CHAPTER 11 STOCKHOLDERS' EQUITY: PAID-IN CAPITAL

OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES
Brief Exercises B. Ex. 11.1 B. Ex. 11.2 B. Ex. 11.3 B. Ex. 11.4 B. Ex. 11.5 B. Ex. 11.6 B. Ex. 11.7 B. Ex. 11.8 B. Ex. 11.9 B. Ex. 11.10 Learning Objectives 4 4 5 5 5 7 7 8 4, 9 4, 9 Learning Objectives 1–3 1–9 4, 5 4, 5 4–7 5, 6 4, 7 4–7 9 8 9 4 4, 9 8, 9 4, 7

Topic Stockholders' equity Stockholders' equity Dividends on preferred stock Dividends on common and preferred stock Dividends on common and preferred stock Book value Book value Stock split Treasury stock Treasury stock

Skills Analysis Analysis Analysis, communication Analysis Analysis, communication Analysis, communication Analysis Analysis, communication Analysis Analysis

Exercises 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11 11.12 11.13 11.14 11.15

Topic Form of organization Accounting terminology Prepare equity section Dividends on preferred & common Analyzing equity Preferred stock alternatives Reporting effects of transactions Computing book value Treasury stock transactions Effects of stock splits Treasury stock presentation Real World: Carnival Corp. Authorized stock Common stock and treasury stock Treasury stock and stock split Real World: Home Depot Reading an annual report

Skills Analysis, communication Analysis Analysis, communication Analysis, communication Analysis Analysis Analysis Analysis, communication Analysis, communication Communication, judgment Communication, judgment Analysis, communication Analysis, communication Analysis Analysis, communication, research

© The McGraw-Hill Companies, Inc., 2012 Overview

Problems Sets A, B 11.1 A,B 11.2 A,B 11.3 A,B 11.4 A,B 11.5 A,B 11.6 A,B 11.7 A,B 11.8 A,B 11.9 A,B

Topic Reporting stockholders’ equity Reporting stockholders’ equity Reporting stockholders’ equity Comprehensive equity problem Analysis of equity Comprehensive equity analysis Par, book, and market values Comprehensive equity with treasury stock transactions Comprehensive equity with treasury stock transactions and stock splits

Learning Objectives 4, 5, 6 4, 5, 6 4, 5, 6 4, 5 4, 5 1–7 4, 7 4, 5, 7, 9 4, 5, 7, 8, 9

Skills Analysis, communication Analysis, communication Analysis, communication Analysis Analysis Analytical, communication, group Communication, judgment Analysis, communication Analytical, communication, judgment

Critical Thinking Cases 11.1 Factors affecting market prices of preferred and common stocks 11.2 Real World: McDonnell Douglas, Inc., Boeing, Citicorp, Ventitex, Inc. Factors affecting market prices of common stocks 11.3 Selecting a form of business organization 11.4 Securities & Exchange Commission (Ethics, fraud & corporate governance) 11.5 Real World: Staples, Inc. Stockholders' equity items (Internet)

5, 7 7

Communication, judgment Communication

1, 2, 3 1, 2, 3

Communication, judgment Communication, judgment, technology

4, 5, 7, 9

Communication, technology

© The McGraw-Hill Companies, Inc., 2012 Overview (p.2)

DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers.

Problems (Sets A and B)
11.1 A,B Robbinsville Press/Septa, Inc. A short problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to the market price of preferred stock. Waller Publications/Banner Publications A second short problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to dividends in arrears. Manhattan Transport Company/Ray Beam, Inc. A more difficult problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to equity versus debt financing. Barnes Communications, Inc./Markup, Inc. A short but comprehensive problem on corporations. Includes journal entries for issuance of common stock and preferred stock. Also includes dividends on preferred stock, closing entries, and the preparation of the stockholders’ equity section of a corporate balance sheet. Smithfield Products/Manor, Inc. A more difficult problem involving distinction among par values, book values, and market values. Parsons, Inc./Toasty Corporation Analysis of the stockholders’ equity of a publicly owned corporation. Includes a discussion of why a business may opt to become publicly owned and the reasons why the dividend yields on preferred stocks vary. Techno Corporation/Brain Corporation A straightforward discussion of the relationships (if any) among par value, book value, and market value per share. A company has a book value 6,500 times greater than its par value, and a market value 65,000 times as high. Fun problem that makes a point. 20 Easy

11.2 A,B

20 Easy

11.3 A,B

25 Medium

11.4 A,B

35 Medium

11.5 A,B

35 Strong

11.6 A,B

35 Medium

11.7 A,B

15 Easy

© The McGraw-Hill Companies, Inc., 2012 Description Problems

Problems (continued)
11.8 A,B Feller Corporation/Tin Corporation A stockholders’ equity problem involving paid-in capital from treasury stock transactions. Requires the computation of book value per share and reporting for the statement of cash flows. 11.9 A,B Herndon Industries/Parker Industries A comprehensive equity problem involving treasury stock transactions in two different years, preferred and common stock transactions, book value calculations, and an understanding of stock splits. Factors Affecting the Market Prices of Preferred and Common Stocks Students are asked to explain whether the prices of preferred stock, common stock, and convertible preferred stock are likely to rise or fall if profitability increases dramatically and interest rates rise slightly. A problem that stimulates lively classroom discussion. 11.2 Factors Affecting the Market Prices of Common Stocks Students are to explain the reason for changes in the market prices of stocks of various real companies. A difficult problem that is very thought-provoking. Selecting a Form of Organization Students are to interview the owners of two small businesses with different forms of organization and find out why the particular form was selected—and if they have any misgivings. S.E.C. Enforcement Division Ethics, Fraud & Corporate Governance Students do an internet search to locate the website of the Securities & Exchange Commission and respond to questions about the S.E.C. Examining Stockholders' Equity Internet Students are asked to identify and discuss elements of stockholders’ equity appearing in the balance sheet of Staples, Inc. 25 Strong 15 Medium

30 Strong

Critical Thinking Cases
11.1 15 Medium

11.3

Interview; No time estimate

11.4

20 Easy

11.5

30 Easy

*Supplemental Topic, “Special Types of Liabilities.”

© The McGraw-Hill Companies, Inc., 2012 Desc. of Cases

Inc. A sole proprietor generally must sell his or her entire interest in the business. 4.. The market price of a share of stock may be above or below its par value. that is. Cumulative means that unpaid dividends on preferred stock are carried forward and must be fully paid before any dividends can be paid on common stock. the amount below which stockholders’ equity cannot be reduced except by losses. b. Convertible means that each share of preferred stock may be returned to the corporation in exchange for a given number of shares of common stock under specified conditions. Sole proprietors are personally liable for the debts of the business. such as the New York Stock Exchange. 3 Paid-in capital of a corporation represents the amount invested by stockholders and is generally not available for dividends. Par value is not an indication of a fair market price for a share of stock. however.SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1. The primary significance of par value is that a corporation cannot declare a dividend if this action would reduce total stockholders’ equity below the par value of the outstanding stock. Thus. 5. d. A corporation. Continuity of existence. The distinction between paid-in capital and retained earnings is useful because it shows how much of the total stockholders’ equity represents investments by the owners and how much has been accumulated through profitable operations since the company started in business. Retained earnings represents the cumulative amount of net income not distributed to shareholders as dividends. © The McGraw-Hill Companies. A sole proprietorship is terminated upon sale or abandonment by the owner and upon that person’s death or incapacitation. a. A sole proprietorship is not a taxable entity. a. the amount of dividends paid by the stock. interest rates. A corporation is subject to federal income tax on its income. Owners’ liability for debts of the business. Federal taxation on income. Shares of stock in a corporation are freely transferable. The market price of stock is determined by such factors as the profitability and solvency of the issuing company. Large corporations are often said to be publicly owned because they are literally owned by the general public. and general market conditions. Many large corporations have hundreds of thousands. This creates a new business owned by a new sole proprietor. c. even millions. Par value represents the legal capital per share. 2012 Q1-5 . is responsible for its own debts. and stockholders are also subject to a personal income tax on any amounts they receive as dividends. Corporations continue in existence regardless of changes in ownership. whether or not it is actually withdrawn by the owner. 2. b. but the owner must pay personal taxes on the income earned by the business. the stockholders of a corporation are not personally liable for the debts of the business entity. The capital stock of many large corporations is actively traded on organized stock exchanges. of individual stockholders. even if that interest is but a single share of capital stock. the amount of money that a stockholder might lose by investing in a corporation is limited to the amount of his or her investment. Anyone may purchase an ownership interest in such corporations. Transferability of ownership interest.

liabilities. (f) Income Taxes Payable is classified as a liability. it would be possible to declare only the current year’s dividends on preferred and then declare a dividend on common. 9. These shares belong to IBM’s stockholders. or stockholders’ equity. many assets would be sold at prices different from their carrying values in the accounting records. and as a result the noncumulative feature is not attractive to most investors. therefore. (d) Retained Earnings. The purpose of a stock split is to reduce the per-share market price of the company’s stock down to a more appropriate “trading range”—that is. a. This historical amount is not affected by subsequent changes in market price. Noncumulative preferred stock is entitled to dividends only if and when they are declared. and (e) Additional Paid-in Capital are all classified as stockholders’ equity accounts. or liquidation value if given. 8 Book value per share represents the amount of net assets (or stockholders’ equity) associated with each share of common stock. Inc. A change in the market price of IBM’s outstanding shares of capital stock has no effect upon IBM’s balance sheet. Therefore. If a corporation were liquidated. It is determined by dividing the total stockholders’ equity in the corporation.6. not to IBM. but liabilities are increased. Book value does not represent the amount common stockholders would receive in the event of liquidation. b. If noncumulative preferred dividends had not been declared for several years. 7. a price that is appealing to a greater number of potential investors.. This means a weak form of dividend preference. 10. Total assets are not affected by the declaration of a dividend. 11. © The McGraw-Hill Companies. are decreased. When a corporation obtains a bank loan there is no effect upon book value per share of common stock. (c) Preferred Stock. less the amount assigned to preferred stock (par value. Net assets (stockholders’ equity). therefore. Declaration of a dividend reduces book value per share. (a) Cash is classified as an asset. (b) Organization Costs typically are classified as an expense. The resulting gains or losses would cause stockholders’ equity to change accordingly. IBM’s paid-in capital accounts will continue to show the amount received by IBM at the time the capital stock was issued. Noncumulative preferred stock does not have the protection afforded by the cumulative requirements that any dividends in arrears must be paid before dividends can be paid on common. Assets and liabilities both increase by the amount of the loan. plus dividends in arrears) by the number of common shares outstanding. Net assets. a change in the market value of these shares has no effect upon the recorded amounts of IBM’s assets. 2012 Q6-11 . are unchanged.

Treasury stock is corporate stock that has been issued and then reacquired by the issuing company. Include preferred stock—Preferred stock offers investors an opportunity to invest on what may be a more predictable and secure basis than common stock. and then distribute additional assets in payment for shares of its own stock. 13. 15. a case can be made for different features. primarily whether the dividend is cumulative or not. One reason for acquiring treasury stock is to have stock available to issue to officers and employees under profit-sharing agreements. it represents a reduction in the amount of stockholders’ investment in the corporation. thereby reducing the net assets of the corporation below the amount of the paid-in capital or even below the amount of stated (legal) capital. Treasury stock is not an asset.12. if preferred stock is included in the capital structure. but does not affect the total amount of paid-in capital. If this restriction were not imposed. © The McGraw-Hill Companies. Some investors may be willing to invest in preferred stock while they would not be willing to accept the greater uncertainty and risk of common stock. The purpose of this rule is to protect corporate creditors. be reduced below the amount of paid-in capital. particularly for a new company. as a result of the purchase of treasury shares. Once the company is up and running. but it detracts from the attractiveness of the common stock. While dividends are not guaranteed. Do not include preferred stock—The presence of preferred stock may make common stock less attractive in light of the dividend preference of preferred stock. stock options. the most important decision is whether the dividend is cumulative. 2012 Q12-15 . preferred stock may be undesirable in terms of the long-term capital structure of the company. The restriction of retained earnings for dividend purposes to the extent of the cost of treasury shares assures creditors that the stockholders’ equity of a corporation will not.. a corporation might distribute assets equal to the entire amount of its retained earnings as dividends. For this reason the cost of the treasury shares is reported in the balance sheet as a reduction of the stockholders’ equity. they are more predictable than on common stock. 14. the preferred stock is more attractive to investors. If the dividend is cumulative. Purchases of treasury stock may also be intended to support the market price of the stock or to increase earnings per share. The major types of transactions and activities that change the amount of paid-in capital and the direction of that change are as follows: Direction of change Transaction/activity Increase Sale of capital stock Decrease Purchase of treasury stock Increase Sale of treasury stock None* Stock split *A stock split increases the number of shares of stock and lowers the market price of that stock. This may be a factor in designing the company’s capital structure in light of the capital requirements of the new company. The lack of the cumulative feature may make preferred stock a relatively weak investment alternative and effectively defeat the purpose of including preferred stock in the capital structure. for whom stockholders’ equity represents the margin of safety against loss from a shrinkage of asset values. Inc. No definitive answer can be given to this question because a case can be made for having preferred stock and for not having preferred stock. or bonus plans. Features of preferred stock—Assuming preferred stock is included in the capital structure. Similarly. Following are comments under different assumptions about the desirability of preferred stock.

000 x $100 par x 8% x 4 years = $320.2 B. the entire dividend goes to preferred stock and the common stockholders will receive none of the $120.000 shares x $100 par x 6% x 2 years Dividends available for common stock Total dividend declared Dividend requirements for noncumulative preferred stock: 10.000 shares @ $3) Retained earnings Total stockholders' equity Preferred stock (1.000 $0.Ex.. 11.000 shares @ $10) Common stock (10. 11.4 .000 shares @ $100) Common stock (10.1 Common stock (10.Ex. Inc.000 $100.000 10.Ex.000 $480.000 shares $200. determined as follows: 10.000 dividends declared.000/100.000 shares @ $10) Additional paid-in capital (10.000 100.40 B.000 20.B. but they are not formally included as a liability in the balance sheet until declared by the Board of Directors of the company.000 shares @ $25) Additional paid-in capital: Preferred stock (1.000 © The McGraw-Hill Companies.000. 2012 BE11.000 B. B.2.000 30.000 $80.000 80. 11. satisfaction of the full claim of the preferred stockholders in this case will require $320.000 $205.000 $40.000 x $100 par x 8% x 1 year Dividends available for common stock Dividends per share on common stock: $40.3 Dividends on arrears on preferred stock for three years are calculated as follows: 100.000 shares x $100 par value x 6% dividend rate x 3 years = $1.000 The amount of dividends in arrears must be disclosed in the financial statements.000 75.5 If the preferred stock is cumulative. 11.800.000 250. 11. In fact.1.4 Total dividend declared Dividend requirements for preferred stock: 10.3.000 $120.000 shares @ $2) Retained earnings Total stockholders' equity $100.Ex.Ex.000 120.

000 Dividends in arrears (40.Ex.000 $14.000.000 shares x $5) Amount attributable to common stock Book value per share of common stock: $7.Ex.000 + $1.500. 11.000 shares @ $10) Additional paid-in capital (100.000 shares @ $25) Additional paid-in capital on common stock (1. or $5 per share.000 shares x ($55 .000.500.000 (550. Common stock (100. 11. it reflects a per-share amount of the assets. The split will have no impact on the total stockholders' equity attributable to common stock. While the number of shares will double.000 350.000. It will reduce the market price of the stock to approximately half of its current price: $50 x 1/2 = $25.350.000 shares @ $15) Less: Treasury stock (10.6.000. B.750.000 B.350.7 Total stockholders' equity ($4.000.10 .9 B.000.8. less liabilities.000 + $750.000 Less: Preferred stock at par value 200.550.000 $2.000 $7.950.000 5. included in the company's balance sheet.000)/100.50 This amount does not reflect the current market value of the stock.000 to 200..850.8 The stock split will double the number of shares outstanding from 100. Instead.000) $1.000 + $600. the par value will be reduced to half.000 shares @ $5) Additional paid-in capital on treasury stock [70.000 shares $11.000) $4.000 $30. 2012 BE11.7.000 1. 11.000 shares = $23.000 $25.000 shares x $55) Total stockholders' equity $1.70 B.6 The book value on common stock is calculated by adding all stockholders' equity accounts together and dividing by the number of shares of common stock outstanding: ($1. Inc.B.000 $28.200.350.000 4.000 shares x $50) Total stockholders' equity © The McGraw-Hill Companies.9.000 + $800.Ex.000.000/500. 11.500.000.000. leaving the total stockholders' equity attributable to common stock unchanged.000 1.000 + $5.Ex.000.Ex.10 Common stock (1. 11.$50)] Less: Treasury stock (30.

Retained earnings i. Advantages: (a) Easy to form (b) No double taxation on distributed earnings Disadvantages: Personal liability of owner for debts of the business (a) Business ceases with death of owner (b) (2) Organizing the scuba diving school as a corporation. after you exhausted any insurance coverage and assets that the business might have. Ex.) j. Common stock e.2 . 2012 E11.. Market value c. Potentially.2 a. a scuba diving student could be seriously injured in the class. Publicly owned corporation g.SOLUTIONS TO EXERCISES Ex. (1) Organizing the scuba diving school as a sole proprietorship.) © The McGraw-Hill Companies. 11. None (Book value is common stockholders’ equity divided by the number of common shares outstanding. your personal assets would be at risk to pay for the person’s injuries. None (Retained earnings is not an amount of cash. Advantages: No personal liability of owners for debts of the business (a) Readily transferable ownership shares (b) Continuous existence (c) Disadvantages: Double taxation on distributed earnings (a) Greater regulation (b) b. None (Dividends in arrears are prior years’ dividends owed to holders of cumulative preferred stock.1. it is an element of owners’ equity. A corporation would probably be the better form of organization because of the characteristic of limited liability of the owners. Paid-in capital h.1 a. With the sole proprietorship form of organization. 11. Inc. Double taxation b.) d.) f. None (The price of preferred stock varies inversely with interest rates.

b.000. 11.000 Dividends on common stock in third year ………………………………… $736.000 ÷ 40.000. No.09 x 40.12 x 8.000 ÷ 8.000 shares issued and outstanding…………………………………… 140.500 b.5 a.3. Ex.050.000 shares authorized. 11.500 Common stock …………………………………………………… 770.000) …………… 96.000.000) ………… 180.00 per share $ 0. 100. Capital stock is recorded at the amount for which it was originally issued.000.4.000 x $100 x 7%) c.000 Dividends ($50 x . $ 13. Current year’s dividend ($50 x .000 total par value.000 636. 2.50 per share $ 12. $100 par value.000 legal capital.Ex.000.000 preferred.000 additional paid-in capital) © The McGraw-Hill Companies. plus $20.000.000 shares ($15.000 Total stockholders’ equity ………………………………………… $ 1.000 ($15.549.000 b. Total dividends paid in third year ……………………………………… Dividends on 9% cumulative preferred stock: $360. 9% cum.000 Additional paid-in capital: Preferred stock …………………………………………………… 7.000.000 shares) …… c.000 x 2 years) ………….167. 12% noncum.500 shares issued and outstanding ……… $ 250.500 Retained earnings ……………………………………………………… 382.000 ÷ 400. Inc.. 2012 E11. Dividends per share: Preferred stock.000 Total paid-in capital …………………………………………………… $ 1. the preferred shares must have been issued at their respective par values ($50 per share for the 9% cumulative preferred stock. $2 stated value.000 Total paid on 9% cumulative preferred stock …… $540.000 total paid-in capital ($35.000 total par value x 7% or 150. 150. The market value of a corporation’s stock has no effect on the amount in the financial statements.000 shares) Common stock ($100.000 $100. plus $44. Thus.000 shares authorized. $35.000 shares issued] d.000 common) $79. and $100 per share for the noncumulative preferred stock).000 legal capital ($15. ($96.5 .09 x 40.000 Dividends on 12% noncumulative preferred stock: Current year’s dividend ($100 x . $16 [($20 million par value + $44 million additional paid-in capital) ÷ 4. 5.000 Common stock.000.000 shares) … Preferred stock. 11.4 a.25 per share The stockholders’ equity section of the balance sheet reports no additional paid-in capital. Stockholders’ equity: 8% cumulative preferred stock.000. 70. $1. divided by $100 par value per share) Ex. ($540.3 a.

450.45 million ÷ 4 million shares) ………… No.000 Less: Par value of preferred stock (150.11 Book value per share ($128.000 shares x $100) ………… Equity of common stockholders ……………………………………… $ 128. b. Total dividend ………………………………………………………… Amount to preferred stock …………………………………………… Amount to common stock …………………………………………… $50.000. c.450. 2012 E11.000 Common shares outstanding ………………………………………… $32.000 Ex.000) $36. f.e. 11.000 Amount to common stock …………………………………………… (28.000 $50.000 4.000 (14. 11.000 (7.000 × $25 × 8%) a.7 .000 b.7 Event a.6. Total stockholders’ equity …………………………………………… $ 143.6 Annual dividends on the preferred stock are $14. Changes in the market value of capital stock do not directly affect a corporation’s financial position and are not reflected in the equity section of the balance sheet.000) $22.000 15. Inc. Total dividend ………………………………………………………… Amount to preferred stock: Current year ………………………………………… $14. Ex. Current Assets I NE D Stockholders’ Equity I NE D Net Income NE NE NE Net Cash Flow (from Any Source) I NE D © The McGraw-Hill Companies.000 In arrears …………………………………………… 14..000.

000 b.9 . depending primarily on the amounts at which the corporation’s assets are sold. The restriction on retained earnings simply limits the amount of dividends the corporation can pay as long as it holds treasury stock. 198.8 a. Ex.000 shares of treasury stock.9 a. © The McGraw-Hill Companies..Ex. for $33 per share. Inc. Restriction of retained earnings for treasury stock owned at year-end: $175.000 216. c. Book value per share of common stock: Total stockholders’ equity (from part a ) ……………………………… $ Less: Claims of preferred stockholders ($200. The stockholders may receive more or less than the book value per share if the corporation is liquidated.000. Dec. a restriction on retained earnings does not affect the total amount of retained earnings reported in the balance sheet.800 952.800 806. Feb.800 146. not the assets’ liquidation values.000 60.000 425.000 June 4 Cash ……………………………………… Treasury Stock …………………… Additional Paid-in Capital: ……… Treasury Stock…………………….000) ……………………………… Equity of common stockholders ………………………………………… $ Number of shares of common stock outstanding ……………………… Book value per share ($590. 10 425. No. No.000 shares of treasury stock. but does not reduce the total amount of retained earnings of a company. The book value per share represents the stockholders’ share of the net book value of the corporation’s assets. Sold 6.83 c.000 shares issued …………………………… Additional paid-in capital ………………………………………………… Total paid-in capital ……………………………………………… $ Less: Deficit ……………………………………………………………… Total net assets (stockholders’ equity) …………………………………… $ b.000 shares) $ 200.000 plus dividends in arrears.000 shares of treasury stock at $25 per share. Cash ………………………………………… Additional Paid-in Capital: Treasury Stock ………………………………………… Treasury Stock …………………… Sold 4. 60. cost $150. $5 par.000 shares still owned x $25 per share cost).000 590.000 48.000 300.000 Treasury Stock …………………………… Cash ………………………………………………… Purchased 17. for $22 per share.000 12.000 806. $16.000 ÷ 60. Net assets (stockholders’ equity): 8% cumulative preferred stock ………………………………………… $ Common stock.000 (7.000 100. 11.000 9.. cost $100.8. 11.000 452. 22 88.000.000 150. 2012 E11. A restriction of retained earnings is disclosed.

10-12 . Had the stock been split 2-for-1. When treasury stock is purchased. Ex. shares do not represent an asset of the company. They are not included in the company’s balance sheet. it may become too expensive for many investors. This practice is not generally considered unethical. At some time in the future they may result in an increase in assets if they are issued for cash or other assets. c.340 million. For a company to classify its treasury stock as a short-term investment is not appropriate. given that information pertaining to the purchase is fully disclosed in the company’s financial statements.12 a.. Had the stock been split 4-for-1. Ex. the decision to split the company’s stock was probably made with the intent of making it more affordable to investors. as it had in the case of Fido Corporation. Companies sometimes purchase shares of their own common stock to help boost the market price per share. but unissued shares. if the company acquires a significantly large amount of its outstanding stock. Carnival Corporation could sell approximately 1. b. but unissued.Ex. When the market price of a corporation’s common stock appreciates in value significantly. © The McGraw-Hill Companies. Inc. 11. 2012 E11. it would begin trading at approximately $20 per share immediately after the split ($80 ÷ 4 = $20). but until that time they simply represent the potential for future increases in assets. This figure is determined by subtracting the number of issued shares from the number of authorized shares 1.340 million additional shares. the corporation is actually reducing its assets (cash). b.10 a. treasury stock should not appear in the balance sheet as a current asset. and eliminating part of its stockholders’ equity. 11. 11. Thus. For this reason. other than through disclosure of the numbers of authorized and issued shares. the event would be reported in the financial press. Furthermore.960 million – 620 million = 1. b.11 a. as was done above. Authorized. This permits the reader of the financial statements to calculate the number of authorized. it would begin trading at approximately $40 per share immediately after the split ($80 ÷ 2 = $40).

000 x $10)…………… Additional Paid-in Capital on Common Stock………………………………………….000 shares authorized.100.400.100.Ex.000 © The McGraw-Hill Companies.000 Additional paid-in capital: Preferred stock Common stock Total paid-in capital Less: Treasury (common) stock at cost.000 x $12)……………………………… Common Stock (550. Cash…………………………………………… Note: No entry is required to record the authorization to issue preferred and common stock.13 a. 1.000 $11. $100 par value.000 shares authorized.000 (2.000 shares issued $ 5.000 Common stock. 40.000 b. 6.600. Cash (550. $10 par value.600. 2012 E11. 11.000 shares Total stockholders' equity 400.400.13 .000 2.000 400.000 1.400.400. Stockholders' Equity: Preferred stock.000.000 5.000 x $110)……………………………… Preferred Stock (40.500.000 4. 40. 550.500. 50. Inc.000 1.000 x $100)…………… Additional Paid-in Capital on Preferred Stock………………………………………….000.. Cash (40.000 shares issued and outstanding $4.000. Treasury Stock/Common (40.000 x $60)…………..000 2.000 4. 6%.000) $8.000.

830.. 200.$10) = $800. © The McGraw-Hill Companies.000.000 30.000 800.000 Additional paid-in capital on treasury stock: 10.000 $1. additional paid-in capital.Ex. Common Stock. After a 2:1 stock split is distributed. retained earnings.000 shares authorized.650.000 120. treasury stock. 100.000 b.000 $1.000 (300. the par value of the common stock will be reduced to half ($10 x 1/2 = $5) and all of the share numbers will double. Inc.000 Treasury stock: 15.000 $1. 2012 E11. $10 par value.14 a. The 2:1 split has no effect on the total figures for common stock.000 shares x ($18 . 11.000) $1.$20) = $30. or total stockholders' equity.000 shares x $20 = $300.000 shares issued Additional paid-in capital on common stock Additional paid-in capital on treasury stock Transactions Total paid-in capital Retained earnings Total paid-in capital and retained earnings Less: Treasury stock Total stockholders' equity Calculations: Additional paid-in capital on common stock: 100.000 shares x ($23 .950.14 .

b.Ex. The total stockholders’ equity figure represents the amount invested in the company by owners over time. © The McGraw-Hill Companies. It represents the maximum number of shares that the company is authorized to issue by its state of incorporation.15 . The amount reported is an historical concept that may or may not bear a close relationship to the stock's current market value. The par value is $.05 per share.15 a. Inc. c. 11. it is over 73 times the par value of the shares that have been issued. Authorized shares are the number of shares specified in the company’s articles of incorporation. plus the amount of earnings retained in the company. The number of authorized shares of common stock is 10 billion. $19. The common stock originally sold above par value because the paid-in capital in excess of par value is large. This amount is not how much the outstanding stock is actually worth.393 million. In fact. 2012 E11..

000 255.000 b.000 shares Common stock.000.20 Minutes.000 3.000 $ 1. There are no dividends in arrears at December 31. Common shareholders could not have received dividends in each year of the company’s existence had any dividends been in arrears on the preferred stock. Inc. $1 par value. SOLUTIONS TO PROBLEMS SET A PROBLEM 11.000 3. December 31.000 2.75 x 170.1A . 2011: Net income for the four-year period 2008-2011 Less: Preferred dividends ($80. 2011.000 510.805.000 $ $ 170.550.000 shares. © The McGraw-Hill Companies.000 shares issued and outstanding 170.000 *Computation of retained earnings at December 31. $100 par value.000 per year for four years) $ Common dividends ($0.000 830.1A ROBBINSVILLE PRESS ROBBINSVILLE PRESS Partial Balance Sheet December 31.000 shares Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 1. 2011 $ 320. We know this because common dividends were paid in each of the four years that the company was in existence. 2012 P11.000 shares x 4 years) Retained earnings. Easy a. 2011 Stockholders' equity 8% cumulative preferred stock. authorized 500.085.380.000 255.. issued and outstanding 10. authorized 100.

000 x 5 years) Common dividends ($1 x 300.000.2A WALLER PUBLICATIONS WALLER PUBLICATIONS Partial Balance Sheet December 31. $100 par value. issued. PROBLEM 11. Note to financial statements: As of December 31. issued and outstanding 300.000 8. $100 par value. Easy a. amounting in total to $200.500. December 2010 Less: Net loss of 2011 Retained earnings.000 $ $ 4.000 1.000 2.000 b.000.000. 2011 Stockholders' equity 10% cumulative preferred stock.210.700. c.460. 2011: Net income for the five-year period 2006-2010 Less: Preferred dividends ($200.500.000 1. No.750. Dividends do not represent a liability of the corporation until they are declared by the board of directors.960.000 shares x 5 years) Retained earnings.000 shares Additional paid-in capital: common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 2.2A . $1 par value. 2012 P11.000 210.000 1. and outstanding 20.000 210. Inc. © The McGraw-Hill Companies. December 31.000 shares Common stock. authorized 1 million shares. authorized.000 $ $ *Computation of retained earnings at December 31.000 5. cumulative preferred stock were in arrears to the extent of $10 per share.000. 2011 $ $ 1.. 2011.000 300. dividends on the 10%.000 8.20 Minutes.

000 shares) Retained earnings.25 Minutes.000 in arrears for 2 years) 2011 (8% x $100 x 5.000 (120. Debt must be repaid at some future date.000) 640. A corporation might decide to use cumulative preferred stock rather than debt to finance operations for any of the following reasons (only 2 required): 1. issued.3A .000 shares authorized. PROBLEM 11.000 50. $2 par.000 160.000) $ $ (90. Medium a.000 1.3A MANHATTAN TRANSPORT COMPANY MANHATTAN TRANSPORT COMPANY Partial Balance Sheet December 31. $100 par. debt must be periodically refinanced.000 shares) Dividends on common stock: 2010 ($0.000 shares authorized. 2011 Stockholders' equity 8% cumulative preferred stock.060. Increasing the amount of debt on a balance sheet can adversely affect financial ratios..000 shares) 2011 ($9 x 5. 10.000 shares authorized.000 in arrears) 2010 ($40.000 shares) 2011 ($1.000) Dividends on $9 preferred stock: 2010 ($9 x 5. 31.000 640. they do not have to be paid each year and do not become a legal obligation of the corporation until they are declared. Inc. 100.000 $ $ *Computation of retained earnings at December 31.000 $ 170.000 shares = $40.000 shares issued and outstanding Common stock. Although cumulative dividends must eventually be paid if the corporation is profitable. Preferred stock generally does not mature.000 200.452. and outstanding $9 cumulative preferred stock.000) (210.000 2. 2011: Retained earnings at Dec.000 890. © The McGraw-Hill Companies. 5.000 shares issued and outstanding Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 500. 2.000 1. To be a permanent source of capital.000 512. 5.000 45. 2011 $ $ $ 80. 2009 Add: Net income for 2010 and 2011 Net income for four-year period Less: Dividends paid on 8% preferred stock: 2009 ($40. no-par value. 3. Interest on debt is a legal obligation of the corporation and must be paid each year. 2012 P11.000 40.000 b.812.60 x 100.50 x 100. December 31. 200.000 600.000 45.

June 4 Land Common Stock Additional Paid-in Capital: Common Stock Issued 15. 2012 P11..4A BARNES COMMUNICATIONS.000 240.000 6.000 30.200 25.000 250.000 147.000 25.000 shares of common stock in exchange for land valued at $225.000 25.000 shares x $15).000 225.000 195. 20 Dividends Payable Cash To record payment of dividend declared Nov.000 © The McGraw-Hill Companies. cumulative preferred stock at par value.000 shares of $2 par value common stock at $14 per share.000 (15.000 7 Organization Costs Expense Common Stock Additional Paid-in Capital: Common Stock Issued 500 shares of common stock to Barnes in exchange for services relating to formation of the corporation. 20__ Jan 6 Cash Common Stock Additional Paid-in Capital: Common Stock Issued 20. 280.000 ÷ 500 shares) = $14 per share.500 preferred shares outstanding. Medium PROBLEM 11. 10%.000 Dec 25.200 147. 31 Income Summary Retained Earnings To close the Income Summary account for the year.000 25.500 shares of $100 par value. Inc. 12 Cash 10% Cumulative Preferred Stock Issued 2. 7.000 250.4A . Implied issuance price ($7.000 40.35 Minutes. 20. 15. INC. Nov 15 Dividends (Preferred Stock) Dividends Payable To record declaration of annual dividends of $10 per share on 2. General Journal a. Payable Dec. 31 Retained Earnings Dividends To close the Dividends account.000 1.000 25.

Partial Balance Sheet December 31. 20xx Add: Net income in 20xx Less: Preferred dividends in 20xx Retained earnings at December 31.200 884.200 © The McGraw-Hill Companies. INC.000 71.. BARNES COMMUNICATIONS. authorized 400.200 (25.500 shares Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 250. INC. 2012 P11. 20xx. issued and outstanding 2.000 122.000 shares. Inc.500 shares Common stock.200 $ $ *Computation of retained earnings at December 31.PROBLEM 11. (concluded) b. issued and outstanding 35.2) .000 762. 20xx: Retained earnings at January 1.4A BARNES COMMUNICATIONS.4A (p. $2 par. authorized 50. $100 par.000 shares.000 441. 20xx___ Stockholders' equity 10% cumulative preferred stock.000) 122. $ $ 147.

300.092.000 4.000 900.225. Strong PROBLEM 11.225.50 x 24.500 ¸ 450. beginning of the year Add: Net income for the year Subtotal Less: Retained earnings.300. h.400.000 2 450.000 180. $ $ $ $ c.000 20.000 2.000 1.220.500 3.970.27 717.000 450.912.25 b. © The McGraw-Hill Companies.000 shares) Par value of all common stock outstanding Par value per share of common stock Number of shares of common stock outstanding ($900.000 shares (a ) x $100 per share] Equity of common stockholders Number of shares of common stock outstanding (c ) Book value per share ($11.000 ÷ $2 per share) Par value of all common stock issued Paid-in capital in excess of par: Common Total issuance price of all common stock Number of shares of common stock issued (c) Average issuance price per share of common ($9.325.820.000 ÷ $100) Dividend requirement per share of preferred stock (7 1/2% x $100) Number of shares of preferred stock outstanding (a) Annual preferred stock dividend requirement ($7.000 3.50 24. g.625.500 450.000 11.000 ÷ 450.000 8.500 2.000 11.687.000 14. end of the year Total dividends paid during the year Less: Dividends on preferred stock (part b ) Total dividends on common stock Number of common shares outstanding Dividends per share of common stock ($1.. d. Inc.000 900.000 900.400. 2012 P11.595.325.820. $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ e.000 3.5A .500 180.000 shares) Retained earnings.5A SMITHFIELD PRODUCTS a.000 9.000) $ $ 2.400.000 4.400.000 8.50 2.000 7.000 26.000 450. Par value of all preferred stock outstanding Par value per share of preferred stock Number of shares of preferred stock outstanding ($2.912.000 100 24. f.000 ¸ 450.000 shares) Par value of preferred stock Par value of common stock Total legal capital Total legal capital (e) Add: Additional paid-in capital: Common stock Total paid-in capital Total stockholders’ equity Less: Par value of preferred stock [24.000 2.35 Minutes.

35 Minutes.20 345 5.342/13.250 6.819/$0. INC.592 86..20 x 345) Par value of preferred stock Par value of common stock Additional paid-in capital Total paid-in capital Total stockholders’ equity Less: Preferred stock par value = ($250 x 345 shares) Equity of common stockholders Number of shares of common stock outstanding Book value per share ($151.638 11.50 13. CORPORATION In Thousands (Except for Per Share Amounts) $ 6.10 a. c.638 $ $ $ $ $ $ $ 17.50) Dividend requirement per share of preferred stock Numbers of shares of preferred stock outstanding Annual dividends paid to preferred stockholders ($17.638 shares) b.329 237. Par value of all common stock outstanding Par value per share Number of shares outstanding ($6. d.260 180.250 151.934 86.819 87. 2012 P11.819 0.6A .342 13. Inc. © The McGraw-Hill Companies. Medium PROBLEM 11.6A PARSONS.

PROBLEM 11. The term convertible means that at the option of the preferred stockholder. $50 par preferred selling at $57 has a dividend yield of 7% [(8% x $50 par) ÷ $57].9% ($17. The two principal factors that cause one preferred to yield less than another are: (1) the appearance of greater ability to pay the preferred dividends each year. © The McGraw-Hill Companies. Some publicly owned corporations have millions of stockholders. f. The primary disadvantages of being publicly owned are the increased governmental regulations and financial reporting requirements. immediately salable at quoted market prices. each preferred share can be converted into a specified number of common shares.6A(p. (concluded) e. g. 2012 P11. This information is disclosed in the notes accompanying the corporation’s financial statements. In comparison. including pension funds. Inc. the stockholder must know into how many shares of common each preferred share can be converted.6A PARSONS. and (2) special features that appeal to investors. Closely held corporations are usually unable to raise the large amounts of capital available to publicly owned corporations. At $248 per share.2) . A higher yield means that investors demand a higher return to induce them to purchase the stock. Parson's preferred has a dividend yield of 6.20 ÷ $248). mutual funds. INC. such as Parson’s conversion feature. the more investors favor the stock. and other corporations. A major advantage to the stockholders of a publicly owned corporation is that their equity investments are highly liquid assets. The basic advantage of being publicly owned is that the corporation has the opportunity to raise large amounts of equity capital from many investors. To evaluate the value of this conversion feature. or a high call price. The dividend yield on preferred stock indicates how much investors value certain features of the stock. an 8%. The lower the yield. cumulative dividends..

representing the amounts invested by the stockholders. stockholders may gain insight into whether management has increased or diminished the value of the resources entrusted to their care. On the other hand. © The McGraw-Hill Companies.7A . the amount of par value has no direct effect upon either book value or market value. The very low par value offers little protection to the company’s creditors.15 Minutes.50) is far above par value indicates either that (1) the stock initially was issued at a price far above par value. Book value per share is equal to the net assets represented by each share of common stock. b. Easy PROBLEM 11. plus the amounts earned and retained by the corporation. Book value is a historical cost concept. If the company performs as its market price implies that it will. Thus. par value may be viewed as a minimum cushion of equity capital existing for the protection of creditors. or (2) that the company has retained substantial amounts of earnings. This implies that investors believe that management and product lines make the company worth far more than the amounts of capital historically invested. The fact that book value per share ($6. 2012 P11. Earnings and cash flows are far more relevant to a company’s debt-paying ability than is the cushion provided by par value. Even if there had been stock splits in prior years. Another reason for the small par value is the possibility of stock splits in the past. It does mean. the total dollar amount of book value would not have been affected. The market value of a share of stock is established in the marketplace. rather than to historical amounts. Par value is the legal capital per share—the amount by which stockholders’ equity cannot be reduced except by losses. Inc. However. that the amount of the company’s legal capital—serving as a cushion for creditors—is quite low. Market value is related primarily to investors’ future expectations of the company’s performance. its earnings and cash flows should make the creditors’ positions quite secure. a market value of many times book value implies that little cushion is required for creditors’ claims to be secure.7A TECHNO CORPORATION a. the corporation can set par value at any level that it chooses. It represents the pershare price at which willing sellers can and will sell shares of the stock to willing buyers. By comparing book value with current market value. however. The company’s par value—one-tenth of a cent per share—is quite low.. The market value of $65 is 10 times book value.

000 25. The treasury stock purchase of $35.15 Minutes.000 Additional paid-in capital: Common stock Additional paid-in capital: Treasury stock Total paid-in capital Retained earnings* Total stockholders’ equity $ $ *Computation of retained earnings at Dec.000 in 2010 was reported as a financing cash outflow in the statement of cash flows for that year. Dec.80 ($590. Stockholders’ equity: Common stock. Medium PROBLEM 11. $1 par. 2012 P11.000 b. The reissue of the treasury stock for $40.000 590. issued. The company’s book value per share is $11. 2011: Net income in 2009 Net income in 2010 Net income in 2011 Retained earnings.000 shares authorized.000 185.000 total stockholders’ equity ÷ 50.000 78. and outstanding $ 50. 2011 $ $ 82. 31.8A FELLER CORPORATION a.000 350..8A .000 405. 31.000 in the following year was reported as a financing cash inflow in the 2011 statement of cash flows. 50. © The McGraw-Hill Companies.000 shares outstanding).000 5. c. Inc.000 185.

2012 P11. of which 10.000 200.50 Retained earnings.000 shares x 5 years Less: Common dividends 2007–2008: 120.000 b.000 x 3).000 ÷ 10.000 shares (110.925. Stockholders’ equity: 10% preferred stock. the market value would have fallen to approximately $10 per share ($30 ÷ 3).9A HERNDON INDUSTRIES a.000 ÷ 110.9A . 200. and the number of shares outstanding would have increased to 330.700. and outstanding 30.000 of preferred stock = $3.000 shares outstanding x $0.000 shares = $25 per share Paid-in capital per share reissued: $5 per share ($25 .000 ÷ 20.000 shares outstanding = $33.695. 31.000 shares are held in treasury Additional paid-in capital: Common stock Additional paid-in capital: Treasury stock* Total paid-in capital Retained earnings** Subtotal Less: Treasury stock (10. $10 par. Had the company decided to split its common stock 3-for-1 on December 31.000 shares issued. The company’s book value per share is approximately $33.000. c.000 shares Common stock.000 6. Strong PROBLEM 11.000 4.000 total stockholders’ equity  $3.50 x 2 yrs $ $ 1. 2011 1.895.000 720.000.000 shares x $20 cost per share) Total stockholders’ equity at Dec.000 ($5 per share x 10.000 $ $ $ 1. authorized. 2011.925.59). 31.695.50 x 2 yrs 2009–2010: 100.695.30 Minutes.970.000 shares = $20 per share Reissue price per share: $250. Dec.000 1. Inc.$20) Total paid-in capital on treasury stock: $50.000 6.000 *Computation of additional paid-in capital on treasury stock: Purchase price per share: $400. $3. © The McGraw-Hill Companies. The par value would have been reduced to $3.000 120.000 2011: 110.500.000 55.59 ($6.775. issued. cumulative. 31.33 ($10 ÷ 3). 120..000. $100 par.000 shares authorized.000 50.000 1.000 shares reissued) **Computation of retained earnings at Dec.000 shares outstanding x $0. 2011: Net income (for years 2007–2011) Net in Preferred dividend (for years 2007–2011) $100 x 10% x 30.000 shares outstanding x $0. 2011 $ 3.000 $ 3.200.000 100.695.

000 *Computation of retained earnings at December 31.000 128. Inc. authorized 1. Easy a.000 shares x 4 years) Retained earnings.000 2. December 31. There are no dividends in arrears at December 31.800.000 $ $ 80.250. $100 par value. 2011 $ $ 20. INC. 2011 We know this because common dividends were paid in each of the four years that the company was in existence.40 x 80.000 per year for four years) Common dividends ($0.1B SEPTA. Common shareholders could not have received dividends in each year of the company’s existence had any dividends been in arrears on the preferred stock.120. authorized 200.652.000 shares Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 50.. 2011 Stockholders' equity 10% cumulative preferred stock. issued and outstanding 500 shares Common stock. Partial Balance Sheet December 31.000 1.902.20 Minutes. it may actually have fallen below its original price of $100 per share).000 shares Issued and outstanding 80. 2012 P11. Thus.000 148.1B .000 $ 1. at December 31. $1 par value. SEPTA.652. The market price of preferred stock usually decreases as interest rates increase.000 shares. SOLUTIONS TO PROBLEMS SET B PROBLEM 11. 2011: Net income for the four-year period 2008-2011 Less: Preferred dividends ($5.000 b. c. © The McGraw-Hill Companies.000 1. callable at $110. INC. 2011.000 1. the market price of Septa's preferred stock was probably lower than its call price of $110 (in fact.000 1.

$100 par value.000 x 5 years) Common dividends ($. $1 par value.000 7.600. cumulative preferred stock were in arrears to the extent of $10 per share. 2011 $ $ 500.000 2.000 7. 2011: Net income for the five-year period 2006-2010 Less: Preferred dividends ($100.100. issued.000 900. 2012 P11. Inc.000.600.000 400. 2011 Stockholders' equity 10% cumulative preferred stock.900.000 2.000. authorized 1 million shares.000 $ $ 4.000 shares x 5 years) Retained earnings.000 $ *Computation of retained earnings at December 31.000 shares Common stock. amounting in total to $100. PROBLEM 11. dividends on the 10%. December 2010 Less: Net loss of 2011 Retained earnings.000 5.100. authorized.000 b.20 Minutes.. and outstanding 10.100. 2011. © The McGraw-Hill Companies. Easy a. Dividends do not represent a liability of the corporation until they are declared by the board of directors.80 x 400. $100 par value. No.000 1.000.000 900.000 1. December 31.2B . issued and outstanding 400. Note to financial statements: As of December 31.2B BANNER PUBLICATIONS BANNER PUBLICATIONS Partial Balance Sheet December 31. c.000 shares Additional paid-in capital: common stock Total paid-in capital Retained earnings* Total stockholders' equity $ $ 1.000.

A corporation might decide to use cumulative preferred stock rather than debt to finance operations for any of the following reasons (only 2 required): 1.000 shares) 2011 ($6 x 5. issued.000 260. $ 1.463.000 3. Partial Balance Sheet December 31. Inc.3B .000 130. and outstanding $6 cumulative preferred stock. INC. Interest on debt is a legal obligation of the corporation and must be paid each year.000 shares issued and outstanding Common stock.000 shares authorized.000 shares issued and outstanding Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity PROBLEM 11. 2009 Add: Net income for 2010 and 2011 Net income for four-year period Less: Dividends paid on 10% preferred stock: 2009 ($100.000 in arrears) 2010 ($100.000 30. © The McGraw-Hill Companies.000) 1.000 4.3B RAY BEAM.000 $ $ *Computation of retained earnings at December 31. $1 par.930.000 (300.000 $ 530.000 1. RAY BEAM.000 1. 3. 2. 2011 Stockholders' equity 10% cumulative preferred stock.000) $ $ (60.000 in arrears for 2 years) 2011 (10% x $100 x 10.000 320.000 shares) Retained earnings. Increasing the amount of debt on a balance sheet can adversely affect financial ratios. 2012 P11. Debt must be repaid at some future date.000 1. Although cumulative dividends must eventually be paid if the corporation is profitable. $100 par value. 2011: Retained earnings at Dec. 5. Medium a.000 shares = $100.000 30. 31.000 shares authorized.90 x 130.000 100.000 1.00 x 130.193. no-par value. INC. they do not have to be paid each year and do not become a legal obligation of the corporation until they are declared.193.000 b. December 31.000 shares authorized.000 shares) Dividends on common stock: 2010 ($0. 2011 $ $ $ 200.000 shares) 2011 ($2. To be a permanent source of capital.000) Dividends on $6 preferred stock: 2010 ($6 x 5. 8. Preferred stock generally does not mature. 260.000 117.820.25 Minutes. 10.000.000) (377. debt must be periodically refinanced.270.400. 130..

Medium PROBLEM 11. 20__ Jan 7 Cash Common Stock Additional Paid-in Capital: Common Stock Issued 30. 18 Cash 5% Cumulative Preferred Stock Issued 4.000 shares x $12). 11 Dividends Payable Cash To record payment of dividend declared Nov.000 30.000 20.000 270. 31 Income Summary Retained Earnings To close the Income Summary account for the year.000 20.000 810. 2012 P11.000 400.000 1.000 (10. General Journal a.4B .000 120.. Inc.000 shares) = $12 per share. INC.000 12. Payable Dec.000 110.000 ÷ 1.000 810. 25.000 20. cumulative preferred stock at par value. 20. 12 Organization Costs Expense Common Stock Additional Paid-in Capital: Common Stock Issued 1. 5%.000 300. 31 Retained Earnings Dividends (Preferred Stock) To close the Dividends account.000 11. Nov 25 Dividends (Preferred Stock) Dividends Payable To record declaration of annual dividends of $5 per share on 4. Implied issuance price ($12.000 © The McGraw-Hill Companies.000 shares of $1 par value common stock at $10 per share.4B MARKUP. 11.000 Dec 20.35 Minutes. July 5 Land Common Stock Additional Paid-in Capital: Common Stock Issued 10.000 400.000 20.000 shares of $100 par value.000 shares of common stock to Deal in exchange for services relating to formation of the corporation.000 shares of common stock in exchange for land valued at $120.000 preferred shares outstanding.000 10.

issued and outstanding 4. INC.000 $ $ *Computation of retained earnings at December 31.000 shares Additional paid-in capital: Common stock Total paid-in capital Retained earnings* Total stockholders' equity $ 400.. $100 par.000 832.000 1.000 (20.000 41. 2012 P11. Inc. $ $ 810. 20xx Stockholders' equity 5% cumulative preferred stock. authorized 100.000 391. authorized 100.000 © The McGraw-Hill Companies. Easy b.000 shares. PROBLEM 11.000 shares Common stock.000) 790. issued and outstanding 41.000 790. 20xx: Retained earnings at January 1. $1 par. (concluded) MARKUP. INC.2) . 20xx.4B MARKUP.000 shares. Partial Balance Sheet December 31. 20xx Add: Net income in 20xx Less: Preferred dividends in 20xx Retained earnings at December 31.20 Minutes.4B (p.622.

800.700.000 440.000 6. $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ e.000 6. Strong PROBLEM 11.800.000 2.000 shares) Par value of preferred stock Par value of common stock Total legal capital Total legal capital (e) Add: Additional paid-in capital: Common stock Donated capital Total paid-in capital Total stockholders’ equity Less: Par value of preferred stock [44. Inc.000 1.700.400.000 15.000 3.400.000 6 4.000 10 44.400.200.700.000 18.800.200.400.400.400.200. 2012 P11.000 8.000 ÷ 1.000 7.160..000 ÷ $100) Dividend requirement per share of preferred stock (10% x $100) Number of shares of preferred stock outstanding (a) Annual preferred stock dividend requirement ($10 x 44.000.000 shares) Par value of all common stock outstanding Par value per share of common stock Number of shares of common stock outstanding ($3.000 1.760. end of the year Total dividends paid during the year Less: Dividends on preferred stock (part b ) Total dividends on common stock Number of common shares outstanding Dividends per share of common stock ($2. INC.000 6. d.840.35 Minutes. $ $ $ $ c.09 1.000 shares (a ) x $100 per share] Equity of common stockholders Number of shares of common stock outstanding (c ) Book value per share ($13.000 10.000 400. Par value of all preferred stock outstanding Par value per share of preferred stock Number of shares of preferred stock outstanding ($4.700.800.000 13.400.000 3.700.760.700.5B MANOR.000 4.000 3.700.41 b.000 7.000 1.400.000) $ $ 4.000 3.000.400.000 2.160.000 100 44.000 4. © The McGraw-Hill Companies. h. a.800.000 ÷ 1.000 2 1. f.000 shares) Retained earnings. beginning of the year Add: Net income for the year Subtotal Less: Retained earnings.000 ÷ $2 per share) Par value of all common stock issued Paid-in capital in excess of par: Common Total issuance price of all common stock Number of shares of common stock issued (c) Average issuance price per share of common ($10.000 ÷ 1.000 440.000 1. g.400.5B .

d.35 Minutes.200 42.6B TOASTY CORPORATION In Thousands (Except for Per Share Amounts) $ 9. 2012 P11. © The McGraw-Hill Companies.400 187.600/$3) Dividend requirement per share of preferred stock Numbers of shares of preferred stock outstanding Annual dividends paid to preferred stockholders ($10 x 250) Par value of preferred stock Par value of common stock Additional paid-in capital Total paid-in capital Total stockholders’ equity Less: Preferred stock par value = ($200 x 250 shares) Equity of common stockholders Number of shares of common stock outstanding Book value per share ($137.000 9.800 136.81 a. c.200 $ $ $ $ $ $ $ $ 10 250 2.600 $ 3 3. Par value of all common stock outstanding Par value per share Number of shares outstanding ($9.200 shares) b..500 50.000 3. Inc.6B . Medium PROBLEM 11.000 137.000 50.000 ÷ 3.600 76.

immediately salable at quoted market prices. Inc. The lower the yield.2) . The term convertible means that at the option of the preferred stockholder. To evaluate the value of this conversion feature. the stockholder must know into how many shares of common each preferred share can be converted.26% ($10 ÷ $190). The dividend yield on preferred stock indicates how much investors value certain features of the stock. Closely held corporations are usually unable to raise the large amounts of capital available to publicly owned corporations. The two principal factors that cause one preferred to yield less than another are: (1) the appearance of greater ability to pay the preferred dividends each year. In comparison. At $190 per share. A major advantage to the stockholders of a publicly owned corporation is that their equity investments are highly liquid assets. mutual funds.6B TOASTY CORPORATION (concluded) e. Toasty’s preferred has a dividend yield of 5. This information is disclosed in the notes accompanying the corporation’s financial statements. a 6%. or a high call price.PROBLEM 11. such as Toasty’s conversion feature.77% [(6% x $50 par) ÷ $52]. The primary disadvantages of being publicly owned are the increased governmental regulations and financial reporting requirements. The basic advantage of being publicly owned is that the corporation has the opportunity to raise large amounts of equity capital from many investors. the more investors favor the stock. g. A higher yield means that investors demand a higher return to induce them to purchase the stock. f. and (2) special features that appeal to investors..6B(p. $50 par preferred selling at $52 has a dividend yield of 5. 2012 P11. including pension funds. Some publicly owned corporations have millions of stockholders. © The McGraw-Hill Companies. each preferred share can be converted into a specified number of common shares. and other corporations. cumulative dividends.

representing the amounts invested by the stockholders. © The McGraw-Hill Companies.7B BRAIN CORPORATION a. the amount of par value has no direct effect upon either book value or market value. However.15 Minutes.. Earnings and cash flows are far more relevant to a company’s debt-paying ability than is the cushion provided by par value. or (2) that the company has retained substantial amounts of earnings. If the company performs as its market price implies that it will. It does mean. Par value is the legal capital per share—the amount by which stockholders’ equity cannot be reduced except by losses. plus the amounts earned and retained by the corporation. however. It represents the pershare price at which willing sellers can and will sell shares of the stock to willing buyers. The company’s par value—five cents per share—is quite low. Inc. On the other hand. the total dollar amount of book value would not have been affected. The fact that book value per share ($10. Book value per share is equal to the net assets represented by each share of common stock. its earnings and cash flows should make the creditors’ positions quite secure. By comparing book value with current market value. rather than to historical amounts.7B . Even if there had been stock splits in prior years. Thus. b. par value may be viewed as a minimum cushion of equity capital existing for the protection of creditors. The market value of $96 is 9. that the amount of the company’s legal capital—serving as a cushion for creditors—is quite low. This implies that investors believe that management and product lines make the company worth far more than the amounts of capital historically invested. the corporation can set par value at any level that it chooses. Easy PROBLEM 11. Another reason for the small par value is the possibility of stock splits in prior years. The very low par value offers little "cushion" to the company’s creditors. stockholders may gain insight into whether management has increased or diminished the value of the resources entrusted to their care. a market value of many times book value implies that little cushion is required for creditors’ claims to be secure.6 times book value. Market value is related primarily to investors’ future expectations of the company’s performance. Book value is a historical cost concept.00) is far above par value indicates either that (1) the stock initially was issued at a price far above par value. 2012 P11. The market value of a share of stock is established in the marketplace.

000 510.000 330.8B TIN CORPORATION a. 31.000 100. The treasury stock purchase of $30. 50.000 350.000 330.000 shares authorized.80 ($840. $3 par.000 in the following year was reported as a financing cash inflow in the 2011 statement of cash flows. issued. Inc. Dec.000 b. Medium PROBLEM 11.000 80. Stockholders’ equity: Common stock.000 840. The reissue of the treasury stock for $40. 2012 P11.. The company’s book value per share is $16. 31.8B . c.000 total stockholders’ equity ÷ 50. 2011: Net income in 2009 Net income in 2010 Net income in 2011 Retained earnings.000 in 2010 was reported as a financing cash outflow in the statement of cash flows for that year.000 10.000 $ $ *Computation of retained earnings at Dec. 2011 $ $ 150.000 shares outstanding).15 Minutes. © The McGraw-Hill Companies. an outstanding Additional paid-in capital: Common stock Additional paid-in capital: Treasury stock Total paid-in capital Retained earnings* Total stockholders’ equity $ 150.

000 shares Common stock.760 $ 238.00 ($20 ÷ 2).000 shares x 5 years Less: Common dividends 2007–2008: 80.000 shares outstanding x $0. and the number of shares outstanding would have increased to 159. 31.9B .440 16.000 300. Inc.051.800 47.000 shares = $40 per share Reissue price per share: $30. 80. Strong PROBLEM 11.440 total stockholders’ equity  $1.000 3. cumulative.600 shares outstanding x $0.000.000 ÷ 1. $6.600.440 7.051.000 3.60 x 2 yrs $ 3. c.$40) Total paid-in capital on treasury stock: $6.000 $ $ 1.000 $ 2011: 79. Stockholders’ equity: 6% preferred stock. the market value would have fallen to approximately $28 per share ($56 ÷ 2).000 shares outstanding x $0. of which 400 shares are held in treasury Additional paid-in capital: Common stock Additional paid-in capital: Treasury stock* Total paid-in capital Retained earnings** Subtotal Less: Treasury stock (400 shares x $40 cost per share) Total stockholders’ equity at Dec. The par value would have been reduced to $10..000 1.000 94.600 x 2).261. 2012 P11.000 7.000 of preferred stock book value = $6.440 b.051. 2011 96.02).30 Minutes. $20 par.051.440 ÷ 79.000 ($10 per share x 600 shares reissued) **Computation of retained earnings at Dec. authorized and issued and outstanding 10.000 shares authorized. Had the company decided to split its common stock 2-for-1 on December 31.800.9B PARKER INDUSTRIES a. $100 par. 2009. 100.60 x 2 yrs 2009–2010: 79.560 3.02 ($7.200. 2011 $ 1.440 *Computation of additional paid-in capital on treasury stock: Purchase price per share: $40. 31. 31.806. 2011: Net income (for years 2007–2011) Less: Preferred dividend (for years 2007–2011) $100 x 6% x 10.000.600 shares outstanding = $76. The company’s book value per share is approximately $76.440.000 ÷ 600 shares = $50 per share Paid-in capital per share reissued: $10 per share ($50 . Dec.067.000 shares issued.200 shares (79. © The McGraw-Hill Companies.261.000 6.60 Retained earnings.

b. As the market price of the common stock increases. the market price of the convertible preferred should also increase to remain approximately equal in value to three shares of common stock. The market price of preferred stock tends to vary inversely with the level of interest rates.. and it is approximately three times the current market price of the common stock. which pays a higher dividend.1 . each share of this preferred stock probably is convertible into about three shares of common stock. Medium CASE 11. c. 2012 Case 11. the market price of its common stock probably will rise significantly. Inc. The improved profitability of the company may lead to larger increases in the dividends paid to common stockholders than the 5 and 10 cent increases of prior years. The market price of common stock is strongly affected by such factors as the company’s expected future earnings and the probable rate of future common stock dividends. as indicated by the fact that its market price ($125) exceeds the market price of ADM’s 10% preferred stock ($90). © The McGraw-Hill Companies.SOLUTIONS TO CRITICAL THINKING CASES 15 Minutes. Therefore.1 FACTORS AFFECTING THE MARKET PRICES OF PREFERRED AND COMMON STOCKS a. The market price of the 7%. The market price of the 10%. If ADM’s profitability increases dramatically. $100 par value convertible preferred stock should rise approximately in proportion to the increase in the market value of the common stock. This issue of preferred stock is already deriving much of its market value from its conversion feature. $100 par value preferred stock may be expected to decline gradually as long-term interest rates rise. The current market price of the convertible preferred stock is too high to be explained by its $7 per year dividend.

The fall in the price of Citicorp’s common stock probably is based on two factors. The visit by the Federal Drug Administration signaled to the market that Ventitex may be having problems with approval for one or more of its products. This caused the stock price to drop. 2012 Case 11. b. Therefore. Strong CASE 11. this increase in the discount rate has additional significance to Citicorp. This reduction in expectations about future earnings will further reduce the bank’s stock price.2 .. Since investors will demand a higher yield on their investments. which will reduce its net income. stock and bond prices may suffer an overall decline. at least in the short run. If approval is denied. the increase in the price of the shares of McDonnell Douglas resulted from an increase in investors’ expectations about future earnings of the company based on this large order by Saudia Airlines. The increase in the discount rate increases Citicorp’s cost of funds. investors are reducing their expectations of the company’s future earnings and increasing their assessments of the risk of the business. © The McGraw-Hill Companies. The increase in the discount rate by the Federal Reserve Board signals a general increase in interest rates which will affect the required yield on all investments. As a financial institution. Inc. Thus.2 FACTORS AFFECTING THE MARKET PRICES OF COMMON STOCKS a.25 Minutes. the company will not be able to sell the products. The value of a share of common stock is based on investors’ expectations about future earnings and cash flows of the business. c.

and the costs and complications resulting from the corporation being a taxable entity. • Some students may encounter professional corporations.3 SELECTING A FORM OF ORGANIZATION We do not provide comprehensive solutions for group problems that involve interviews. • Students may find that many people entered a business without giving much thought to the form of entity. But the following items normally come to light in our classes. 2012 Case 11. They may also encounter S corporations.Group assignment: No time estimate CASE 11. © The McGraw-Hill Companies. which. which often are used by one or more members of a partnership. Inc. These professional corporations are intended to limit the individuals’ personal liability—although they require the individual to carry “malpractice” insurance and do not exonerate them from liability for some types of professional misconduct.. are treated as unincorporated organizations. • The normal reason why a business may change its form of entity is to attract more capital.3 . for tax purposes. • Among the “unforeseen complications” that often come to light are the problems when partners do not see eye to eye.

2012 Case 11. Medium CASE 11. and negotiates settlements. Messages in chat rooms and bulletin board postings urge people to buy stock quickly or to sell before the price goes down. Then the fraudsters behind the scheme sell their shares at the peak price and stop hyping the stock.4 . FRAUD & CORPORATE GOVERNANCE (a) The four divisions of the Securities and Exchange Commission are: Corporate Finance Enforcement Investment Management Market Regulation (b) The Division of Enforcement investigates possible violations of securities laws. (c) The publication is Pump & Dump. (d) A pump & dump scheme works as follows. The S. pushing up the price of the stock. either in a federal court or before an administrative law judge.E. A company's web site may feature a glowing press release about its financial performance or some other aspect of the company.E.4 S. such as a new product or innovation. Inc. recommends Commission action when appropriate.com: Tips for Avoiding Stock Scams on the Internet.C. suggests investors consider the following to avoid such schemes: • Consider the source • Find out where the stock trades • Independently verify the claims that are made about the stock • Research the investment opportunity • Watch out for high-pressure pitches to invest • Always be skeptical © The McGraw-Hill Companies.20 Minutes. ENFORCEMENT DIVISION ETHICS. Newsletters that purport to offer unbiased recommendations may tout the company as the latest "hot" stock.C. which results in a rapid drop in stock price. Investors lose some or all of their investment.. Uninformed investors then purchase the stock in large numbers.

000 shares are authorized. will vary depending on the most recent balance used to answer these questions. 2008. 2008.5 . as of this date.796 thousand.728. The company has one classification of common stock: Staples. and c.338. none of these shares has been issued.] © The McGraw-Hill Companies. Inc. The par value of each share is $.30 Minutes.591 shares.773 thousand. 849. reports that five million shares of $0. 2007. Inc.568 shares had been issued.511. The company’s balance sheet dated February 2.01 par preferred stock have been authorized.0006. costing $2.605. At February 2.. [NOTE: The numbers in parts b. The company’s balance sheet dated February 2.103 shares had been issued and at February 3.336. 867. 2008 reports 162.5 EXAMINING STOCKHOLDERS' EQUITY INTERNET a. 2012 Case 11. However.100. Easy CASE 11.588 shares of stock held in treasury at a total cost of $3. b.272. This represents an increase from 130. one year earlier. Stock 2. c.

Sign up to vote on this title
UsefulNot useful