. Compute the company’s return on common stockholders’ equity for 2021 and 2022.

c. Compute the company’s debt to assets ratio for 2021 and 2022.

d. Discuss the impact that the borrowing had on the company’s profitability and solvency. Was it a good idea to borrow the money to buy the treasury stock?

*E11.21 (LO 5), AP On January 1, 2022, Lenne Corporation had $1,200,000 of common stock outstanding that was issued at par and retained earnings of $750,000. The company issued 30,000 shares of common stock at par on July 1 and earned net income of $400,000 for the year.

Instructions

Journalize the declaration of a 15% stock dividend on December 10, 2022, for the following two independent assumptions.

a. Par value is $10 and market price is $15.

b. Par value is $5 and market price is $8.


Problems: Set A

P11.1A (LO 2, 4), AP Tidal Corporation was organized on January 1, 2022. It is authorized to issue 20,000 shares of 6%, $50 par value preferred stock and 500,000 shares of no-par common stock with a stated value of $1 per share. The following stock transactions were completed during the first year.

Jan.  10 Issued 70,000 shares of common stock for cash at $4 per share.
Mar.   1 Issued 12,000 shares of preferred stock for cash at $53 per share.
May   1 Issued 120,000 shares of common stock for cash at $6 per share.
Sept.  1 Issued 5,000 shares of common stock for cash at $5 per share.
Nov.   1 Issued 3,000 shares of preferred stock for cash at $56 per share.

Instructions

a. Journalize the transactions.

b. Post to the stockholders’ equity accounts. (Use T-accounts.)

c. Prepare the paid-in capital portion of the stockholders’ equity section at December 31, 2022.

P11.2A (LO 2, 3, 4), AP The stockholders’ equity accounts of Cyrus Corporation on January 1, 2022, were as follows.

Preferred Stock (7%, $100 par noncumulative, 5,000 shares authorized) $  300,000
Common Stock ($4 stated value, 300,000 shares authorized) 1,000,000
Paid-in Capital in Excess of Par Value—Preferred Stock 15,000
Paid-in Capital in Excess of Stated Value—Common Stock 480,000
Retained Earnings 688,000
Treasury Stock (5,000 common shares) 40,000

During 2022, the corporation had the following transactions and events pertaining to its stockholders’ equity.

Feb.  1 Issued 5,000 shares of common stock for $30,000.
Mar. 20 Purchased 1,000 additional shares of common treasury stock at $7 per share.
Oct.  1 Declared a 7% cash dividend on preferred stock, payable November 1.
Nov.  1 Paid the dividend declared on October 1.
Dec.  1 Declared a $0.50 per share cash dividend to common stockholders of record on December 15, payable December 31, 2022.
31 Determined that net income for the year was $280,000. Paid the dividend declared on December 1.

Instructions

a. Journalize the transactions. (Include entries to close net income and dividends to Retained Earnings.)

b. Enter the beginning balances in the accounts and post the journal entries to the stockholders’ equity accounts. (Use T-accounts.)

c. Prepare the stockholders’ equity section of the balance sheet at December 31, 2022.

d. Calculate the payout ratio, earnings per share, and return on common stockholders’ equity. (Note: Use the common shares outstanding on January 1 and December 31 to determine the average shares outstanding.)

P11.3A (LO 2, 3, 4), AP On December 31, 2021, Jons Company had 1,300,000 shares of $5 par common stock issued and outstanding. At December 31, 2021, stockholders’ equity had the amounts listed here.

Common Stock $6,500,000
Additional Paid-in Capital 1,800,000
Retained Earnings 1,200,000

Transactions during 2022 and other information related to stockholders’ equity accounts were as follows.

  • 1. On January 10, issued at $107 per share 120,000 shares of $100 par value, 9% cumulative preferred stock.
  • 2. On February 8, reacquired 15,000 shares of its common stock for $11 per share.
  • 3. On May 9, declared the yearly cash dividend on preferred stock, payable June 10, to stockholders of record on May 31.
  • 4. On June 8, declared a cash dividend of $1.20 per share on the common stock outstanding, payable on July 10, to stockholders of record on July 1.
  • 5. Net income for 2022 was $3,600,000.

Instructions

a. Record the journal entries that are required for items 1–5 above.

b. Prepare the stockholders’ equity section of Jons’ balance sheet at December 31, 2022.

P11.4A (LO 3, 4), AP The ledger of Waite Corporation at December 31, 2022, after the books have been closed, contains the following stockholders’ equity accounts.

Preferred Stock (10,000 shares issued) $1,000,000
Common Stock (300,000 shares issued) 1,500,000
Paid-in Capital in Excess of Par Value—Preferred Stock 200,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,600,000
Retained Earnings 2,860,000

A review of the accounting records reveals this information:

  • 1. Preferred stock is 8%, $100 par value, noncumulative. Since January 1, 2021, 10,000 shares have been outstanding; 20,000 shares are authorized.
  • 2. Common stock is no-par with a stated value of $5 per share; 600,000 shares are authorized.
  • 3. The January 1, 2022, balance in Retained Earnings was $2,380,000.
  • 4. On October 1, 60,000 shares of common stock were sold for cash at $9 per share.
  • 5. A cash dividend of $400,000 was declared and properly allocated to preferred and common stock on November 1. No dividends were paid to preferred stockholders in 2021.
  • 6. Net income for the year was $880,000.
  • 7. On December 31, 2022, the directors authorized disclosure of a $160,000 restriction of retained earnings for plant expansion. (Use Note A.)

Instructions

a. Reproduce the Retained Earnings account (T-account) for the year.

b. Prepare the stockholders’ equity section of the balance sheet at December 31.

P11.5A (LO 2, 4), AP Layes Corporation has been authorized to issue 20,000 shares of $100 par value, 7%, noncumulative preferred stock and 1,000,000 shares of no-par common stock. The corporation assigned a $5 stated value to the common stock. At December 31, 2022, the ledger contained the following balances pertaining to stockholders’ equity.

Preferred Stock $  150,000
Paid-in Capital in Excess of Par Value—Preferred Stock 20,000
Common Stock 2,000,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,520,000
Treasury Stock (4,000 common shares) 36,000
Retained Earnings 82,000
Accumulated Other Comprehensive Income 51,000

The preferred stock was issued for $170,000 cash. All common stock issued was for cash. In November 4,000 shares of common stock were purchased for the treasury at a per share cost of $9. No dividends were declared in 2022.

Instructions

a. Prepare the journal entries for the following.

  • 1. Issuance of preferred stock for cash.
  • 2. Issuance of common stock for cash.
  • 3. Purchase of common treasury stock for cash.

b. Prepare the stockholders’ equity section of the balance sheet at December 31, 2022.

P11.6A (LO 2, 3, 4), AP On January 1, 2022, Kimbel Inc. had these stockholders’ equity balances.

Common Stock, $1 par (2,000,000 shares authorized, 600,000 shares issued and outstanding) $  600,000
Paid-in Capital in Excess of Par Value 1,500,000
Retained Earnings 700,000
Accumulated Other Comprehensive Income 60,000

During 2022, the following transactions and events occurred.

  • 1. Issued 50,000 shares of $1 par value common stock for $3 per share.
  • 2. Issued 60,000 shares of common stock for cash at $4 per share.
  • 3. Purchased 20,000 shares of common stock for the treasury at $3.80 per share.
  • 4. Declared and paid a cash dividend of $207,000.
  • 5. Earned net income of $410,000.
  • 6. Had other comprehensive income of $17,000.

Instructions

Prepare the stockholders’ equity section of the balance sheet at December 31, 2022.

P11.7A (LO 4), AP Writing Spahn Company manufactures backpacks. During 2022, Spahn issued bonds at 10% interest and used the cash proceeds to purchase treasury stock. The following financial information is available for Spahn Company for the years 2022 and 2021.

2022 2021
Sales revenue $ 9,000,000 $ 9,000,000
Net income 2,240,000 2,500,000
Interest expense 500,000 140,000
Tax expense 670,000 750,000
Dividends paid on common stock 890,000 1,026,000
Dividends paid on preferred stock 300,000 300,000
Total assets (year-end) 14,500,000 16,875,000
Average total assets 15,687,500 17,763,000
Total liabilities (year-end) 6,000,000 3,000,000
Avg. total common stockholders’ equity 9,400,000 14,100,000

Instructions

a. Use the information above to calculate the following ratios for both years: (1) return on assets, (2) return on common stockholders’ equity, (3) payout ratio, (4) debt to assets ratio, and (5) times interest earned.

b. Referring to your findings in part (a), discuss the changes in the company’s profitability from 2021 to 2022.

c. Referring to your findings in part (a), discuss the changes in the company’s solvency from 2021 to 2022.

d. Based on your findings in (b), was the decision to issue debt to purchase common stock a wise one?

*P11.8A (LO 3, 4, 5), AP On January 1, 2022, Tacoma Corporation had these stockholders’ equity accounts.

Common Stock ($10 par value, 70,000 shares issued and outstanding) $700,000
Paid-in Capital in Excess of Par Value 500,000
Retained Earnings 620,000

During the year, the following transactions occurred.

Jan. 15 Declared a $0.50 cash dividend per share to stockholders of record on January 31, payable February 15.
Feb. 15 Paid the dividend declared in January.
Apr. 15 Declared a 10% stock dividend to stockholders of record on April 30, distributable May 15. On April 15, the market price of the stock was $14 per share.
May 15 Issued the shares for the stock dividend.
Dec.  1 Declared a $0.60 per share cash dividend to stockholders of record on December 15, payable January 10, 2023.
31 Determined that net income for the year was $400,000.

Instructions

a. Journalize the transactions. (Include entries to close net income and dividends to Retained Earnings.)

b. Enter the beginning balances and post the entries to the stockholders’ equity T-accounts. (Note: Open additional stockholders’ equity accounts as needed.)

c. Prepare the stockholders’ equity section of the balance sheet at December 31.

d. Calculate the payout ratio and return on common stockholders’ equity.


Continuing Case

Cookie Creations

(Note: This is a continuation of the Cookie Creations case from Chapters 1 through 10.)

CC11 Part 1 Because Natalie has been so successful with Cookie Creations and her friend Curtis Lesperance has been just as successful with his coffee shop, they conclude that they could benefit from each other’s business expertise. Curtis and Natalie next evaluate the different types of business organization. Because of the advantage of limited personal liability, they decide to form a corporation.

An image shows three stuffed macrons pink, green and yellow stacked one on top of each other.

Natalie and Curtis are very excited about this new business venture. They come to you with information they have gathered about their companies and with a number of questions.

Part 2 After establishing their company’s fiscal year to be October 31, Natalie and Curtis began operating Cookie & Coffee Creations Inc. on November 1, 2022. On that date, they issued both preferred and common stock. Natalie and Curtis now want to prepare financial information for the first year of operations.

Go to WileyPLUS for complete case details and instructions.


Comprehensive Accounting Cycle Review

ACR11.1 (LO 2, 3, 4), AP Hawkeye Corporation’s balance sheet at December 31, 2021, is presented as follow.

Hawkeye Corporation
Balance Sheet
December 31, 2021
Cash $ 24,600  Accounts payable $ 25,600
Accounts receivable 45,500  Common stock ($10 par) 80,000
Allowance for doubtful accounts (1,500) Retained earnings 127,400
$233,000
Supplies 4,400 
Land 40,000 
Buildings 142,000 
Accumulated depreciation—buildings (22,000)
$233,000 

During 2022, the following transactions occurred.

  • 1. On January 1, Hawkeye issued 1,200 shares of $40 par, 7% preferred stock for $49,200.
  • 2. On January 1, Hawkeye also issued 900 shares of the $10 par value common stock for $21,000.
  • 3. Hawkeye performed services for $320,000 on account.
  • 4. On April 1, 2022, Hawkeye collected fees of $36,000 in advance for services to be performed from April 1, 2022, to March 31, 2023.
  • 5. Hawkeye collected $276,000 from customers on account.
  • 6. Hawkeye bought $35,100 of supplies on account.
  • 7. Hawkeye paid $32,200 on accounts payable.
  • 8. Hawkeye reacquired 400 shares of its common stock on June 1, for $28 per share.
  • 9. Paid other operating expenses of $188,200.
  • 10. On December 31, 2022, Hawkeye declared the annual cash dividend on preferred stock and a $1.20 per share dividend on the outstanding common stock, all payable on January 15, 2023.
  • 11. An account receivable of $1,700 which originated in 2021 is written off as uncollectible.

Adjustment data:

  • 1. A count of supplies indicates that $5,900 of supplies remain unused at year-end.
  • 2. Recorded revenue from item 4 above.
  • 3. The allowance for doubtful accounts should have a balance of $3,500 at year end.
  • 4. Depreciation is recorded on the building on a straight-line basis based on a 30-year life and a salvage value of $10,000.
  • 5. The income tax rate is 30%. (Hint: Prepare the income statement up to income before taxes and multiply by 30% to compute the amount.)

Instructions

(You may want to set up T-accounts to determine ending balances.)

a. Prepare journal entries for the transactions listed above and adjusting entries.

b. Prepare an adjusted trial balance at December 31, 2022.

c. Prepare an income statement and a retained earnings statement for the year ending December 31, 2022, and a classified balance sheet as of December 31, 2022.

ACR11.2 (LO 2, 3, 4), AP Karen Noonan opened Clean Sweep Inc. on February 1, 2022. During February, the following transactions were completed.

Feb.  1 Issued 5,000 shares of Clean Sweep common stock for $13,000. Each share has a $1.50 par.
1 Borrowed $8,000 on a 2-year, 6% note payable.
1 Paid $9,020 to purchase used floor and window cleaning equipment from a company going out of business
($4,820 was for the floor equipment and $4,200 for the window equipment).
1 Paid $220 for February Internet and phone services.
3 Purchased cleaning supplies for $980 on account.
4 Hired 4 employees. Each will be paid $480 per 5-day work week (Monday–Friday). Employees will begin working Monday, February 9.
5 Obtained insurance coverage for $9,840 per year. Coverage runs from February 1, 2022, through
January 31, 2023. Karen paid $2,460 cash for the first quarter of coverage.
5 Discussions with the insurance agent indicated that providing outside window cleaning services
would cost too much to insure. Karen sold the window cleaning equipment for $3,950 cash.
16 Billed customers $3,900 for cleaning services performed through February 13, 2022.
17 Received $540 from a customer for 4 weeks of cleaning services to begin February 21, 2022.
(By paying in advance, this customer received 10% off the normal weekly fee of $150.)
18 Paid $300 on amount owed on cleaning supplies.
20 Paid $3 per share to buy 300 shares of Clean Sweep common stock from a shareholder who disagreed
with management goals. The shares will be held as treasury shares.
23 Billed customers $4,300 for cleaning services performed through February 20.
24 Paid cash for employees’ wages for 2 weeks (February 9–13 and 16–20).
25 Collected $2,500 cash from customers billed on February 16.
27 Paid $220 for Internet and phone services for March.
28 Declared and paid a cash dividend of $0.20 per share.

Instructions

a. Journalize the February transactions. (You do not need to include an explanation for each journal entry.)

b. Post to the ledger accounts (Use T-accounts.)

c. Prepare a trial balance at February 28, 2022.

d. Journalize the following adjustments. (Round all amounts to whole dollars.)

  • 1. Services performed for customers through February 27, 2022, but unbilled and uncollected were $3,800.
  • 2. Received notice that a customer who was billed $200 for services performed February 10 has filed for bankruptcy. Clean Sweep does not expect to collect any portion of this outstanding receivable.
  • 3. Clean Sweep uses the allowance method to estimate bad debts. Clean Sweep estimates that 3% of its month-end receivables will not be collected.
  • 4. Record 1 month of depreciation for the floor equipment. Use the straight-line method, an estimated life of 4 years, and $500 salvage value.
  • 5. Record 1 month of insurance expense.
  • 6. An inventory count shows $400 of supplies on hand at February 28.
  • 7. One week of services were performed for the customer who paid in advance on February 17.
  • 8. Accrue for wages owed through February 28, 2022.
  • 9. Accrue for interest expense for 1 month.
  • 10. Karen estimates a 20% income tax rate. (Hint: Prepare an income statement up to “income before taxes” to help with the income tax calculation.)

e. Post adjusting entries to the T-accounts.

f. Prepare an adjusted trial balance.

g. Prepare a multiple-step income statement, a retained earnings statement, and a properly classified balance sheet as of February 28, 2022.

h. Journalize closing entries.


Expand Your Critical Thinking

Financial Reporting Problem: Apple Inc.

CT11.1 The stockholders’ equity section of Apple Inc.‘s balance sheet is shown in the Consolidated Statement of Financial Position in Appendix A. The complete annual report, including the notes to its financial statements, is available at the company’s website.

Instructions

Answer the following questions.

a. What is the par or stated value per share of Apple’s common stock?

b. What percentage of Apple’s authorized common stock was issued at September 30, 2017? (Round to the nearest full percent.)

c. How many shares of common stock were outstanding at September 24, 2016, and at September 30, 2017?

d. Calculate the payout ratio, earnings per share, and return on common stockholders’ equity for 2017.

Comparative Analysis Problem: Columbia Sportswear Company vs. VF Corporation

CT11.2 The financial statements of Columbia Sportswear Company are presented in Appendix B. Financial statements of VF Corporation are presented in Appendix C.

Instructions

a. Based on the information in these financial statements, compute the 2016 return on common stockholders’ equity, debt to assets ratio, and return on assets for each company.

b. What conclusions concerning the companies’ profitability can be drawn from these ratios? Which company relies more on debt to boost its return to common shareholders?

c. Compute the payout ratio for each company. Which pays out a higher percentage of its earnings?

Comparative Analysis Problem: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.

CT11.3 The financial statements of Amazon.com, Inc. are presented in Appendix D. Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E.

Instructions

a. Based on the information in these financial statements, compute the return on common stockholders’ equity, debt to assets ratio, and return on assets for each company for the most recent year provided.

b. What conclusions concerning the companies’ profitability can be drawn from these ratios? Which company relies more on debt to boost its return to common shareholders?

c. Compute the payout ratio for each company. Which pays out a higher percentage of its earnings?

Interpreting Financial Statements

CT11.4 Marriott Corporation split into two companies: Host Marriott Corporation and Marriott International. Host Marriott retained ownership of the corporation’s vast hotel and other properties, while Marriott International, rather than owning hotels, managed them. The purpose of this split was to free Marriott International from the “baggage” associated with Host Marriott, thus allowing it to be more aggressive in its pursuit of growth. The following information (in millions) is provided for each corporation for their first full year operating as independent companies.

Host Marriott Marriott International
Sales revenue $1,501  $8,415
Net income    (25)    200
Total assets  3,822   3,207
Total liabilities  3,112   2,440
Common stockholders’ equity    710     767

Instructions

a. The two companies were split by the issuance of shares of Marriott International to all shareholders of the previous combined company. Discuss the nature of this transaction.

b. Calculate the debt to assets ratio for each company.

c. Calculate the return on assets and return on common stockholders’ equity for each company.

d. The company’s debtholders were fiercely opposed to the original plan to split the two companies because the original plan had Host Marriott absorbing the majority of the company’s debt. They relented only when Marriott International agreed to absorb a larger share of the debt. Discuss the possible reasons the debtholders were opposed to the plan to split the company.

Real-World Focus

CT11.5 You should become familiar with reviewing the stockholders’ equity section of an annual report to identify its major components.

Instructions

Select a well-known company, search the Internet for its most recent annual report, and then answer the following questions.

a. What is the company’s name?

b. What classes of capital stock has the company issued?

c. For each class of stock:

1. How many shares are authorized, issued, and/or outstanding?

2. What is the par value?

d. What are the company’s retained earnings?

e. Has the company acquired treasury stock? How many shares?

Decision-Making Across the Organization

CT11.6 During a recent period, the fast-food chain Wendy’s International purchased many treasury shares. This caused the number of shares outstanding to fall from 124 million to 105 million. The following information was drawn from the company’s financial statements (in millions).

Information for the
Year after Purchase
of Treasury Stock
Information for the
Year before Purchase
of Treasury Stock
Net income $  193.6 $  123.4
Total assets  2,076.0  1,837.9
Average total assets  2,016.9  1,889.8
Total common stockholders’ equity  1,029.8  1,068.1
Average common stockholders’ equity  1,078.0  1,126.2
Total liabilities  1,046.3    769.9
Average total liabilities    939.0    763.7
Interest expense     30.2     19.8
Income taxes    113.7     84.3
Cash provided by operations    305.2    233.8
Cash dividends paid on common stock     26.8     31.0
Preferred stock dividends        0        0
Average number of common shares outstanding    109.7    119.9

Instructions

Use the information provided to answer the following questions.

a. Compute earnings per share, return on common stockholders’ equity, and return on assets for both years. Discuss the change in the company’s profitability over this period.

b. Compute the dividend payout ratio. Also compute the average cash dividend paid per share of common stock (dividends paid divided by the average number of common shares outstanding). Discuss any change in these ratios during this period and the implications for the company’s dividend policy.

c. Compute the debt to assets ratio and times interest earned. Discuss the change in the company’s solvency.

d. Based on your findings in (a) and (c), discuss to what extent any change in the return on common stockholders’ equity was the result of increased reliance on debt.

e. Does it appear that the purchase of treasury stock and the shift toward more reliance on debt were wise strategic moves?

Communication Activity

CT11.7 Earl Kent, your uncle, is an inventor who has decided to incorporate. Uncle Earl knows that you are an accounting major at U.N.O. In a recent letter to you, he ends with the question, “I’m filling out a state incorporation application. Can you tell me the difference among the following terms: (1) authorized stock, (2) issued stock, (3) outstanding stock, and (4) preferred stock?”

Instructions

In a brief note, differentiate for Uncle Earl the four different stock terms. Write the letter to be friendly, yet professional.

Ethics Cases

CT11.8 The R&D division of Pele Corp. has just developed a chemical for sterilizing the vicious Brazilian “killer bees” which are invading Mexico and the southern United States. The president of Pele is anxious to get the chemical on the market because Pele profits need a boost—and his job is in jeopardy because of decreasing sales and profits. Pele has an opportunity to sell this chemical in Central American countries, where the laws are much more relaxed than in the United States.

The director of Pele’s R&D division strongly recommends further research in the laboratory to test the side effects of this chemical on other insects, birds, animals, plants, and even humans. He cautions the president, “We could be sued from all sides if the chemical has tragic side effects that we didn’t even test for in the lab.” The president answers, “We can’t wait an additional year for your lab tests. We can avoid losses from such lawsuits by establishing a separate wholly owned corporation to shield Pele Corp. from such lawsuits. We can’t lose any more than our investment in the new corporation, and we’ll invest just the patent covering this chemical. We’ll reap the benefits if the chemical works and is safe, and avoid the losses from lawsuits if it’s a disaster.” The following week, Pele creates a new wholly owned corporation called Cabo Inc., sells the chemical patent to it for $10, and watches the spraying begin.

Instructions

a. Who are the stakeholders in this situation?

b. Are the president’s motives and actions ethical?

c. Can Pele shield itself against losses of Cabo Inc.?

CT11.9 Cooper Corporation has paid 60 consecutive quarterly cash dividends (15 years). The last 6 months have been a real cash drain on the company, however, as profit margins have been greatly narrowed by increasing competition. With a cash balance sufficient to meet only day-to-day operating needs, the president, Sonny Boyd, has decided that a stock dividend instead of a cash dividend should be declared. He tells Cooper’s financial vice president, Dana Marks, to issue a press release stating that the company is extending its consecutive dividend record with the issuance of a 5% stock dividend. “Write the press release convincing the stockholders that the stock dividend is just as good as a cash dividend,” he orders. “Just watch our stock rise when we announce the stock dividend; it must be a good thing if that happens.”

Instructions

a. Who are the stakeholders in this situation?

b. Is there anything unethical about president Boyd’s intentions or actions?

c. What is the effect of a stock dividend on a corporation’s stockholders’ equity accounts? Which would you rather receive as a stockholder—a cash dividend or a stock dividend? Why?

All About You

CT11.10 In response to the Sarbanes-Oxley Act, many companies have implemented formal ethics codes. Many other organizations also have ethics codes.

Instructions

Obtain the ethics code from an organization that you belong to (e.g., student organization, business school, employer, or a volunteer organization). Evaluate the ethics code based on how clearly it identifies proper and improper behavior. Discuss its strengths, and how it might be improved.

FASB Codification Activity

CT11.11 If your school has a subscription to the FASB Codification, log in and prepare responses to the following.

a. What is the stock dividend?

b. What is a stock split?

c. At what percentage point does the issuance of additional shares qualify as a stock dividend, as opposed to a stock split?

Considering People, Planet, and Profit

CT11.12 The January 19, 2012, edition of the Wall Street Journal contains an article by Angus Loten entitled “With New Law, Profits Take a Back Seat.”

Instructions

Read the article online and then answer the following questions.

a. Summarize the nature of the new law that is discussed in the article.

b. What do some proponents of the law say is the “biggest value” of the law? How does the article say that this would have impacted Ben & Jerry’s?

c. What are some criticisms of the law?

d. How does incorporation as a benefit corporation differ from B Corp certification?

e. What are some of the companies that the article cites as either having adopted benefit corporation standing or are considering it?

A Look at IFRS

The accounting for transactions related to stockholders’ equity, such as issuance of shares and purchase of treasury stock, are similar under both IFRS and GAAP. Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of stockholders’ equity information.

KEY POINTS

Following are the key similarities and differences between GAAP and IFRS as related to stockholders’ equity, dividends, retained earnings, and income reporting.

Similarities

  • Aside from the terminology used, the accounting transactions for the issuance of shares and the purchase of treasury stock are similar.
  • Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares.
  • The accounting related to prior period adjustment is essentially the same under IFRS and GAAP.
  • The income statement using IFRS is called the statement of comprehensive income. A statement of comprehensive income is presented in a one- or two-statement format. The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic. In the two-statement approach, a traditional income statement is prepared. It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items. Regardless of which approach is reported, income tax expense is required to be reported.
  • The computations related to earnings per share are essentially the same under IFRS and GAAP.

Differences

  • Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.
  • Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors.
  • There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology.
    GAAP IFRS
    Common stock Share capital—ordinary
    Stockholders Shareholders
    Par value Nominal or face value
    Authorized stock Authorized share capital
    Preferred stock Share capital—preference
    Paid-in capital Issued/allocated share capital
    Paid-in capital in excess of par—common stock Share premium—ordinary
    Paid-in capital in excess of par—preferred stock Share premium—preference
    Retained earnings Retained earnings or Retained profits
    Retained earnings deficit Accumulated losses
    Accumulated other comprehensive income General reserve and other reserve accounts

    As an example of how similar transactions use different terminology under IFRS, consider the accounting for the issuance of 1,000 shares of $1 par value common stock for $5 per share. Under IFRS, the entry is as follows.

    Cash 5,000
     Share Capital—Ordinary 1,000
     Share Premium—Ordinary 4,000
  • A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital.
  • IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.
  • Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and shareholders’ funds.

IFRS Practice

IFRS Self-Test Questions

1. Which of the following is true?

  1. In the United States, the primary corporate stockholders are financial institutions.
  2. Share capital means total assets under IFRS.
  3. The IASB and FASB are presently studying how financial statement information should be presented.
  4. The accounting for treasury stock differs extensively between GAAP and IFRS.

2. Under IFRS, the amount of capital received in excess of par value would be credited to:

  1. Retained Earnings.
  2. Contributed Capital.
  3. Share Premium.
  4. Par value is not used under IFRS.

3. Which of the following is false?

  1. Under GAAP, companies cannot record gains on transactions involving their own shares.
  2. Under IFRS, companies cannot record gains on transactions involving their own shares.
  3. Under IFRS, the statement of stockholders’ equity is a required statement.
  4. Under IFRS, a company records a revaluation surplus when it experiences an increase in the price of its common stock.

4. Which of the following does not represent a pair of GAAP/IFRS-comparable terms?

  1. Additional paid-in capital/Share premium.
  2. Treasury stock/Repurchase reserve.
  3. Common stock/Share capital.
  4. Preferred stock/Preference shares.

5. The basic accounting for cash dividends and stock dividends:

  1. is different under IFRS versus GAAP.
  2. is the same under IFRS and GAAP.
  3. differs only for the accounting for cash dividends between GAAP and IFRS.
  4. differs only for the accounting for stock dividends between GAAP and IFRS.

6. Which item in not considered part of reserves?

  1. Unrealized loss on available-for-sale investments.
  2. Revaluation surplus.
  3. Retained earnings.
  4. Issued shares.

7. Under IFRS, a statement of comprehensive income must include:

  1. accounts payable.
  2. retained earnings.
  3. income tax expense.
  4. preference stock.

8. Which set of terms can be used to describe total stockholders’ equity under IFRS?

  1. Shareholders’ equity, capital and reserves, other comprehensive income.
  2. Capital and reserves, shareholders’ equity, shareholders’ funds.
  3. Capital and reserves, retained earnings, shareholders’ equity.
  4. All of the answer choices are correct.

9. Earnings per share computations related to IFRS and GAAP:

  1. are essentially similar.
  2. result in an amount referred to as earnings per share.
  3. must deduct preferred (preference) dividends when computing earnings per share.
  4. All of the answer choices are correct.

IFRS Exercises

IFRS11.1 On May 10, Jaurez Corporation issues 1,000 shares of $10 par value ordinary shares for cash at $18 per share. Journalize the issuance of the shares.

IFRS11.2 Meenen Corporation has the following accounts at December 31, 2022 (in euros): Share Capital—Ordinary, €10 par, 5,000 shares issued, €50,000; Share Premium—Ordinary €10,000; Retained Earnings €45,000; and Treasury Shares—Ordinary, 500 shares, €11,000. Prepare the equity section of the statement of financial position (balance sheet).

IFRS11.3 Overton Co. had the following transactions during the current period.

Mar.  2 Issued 5,000 shares of $1 par value ordinary shares to attorneys in payment of a bill for $30,000 for services performed in helping the company to incorporate.
June 12 Issued 60,000 shares of $1 par value ordinary shares for cash of $375,000.
July  11 Issued 1,000 shares of $100 par value preference shares for cash at $110 per share.
Nov. 28 Purchased 2,000 treasury shares for $80,000.

Instructions

Journalize the above transactions.

International Financial Reporting Problem: Louis Vuitton

IFRS11.4 The financial statements of Louis Vuitton are presented in Appendix F. The complete annual report, including the notes to its financial statements, is available at the company’s website.

Instructions

Use the company’s annual report to answer the following questions.

a. Determine the following amounts at December 31, 2016: (1) total equity, (2) total revaluation reserve, and (3) number of treasury shares.

b. Examine the equity section of the company’s balance sheet. For each of the following, provide the comparable label that would be used under GAAP: (1) share capital, (2) share premium, and (3) net profit, group share.

c. Did the company declare and pay any dividends for the year ended December 31, 2016?

d. Compute the company’s return on ordinary shareholders’ equity for the year ended December 31, 2016.

e. What was Louis Vuitton’s earnings per share for the year ended December 31, 2016?

Answers to IFRS Self-Test Questions1. c  2. c  3. d  4. b  5. b  6. d  7. c  8. b  9. d