CHAPTER 11

Stockholders Equity
OVERVIEW OF EXERCISES PRO!"E#S A$% CASES
Esti&'ted
Ti&e i(
"e'r(i() O*+ecti,e E-ercises #i(utes "e,el
1. Identify the components of the Stockholders Equity category 1 10 Easy
of the balance sheet and the accounts found in each 2 10 Mod
component.
/. emonstrate an understanding of the characteristics of common
and preferred stock and the differences bet!een the classes of
stock.
0. etermine the financial statement impact !hen stock is issued " 10 Mod
for cash or other consideration. # 20 Mod
1. escribe the financial statement impact of stock treated as $ 1$ Mod
treasury stock. % 1$ Mod
2. &ompute the amount of cash di'idends !hen a firm has issued ( 10 Mod
both preferred and common stock. ) 1$ Mod
* 20 Mod
3. emonstrate an understanding of the difference bet!een cash 10 1$ Mod
and stock di'idends and the effect of stock di'idends.
4. etermine the difference bet!een stock di'idends and stock 11 1$ iff
splits. 12 1$ iff
5. emonstrate an understanding of the statement of stock+ 1" 10 Easy
holders equity and comprehensi'e income. 1# 1$ iff
6. ,nderstand ho! in'estors use ratios 1$ $ Mod
to e'aluate o!ners equity.
17. E-plain the effects that transactions in'ol'ing stockholders 1% $ Mod
equity ha'e on the statement of cash flo!s. 1( $ Mod
1) $ Mod
1* $ Easy
11. escribe the important differences bet!een the sole proprie+ 20 1$ Mod
torship and partnership forms of organi.ation 'ersus the 21 10 Mod
corporate form /ppendi- 0.
118/ 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
7E-ercise8 problem8 or case co'ers t!o or more learning ob9ecti'es
3e'el : ifficulty le'els; Easy< Moderate =Mod0< ifficult =iff0
&>/?5E@ 11 S54&A>43E@S EB,I5C 1180
Pro*le&s Esti&'ted
'(d Ti&e i(
"e'r(i() O*+ecti,e Alter('tes #i(utes "e,el
1. Identify the components of the Stockholders Equity category 1 20 Mod
of the balance sheet and the accounts found in each 127 1$ Mod
component. 1#7 1$ iff
/. emonstrate an understanding of the characteristics of 2 1$ Mod
common and preferred stock and the differences bet!een the
classes of stock.
0. etermine the financial statement impact !hen stock is 1"7 20 Mod
issued for cash or other consideration.
1. escribe the financial statement impact of stock 127 1$ Mod
treated as treasury stock. 1"7 20 Mod
1#7 1$ Mod
2. &ompute the amount of cash di'idends !hen a firm has issued " 20 Mod
both preferred and common stock.
3. emonstrate an understanding of the difference bet!een cash # 1$ iff
and stock di'idends and the effect of stock di'idends.
4. etermine the difference bet!een stock di'idends and stock $ 20 Mod
splits. 1"7D 20 Mod
5. emonstrate an understanding of the statement of stock+ % 20 Mod
holders equity and comprehensi'e income. ( 10 Mod
6. ,nderstand ho! in'estors use ratios to
e'aluate o!ners equity.
17. E-plain the effects that transactions in'ol'ing stockholders ) 1$ iff
equity ha'e on the statement of cash flo!s.
11. escribe the important differences bet!een the sole proprie+ * 1$ Mod
torship and partnership forms of organi.ation 'ersus the 10 20 Mod
corporate form =/ppendi- 0. 11 10 Mod
7E-ercise8 problem8 or case co'ers t!o or more learning ob9ecti'es
D 4riginal problem only
3e'el : ifficulty le'els; Easy< Moderate =Mod0< ifficult =iff0
1181 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
Esti&'ted
Ti&e i(
"e'r(i() O*+ecti,e C'ses #i(utes "e,el
1. Identify the components of the Stockholders Equity category 17 1$ Mod
of the balance sheet and the accounts found in each 27 1$ Mod
component. #7 10 Mod
/. emonstrate an understanding of the characteristics of 17 1$ Mod
common and preferred stock and the differences bet!een the #7 10 Mod
classes of stock. $ 10 Mod
0. etermine the financial statement impact !hen stock is
issued for cash or other consideration.
1. escribe the financial statement impact of stock treated as
treasury stock.
2. &ompute the amount of cash di'idends !hen a firm has issued ( 1$ Mod
both preferred and common stock.
3. emonstrate an understanding of the difference bet!een cash
and stock di'idends and the effect of stock di'idends.
4. etermine the difference bet!een stock di'idends and stock splits.
5. emonstrate an understanding of the statement of stock+ 27 1$ Mod
holders equity and comprehensi'e income.
6. ,nderstand of ho! in'estors use ratios % 1$ Mod
to e'aluate o!ners equity.
17. E-plain the effects that transactions in'ol'ing stockholders " 1$ Mod
equity ha'e on the statement of cash flo!s.
11. escribe the important differences bet!een the sole proprietorship
and partnership forms of organi.ation 'ersus the corporate form
=/ppendi- 0.
7E-ercise8 problem8 or case co'ers t!o or more learning ob9ecti'es
3e'el : ifficulty le'els; Easy< Moderate =Mod0< ifficult =iff0
&>/?5E@ 11 S54&A>43E@S EB,I5C 1182
9 : E S T I O $ S
1. 5he t!o ma9or components of stockholders equity are contributed capital
and retained earnings. /ccounts in contributed capital include the
&ommon Stock and ?referred Stock accounts and the /dditional ?aid+in
&apital accounts. 5he primary account in the retained earnings
component is the @etained Earnings account.
/. 5he number of shares authori.ed is the total number that the corporation
can issue8 as indicated in the corporate charter. Shares issued are shares
that ha'e been distributed to stockholders. Shares outstanding is the
number of shares in the stockholders hands as of the balance sheet date.
5he difference bet!een shares issued and shares outstanding is normally
the result of treasury stock.
0. 1irms designate the par 'alue of the stock for legal reasons. ?ar 'alue is
not an indication of the selling price or market 'alue of the stock.
1. 5he balance of the @etained Earnings account is not equal to the firms net
income for the year. 5he account indicates the amount of income for all
pre'ious years that has been earned but has not been paid out as
di'idends to the stockholders.
2. ?referred stock normally must be paid a di'idend before a di'idend may
be paid to common stock. If the preferred stock is cumulati'e8 the
preferred stockholders do ha'e the right to di'idends in arrears8 ho!e'er8
preferred stockholders do not ha'e a right to di'idends in arrears until the
time the di'idend is declared.
3. ?referred stock is generally a lo!er risk stock that pro'ides a stable return
but does not pro'ide for the potentially high return of a common stock.
5he ad'antages of preferred stock are the safety and stability it pro'ides.
4. &ommon shareholders are considered residual shareholders because the
amount of book 'alue of preferred shareholders is subtracted from total
stockholders equity before the common book 'alue is determined.
&ommon shareholders also ha'e a right to the earnings after preferred
di'idends are distributed.
5. 5he asset should be recorded at the fair market 'alue of the consideration
gi'en =the stock0 or the fair market 'alue of the consideration recei'ed =the
asset08 !hiche'er is more readily determinable. 1air market 'alue may be
determined by reference to sales of the stock on the stock e-change or8 in
some cases8 by an appraisal of the asset.
6. 5reasury stock is stock that has been issued and then repurchased by a
corporation. 5here are a 'ariety of uses of treasury stock8 including use in
employee benefit plans8 pre'ention of an un!anted takeo'er8 and
reduction in the number of shares of stock to impro'e financial ratios.
5reasury Stock is a contra equity account and is sho!n as a reduction of
stockholders equity.
1183 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
17. 6ains or losses on treasury stock are not recorded on the income
statement. @ather8 the amounts are sho!n as additions or deductions of
stockholders equity. /dditions appear in the ?aid+in &apitalE5reasury
Stock account. eductions reduce that account or the @etained Earnings
account if the ?aid+in &apital account is not present. 2o income statement
amounts are recorded to pre'ent manipulation of income by firms !ho
!ould buy and sell their o!n stock in order to sho! a Fprofit.G
11. 1irms do not pay out all of their income as di'idends because there are
other alternati'e uses of the income. Managements ob9ecti'e should be
to ma-imi.e the !ealth of the stockholders. Sometimes that can be
achie'ed by paying di'idends< other times it can be achie'ed by retaining
the income and rein'esting it in alternati'es that !ill produce a satisfactory
return.
1/. / stock di'idend occurs !hen a company issues shares of stock to its
e-isting stockholders instead of paying cash as a di'idend. Stock
di'idends should be recorded as a reduction of @etained Earnings and an
increase in Stock i'idend istributable. 5herefore8 stock di'idends do
not affect total stockholders equity. 2ormally8 retained earnings is
reduced by the market 'alue of the stock distributed.
10. It is better to recei'e a stock di'idend !hen the company is using earnings
to e-pand and rein'est in the business. /lso8 stock di'idends are not
considered ta-able income. / cash di'idend is preferred by in'estors !ho
need the cash to meet current needs8 like senior citi.ens.
11. Stock di'idends do not reduce the par 'alue per share of the stock. Stock
splits do reduce the par 'alue per share. Splits do not require any 9ournal
entry but should be noted in the notes that accompany the balance sheet.
12. Hook 'alue per share is calculated as the total common stockholders
equity di'ided by the number of shares of common stock. It is a measure
of the rights of the common stockholders to the assets of the firm in the
e'ent of liquidation. It does not mean that the common stockholders !ill
recei'e a di'idend equal to the book 'alue per share.
13. 5he market 'alue per share of the stock is related to the income of the
corporation8 but many other factors also influence the market 'alue.
6eneral economic factors such as inflation8 factors related to the particular
industry8 ta- consequences8 and the mood of current and potential
in'estors all ha'e an impact on the market 'alue of the stock. ,ltimately8
the market 'alue is determined by !hat in'estors are !illing to pay.
14. 5he statement of stockholders equity e-plains all reasons for the
difference bet!een the beginning and ending balances of each of the
accounts in the stockholders equity category. 5he retained earnings
statement details the changes in only one component of stockholders
equityEretained earnings.
15. 5he ad'antages of organi.ing as a corporation include limited liability and
the increased ability to raise funds from a !ider group of unrelated
&>/?5E@ 11 S54&A>43E@S EB,I5C 1184
in'estors. &ompanies choose not to incorporate because it costs to file
papers !ith the state and to issue stock8 and corporations must file annual
reports8 open to public inspection.
16. ?artners could share income equally as a fraction or percentage or an
allocation based on in'estment8 salary8 or other factors. 5he partners can
share income based on any method that is reasonable8 pro'ided that the
method has been agreed upon8 in !riting8 by the partners.
E X E R C I S E S
"O 1
EXERCISE 1181 STOC;HO"%ERS E9:IT< ACCO:$TS
1. Ces8 ?referred Stock8 Increase
/. Ces8 /dditional ?aid+in &apital8 Increase
0. 2ot recorded until declared
1. Ces8 &ash i'idends ?ayable is recorded as a liability8 ecrease @etained
Earnings
2. Ces8 Stock i'idend istributable8 2o change in total stockholders equity
3. Ces8 5reasury Stock8 ecrease
4. Ces8 /dditional ?aid+in &apitalE5reasury Stock8 Increase
5. Ces8 @etained Earnings Increase
"O 1
EXERCISE 118/ SO"VE FOR :$;$OW$S
1. 5otal par 'alue : I10 J 108000 : I1008000
/dditional ?aid+in &apital : I"$08000 K I1008000 : I2$08000
5otal Stockholders Equity : I"$08000 L I1008000 =@etained Earnings0 K
I108000 =5reasury Stock0 : I##08000
/. 2umber of shares of 5reasury Stock : number of shares issued K number
outstanding : 108000 K *8200 : )00 shares
&ost per share : I108000M)00 shares : I12.$0
1185 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
"O 0
EXERCISE 1180 STOC; ISS:A$CE
1. '. 5he effect on the accounting equation of the issuance of common stock
for cash is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash ($80007 &ommon
Stock 2$800077
/dditional
?aid+in
&apital $08000777
7I1$ J $8000 : I($8000
77I$ J $8000 : I2$8000
777I10 J $8000 : I$08000
*. 5he effect on the accounting equation of issuing common stock for a
building is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
Huilding 1($8000 &ommon
Stock "$80007
/dditional
?aid+in
&apital 1#08000
7I$ J (8000 : I"$8000
c. 5he effect on the accounting equation of issuing common stock to acquire
a patent is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
?atent $080007 &ommon
Stock 10800077
/dditional
?aid+in
&apital #08000
7I2$ J 28000 : I$08000
77I$ J 28000 : I108000
/. &ommon Stock8 I$ par 'alue; 1#8000 shares issued and
outstanding I (08000
/dditional ?aid+in &apital =$08000 L 1#08000 L #080000 2"08000
5otal &ontributed &apital I "008000
&>/?5E@ 11 S54&A>43E@S EB,I5C 1186
"O 0
EXERCISE 1181 STOC; ISS:A$CES
1. '. 5here is no effect on the accounting equation.
*. 5he effect on the accounting equation of the issuance of common stock
on March 108 200#8 is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash 1($80007 &ommon
Stock $0800077
/dditional
?aid+in
&apitalE
&ommon 12$8000
7I"$ J $8000 : I1($8000
77I10 J $8000 : I$08000
c. 5he effect on the accounting equation of the March 1)8 200#8 issuance of
preferred stock is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash 1280007 ?referred
Stock 10800077
/dditional
?aid+in
&apitalE
?referred 28000
7I120 J 100 : I128000
77I100 J 100 : I108000
d. 5he effect on the accounting equation of the /pril 128 200#8 issuance of
common stock is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash #$080007 &ommon
Stock 100800077
/dditional
?aid+in
&apitalE
&ommon "$08000
7I#$ J 108000 : I#$08000
77I10 J 108000 : I1008000
11817 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
/. )N ?referred stock8 I100 par 'alue8 $8000 shares authori.ed8
100 shares issued and outstanding I 108000
&ommon stock8 I10 par 'alue8 280008000 shares authori.ed8
1$8000 shares issued and outstanding 1$08000
/dditional ?aid+in &apitalE?referred stock 28000
/dditional ?aid+in &apitalE&ommon stock #($8000
5otal contributed capital I %"(8000
0. 5he balance sheet does not indicate the market 'alue of the stock. Market
'alue is a function of the demand for the stock at 'arious economic
indicators such as interest rates and inflation. It is the amount in'estors are
!illing to pay.
"O 1
EXERCISE 1182 TREAS:R< STOC;
1. '. 5he effect on the accounting equation of the purchase of treasury stock
on Ouly 1 is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash =#080000 5reasury
Stock =#0800007
7I20 J 28000 : I#08000
*. 5he effect on the accounting equation of the purchase of treasury stock
on /ugust 1 is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash =(82000 5reasury
Stock =(82000
/. @esale price of 5reasury Stock =28#00 J I2)0 I%(8200
3ess; &ost of 5reasury Stock =I#08000 L I(82000 #(8200
E-cess of selling price o'er cost I 208000
5his Fe-cess8G or Fgain8G is sho!n on the balance sheet as an increase in the
/dditional ?aid+in &apitalE5reasury Stock account.
&>/?5E@ 11 S54&A>43E@S EB,I5C 11811
"O 1
EXERCISE 1183 TREAS:R< STOC; TRA$SACTIO$S
1. '. 5he effect on the accounting equation of the 1ebruary 1 purchase of
treasury stock is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash =10080000 5reasury
Stock =100800007
7I20 J $8000 : I1008000
*. 5he effect on the accounting equation of the March 1 purchase of
treasury stock is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash =1$8%000 5reasury
Stock =1$8%0007
7I1" J 18200 : I1$8%00
/. 5he company sold treasury stock at amounts less than those it had paid to
reacquire the stock. In a sense8 the company had a loss of I) per share on
the stock purchased 1ebruary 1 and I1 per share on the stock purchased
March 18 but the FlossG is not sho!n on the income statement. Instead8 the
FlossG reduces stockholders equity.
0. Heginning balance I "*08000
@eacquisition of treasury stockE1eb. 1 =1008000 0
I 2*08000
@eacquisition of treasury stockEMarch 1 =1$8%00 0
I 2(#8#00
@eissue of all treasury stock (#8#00 7
Ending balance I "#)8)00
7&ost of 5reasury Stock I11$8%00 K loss of I#18200 : I(#8#00. /lso8 I12
per share - %8200 : I(#8#008 so o'erall the total stockholders equity
decreased by I#18200.
"O 2
EXERCISE 1184 CASH %IVI%E$%S
1181/ 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
1. ?referred di'idends per year : 18000 J I100 J *N : I*8000
<e'r PreCerred %i,ide(ds Co&&o( %i,ide(ds
2001 I +0+ I +0+
2002 1080007 +0+
200" 1(800077 "8000
200# *8000 1%8000
7I*8000 =from 20010 L I18000 =for 20020 : I108000.
77I)8000 =from 20020 L I*8000 =for 200"0 : I1(8000.
/. <e'r PreCerred %i,ide(ds Co&&o( %i,ide(ds
2001 I +0+ I +0+
2002 *8000 18000
200" *8000 118000
200# *8000 1%8000
"O 2
EXERCISE 1185 CASH %IVI%E$%S
1. ?referred; I2008000 J )N : I1%8000
&ommon; I1008000 K I1%8000 : I)#8000
/. 5he effect on the accounting equation of the Ouly 1 declaration of a di'idend
is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
i'idends @etained
?ayable 1008000 Earnings =10080000
5he effect on the accounting equation of the /ugust 1 payment of a di'idend
is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ash =10080000 i'idends
?ayable =10080000
0. ?referred; I1%8000 J " years : I#)8000
&ommon; I1008000 K I#)8000 : I$28000
"O 3
EXERCISE 1186 STOC; %IVI%E$%S
1. '. 5he effect on the accounting equation of the Oanuary 1$ declaration of a
10N stock di'idend is as follo!s;

&>/?5E@ 11 S54&A>43E@S EB,I5C 11810
!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
Stock
i'idend
istribut+
able #080007
/dditional
?aid+in
&apitalE
&ommon
Stock )08000
@etained
Earnings =1208000077
7#08000 J 10N J I10 : I#08000
77#08000 J 10N J I"0 : I1208000
*. 5he effect on the accounting equation of the Oanuary "0 issuance of the
stock di'idend is as follo!s;

!A"A$CE SHEET I$CO#E STATE#E$T
Assets = "i'*ilities > O?(ers@ Equity > Re,e(ues A E-Be(ses
&ommon
Stock #08000
Stock i'i+
dend is+
tributable =#080000
/. WORTH< CO#PA$<
PARTIA" !A"A$CE SHEET
DA$:AR< 01 /771
Stockholders Equity
&ommon Stock8 I10 par8 ##8000 shares issued and
outstanding I ##080007
/dditional ?aid+in &apitalE&ommon Stock 1)0800077
@etained Earnings 2)08000 777
5otal Stockholders Equity I *008000
7#08000 shares J 110N J I10 par : I##08000.
77I1008000 L I)08000 : I1)08000.
777I#008000 K I1208000 : I2)08000.
4'erall8 these transactions did not change total stockholders equity. 5hey
reclassified some equity from the retained earnings category to contributed
capital.
"O 4
EXERCISE 11817 STOC; %IVI%E$%S VERS:S STOC; SP"ITS
1. Assets = "i'*ilities > O?(ers Equity
11811 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
Stock i'idend; ERet'i(ed E'r(i()sF
A277777
ECo&&o( Stock
%i,ide(d %istri*ut'*leF
E27777 X 177G X H17F
>277777
Stock Split; 2o Entry
/. Stockholders Equity &ategory;
'. Stock %i,ide(d
&ommon stock8 I10 par8 1008000 shares issued
and outstanding I
1800080007
/dditional paid+in capitalEcommon stock ($08000
@etained earnings ")08000 77
5otal Stockholders Equity I 281"08000
7$08000 shares J 200N J I10 : I180008000.
77I))08000 K I$008000 : I")08000
*. Stock SBlit
&ommon stock8 I$ par8 1008000 shares issued
and outstanding I $0080007
/dditional paid+in capitalEcommon stock ($08000
@etained earnings ))08000
5otal Stockholders Equity I 281"08000
7?ar : I10M2 : I$< shares : $08000 J 2 : 1008000.
"O 4
EXERCISE 11811 STOC; %IVI%E$%S A$%
STOC; SP"ITS
1. Oan. 1 Halance %08000 shares
May 1 %08000 J 1$N *8000
%*8000
2o'. 1 J 2
5otal shares outstanding 1")8000 shares
/. I10M2 : I$ per share
0. Stockholders equity
&ommon stock8 I$ par 'alue8 1")8000 shares
&>/?5E@ 11 S54&A>43E@S EB,I5C 11812
issued and outstanding I %*08000
/dditional paid+in capital7 $(08000
@etained earnings PI182#08000 K =*8000 J I200Q 180%08000
5otal stockholders equity I 28"208000
7*8000 shares J =I20 K I100 : I*08000 from May 1.
I*08000 L I#)08000 : I$(08000
"O 5
EXERCISE 1181/ REPORTI$I CHA$IES I$
STOC;HO"%ERS E9:IT< ITE#S
R<%E I$C.
STATE#E$T OF STOC;HO"%ERS E9:IT<
FOR THE <EAR E$%E% APRI" 07 /771
Additio('l Tot'l
Co&&o( P'id8i( Ret'i(ed Stockholders
Stock C'Bit'l E'r(i()s Equity
Halance8 May 18 200" I "#$8000 I 182*)8000 I "801"8000
I#8%$%8000
2et income $$%8000 $$%8000
i'idends =()8000 0 =()8000 0
Halance8 /pril "08 200# I "#$8000 I 182*)8000 I "8#*18000 I $81"#8000
"O 5
EXERCISE 11810 CO#PREHE$SIVE I$CO#E
5he ,nreali.ed 6ainM3oss+/'ailable+1or+Sale Securities account occurred !hen
the company ad9usted its in'estments for the changes in the market 'alue of the
securities. Rhen a company buys stock in another company and the 'alue of
the stock changes8 it is necessary to !rite up or do!n the stock. In the case of
a'ailable+for+sale securities8 the ad9ustment is not considered a gain or loss on
the income statement. Instead8 the ad9ustment is recorded directly to the
stockholders equity category.
5he account titled 1oreign &urrency 5ranslation /d9ustments occurred !hen
assets held in currencies other than ,.S. dollars !ere con'erted to dollars.
uring that con'ersion8 a gain or loss occurs. 5his gain or loss is not the result
of selling the assets and is often referred to as a FpaperG gain or loss.
5here are arguments pro and con on the concept of comprehensi'e income.
Some firms belie'e that some items should not be presented on the income
statement because of their si.e or 'olatility. ?resentation on the income
statement may make it difficult for statement users to predict future income.
4ther firms belie'e that all income items should be reflected on the income
statement. 5hey belie'e that income is more useful if the statement user can
'ie! the effects of all items.
"O 6
EXERCISE 11811 %IVI%E$% PA<O:T RATIO A$%
!OO; VA":E PER SHARE
11813 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
1. i'idend ?ayout @atio; I#$8000MI)08000 : $%.2$N
$oteJ 5he solution assumes that the common stockholders ha'e a right to
the total net income of I)08000. 5he preferred stock is not cumulati'e8 and
it does not indicate that a cash di'idend !as declared to the preferred
stockholders. 1urther8 it appears that the preferred stockholders recei'ed a
stock di'idend during the year8 rather than a cash di'idend. 5herefore8 the
I#$8000 of income should be attributable to the common stockholders.
/. Hook Salue per Share;
5otal Stockholders Equity :
?referred Stock I 1108000
?aid+in &apitalE?referred $$8000
&ommon Stock $008000
?aid+in &apitalE&ommon $08000
@etained Earnings 2208000
I *"$8000
3ess; 3iquidation 'alue of preferred stock
=18100 shares J I1200 1"28000
2et assets applicable to common stock I )0"8000
2umber of shares of common stock;
I$008000MI$ per share : 1008000 shares
Hook 'alue per share : I)0"8000M1008000 : I).0"
"O 17
EXERCISE 11812 I#PACT OF TRA$SACTIO$S I$VO"VI$I
ISS:A$CE OF STOC; O$ STATE#E$T OF CASH F"OWS
1EIssuance of common stock for cash
1EIssuance of preferred stock for cash
2EIssuance of common stock for equipment
2EIssuance of preferred stock for land and building
2E&on'ersion of preferred stock into common stock
$oteJ E'en though they are financing transactions8 no cash changed hands in
the transactions marked F2.G /s a result8 they !ould not be listed under the
financing category of the statement of cash flo!s. >o!e'er8 they !ould be
reported in a supplementary schedule relating to the statement of cash flo!s.
"O 17
EXERCISE 11813 I#PACT OF TRA$SACTIO$S
I$VO"VI$I TREAS:R< STOC; O$ STATE#E$T OF
CASH F"OWS
1E@epurchase common stock as treasury stock
&>/?5E@ 11 S54&A>43E@S EB,I5C 11814
1E@eissuance of common stock =held as treasury stock0
2E@etirement of treasury stock
$oteJ E'en though it is a financing transaction8 no cash changed hands in the
retirement of treasury stock transaction. /s a result8 it !ould not be listed under
the financing category of the statement of cash flo!s. >o!e'er8 this transaction
!ould be reported in a supplementary schedule relating to the statement of cash
flo!s.
"O 17
EXERCISE 11814 I#PACT OF TRA$SACTIO$S
I$VO"VI$I %IVI%E$%S O$ STATE#E$T OF CASH
F"OWS
1E?ayment of cash di'idend on common stock
1E?ayment of cash di'idend on preferred stock
2Eistribution of stock di'idend
2Eeclaration of stock split
$oteJ E'en though they are financing transactions8 no cash changed hands in
the transactions marked F2.G /s a result8 they !ould not be listed under the
financing category of the statement of cash flo!s. >o!e'er8 they !ould be
reported in a supplementary schedule relating to the statement of cash flo!s.
"O 17
EXERCISE 11815 %ETER#I$I$I %IVI%E$%S PAI% O$
STATE#E$T OF CASH F"OWS
1. i'idends payable8 ec. "18 200" I )08000
?lus di'idends declared during 200# #008000
3ess cash payments during 200# =J 0
i'idends payable8 ec. "18 200# I 1008000
I)08000 L #008000 K J : I1008000
J : I")08000
/. &lifford !ould report the cash di'idend payments of I")08000 as a cash
outflo! in the financing acti'ities category of its 200# statement of cash
flo!s.
"O 11
EXERCISE 11816 SO"E PROPRIETORSHIP EAPPE$%IX F
1. 5he o!ners equity section of ?ar 6olfs balance sheet consists of the
o!ners capital account as follo!s;
Roods8 &apital =I$08000 K I108000 K I2080000 I 208000
"O 11
EXERCISE 118/7 PART$ERSHIPS EAPPE$%IX F
"e?is D'&'l "'Bi(
Heginning balance I 208000 I$08000 I"08000
/dd; /llocation of net income 1%8%%( 7 1%8%%( 1%8%%%
I"%8%%( I%%8%%( I#%8%%%
11815 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
3ess; Rithdra!als =$8000 0 =128000 0 =*8000 0
Ending balance I"18%%( I $#8%%( I "(8%%%
7I$08000M" : I1%8%%( rounded.
P R O ! " E #S
"O 1
PRO!"E# 1181 STOC;HO"%ERS E9:IT< CATEIOR<
PEE"ER CO#PA$<
PARTIA" !A"A$CE SHEET
%ECE#!ER 01 /771
Stockholders Equity
?referred stock8 I100 par8 (N8 18000 shares authori.ed8 $00
shares issued and outstanding I $08000
&ommon stock8 I$ par8 108000 shares authori.ed8 $8000 shares
issued8 #8%00 shares outstanding 2$8000
/dditional paid+in capitalEpreferred stock 108000
/dditional paid+in capitalEcommon stock "%$8000
/dditional paid+in capitalEtreasury stock $00
5otal &ontributed &apital I #$08$00
@etained earnings 1"8$00
3ess; treasury stock8 #00 shares8 common =2#8000 0
5otal Stockholders Equity I ##08000
1M10 ?referred stock; $00 J I100 par : I$08000
/dditional paid+in capital; $00 J =I120 K I1000 : I108000
1M10 &ommon stock; #8000 J I$ par : I208000
/dditional paid+in capital; #8000 J =I)0 K I$0 : I"008000
1M20 &ommon stock; 18000 J I$ par : I$8000
/dditional paid+in capital; 18000 J =I(0 K I$0 : I%$8000
/cquisition of treasury stock;
5reasury stock; $00 J I%0 : I"08000
@esale of treasury stock;
5reasury stock; 100 J I%0 : I%8000
/dditional paid+in capital; 100 J =I%$ K I%00 : I$00
12M"1 2et income; @etained earnings I#08000
12M"1 ?referred di'idend;
=$00 J I100 par J (N0 : I"8$00 decrease in retained earnings
&ommon stock di'idend;
#8%00 outstanding J I$ per share : I2"8000 decrease in retained earnings
&>/?5E@ 11 S54&A>43E@S EB,I5C 11816
"O /
PRO!"E# 118/ EVA":ATI$I A"TER$ATIVE
I$VEST#E$TS
1. &ommon stock has o!nership pri'ileges. 5he residual of the company
belongs to the common shareholders !ith the possibility of much greater
returns if the company is successful.
?referred stock has preference o'er common stockholders in di'idend
payouts8 but is limited in its possible return.
Honds earn interest that is a legal obligation of the company.
/. 5he return on the preferred stock depends upon its issue price. If it is
assumed that the stock is issued at par 'alue8 the return is )N. Since all
three instruments yield the same rate of return8 )N8 Ellen should choose to
in'est in the bonds because they carry the lo!est risk. /s risk increases8
the e-pected rate of return on an in'estment should increase.
"O 2
PRO!"E# 1180 %IVI%E$%S FOR PREFERRE% A$%
CO##O$ STOC;
1. PreCerred Stock Co&&o( Stock
I1008000 J )N : I)8000 I$*8000 K I)8000 : I$18000
?er share; I)8000M18000 : I).00 I$18000M208000 : I2.$$
/. PreCerred Stock Co&&o( Stock
I)8000 J " years : I2#8000 I$*8000KI2#8000 : I"$8000
?er share; I2#8000M18000 : I2#.00 I"$8000M208000 : I1.($
"O 3
PRO!"E# 1181 EFFECT OF STOC; %IVI%E$%
1. 5he memo to the board of directors should include the follo!ing points;
'. / stock di'idend does not change the total stockholders equity amount.
*. / stock di'idend does reduce the balance of @etained Earnings and
transfers the amount of the stock di'idend to the contributed capital
component of stockholders equity.
c. / stock di'idend results in additional shares of stock outstanding.
5herefore8 it affects the financial ratios of the firm. 1or e-ample8 book
'alue per share and earnings per share decline as a result of the stock
di'idend.
/. 5he statement to the stockholders should stress the follo!ing points;
'. Each stockholder has the same proportionate o!nership of the company
after the di'idend as before the di'idend.
118/7 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
*. / stock di'idend is likely to cause the market price per share of the stock
to decline. 5he additional shares recei'ed by the stockholder should
offset the decline in the per share price and lea'e the stockholder at
least as !ell off as before the di'idend.
c. Rhat happens to the stock price after the stock di'idend is dependent on
the companys profitability and a !ide 'ariety of industry and economic
factors.
"O 4
PRO!"E# 1182 %IVI%E$%S A$% STOC; SP"ITS
1. March 1 @etained Earnings and total stockholders equity decrease.
/pril 1 5otal stockholders equity remains unchanged.
Oune 1 &ommon Stock istributable increases by I(8$00 =1$8000 J $N
J I100. /dditional ?aid+in &apitalE&ommon Stock increases
by I%8000 =1$8000 J $N J )0. @etained Earnings decrease by
I1"8$00. 5otal stockholders equity does not change.
Ouly 1 &ommon Stock istributable decreases and common stock
increases by I(8$00.
Sept. 1 @etained Earnings and total stockholders equity decrease by
I(8)($ P=1$8000 L ($00 J I.$0Q.
4ct. 1 5otal stockholders equity does not change.
ec. 1 5he par 'alue of common stock changes from I10 to I$ as the
number of shares issued and outstanding doubles from 1$8($0
to "18$008 but the total par 'alue does not change. 5he total
stockholders equity also does not change.
/. 5he stockholders equity category as of ecember "18 200#8 !ould appear
as follo!s;
FRE%ERI;SE$S I$C.
PARTIA" !A"A$CE SHEET
%ECE#!ER 01 /771
Stockholders Equity
&>/?5E@ 11 S54&A>43E@S EB,I5C 118/1
?referred stock8 I)0 par8 (N8 "8000 shares issued
and outstanding I 2#08000
&ommon stock8 I$ par8 "18$00 shares7 issued and
outstanding 1$(8$00
/dditional paid+in capitalEpreferred stock %08000
/dditional paid+in capitalEcommon stock 2"18000 77
5otal &ontributed &apital I %))8$00
@etained earnings 28(118)2$777
5otal Stockholders Equity I "8#008"2$
7=1$8000 L ($0 stock di'idend0 J 2 stock split : "18$00.
77I22$8000 L I%8000 stock di'idend : I2"18000.
777I281008000 K I1%8)00 cash di'idend K I1"8$00 stock di'idend K I(8)($
cash di'idend L I%$08000 net income : I28(118)2$.
0. / stock di'idend results in the capitali.ation of part of the @etained Earnings
account. 5he 'alue of the shares issued in the stock di'idend is deducted
from the @etained Earnings account and added to the &apital Stock account
=and the /dditional ?aid+in &apital account for small stock di'idends0. 5he
number of outstanding shares is increased8 and the par 'alue of the shares
is unchanged. In a stock split8 there is no change to any of the capital
accounts. 5here is an increase in the number of outstanding shares8 !hich
is offset by a corresponding decrease in the par 'alue of those shares.
"O 5
PRO!"E# 1183 STATE#E$T OF STOC;HO"%ERS E9:IT<
PreCerred Co&&o( P'id8i( Tre'sury Ret'i(ed
Stock Stock C'Bit'l Stock E'r(i()s
Halance8 Oanuary 1 I 0 I 0 I 0 I 0 I 0
Sale of preferred stock $08000 108000
Sale of common stock 208000 "008000
Issuance of common
stock for building site $8000 %$8000
118// 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
?urchase of treasury
stock I="080000
Sale of treasury stock $00 %8000
2et income I#08000
&ash di'idendsE?re+
ferred ="8$000
&ash di'idendsE&om+
mon
=2"8000 0
Halance8 ecember "1 I $08000 I 2$8000 I "($8$00 I =2#8000 0 I 1"8$00
E-Bl'('tio(sJ
1M10 ?referred Stock; $00 J I100 par : I$08000 increase
/dditional ?aid+in &apital; $00 J =I120 K I1000 : I108000 increase
1M10 &ommon Stock; #8000 J I$ : I208000 increase
/dditional ?aid+in &apital; #8000 J =I)0 K I$0 : I"008000 increase
1M20 &ommon Stock; 18000 J I$ par : I$8000 increase
/dditional ?aid+in &apital; 18000 J =I(0 K I$0 : I%$8000 increase
/cquisition of treasury stock;
5reasury Stock; $00 J I%0 : I"08000 decrease
@esale of treasury stock;
5reasury Stock; 100 J I%0 : I%8000 increase
/dditional ?aid+in &apital; 100 J =I%$ K I%00 : I$00 increase
12M"1 2et income;
@etained Earnings; I#08000 increase
12M"1 &ash di'idends;
?referred Stock;
=$00 J I100 J (N0 : I"8$00 decrease in @etained Earnings
&ommon Stock;
#8%00 outstanding J I$ per share : I2"8000 decrease in @etained
Earnings
"O 5
PRO!"E# 1184 WA"#ARTS CO#PREHE$SIVE I$CO#E
1. &omprehensi'e Income for the year ended Oanuary "18 200" =in millions0;
2et income I )80"*
&urrency translation 1811"
>edge accounting ad9ustment =1#)0
Minimum pension liability ad9ustment =20%0
&omprehensi'e income I )8(*)
&>/?5E@ 11 S54&A>43E@S EB,I5C 118/0
5he effect of including these items on the income statement !ould ha'e
been to increase net income. Rhile this !ould sho! all sources of income
for the period8 these numbers could lead readers to belie'e this is an
ordinary result of operations.
/. Some items8 such as the market 'alue ad9ustments on in'estments and the
foreign currency translation ad9ustment8 are considered to be FpaperG gains
or losses< these ad9ustments are not presented on the income statement
because they are also unreali.ed. 5hese ad9ustments are often 'olatile and
may be quite si.able. 1urther8 no cash inflo!s or outflo!s directly result
from these ad9ustments. /ccordingly some of the stockholders of
Ralgreens may prefer that these items be reported on the statement of
stockholders equity. Including these items on the income statement might
make it difficult for in'estors to predict future income. 4n the other hand8
because this information may be useful in e'aluating the effecti'eness of the
companys management8 others might prefer to see these items reported on
the income statement.
"O 17
PRO!"E# 1185 EFFECTS OF STOC;HO"%ERS
E9:IT< TRA$SACTIO$S O$ STATE#E$T OF CASH
F"OWS
&ash flo!s from financing acti'ities;
Issuance of preferred stock =$00 J I1200 I %08000
Issuance of common stock =#8000 J I)00 "208000
?urchase of treasury stock =$00 J I%00 ="080000
@eissuance of treasury stock =100 J I%$0 %8$00
2et cash flo! from financing acti'ities I "$%8$00
5he follo!ing transactions !ould not appear in the financing acti'ities section of
the statement of cash flo!s;
T ?eeler obtained the building site by issuing 18000 shares of common
stock< no cash changed hands. /s a result8 this transaction !ould be
reported as a non+cash in'esting and financing transaction on the
statement of cash flo!s.
T /ssuming that the indirect method is used8 the companys 200# net
income !ould appear as the first item under the cash flo!s from operating
acti'ities section of the statement of cash flo!s.
T 5he di'idend declared on ec. "18 200#8 !ill not be paid until 200$. /s a
result8 the payment of this di'idend !ill appear as a cash outflo! in the
financing section of the 200$ statement of cash flo!s.
"O 11
PRO!"E# 1186 I$CO#E %ISTRI!:TIO$ OF A
PART$ERSHIP EAPPE$%IX F
1. If income is I$080008 it should be distributed as follo!s;
118/1 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
A**ott Costello
Salary to /bbott I 208000
Interest to &ostello; 10N J I"008000 I "08000
5otal distributed I 208000 I "08000
/. If income is I)080008 it should be distributed as follo!s;
A**ott Costello
Salary to /bbott I 208000
Interest to &ostello; 10N J I"008000 I"08000
@emainder on 2;1 ratio;
=I)08000 K I$080000 J 2M" 208000
=I)08000 K I$080000 J 1M" 108000
5otal istributed I #08000 I #08000
0. If income is I10080008 it should be distributed as follo!s;
A**ott Costello
Salary to /bbott I 208000
Interest to &ostello 10N J I"008000 I "08000
@emainder in 2;1 ratio;
=I1008000 K I$080000 J 2M" : ""8"""
=I1008000 K I$080000 J 1M" : 1%8%%(
5otal distributed I $"8""" I "%8%%(
"O 11
PRO!"E# 11817 SO"E PROPRIETORSHIPS EAPPE$%IX F
1. Heginning balance I 0
In'estments by o!ner 1208000
I 1208000
/dd; 2et income 2#8000
3ess; Rithdra!als =128000 0
Ending balance I 1"28000
/. 5he capital account indicates the amount of the o!ners in'estment that has
not been !ithdra!n. It is based on accrual accounting and does not
indicate the amount of cash in the business.
"O 11
PRO!"E# 11811 PART$ERSHIPS EAPPE$%IX F
/llocation of net income; 2erise 4Hrien 5otal
2et income I218200
3ess; Salary I(8200
3ess; Interest =I1008000 - %N0 I%8000 I1"8200
@emainder to /llocate I )8000
Halance of Equity #8000 #8000 )8000
I118200 I108000 I 0
&>/?5E@ 11 S54&A>43E@S EB,I5C 118/2
7It is assumed that the net income amount is after the amount of salary to 2erise
has been deducted8 so total net income !ould ha'e been I218200.
$erise O!rie(
Heginning balance I 0 I 0
/dd; In'estments 2$8000 1008000
/llocation of net income 118200 108000
I "%8200 I 1108000
3ess; Rithdra!als 71"8200 #8000
Ending balance I 2"8000 I 10%8000
7 Salary allocation of I%00 - 12 : I(8200 L I%8000 !ithdra!als : I1"8200
#:"TI8CO$CEPT PRO!"E#S
"O 11
PRO!"E# 1181/ A$A"<SIS OF STOC;HO"%ERS E9:IT<
1. ?referred stock issued : I1208000MI"0 par : #8000 shares
/. ?referred stock outstanding : #8000 K 100 =5reasury Stock0 : "8*00 shares
0. =I1208000 L I%80000M#8000 : I"1.$0
1. I(08000M(8000 : I10 per share
2. =I(08000 L I$%080000M(8000 : I*0 per share
3. I"8200M100 shares : I"2 per share
4. I($(8000 L I#08000 K I"8200 : I(*"8)00
5. PI(*"8)00 K ="8*00 preferred shares J I"0 par0QM(8000 : I*%.%*
118/3 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
"O 014
PRO!"E# 11810 EFFECTS OF STOC;HO"%ERS E9:IT<
TRA$SACTIO$S O$ THE !A"A$CE SHEET
1. Assets = "i'*ilities > O?(ers Equity
'. >277777 >277777
*. >177777 >177777
c. A13777 A13777
d. >17677 A17677K
e. 2o accounting entry
C. >157777 >157777
7=1008000 L 108000 K 180000=I.100.
$oteJ 5he net income in transaction C. results in an increase of I1)08000 in
o!ners equity. 5he corresponding I1)08000 may ha'e been an increase in
assets =as sho!n08 a decrease in liabilities8 or some combination of the t!o.
/. HORTO$ I$C.
PARTIA" !A"A$CE SHEET
%ECE#!ER 01 /771
Stockholders Equity
&ommon stock8 280008000 authori.ed8 2208000 issued8
21)8000 outstanding8 I.$0 par 'alue I 1108000
/dditional paid+in capital =#008000 L *080000 #*08000
@etained earnings =K108*00 L 1)080000 1%*8100
3ess; 5reasury stock =1%8000 0
5otal Stockholders Equity I ($"8100
0. $oteJ 5he &ompany is authori.ed to issue 280008000 shares of common
stock8 I.$0 par 'alue. /t the end of the year8 2208000 shares are issued<
ho!e'er8 only 21)8000 are outstanding because the &ompany has
repurchased 28000 shares of common stock for further distribution. 5he
figures presented reflect the retroacti'e treatment of a 2 for 1 stock split
during the year.
&>/?5E@ 11 S54&A>43E@S EB,I5C 118/4
"O 11
PRO!"E# 11811 STOC;HO"%ERS E9:IT<
SECTIO$ OF THE !A"A$CE SHEET
1. IVES I$C.
!A"A$CE SHEET
AS OF XXX
Assets
&ash I "8$00
/ccount recei'able $8000
?lant8 property8 and equipment 10)8000
5otal assets I 11%8$00
"i'*ilities
/ccounts payable I $8$00
i'idends payable 18$00
Stockholders Equity
&ommon stock8 I1 par8 1008000 shares outstanding 1008000
/dditional paid+in capital 118000
@etained earnings =1800007
5reasury Stock =$00 0
5otal 3iabilities and o!ners equity I 11%8$00
5reasury stock is not an asset< it is a contra o!ners equity account.
@etained earnings is not an asset< it is the accumulated8 undistributed profit
of the company8 !hich here8 is negati'e.
75otal assets of I11%8$00 minus total equities of I11(8$00 gi'es a negati'e
@etained Earnings of I18000.
/. 5he @etained Earnings account has a negati'e balance because the
accumulated earnings of the company represent a net loss andMor di'idends
paid out ha'e e-ceeded the cumulati'e earnings.
118/5 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
A"TER$ATE PRO!"E#S
"O 1
PRO!"E# 1181A STOC;HO"%ERS E9:IT< CATEIOR<
;E!"ER CO#PA$<
PARTIA" !A"A$CE SHEET
%ECE#!ER 01 /771
Stockholders Equity
?referred stock8 I100 par8 (N8 28000 shares authori.ed8
18000 shares issued I 1008000
&ommon stock8 I$ par8 208000 shares authori.ed8 108000
shares issued8 *8100 shares outstanding $08000
/dditional paid+in capitalEpreferred stock 208000
/dditional paid+in capitalEcommon stock ("08000
/dditional paid+in capitalEtreasury stock $00
5otal &ontributed &apital I *008$00
@etained earnings 2(8$00
3ess; 5reasury stock8 *00 shares8 common =$#8000 0
5otal Stockholders Equity I )(#8000
1M10 ?referred Stock; 18000 J I100 par : I1008000
/dditional ?aid+in &apital; 18000 J =I120 K I1000 : I208000
1M10 &ommon Stock; )8000 J I$ : I#08000
/dditional ?aid+in &apital; )8000 J =I)0 K I$0 : I%008000
1M20 &ommon Stock; 28000 J I$ par : I108000
/dditional ?aid+in &apital; 28000 J =I(0 K I$0 : I1"08000
5reasury stock acquired;
5reasury Stock; 18000 J I%0 : I%08000
5reasury stock resold;
5reasury Stock; 100 J I%0 : I%8000
/dditional ?aid+in &apital; 100 J =I%$ K I%00 : I$00
12M"1 2et income;
@etained Earnings; I)08000
12M"1 i'idend;
?referred; 18000 J I100 par J (N : I(8000 decrease
&ommon; *8100 shares J I$ : I#$8$00 decrease
&>/?5E@ 11 S54&A>43E@S EB,I5C 118/6
"O /
PRO!"E# 118/A EVA":ATI$I A"TER$ATIVE I$VEST#E$TS
1. Co&&o( stockEdi'idends become an obligation of the company after they
are declared. ?rior to the declaration8 the company is not obligated to pay
di'idends to common shareholders.
PreCerred stockEdi'idends become an obligation of the company after they
are declared. ?rior to the declaration8 the company is not obligated to pay
di'idends. >o!e'er8 preferred stockholders ha'e preference o'er common
stockholders and !ill recei'e di'idends before common stockholders.
!o(dsEthe interest and principal payments are a legal obligation of the
company.
/. @ob should in'est in the common stock because the return is greatest. @ob
must be a!are8 ho!e'er8 that the risk is also the greatest. If the company
fails to perform as it has in the past and is e-pected to perform in the future8
@ob not only !ould lose di'idends but might lose the in'estment in stock.
"O 2
PRO!"E# 1180A %IVI%E$%S FOR PREFERRE% A$%
CO##O$ STOC;
1. PreCerred Stock Co&&o( Stock
I2008000 J )N : I1%8000 I11)8000 K I1%8000 : I1028000
?er share; I1%8000M28000 : I).00 I1028000M#08000 : I2.$$
/. PreCerred Stock Co&&o( Stock
I1%8000 J " years : I#)8000 I11)8000 K I#)8000 : I(08000
?er share; I#)8000M28000 : I2#.00 I(08000M#08000 : I1.($
"O 3
PRO!"E# 1181A EFFECT OF STOC; %IVI%E$%
1. 5he statement should include the follo!ing points;
'. / stock di'idend does not change the total stockholders equity amount.
*. / stock di'idend does reduce the balance of @etained Earnings and
transfers the amount of the stock di'idend to the contributed capital
component of stockholders equity.
c. / stock di'idend results in additional shares of stock outstanding.
5herefore8 it affects the financial ratios of the firm. 1or e-ample8 book
'alue per share and earnings per share decline as a result of the stock
di'idend.
11807 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
/. 5he statement to the stockholders should stress the follo!ing points;
'. Each stockholder has the same proportionate o!nership of the company
after the di'idend as before the di'idend.
*. / stock di'idend is likely to cause the market price per share of the stock
to decline. 5he additional shares recei'ed by the stockholder should
offset the decline in the per share price and lea'e the stockholder at
least as !ell off as before the di'idend.
c. Rhat happens to the stock price after the stock di'idend is dependent on
the companys profitability and a !ide 'ariety of industry and economic
factors.
"O 4
PRO!"E# 1182A %IVI%E$%S A$% STOC; SP"ITS
1. March 1 &ash di'idends increase =or @etained Earnings decrease0 and
total stockholders equity decreases.
/pril 1 5otal stockholders equity remains unchanged.
Oune 1 &ommon Stock istributable increases by I)8000 =108000 J )N
J I100. /dditional ?aid+in &apitalE&ommon Stock increases
by I128)00 =108000 J )N J I1%0. @etained Earnings decrease
by I208)00. 5otal stockholders equity does not change.
Ouly 1 &ommon Stock istributable decreases and &ommon Stock
increases by I)8000.
Sept. 1 @etained Earnings and total stockholders equity decrease by
I(8$%0 P=108000 L )000 J I.(0Q.
4ct. 1 5otal stockholders equity does not change.
ec. 1 5he par 'alue of common stock changes from I10 to I"."" as
the number of shares issued and outstanding triples from
108)00 to "28#008 but the total par 'alue does not change. 5he
total stockholders equity also does not change.
&>/?5E@ 11 S54&A>43E@S EB,I5C 11801
/. SVE$!ERI I$C.
PARTIA" !A"A$CE SHEET
%ECE#!ER 01 /771
Stockholders Equity
?referred stock8 I)0 par8 )N8 18000 shares issued
and outstanding I )08000
&ommon stock8 I"."" par8 "28#007 shares issued
and outstanding 10)800077
/dditional paid+in capitalEpreferred %08000
/dditional paid+in capitalEcommon 2"(8)00 777
5otal &ontributed &apital I #)$8)00
@etained earnings 28%%$82#0 7777
5otal Stockholders Equity I "81$180#0
7=108000 L )00 stock di'idend0 J " =stock split0 : "28#00.
77ifference due to rounding of par 'alue.
777I22$8000 L I128)00 stock di'idend : I2"(8)00.
7777I18*)08000 K I%8#00 cash di'idend K I208)00 stock di'idend K I(8$%0
cash di'idend L I(208000 net income : I28%%$82#0.
0. / stock di'idend results in the capitali.ation of part of the @etained Earnings
account. 5he 'alue of the shares issued in the stock di'idend is deducted
from the @etained Earnings account and added to the &apital Stock account
=and the /dditional ?aid+in &apital account for small stock di'idends0. 5he
number of outstanding shares is increased8 and the par 'alue of the shares
is unchanged. In a stock split8 there is no change to any of the capital
accounts. 5here is an increase in the number of outstanding shares !hich
is offset by a corresponding decrease in the par 'alue of those shares.
1180/ 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
"O 5
PRO!"E# 1183A STATE#E$T OF STOC;HO"%ERS
E9:IT<
PreCerred Co&&o( P'id8i( Tre'sury Ret'i(ed
Stock Stock C'Bit'l Stock E'r(i()s
Halance8 Oanuary 1 I 0 I 0 I 0 I 0 I 0
Sale of preferred stock 1008000 208000
Sale of common stock #08000 %008000
Issuance of common
stock for building site 108000 1"08000
?urchase of treasury
stock I =%080000
Sale of treasury stock $00 %8000
2et income I)08000
&ash di'idendsE?re+
ferred =(80000
&ash di'idendsE&om+
mon
=#$8$00 0
Halance8 ecember "1 I 1008000 I $08000 I ($08$00 I =$#8000 0 I 2(8$00
E-Bl'('tio(sJ
1M10 ?referred Stock; 18000 J I100 par : I1008000 increase
/dditional ?aid+in &apital; 18000 J =I120 K I1000 : I208000 increase
1M10 &ommon Stock; )8000 J I$ : I#08000 increase
/dditional ?aid+in &apital; )8000 J =I)0 K I$0 : I%008000 increase
1M20 &ommon Stock; 28000 J I$ par : I108000 increase
/dditional ?aid+in &apital; 28000 J =I(0 K I$0 : I1"08000 increase
/cquisition of treasury stock;
5reasury Stock; 18000 J I%0 : I%08000 decrease
@esale of treasury stock;
5reasury Stock; 100 J I%0 : I%8000 increase
/dditional ?aid+in &apital; 100 J =I%$ K I%00 : I$00 increase
12M"1 2et income;
@etained Earnings; I)08000 increase
12M"1 &ash di'idends;
?referred Stock;
=18000 J I100 J (N0 : I(8000 decrease in @etained Earnings
&ommon Stock;
*8100 outstanding J I$ per share : I#$8$00 decrease in
@etained Earnings
&>/?5E@ 11 S54&A>43E@S EB,I5C 11800
"O 5
PRO!"E# 1184A SO:THWEST AIR"I$ES CO#PREHE$SIVE I$CO#E
1. South!ests net income is lo!er than the amount of its comprehensi'e
income. 5he difference bet!een South!ests net income and its
comprehensi'e income is caused by I)(821"8000 ad9ustment for unreali.ed
gain on deri'ati'es and a I2801(8000 ad9ustment for other items that are not
specified. /n unreali.ed gain means the market 'alue of in'estments has
increased from the date of the last financial statement.
/. Some of the items included in comprehensi'e income8 such as market 'alue
ad9ustments in deri'ati'es and FotherG8 are considered to be FpaperG gains or
losses. 5hese ad9ustments are not presented on the income statement
because they are not reali.ed. 5hese ad9ustments are often 'olatile and
may be quite si.able. 1urther8 no cash inflo!s or outflo!s directly result
from these ad9ustments. Including these items in net income might make it
difficult for in'estors to predict future income. 4n the other hand8 this
information may be useful in e'aluating the effecti'eness of the companys
management.
"O 17
PRO!"E# 1185A EFFECTS OF STOC;HO"%ERS
E9:IT< TRA$SACTIO$S O$ STATE#E$T OF CASH
F"OWS
&ash flo!s from financing acti'ities;
Issuance of preferred stock =18000 J I1200 I 1208000
Issuance of common stock =)8000 J I)00 %#08000
?urchase of treasury stock =18000 J I%00 =%080000
@eissuance of treasury stock =100 J I%$0 %8$00
2et cash flo!s from financing acti'ities I (0%8$00
5he follo!ing transactions !ould not appear in the financing acti'ities section of
the statement of cash flo!s;
T Aebler obtained the building site by issuing 28000 shares of common
stock< no cash changed hands. /s a result8 this transaction !ould be
reported as a non+cash in'esting and financing transaction on the
statement of cash flo!s.
T /ssuming the indirect method is used8 the companys 200# net income
!ould appear as the first item under the cash flo!s from operating
acti'ities section of the statement of cash flo!s.
T 5he di'idend declared8 on ecember "18 200#8 !ill not be paid until 200$.
/s a result8 the payment of this di'idend !ill appear as a cash outflo!8 in
the financing section of the 200$ statement of cash flo!s.
11801 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
"O 11
PRO!"E# 1186A I$CO#E %ISTRI!:TIO$ OF A
PART$ERSHIP EAPPE$%IX F
1. If income is I10080008 it should be distributed as follo!s;
;'tL ;'(
Salary to Aat. I#08000
Interest to Aan; 10N J I%008000 I %08000
5otal distributed I #08000 I %08000
/. If income is I1%080008 it should be distributed as follo!s;
;'tL ;'(
Salary to Aat. I#08000
Interest to Aan; 10N J I%008000 I%08000
@emainder in 2;1 ratio;
=I1%08000 K I10080000 J 2M" #08000
=I1%08000 K I10080000 J 1M" 208000
5otal istributed I )08000 I )08000
0. ;'tL ;'(
Salary to Aat. I#08000
Interest to Aan; 10N J I%008000 I%08000
@emainder in 2;1 ratio;
=I2008000 K I10080000 J 2M" : %%8%%(
=I2008000 K I10080000 J 1M" : ""8"""
5otal distributed I 10%8%%( I %"8"""
$oteJ 6enerally8 salary and interest are allocated first to the partners
accounts and then8 if there is a deficit8 the deficit is allocated in the agreed
ratio. 5he result8 in this case8 is a negati'e amount distributed to Aat..
"O 11
PRO!"E# 11817A SO"E PROPRIETORSHIPS EAPPE$%IX F
1. Heginning balance I 0
In'estments by o!ner 1$08000
I 1$08000
/dd; 2et income "08000
3ess; Rithdra!als =1$8000 0
Ending balance I 1%$8000
/. 5he capital account indicates the amount of the o!ners income that has not
been !ithdra!n. It is based on accrual accounting and does not indicate
the amount of cash in the business.
"O 11
PRO!"E# 11811A PART$ERSHIPS EAPPE$%IX F
&>/?5E@ 11 S54&A>43E@S EB,I5C 11802
3ocke Aeyes 5otal
/llocation of 2et Income I"08#007
3ess; Salary I108)00 I)8#00
3ess; @eturn on In'estment I1*8200
=1#08000 - %N0
5otal /llocated I118200
@emainder to /llocate Equally $8%00 $8%00 118200
I1%8#00 I1#8000 I 0
7 2et Income !as I12%8000 K =I10%8000 K I108)000 : I"08#00
"ocke ;eyes
Heginning balance I 0 I 0
/dd; In'estments "$8000 1#08000
/llocation of net income 1%8#00 1#80 00
I $18#00 I 1$#8000
3ess; Rithdra!als 1*8200 7 $8%00
Ending balance I "28200 I 1#)8#00
7 =I(00 - 120 L I108)00 Salary /llocation : I1*8200
A"TER$ATE #:"TI8CO$CEPT PRO!"E#S
"O 11
PRO!"E# 1181/A A$A"<SIS OF STOC;HO"%ERS E9:IT<
1. ?referred stock issued : I#008000MI$0 par : )8000 shares
/. ?referred stock outstanding : )8000 K 200 =5reasury Stock0 : (8)00 shares
0. =I#008000 L I1280000M)8000 : I$1.$0
1. I2)08000M1#8000 : I20
2. =I2)08000 L I*)080000M1#8000 : I*0
3. I128)00M200 : I%#
4. I18%(#8000 L I)08000 K I128)00 : I18(#18200
5. PI18(#18200 K =(8)00 J I$00QM1#8000 : I*%.$1
"O 01
PRO!"E# 11810A EFFECTS OF STOC;HO"%ERS E9:IT<
11803 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
TRA$SACTIO$S O$ THE !A"A$CE SHEET
1. Assets = "i'*ilities > O?(ers Equity
'. >177777 >177777
*. >177777 >177777
c. A17777 A17777
d. >6277 A6277K
e. >017777 >017777
7=108000 L 108000 K 180000=I.$00.
$oteJ 5he net income of transaction e. increases o!ners equity by
I"#08000 =as sho!n0. 5he corresponding amount may be an increase to
assets8 a decrease in liabilities8 or some combination.
/. &ontributed capital is the amount gi'en in e-change for assets. In the first
transaction8 the company ga'e stock for cash8 an asset. In the second
transaction8 the company ga'e stock for a patent8 also an asset.
&ontributed capital may also be gi'en for payment of debt. @etained
earnings is the second category of o!ners equity and it represents the
amount of undistributed8 accumulated earnings of the company. >iltons
retained earnings balance is the income of I"#08000 less di'idends of
I*8$00 : I""08$00.
0. 5he book 'alue of the common stock at the end of the year is computed as
follo!s;
Stockholders EquityJ
&ommon stock I 208000
/dditional paid+in capitalEcommon stock 1)08000
@etained earnings =I"#08000 K I*8$000 ""08$00
3ess; 5reasury stock =108000 0
5otal I $208$00
2umber of shares of stock outstanding : 108000 L 108000 K 18000 : 1*8000
Hook 'alue per share : I$208$00M1*8000 : I2(."*
&>/?5E@ 11 S54&A>43E@S EB,I5C 11804
"O 11
PRO!"E# 11811A STOC;HO"%ERS E9:IT<
SECTIO$ OF THE !A"A$CE SHEET
1. IRAI$FIE"% CO#PA$<
PARTIA" !A"A$CE SHEET
Stockholders Equity
?referred stock8 108000 shares authori.ed8 $8000
shares issued and outstanding8 I10 par8 $N I $08000
&ommon stock8 1800080000 shares authori.ed8 1008000 shares
issued and *(8000 shares outstanding8 I1 par 'alue 1008000
/dditional paid+in capital %)8#00
@etained earnings $#8*00
5reasury stock8 "8000 shares of common =1$8000 0
5otal Stockholders Equity I 2$)8"00
/. i'idends ?ayable is a liability.
% E C I S I O $ C AS E S
REA%I$I A$% I$TERPRETI$I FI$A$CIA" STATE#E$TS
"O 1/
%ECISIO$ CASE 1181 WI$$E!AIO I$%:STRIES
STOC;HO"%ERS E9:IT< CATEIOR<
1. 5here are %080008000 shares of common stock authori.ed8 2$8)))8000
issued. 5he balance sheet indicates the dollar amount of treasury stock but
does not indicate the number of shares. /s a result8 the number of shares
outstanding as of /ugust "18 2002 can not be determined.
2. Hook 'alue per share : =I1(*8)1$80000M=2$8)))80000 : I%.*$ per share
2ote; 2ormally8 book 'alue per share should be based on the number of
shares of stock outstanding. It is not possible to determine the number
outstanding in this case. >o!e'er8 because the number of shares of
treasury stock is relati'ely small8 the distortion caused by this factor is not
large.
". 5he only factor that increased @ein'ested Earnings in 2002 !as the net
income of I$#8%(18000. i'idends of I"8*$#8000 decreased the account.
#. 5he total amount of stockholders equity indicates the rights of the
stockholders8 but they !ould recei'e that amount only if the companys
assets !ere liquidated at the recorded historical cost amounts.
"O 15
%ECISIO$ CASE 118/ CO#PARI$I TWO CO#PA$IES I$ THE SA#E
11805 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
I$%:STR<J WI$$E!AIO I$%:STRIES A$% #O$ACO COACH
CORPORATIO$
1. Rinnebago Industries; %080008000 shares of common stock are authori.ed8
2$8)))8000 are issued. 5he balance sheet discloses that a dollar amount of
treasury stock of I1#"8(2$ !as held but does not disclose the number of
shares of treasury stock. /s a result8 the number of shares of common
stock outstanding cannot be calculated.
Monaco &oach; 5here are $080008000 shares of common stock authori.ed
and 2)8)(181## issued8 and outstanding.
2. Rinnebago Industries; I1(*8)1$8000M2$8)))8000 : I%.*$
Monaco &oach; Hook 'alue per share : I2%08%2(8000M2)8)(181## : I*.0"
per share. 5he total stockholders equity is larger than Rinnebagos8 and
the book 'alue per share is also slightly larger.
/ comparison of book 'alue per share only pro'ides limited information
about the companies and indicates the amount that stockholders !ould
recei'e if the companies !ere liquidated and assets !ere sold for their book
'alues.
". Rinnebago Industries; @ein'ested Earnings increased from I2"#81"*8000
to I2)#8)$%8000.
Monaco &oach; @etained Earnings increased from I1%#8""28000 to
I20)8)"(8000.
2ormally retained earnings is increased by the amount of net income for
the period and reduced by the amount of di'idends declared. 5here are
other factors that can affect the @etained Earnings account but they are not
common.
#. 5he total amount of stockholders equity of Monaco &oach =I2%08%2(80000 is
larger than for Rinnebago Industries =I1(*8)1$80000. 5his does not mean
the stock price is higher for Monaco &oach. It depends on the number of
shares of the company as !ell as in'estors 'ie!s about the future
profitability of the t!o companies.
"O 17
%ECISIO$ CASE 1180 REA%I$I WI$$E!AIO
I$%:STRIES STATE#E$T OF CASH F"OWS
1. 5he purchase of common stock for I)%80(28000 decreases cash8 and the
payment of di'idends of I"8*$#8000 decreases cash. 5he issuance of stock
and proceeds from treasury stock of I#8"$(8000 increases cash.
2. Rinnebago Industries may ha'e purchased treasury stock for any of se'eral
reasons. 5hey may ha'e !anted to ha'e stock a'ailable to distribute to
their employees as bonuses or through an employee benefit plan. 5hey
&>/?5E@ 11 S54&A>43E@S EB,I5C 11806
may ha'e !anted to maintain a fa'orable market price for the stock or
impro'e the appearance of the financial ratios. 5hey also may ha'e !anted
to purchase stock to maintain o!nership control or to pre'ent takeo'er or
buyout attempts. 5he stocks may be reissued to employees or resold to
in'estors at a later date.
". 5he declaration of di'idends reduces retained earnings in the stockholders
equity category of the balance sheet. 5he payment of di'idends !ill ha'e
no effect on the stockholders equity category.
#A;I$I FI$A$CIA" %ECISIO$S
"O 1/
%ECISIO$ CASE 1181 %E!T VERS:S PREFERRE% STOC;
1. 5he purpose of this problem is to allo! students to see the similarities and
differences bet!een a liability and an equity. In the problem8 the loan of 1irst
&ompany is 'ery similar to the preferred stock of Second &ompany. Hoth
securities indicate annual payments of )N =interest or di'idend0. 1urther8
the stock carries a mandatory redemption feature that indicates it must be
repaid or redeemed at the end of fi'e years.
$oteJ 5here are specific 1/SH and SE& guidelines on the classification of
preferred stock !ith mandatory redemption features that you may !ish to
ask the students to reference.
5here may8 ho!e'er8 be differences bet!een the securities of 1irst and
Second companies. 3egally8 the loan payable has a right to assets before
stock. /lso8 the preferred stock di'idend is cumulati'e8 but that is not the
same as interest on a loan. Stockholders do not ha'e the right to di'idends
until they ha'e been declared8 e'en !hen the stock is cumulati'e.
/. Rhether the preferred stock should be considered a liability or an equity is a
matter of 9udgment. 5his is a good opportunity to stress form o'er
substance. 5he proper classification of the security should be based on the
students belief about the substance of the transaction rather than on
!hether the company has chosen to call the security a loan or stock.
"O /
%ECISIO$ CASE 1182 PREFERRE% VERS:S CO##O$ STOC;
PreCerred StockE?referred stock has no 'oting rights. 5he company is not
obligated to pay di'idends until they are declared< ho!e'er8 the cumulati'e
feature requires that the company pay preferred shareholders all di'idends in
arrears before common shareholders recei'e a di'idend.
If one person purchased all $08000 shares of common stock8 the ne!
in'estor !ould o!n 11N =$0M#$00 of the company. 5he original o!ners !ould
o!n 1)N =)0M#$00 of the company. If one or t!o of the original o!ners
purchased the stock8 the po!er could shift to those shareholders. i'idends are
ne'er required on common stock. 5hey become a legal obligation of the
company only after they are declared.
11817 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
In order to de'elop a recommendation8 the issues concerned must be
e'aluated more thoroughly. If the primary concern is the ability to monitor cash
flo!8 then common stock is more attracti'e. >o!e'er8 common stock is not
attracti'e if the current o!ners are concerned that additional shares of stock
may result in loss of 'oting control of the company. 4ne solution may be to
issue common stock that allo!s the current stockholders the right to maintain
their o!nership percentage. /nother solution may be to issue a second class of
common stock that does not ha'e equal 'oting rights.
ACCO:$TI$I M ETHICSJ WHAT WO:"% <O: %ON
"O 6
%ECISIO$ CASE 1183 I$SI%E I$FOR#ATIO$
5he ethical issue in this case is !hether Oim Hrock acted improperly !hen he
ad'ised his father to buy shares of >ubbard Inc. stock. Surprisingly8 in
discussing this case !ith students8 many students do not see that Hrock has a
professional responsibility to his employer. 1urther8 most students are not
a!are of the term Finsider information.G Issues that should be discussed include
the follo!ing;
1. Ras anyone harmed by Hrocks actions8 e.g.8 the parties that sold the stock
at a lo! priceU
/. oes it matter !hether Hrock himself profited or !hether some other party
purchased stock based on his kno!ledgeU
0. o brokers and analysts recei'e information about the firm that is not
a'ailable to the publicU oesnt e'eryone engage in insider informationU
1. If Hrock decides he did act unethically8 !hat action should he take to correct
the situationU
2. Rhat company policies or procedures could be adopted to ensure that
similar situations do not arise in the futureU
"O 2
%ECISIO$ CASE 1184 %IVI%E$% PO"IC<
1. 2o8 Oudith is not correct. 5here is no money in retained earnings. @etained
earnings represents accumulated8 undistributed earnings of the company8
but it is not cash. 5he retained earnings may be tied up in buildings and land
used in production or e'en in current assets like in'entory and supplies. If
the larger di'idend creates a !orking capital problem8 it may 9eopardi.e the
future of the company. It !ould not be good to 'ote for a large di'idend if the
company !ill not ha'e enough cash to meet current obligations.
/. 5here is an ethical dilemma bet!een Oudiths personal interest to support the
arts and the companys interest in making the best decision for the company
as a !hole. It is al!ays in the companys best interest to preser'e enough
!orking capital =cash0 to allo! the company to meet its current obligations.
2o one benefits if the company has to file for bankruptcy. Oudith seems to
be making a decision =and then not trying to con'ince her friends to support
&>/?5E@ 11 S54&A>43E@S EB,I5C 11811
the decision0 that is not in the companys best interest8 but may be in Oudith
interest. Oudith has the right to con'ince other shareholders to 'ote for large
di'idends8 but each shareholder is entitled to make their o!n decision about
the matter.
0. 5his is not a significant enough issue to influence my 'ote on the di'idend.
2o one gains !hen the company pays a large di'idend that endangers the
future of the company putting a hardship on !orking capital. 3arge creditors
!ould not fa'or the increase in di'idend payment8 because this takes money
out of the company that might be used to pay their bills.
FRO# CO$CEPT TO PRACTICE 11.1
5he balance of @ein'ested Earnings !as I2)#8)$%8000. It increased from the
pre'ious years balance of I2"#81"*8000.
This B')e is i(te(tio('lly leCt *l'(k
1181/ 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
SO":TIO$S TO I$TEIRATIVE PRO!"E#S
P'rt 0
1. Entries recorded for 6riffin8 Inc. under capital lease !ould be as follo!s =in
millions0;
Oan. 1 Equipment )
3ease 4bligation )
5o record capital lease.
Assets = "i'*ilities > O?(ers Equity
>5 >5
ec. "1 epreciation E-pense 1
/ccumulated epreciationEEquipment 1
5o record annual depreciation.
Assets = "i'*ilities > O?(ers Equity
A1 A1
ec. "1 Interest E-pense .$
3ease 4bligation 1.0
&ash 1.$
5o record lease payment.
Assets = "i'*ilities > O?(ers Equity
A1.2 A1.7 A.2
6riffins financial ratios under a capital lease are as follo!s;
&urrent ratio; I).0MI#.0 : 2 to l
ebt+to+equity ratio; I1%MI## : ."%
2et income : I10.# million
E?S net income : =I10.# million K .1 million0M#80008000 : I2.$)
=rounded0.
/. Alter('ti,e A. If the equipment had been acquired under an operating
lease instead of a capital lease8 the transaction !ould ha'e been as follo!s;
ec. "1 @ental E-pense 1.$
&ash 1.$
5o record annual lease payment.
Assets = "i'*ilities > O?(ers Equity
A1.2 A1.2
&>/?5E@ 11 S54&A>43E@S EB,I5C 11810
6riffins balance sheet and income statement !ould appear as follo!s;
IRIFFI$ I$C.
!A"A$CE SHEET
%ECE#!ER 01 /771
EI$ #I""IO$SF
Assets
&ash I 1.%
4ther current assets %.#
4ther long+term assets #$ .0
5otal assets I $" .0
"i'*ilities
4ther current liabilities I ".0
4ther long+term liabilities % .0
5otal liabilities I *.0
Stockholders Equity
?referred stock I 1.0
/dditional paid+in capital on preferred
stock 2.0
&ommon stock #.0
/dditional paid+in capital on common stock 1%.0
@etained earnings 21 .0
5otal stockholders equity ## .0
5otal liabilities and stockholders equity I $" .0
IRIFFI$ I$C.
I$CO#E STATE#E$T
FOR THE <EAR E$%E% %ECE#!ER 01 /771
EI$ #I""IO$SF
@e'enues I $0.00
E-penses;
@ent on leased asset I 1.$0
epreciationEother assets ".20
4ther e-penses 2(.#0
Income ta- ="0N rate0 $ .#0
5otal e-penses "( .$0
Income before e-traordinary loss I 12.$0
E-traordinary loss =net of I.* ta-es0 =2 .10 0
2et income I 10 .#0
E?S before e-traordinary loss I ".10
E?S e-traordinary loss =.$" 0
E?SEnet income I 2 .$(
6riffins financial ratios under an operating lease !ould be as follo!s;
&urrent ratio; I).0MI".0 : 2.%( to l
ebt+to+equity ratio; I*MI## : .20
2et income : I10.# million
E?S net income : I2.$( =rounded0.
11811 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
/n operating lease results in off+balance+sheet financing. 5herefore8 the
leased asset does not appear on the balance sheet as an asset and the
obligation does not appear as a liability. 5his causes a more fa'orable
current ratio and debt+to+equity ratio. 2et income and E?S are not affected
because the amount of the lease payment is I1.$ million under either an
operating or a capital lease.
Alter('ti,e !. If 6riffin had issued bonds to purchase the asset8 the
transactions !ould ha'e been as follo!s;
Oan. 1 &ash )
Honds ?ayable )
5o record issuance of bonds to be used
for equipment.
Assets = "i'*ilities > O?(ers Equity
>5 >5
Oan. 1 Equipment )
&ash )
5o record purchase of equipment.
Assets = "i'*ilities > O?(ers Equity
>5
A5
ec. "1 epreciation E-pense 1
/ccumulated epreciationEEquipment 1
5o record annual depreciation.
Assets = "i'*ilities > O?(ers Equity
A1 A1
ec. "1 Interest E-pense .$
Honds ?ayable 1.0
&ash 1.$
5o record payment on bonds.
Assets = "i'*ilities > O?(ers Equity
A1.2 A1.7 A.2
&>/?5E@ 11 S54&A>43E@S EB,I5C 11812
6riffins balance sheet and income statement !ould appear as follo!s;
IRIFFI$ I$C.
!A"A$CE SHEET
%ECE#!ER 01 /771
EI$ #I""IO$SF
Assets
&ash I 1.%
4ther current assets %.#
Equipment =net of accumulated depreciation0 (.0
4ther long+term assets #$ .0
5otal assets I %0 .0
"i'*ilities
&urrent portion of bonds payable I 1.0
4ther current liabilities ".0
Honds payableElong term %.0
4ther long+term liabilities % .0
5otal liabilities I1%.0
Stockholders Equity
?referred stock I 1.0
/dditional paid+in capital on preferred
stock 2.0
&ommon stock #.0
/dditional paid+in capital on common stock 1%.0
@etained earnings 21 .0
5otal stockholders equity ##.0
5otal liabilities and stockholders equity I %0.0
IRIFFI$ I$C.
I$CO#E STATE#E$T
FOR THE <EAR E$%E% %ECE#!ER 01 /771
EI$ #I""IO$SF
@e'enues I$0.00
E-penses;
epreciation of equipment I 1.00
epreciation of other assets ".20
Interest on bonds payable .$0
4ther e-penses 2(.#0
Income ta- ="0N rate0 $ .#0
5otal e-penses "( .$0
Income before e-traordinary loss I12.$0
E-traordinary loss =net of I.* ta-es0 =2 .10 0
2et income I 10 .#0
E?S before e-traordinary loss I ".10
E?S e-traordinary loss =.$" 0
E?SEnet income I 2 .$(
11813 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
6riffins financial ratios if the asset is purchased !ith the proceeds from the
issuance of bonds are as follo!s;
&urrent ratio; I).0MI#.0 : 2 to l
ebt+to+equity ratio; I1%MI## : ."%
2et income : I10.# million
E?S net income : =I10.# million K .1 million0M# : I2.$(
=rounded0.
5he effect on the financial statements of purchasing an asset !ith the bond
proceeds is the same as if the asset !ere acquired !ith a capital lease =?art
1 of this problem0. 5herefore8 the financial ratios are the same as in ?art 1.
Alter('ti,e C. If 6riffin issued preferred stock and purchased the asset8 the
transactions !ould be as follo!s;
Oan. 1 &ash )
?referred Stock 2
/dditional ?aid+in &apital8 ?referred %
5o record issuance of stock.
Assets = "i'*ilities > O?(ers Equity
>5 >/
>3
Oan. 1 Equipment )
&ash )
5o record purchase of equipment.
Assets = "i'*ilities > O?(ers Equity
>5
A5
ec. "1 epreciation E-pense 1
/ccumulated epreciationEEquipment 1
5o record annual depreciation.
Assets = "i'*ilities > O?(ers Equity
A1 A1
ec. "1 @etained Earnings .27
&ash =2008000 J I10 J 10N0 .2
5o record the di'idend paid on
preferred stock.
Assets = "i'*ilities > O?(ers Equity
A./ A./
75he abo'e entry records the di'idend on the additional 2008000 shares of
stock issued. 5he total number of shares outstanding is "008000.
&>/?5E@ 11 S54&A>43E@S EB,I5C 11814
ec. "1 5a- E-pense .17
&ash .1
5o record additional ta- e-pense.
Assets = "i'*ilities > O?(ers Equity
A.1 A.1
7Hecause the di'idend does not result in a ta- deduction8 the ta- e-pense for
the year is increased. 5his transaction records the additional ta-.
If 6riffin issued stock to acquire the equipment8 the financial statements
!ould appear as follo!s;
IRIFFI$ I$C.
!A"A$CE SHEET
%ECE#!ER 01 /771
EI$ #I""IO$SF
Assets
&ash I 2.)
4ther current assets %.#
Equipment =net of accumulated depreciation0 (.0
4ther long+term assets #$ .0
5otal assets I %1 .2
"i'*ilities
4ther current liabilities I ".0
4ther long+term liabilities % .0
5otal liabilities I *.0
Stockholders Equity
?referred stock I ".0
/dditional paid+in capital on preferred
stock ).0
&ommon stock #.0
/dditional paid+in capital on common stock 1%.0
@etained earnings 21 .2
5otal stockholders equity $2 .2
5otal liabilities and stockholders equity I %1 .2
11815 1I2/2&I/3 /&&4,25I26 S43,5I42S M/2,/3
IRIFFI$ I$C.
I$CO#E STATE#E$T
FOR THE <EAR E$%E% %ECE#!ER 01 /771
EI$ #I""IO$SF
@e'enues I$0.00
E-penses;
epreciation of equipment I 1.00
epreciationEother assets ".20
4ther e-penses 2(.#0
Income ta- ="0N rate0 $ .$0
5otal e-penses "( .10
Income before e-traordinary loss I12.*0
E-traordinary loss =net of I.* ta-es0 =2 .10 0
2et income I 10 .)0
E?S before e-traordinary loss I ".1$
E?S e-traordinary loss =.$" 0
E?SEnet income I 2 .%2
6riffins financial ratios !ould appear as follo!s;
&urrent ratio; =I2.) L I%.#0MI".0 : ".0( to l
ebt+to+equity ratio; I*.0MI$2.2 : .1(
2et income : I10.) million
E?S net income : =I10.) million K I." million0M# : I2.%2
=rounded0.
5he use of preferred stock to acquire the equipment causes a difference in
the financial statements because the preferred stock is part of stockholders
equity8 rather than liabilities. /lso8 the di'idend on preferred stock is not ta-
deductible8 !hereas lease payments or interest payments are ta-
deductible. 5he resulting impact is an increase in the current ratio8 net
income8 and E?S but a decrease in the debt+to+equity ratio.
&>/?5E@ 11 S54&A>43E@S EB,I5C 11816