Accounting For Corporations: Questions

Chapter 13
Accounting for Corporations
QUESTIONS
1. Organization expenses (costs) are incurred in creating a corporation. Examples include:
legal fees, promoter fees, accountant fees, costs of printing stock certificates, and fees paid
to obtain a state charter.
2. Organization expenses (costs) are reported as expenses when incurred—as part of operating
expenses. (Instructor note: Prior to SOP 98-5, organization costs were classified as part of
intangible assets and then allocated to amortization expense.)
3. The board of directors of a corporation is responsible for directing the corporation's affairs.
The directors are elected by the corporation’s stockholders.
4. The preemptive right of common stockholders is the right to maintain their relative
ownership interests in the corporation by having the first opportunity to purchase their
proportionate share of any additional common shares issued by the corporation.
5. The general rights of common stockholders include: (1) the right to vote in stockholders’
meetings, (2) the right to sell or otherwise dispose of stock, (3) the preemptive right, (4) the
right to share proportionately in dividends, and (5) the right to share proportionately in
assets remaining after the creditors are paid when, and if, the corporation is liquidated. In
addition, stockholders have the general right to receive timely and useful financial reports
that describe the corporation’s financial position and the results of its activities.
6. Convertible preferred stock is potentially attractive because it offers the safety of a regular
return as well as the opportunity to share in the increased value of the issuer’s common
stock through conversion (or potential conversion).
7. The par value is an arbitrary value placed on a share of stock when it is authorized. The call
price is an amount that a corporation must pay if it exercises the option to buy back and
retire a share of callable preferred stock.
8. The three important dates governing dividends are:
a) date of declaration⎯the date the directors vote to pay a dividend.
b) date of record⎯a future date specified by the directors to identify the particular
shareholders that are to receive the dividend.
c) date of payment⎯the date when shareholders receive the dividend payment.
٩. Cash dividends debited against contributed capital accounts are called liquidating dividends
because they represent a return of amounts originally invested in the corporation by the
stockholders. (They are a return of, not a return on, capital contributions.)
©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 13 1
10. Declaring a stock dividend has no effect on assets, liabilities, or total equity. Also, the
subsequent distribution of the stock dividend has no effect on these items. Instead, the stock
dividend simply increases the number of shares outstanding and results in a transfer of
equity from retained earnings to contributed capital.
11. A stock dividend results in a distribution of additional shares to stockholders and the
capitalization of retained earnings. A stock split calls in the old shares and replaces them
with a different number of new shares with a new par value. Also, no entry is made to any of
the equity accounts with a stock split. In spite of these technical differences, there is no
practical difference in most cases between a stock split and a large stock dividend.
12. A stock dividend should not be considered income because it does not transfer any assets
from the corporation to the stockholders.
13. A treasury stock purchase reduces total assets and total equity by the same amount.
14. Treasury stock purchases affect the corporate assets and stockholders’ equity just like a
cash dividend. To keep a company from dissipating its assets by paying an inordinate
amount of dividends to its stockholders, state laws protect the company’s creditors by
imposing limits on treasury stock purchases.
15. This gain is considered to be unusual but not infrequent. It would be included in the
calculation of income from continuing operations, with other unusual or infrequent gains and
losses—in a category often labeled Other Gains and Losses.
16. This decision (revision in asset life) is a change in an accounting estimate, not a change in
accounting principle. The change would be reflected in the financial statements with
decreased depreciation over the remaining six years of the asset’s revised useful life.
17. With a simple capital structure, earnings per share results are calculated by first subtracting
any declared preferred dividends from net income, and then dividing the difference by the
weighted-average number of shares of outstanding common stock. The resulting figure is
called the basic earnings per share.
18. Krispy Kreme has issued only one class of stock – no par, common stock. Preferred stock
has been authorized but none is outstanding.
19. The par value for Tastykake’s common stock is $0.50 per share (as reported on its balance
sheet). The company has likely set the par value this low to minimize the amount of legal
capital that the company must maintain (and that stockholders would be liable for).
20. As of December 28, 2002, Tastykake’s balance sheet reports 1,012,798 treasury shares as
repurchased. The average cost to Tastykake for these treasury shares is computed as:
$12,538,632/ 1,012,798 = $12.38 per treasury share.
21. Harley-Davidson was a net purchaser of treasury stock for the fiscal year ended December 31,
2002. Its statement of cash flows (under financing) shows a net purchase of treasury stock
of $56,814,000.

2 Fundamental Accounting Principles, 17th Edition
QUICK STUDIES
Quick Study 13-1 (10 minutes)
True statements: 1, 3, 4, and 7

(a) Mar. 1 Cash .................................................................... 255,000
Common Stock, $4 Par Value...................... 178,000
Contributed Capital in Excess of Par
Value, Common Stock............................... 77,000
Issued par value stock for cash.
(b) Apr. 1 Cash .................................................................... 50,000

Common Stock, No-Par Value..................... 50,000
Issued no-par value stock for cash.
(c) Apr. 6 Inventory............................................................. 35,000

Machinery ........................................................... 135,000
Note Payable ................................................. 84,000
Common Stock, $20 Par Value.................... 40,000
Value, Common Stock............................... 46,000
Issued stock for inventory, machinery, and note.

Total cash dividend ........................................... $108,000
To preferred shareholders................................ 60,000*
Remainder to common shareholders .............. $ 48,000
*75,000 shares x $5 par x .08 x 2 years = $60,000.
May 15 Retained Earnings ............................................. 48,000

Common Dividend Payable ........................ 48,000
Declared cash dividend on common.
July 31 Common Dividend Payable .............................. 48,000

Cash .............................................................. 48,000
Paid cash dividend to common.

Catalina Company
Stockholders’ Equity
April 2 (after stock dividend)
Common stock⎯$5 par value, 375,000 shares
authorized, 165,000 shares issued and outstanding ................ $ 825,000
Contributed capital in excess of par value, common stock ........ 652,500
Total contributed capital ................................................................ 1,477,500
Retained earnings ........................................................................... 258,000
Total stockholders' equity ............................................................. $1,735,500
Supporting work
Apr. 2 Retained Earnings....................................................... 375,000

Common Stock*..................................................... 75,000
Contributed Capital in Excess of
Par Value, Common Stock** .............................. 300,000
To record declaration and distribution
of a 10% common stock dividend.
* 150,000 shares x 10% x $5 par value
** 150,000 shares x 10% x ($25 market value - $5 par value)
May 3 Treasury Stock (3,000 shares)............................... 27,000

Cash ................................................................... 27,000
Purchased treasury stock
($27,000 / 3,000 shares = $9 per share cost).
Nov. 4 Cash ......................................................................... 7,080

Treasury Stock (750 x $9*) ............................... 6,750
Contributed Capital, Treasury Stock .............. 330
Reissued treasury stock at a price
greater than its cost.
*Cost of treasury share: $27,000/3,000 shares = $9 per share
Cost of 750 treasury shares: $9 per share x 750 shares = $6,750

1. This material error should be reported on the statement of retained

earnings (and/or the statement of stockholders’ equity) as a prior
period adjustment to the beginning retained earnings balance. Also, if
prior year’s financial numbers are reported, they should be revised to
show the correct numbers.
2. This change in the expected useful life is a change in an accounting

estimate—affecting current and future accounting periods. Therefore,
the current year depreciation should be modified to reflect the change
and the revised depreciation expense reported on the income
statement as a regular part of income from continuing operations. The
remaining two years’ depreciation also should reflect this new estimate
of useful life.

Net income - Preferred dividends
Basic earnings per share: Weighted-average common shares outstanding
= ($450,000 - $10,000) / 200,000 shares
= $2.20 per share
Outstanding Fraction of Weighted

Time Period Shares Year Average
January ........................ 100,000 x 1/12 = 8,333*
February-May .............. 120,000 x 4/12 = 40,000
June-December ........... 160,000 x 7/12 = 93,333*
Weighted-average shares outstanding 141,666
*
Rounded to the nearest whole share.

Outstanding Effect of Fraction of Weighted
Time Period Shares Dividend Year Average
January-March ............ 150,000 x 1.1 x 3/12 = 41,250
April-May...................... 138,000 x 1.1 x 2/12 = 25,300
June-December ........... 151,800* x 1.0 x 7/12 = 88,550
* 138,000 shares x 1.1
Total stockholders' equity ............................................................... $920,000

Less equity attributable to preferred shares:
Call price (10,000 shares x $30).................................................... 300,000
Equity applicable to common shares ............................................. $620,000
Book value of common shares ($620,000/75,000 shares) ............ $ 8.27
Annual cash dividends per share $2.10

Dividend yield = Market value per share = = 7.4%
$28.50
Analysis: The company’s dividend yield of 7.4% indicates that it should be

classified as an income stock. That is, the company annually pays out
cash dividends to its shareholders in an amount that equals 7.4% of the
company’s market value.
Price-earnings ratio = Market value per share = $30.75 = 7.5

Earnings per share $4.10
Analysis: Many analysts consider stocks with a PE less than 5 to 8 as
potentially underpriced. This stock with a PE of 7.5 would meet this criterion.
(Instructor note: This is a good point at which to emphasize that PE is based on
expectations—expectations can prove to be higher or lower than actual results.)

EXERCISES
Exercise 13-1 (15 minutes)
Characteristic Corporations
1. Owner authority and control ..................... One vote per share
2. Ease of formation....................................... Requires government approval
3. Transferability of ownership ..................... Readily transferred
4. Ability to raise large amounts of capital .... High ability
5. Duration of life............................................ Unlimited
6. Owner liability............................................. Limited
7. Legal status ................................................ Separate legal entity
8. Tax status of income ................................. Corporate income is taxed and
its cash dividends are usually
taxed at the 15% rate (some
cases at a lower rate)
1.
Feb. 20 Cash ........................................................................ 144,000
Common Stock, No-Par Value........................ 144,000
Issued common stock for cash.
2.
Feb. 20 Cash ........................................................................ 144,000
Common Stock, $20 Par Value....................... 120,000
Value, Common Stock.................................. 24,000
3.
Feb. 20 Cash ........................................................................ 144,000
Common Stock, $8 Stated Value.................... 48,000
Contributed Capital in Excess of
Stated Value, Common Stock...................... 96,000

1. Organization Expenses .................................................. 30,000

Common Stock, No-Par Value ................................. 30,000
Issued stock to promoters.
2. Organization Expenses .................................................. 30,000

Common Stock, $1 Stated Value ............................. 2,000
Contributed Capital in Excess of Stated
Value, Common Stock ........................................... 28,000
Issued stock to promoters.
3. Cash ................................................................................. 70,000

Common Stock, $10 Par Value ................................ 40,000
Value, Common Stock ........................................... 30,000
4. Cash ................................................................................. 120,000

Preferred Stock, $100 Par Value.............................. 100,000
Value, Preferred Stock........................................... 20,000
Issued preferred stock for cash.
1. E
2. D
3. C
4. B
5. A
6. F

Preferred Common
2003 ($10,000 paid)
Preferred* .................................................... $10,000
Common⎯remainder ................................. ______ $ 0
Total for the year........................................ $10,000 $ 0
2004 ($24,000 paid)

Preferred* .................................................... $24,000
Common⎯remainder ................................. ______ $ 0
Total for the year........................................ $24,000 $ 0
2005 ($100,000 paid)

Preferred* .................................................... $30,000
Common⎯remainder ................................. ______ $ 70,000
Total for the year........................................ $30,000 $ 70,000
2006 ($196,000 paid)

Preferred* .................................................... $30,000
Common⎯remainder ................................. ______ $166,000
Total for the year........................................ $30,000 $166,000
2003-2006 ($330,000 paid) ______ _______

Total for four years .................................... $94,000 $236,000
* The holders of the noncumulative preferred stock are entitled to no more than
$30,000 of dividends in any one year (7.5% x $10 x 40,000 shares).

Preferred Common
2003 ($10,000 paid)
Preferred* .................................................... $ 10,000
Common⎯remainder ................................. _______ $ 0
Total for the year........................................ $ 10,000 $ 0
(Note: $20,000 in preferred stock dividends in arrears.)
2004 ($24,000 paid)

Preferred⎯arrears from 2003.................... $ 20,000
Preferred* .................................................... 4,000
Common⎯remainder ................................. _______ $ 0
Total for the year........................................ $ 24,000 $ 0
(Note: $26,000 in preferred stock dividends in arrears.)
2005 ($100,000 paid)

Preferred⎯arrears from 2004.................... $ 26,000
Preferred* .................................................... 30,000
Common⎯remainder ................................. _______ $ 44,000
Total for the year........................................ $ 56,000 $ 44,000
(Note: $0 in preferred stock dividends in arrears.)
2006 ($196,000 paid)

Preferred* .................................................... $ 30,000
Common⎯remainder ................................. _______ $166,000
Total for the year........................................ $ 30,000 $166,000
(Note: $0 in preferred stock dividends in arrears.)
2003-2006 ($330,000 paid) _______ _______

Total for four years .................................... $120,000 $210,000
* The holders of the cumulative preferred stock are entitled to no more than
$30,000 of dividends declared in any year (7.5% x $10 x 40,000 shares) plus
any dividends skipped in prior years.

1.
a. Retained earnings
Before dividend .................................................................... $ 330,000
$10 par value of 25,000 dividend shares ........................... (250,000)
After dividend ....................................................................... $ 80,000
b. Total stockholders’ equity

authorized, 50,000 shares issued and outstanding....... $ 500,000
Contributed capital in excess of par value........................ 100,000
Total contributed capital ..................................................... 600,000
Retained earnings ................................................................ 80,000
Total stockholders’ equity................................................... $ 680,000
c. Number of outstanding shares

Outstanding shares before the dividend ........................... 25,000
Dividend shares ................................................................... 25,000
Outstanding shares after the dividend .............................. 50,000
2.
a. Retained earnings (no change)
Before and after dividend.................................................... $ 330,000
b. Total stockholders’ equity

authorized, 50,000 shares issued and outstanding....... $ 250,000
Contributed capital in excess of par value........................ 100,000
Total contributed capital ..................................................... 350,000
Retained earnings ................................................................ 330,000
Total stockholders’ equity................................................... $ 680,000
c. Number of outstanding shares

Outstanding shares before the split................................... 25,000
Additional split shares (2-for-1) .......................................... 25,000
Outstanding shares after the split...................................... 50,000
3. From a stockholder’s point of view, there is no practical

difference between the stock dividend and the stock split.
The number of shares will be increased equivalently
under either approach, and the market value change, if
any, should be approximately the same.

1.
Feb. 5 Retained Earnings ................................................. 480,000
Common Stock Dividend Distributable ......... 300,000
Contributed Capital in Excess of Par,
Common Stock ............................................. 180,000
Declared 20% common stock dividend
(60,000 x 20% x $40).
Feb. 28 Common Stock Dividend Distributable ............... 300,000

Common Stock, $25 Par Value....................... 300,000
Distributed common stock dividend.
2.
Before After
Total stockholders’ equity..................... $2,700,000 $2,700,000
Issued and distributable shares ........... ÷ 60,000 ÷ 72,000
Book value per share ............................. $ 45.00 $ 37.50
Shares owned ......................................... x 750 X 900*
Total book value of shares .................... $ 33,750 $ 33,750
* 750 shares x 120% = 900 shares.
3.
February 5 February 28
Market value per share .......................... $ 40 $ 34.00
Shares owned ......................................... x 750 x 900
Total market value of shares owned .... $30,000 $30,600
Note: The total market value of the investor’s holdings is approximately the
same for February 5 and February 28. Assuming that the stock dividend is the
only value-relevant information/event between February 5th and February 28th,
these per share values highlight the lack of value distributed in a stock
dividend.

1.
Oct. 11 Treasury Stock (4,500 x $30) ................................ 135,000
Cash .................................................................. 135,000
Purchased treasury stock.
Nov. 1 Cash (1,200 x $36) ................................................. 43,200

Treasury Stock (1,200 x $30) .......................... 36,000
Contributed Capital, Treasury Stock ............. 7,200
Reissued treasury stock at a price exceeding cost.

Exercise 13-9 (Concluded)
Nov. 25 Cash (3,300 x $25) ................................................. 82,500

Contributed Capital, Treasury Stock ................... 7,200
Retained Earnings ................................................. 9,300
Treasury Stock (3,300 x $30) .......................... 99,000
Reissued treasury stock at a price less than cost.
2. Changes to the equity section include the following

(i) The common stock account description line will change. After the
treasury stock purchase, it should read:
Common stock⎯$10 par value; 36,000 shares
authorized and issued; 4,500 shares in treasury ............ $360,000
The dollar balance of this account does not change with a treasury
stock purchase.
(ii) The descriptions and dollar amounts for Contributed Capital in

Excess of Par Value, Common Stock, and for Total Contributed
Capital will not change.
(iii) The retained earnings dollar balance will not change but its
description should change to:
Retained earnings ($135,000 restricted for treasury stock) ... $432,000
(iv) After the purchase, a deduction for the cost of treasury stock is
reported immediately before the total line for stockholders’ equity as:
Less cost of treasury stock.................................................... $(135,000)
(v) Total stockholders’ equity will change from $900,000 to $765,000.
Revised equity section appears as follows

Common stock⎯$10 par value; 36,000 shares authorized
and issued; 4,500 shares in treasury......................................... $ 360,000
Contributed capital in excess of par value, Common stock....... 108,000
Total contributed capital................................................................ 468,000
Retained earnings, $135,000 restricted by treasury stock ......... 432,000
Total................................................................................................. 900,000
Less cost of treasury stock........................................................... (135,000)
Total stockholders’ equity............................................................. $ 765,000

1. A Income (loss) from continuing operations

2. C Extraordinary gain (loss)
4. D Cumulative effect of change in accounting principle
7. B Gain (loss) from disposing of a discontinued segment
8. B Income (loss) from operating a discontinued segment

RANDA MERCHANDISING, INC.
Income Statement
For Year Ended December 31, 2005
Net sales........................................................................ $2,700,000
Expenses
Cost of goods sold.................................................... $1,380,000
Salaries expense ....................................................... 540,000
Depreciation expense ............................................... 262,500
Total expenses .......................................................... 2,182,500
Income from continuing operations before taxes..... 517,500
Income taxes expense ................................................. 207,000
Income from continuing operations ........................... 310,500
Discontinued segment
Loss from operating wholesale business
segment (net of tax) ............................................... (555,000)
Gain on sale of wholesale business
segment (net of tax) ............................................... 675,000 120,000
Income before extraordinary gain and cumulative
effect of a change in accounting principle ............. 430,500
Extraordinary gain on condemnation of
company property (net of tax).................................. 330,000
Cumulative effect of change in accounting
principle (net of tax) .................................................. 135,000
Net income .................................................................... $ 895,500

1. The income statement for 2006 and thereafter (years 2007-2009) will
report depreciation expense of $33,750 (the straight-line amount).
2. Since Fast Tek is subject to 35% income tax, the after-tax effect of this
change is $37,375 ($57,500 x [1-0.35]). Therefore, the 2006 income
statement will report an after-tax cumulative effect of a change in
accounting principle equal to $37,375 as an increase to net income.

1. Net income.............................................................................. $1,350,000
Less preferred dividends...................................................... (195,000)
Net income available to common stockholders ................. $1,155,000
2.
Outstanding Fraction Weighted
Time Period Shares of Year Average
January-April ................... 270,000 x 4/12 = 90,000
May-October..................... 450,000 x 6/12 = 225,000
November-December ...... 342,000 x 2/12 = 57,000
3. Net income available to common stockholders ................. $1,155,000

Divided by weighted-average outstanding shares............. 372,000
Basic earnings per share...................................................... $3.10

1. Net income.............................................................................. $480,000
Less preferred dividends...................................................... (65,000)
Net income available to common stockholders ................. $415,000
2.
Original Effect Fraction Weighted
Time Period Shares of Split of Year Average
January-May..................... 50,000 3 5/12 62,500
June-August..................... 80,000 3 3/12 60,000
September ........................ 67,000 3 1/12 16,750
October-December .......... 201,000 1 3/12 50,250
3. Net income available to common stockholders ................. $415,000

Divided by weighted-average outstanding shares............. 189,500
Basic earnings per share...................................................... $2.19
1.
Total stockholders’ equity............................................. $ 792,500
Less equity applicable to preferred shares
Call price ($30 x 5,000)................................................. $150,000
Cumulative dividends in arrears (none)..................... 0 (150,000)
Equity applicable to common shares........................... $ 642,500
Book value of preferred stock ($150,000/5,000) .......... $ 30.00
Book value of common stock ($642,500/40,000)......... $ 16.06
2.
Total stockholders’ equity............................................. $ 792,500
Less equity applicable to preferred shares
Call price ($30 x 5,000)................................................. $150,000
Cumulative dividends in arrears (3 x 6% x $125,000) .. 22,500 (172,500)
Equity applicable to common shares........................... $ 620,000
Book value of preferred stock ($172,500/5,000) .......... $ 34.50
Book value of common stock ($620,000/40,000)......... $ 15.50

Dividend yield
1. $15.00 / $216.00 = 6.9%
2. $12.00 / $128.00 = 9.4%
3. $ 6.00 / $ 61.00 = 9.8%
4. $ 1.20 / $ 86.00 = 1.4%
Analysis: The yield of 1.4% on stock #4 is sufficiently low that it probably
would be classified as a growth stock, and not an income stock. Note that
classification involves expectations (not necessarily realizations).

Market Value Divided Earnings Price-Earnings
Stock per Share by per Share Ratio
1............. $166.00 ÷ $10.00 = 16.6
2............. 86.00 ÷ 9.00 = 9.6
3............. 90.00 ÷ 6.50 = 13.8
4............. 240.00 ÷ 36.00 = 6.7
Analysis: Stocks with PE ratios less than about 5 to 8 are likely viewed as
potentially undervalued by the market. Of the stocks above, an analyst
might investigate stock #4 as possibly undervalued with a PE ratio of 6.7.

PROBLEM SET A
Problem 13-1A (30 minutes)
Part 1
a. To record sale of 5,000 shares of $25 par value common stock for $30
per share.
b. To record issuance of 2,500 shares of $25 par value common stock to
the company’s promoters for their efforts in organizing the company
when the market value is $30 per share.
c. To record acquisition of assets and liabilities by issuing 1,000 shares
of $25 par value common stock at $40 per share.
d. To record sale of 1,500 shares of $25 par value common stock for $40
per share.
Part 2
Number of outstanding shares
Issued in (a) ....................................... 5,000
Issued in (b) ....................................... 2,500
Issued in (c) ....................................... 1,000
Issued in (d) ....................................... 1,500
Total.................................................... 10,000
Part 3
Minimum legal capital = Outstanding shares x Par value per share
= 10,000 x $25 = $250,000
Part 4
Total contributed capital from common stockholders
From transaction (a) ........................ $150,000
From transaction (b) ........................ 75,000
From transaction (c) ........................ 40,000
From transaction (d) ........................ 60,000
Total contributed capital ................. $325,000
Part 5
Book value per common share
Total stockholders’ equity (given) ... $347,500
Outstanding shares (from Part 2) .... 10,000
Book value per common share ........ $ 34.75 ($347,500 / 10,000 shares)

Part 1
Jan. 1 Treasury Stock, Common ..................................... 40,000
Cash .................................................................. 40,000
Purchased treasury stock (2,000 x $20).
Jan. 5 Retained Earnings ................................................. 36,000

Common Dividend Payable ............................ 36,000
Declared $2 dividend on 18,000 outstanding shares.
Feb. 28 Common Dividend Payable .................................. 36,000

Cash .................................................................. 36,000
Paid cash dividend.
July 6 Cash*....................................................................... 18,000

Treasury Stock, Common** ............................ 15,000
Contributed Capital, Treasury Stock*** ......... 3,000
Reissued treasury stock.
*(750 x $24) **(750 x $20) ***(750 x $4)
Aug. 22 Cash*....................................................................... 21,250

Contributed Capital, Treasury Stock ................... 3,000
Retained Earnings ................................................. 750
Treasury Stock, Common** ............................ 25,000
*(1,250 x $17) **(1,250 x $20)
Sept. 5 Retained Earnings ................................................. 40,000

Common Dividend Payable ............................ 40,000
Declared $2 dividend on 20,000 outstanding shares.
Oct. 28 Common Dividend Payable .................................. 40,000

Cash .................................................................. 40,000
Paid cash dividend.
Dec. 31 Income Summary................................................... 194,000

Retained Earnings ........................................... 194,000
Closed Income Summary account.

Problem 13-2A (Concluded)
Part 2
CONTEXT CORPORATION
Statement of Retained Earnings
Retained earnings, Dec. 31, 2005.................................... $135,000
Plus net income ................................................................ 194,000
329,000
Less: Cash dividends declared ....................................... (76,000)
Treasury stock reissuances .................................. (750)
Retained earnings, Dec. 31, 2006.................................... $252,250
Part 3
CONTEXT CORPORATION
Stockholders’ Equity Section of the Balance Sheet
December 31, 2006
authorized, 20,000 shares issued and outstanding .... $200,000
Contributed capital in excess of par value,
common stock ................................................................ 30,000
Total contributed capital.................................................. 230,000
Retained earnings (from part 2) ........................................... 252,250
Total stockholders’ equity ............................................... $482,250

Part 1
Explanations for each of the journal entries
Oct. 2 Declared a cash dividend of $2 per share of common stock.
($120,000 / 60,000 shares)
Oct. 25 Paid the cash dividend on common stock.
Oct. 31 Declared a 10% stock dividend when the market value is $25 per
share. ($72,000/$12 par = 6,000 shares = 10% of 60,000 shares;
$150,000/6,000 shares = $25 per share)
Nov. 5 Distributed the common stock dividend.
Dec. 1 Executed a 3-for-1 stock split. ($12 par / $4 par = 3-for-1 ratio)
Dec. 31 Closed the Income Summary account to Retained Earnings.
Part 2
Oct. 2 Oct. 25 Oct. 31 Nov. 5 Dec. 1 Dec. 31
Common stock............. $ 720,000 $ 720,000 $ 720,000 $ 792,000 $ 792,000 $ 792,000

Common stock
dividend distributable.... 0 0 72,000 0 0 0
Contributed capital in
excess of par............... 180,000 180,000 258,000 258,000 258,000 258,000
Retained earnings........ 520,000 520,000 370,000 370,000 370,000 790,000
Total equity..................... $1,420,000 $1,420,000 $1,420,000 $1,420,000 $1,420,000 $1,840,000

Part 1
Outstanding common shares
Jan. 5 Apr. 5 July 5 Oct. 5
Beginning balance ...................... 20,000 20,000 20,000 20,000
Less treasury stock (Mar. 20)..... (1,500) (1,500) (1,500)
Plus dividend shares (July 31)* .... ______ ______ ______ 3,700
Outstanding shares..................... 20,000 18,500 18,500 22,200
*(20% x 18,500)
Part 2
Cash dividend amounts
Jan. 5 Apr. 5 July 5 Oct. 5
Outstanding shares..................... 20,000 18,500 18,500 22,200
Dividend per share ...................... $ 0.50 $ 0.50 $ 0.50 $ 0.50
Total dividend .............................. $10,000 $ 9,250 $ 9,250 $11,100
Part 3
Capitalization of retained earnings for small stock dividend
Number of shares ...................................................................... 3,700
Market value per share.............................................................. $ 12
Total capitalized......................................................................... $ 44,400
Part 4
Cost per share of treasury stock
Total amount paid...................................................................... $ 15,000
Shares purchased ..................................................................... 1,500
Cost per share ........................................................................... $ 10
Part 5
Net income
Retained earnings, beginning balance.................................... $160,000
Less dividends: Jan. 5............................................................ (10,000)
Apr. 5............................................................ (9,250)
July 5............................................................ (9,250)
July 31........................................................... (44,400)
Oct. 5 ............................................................ (11,100)
Total before net income ............................................................ $ 76,000
Plus net income ......................................................................... ?
Retained earnings, ending balance ......................................... $200,000
Therefore, net income = $124,000

Part 1
Effect of income taxes (debits or losses in parentheses)
30% Tax
Pretax Effect After-Tax
h. Cumulative effect of change in accounting principle .... $(63,000) $(18,900) $(44,100)
j. Loss from operating a discontinued segment........... (19,500) (5,850) (13,650)
k. Gain on insurance recovery of tornado damage.... 28,500 8,550 19,950
n. Correction of overstatement of prior year’s sales..... (15,000) (4,500) (10,500)
o. Gain on sale of discontinued segment’s assets........ 33,000 9,900 23,100
Part 2 Income from continuing operations (and its components)
l. Net sales ................................................................. $ 970,500

a. Interest revenue..................................................... 12,000
g. Gain from settling lawsuit..................................... 42,000
Total revenues and gains ..................................... 1,024,500
r. Cost of goods sold ................................................ $487,500
b. Depreciation expense—Equipment ..................... 36,000
m. Depreciation expense—Buildings ....................... 54,000
e. Other operating expenses .................................... 97,500
c. Loss on sale of equipment ................................... 24,750
p. Loss from settling lawsuit .................................... 24,000
Total expenses....................................................... (723,750)
Income from continuing operations before taxes .... 300,750
q. Income taxes expense (30%)................................ (90,225)
Income from continuing operations after taxes ....... $ 210,525

Part 3 Income from discontinued segment
j. Loss from operating a discontinued

segment (after-tax)............................................................ $ (13,650)
o. Gain on sale of discontinued segment’s
assets (after-tax) ............................................................... 23,100
Income from discontinued segment .................................. $ 9,450
Part 4 Income before extraordinary items and the cumulative effect of

changes in accounting principle
Income from continuing oper. after taxes (from Part 2) ........ $210,525
Income from discontinued segment (from Part 3) ................. 9,450
Income before extraordinary items and the
cumulative effect of changes in principle ...................... $219,975
Part 5 Net income

cumulative effect of changes in principle ..................... $219,975
k. Extraordinary item
Gain on insurance recovery of tornado damage (after-
tax) .................................................................................... 19,950
h. Cumulative effect of change in accounting
principle (after-tax)........................................................... (44,100)
Net income............................................................................ $195,825

Part 1
Yes⎯generally accepted accounting principles allow the depreciation change
to be made as long as the change can be justified as producing more useful
financial statements. Consistency with other companies in the industry is
often a satisfactory justification.
Part 2 Double-declining-balance depreciation (Rate = 40%)

Beginning-Year Depreciation Year-End
Book Value Expense Book Value
2003 ............................... $600,000 $240,000 $360,000
2004 ............................... 360,000 144,000 216,000
2005 ............................... 216,000 86,400 129,600
Total................................ $470,400
Part 3 Straight-line depreciation

Book Value Expense* Book Value
2003 ............................... $600,000 $114,000 $486,000
2004 ............................... 486,000 114,000 372,000
2005 ............................... 372,000 114,000 258,000
Total ................................ $342,000
* Annual amount = ($600,000 - $30,000) / 5 years = $114,000
Part 4
Pretax cumulative effect of the accounting change

(see book, part 4).......................................................................... $128,400
After-tax cumulative effect of the accounting change

($128,400 x [1-0.30]) ..................................................................... $ 89,880

Part 5
The cumulative effect should be reported in the lower section of the income
statement after any extraordinary items but before net income. It will increase
income because it results from a retroactive restatement of the asset to a
higher book value.
Part 6
The 2006 income statement will report depreciation expense of $114,000. This
amount is the depreciation expense using the straight-line method.
Part 7
Effect of error on financial statements
On the 2006 income statement, the pre-tax cumulative effect of the change
from double-declining balance to straight-line depreciation of $128,400 (from
part (4)) less the 2006 straight-line depreciation of $114,000 yields an increase
to income before taxes of $14,400. Therefore, treating it as a change in an
accounting estimate (accounted for in current and future periods) would result
in an understatement of income before taxes by $64,200 ($49,800 * + $14,400).
This means net income (after-tax) would be understated by $44,940 [computed
as $64,200 x (1 - .30)].
On the 2006 balance sheet, retained earnings would be understated by
$44,940, income taxes payable would be understated by $19,260 ($64,200 x
.30), and assets would be understated by $64,200.
* Supporting computation⎯Depreciation expense for 2006:

If switching depreciation methods is treated as a change in an
accounting estimate, then the straight-line depreciation amount
is computed and reported in 2006 as follows:
Book value, January 1, 2006....................................... $ 129,600
Less salvage value ...................................................... 30,000
Depreciation expense.................................................. $ 99,600 / 2 years = $49,800

Part 1 Year 2003 weighted-average shares

Outstanding Effect Fraction Weighted
Time Period Shares of Dividend of Year Average
January-March............ 40,000 x 1.1 x 3/12 = 11,000
April-June.................... 36,000 x 1.1 x 3/12 = 9,900
July-September .......... 48,000 x 1.1 x 3/12 = 13,200
October-December ..... 52,800 x 1.0 x 3/12 = 13,200
Part 2 Year 2003 earnings per share components

Reported Divided Earnings
Total by Shares per Share
Income from continuing operations ....... $137,500 47,300 $2.91
Loss on discontinued segment .............. (52,500) 47,300 (1.11)
Net income ................................................ $ 85,000 47,300 $1.80

January-June ........................ 52,800 x 6/12 = 26,400
July-October ......................... 68,800 x 4/12 = 22,933*
November-December ........... 64,000 x 2/12 = 10,667*
*Rounded to nearest whole share.

Income from continuing operations ....... $165,000 60,000 $2.75
Extraordinary gain.................................... 33,000 60,000 0.55
Net income ................................................ $198,000 60,000 $3.30

Problem 13-7A (Continued)

Outstanding Effect of Fraction Weighted
Time Period Shares Split of Year Average
January-July ............... 64,000 x 3 x 7/12 = 112,000
August ......................... 84,000 x 3 x 1/12 = 21,000
September................... 80,000 x 3 x 1/12 = 20,000
October-December ..... 240,000 x 1 x 3/12 = 60,000

Reported Divided by Earnings
Total Shares per Share
Income from continuing operations ....... $167,000 213,000 $ 0.78
Extraordinary loss.................................... (70,000) 213,000 (0.33)
Net income ................................................ $ 97,000 213,000 $ 0.45**
** Adjusted for rounding.
Part 7
Of the three earnings per share figures in part 6, income from continuing
operations is most likely the best predictor of 2006 results. We might also
want to factor in any trend in earnings per share (adjusted for the stock split).
By definition, the 2005 extraordinary loss is both unusual and infrequent and
therefore extremely unlikely to occur again in 2006. However, the nature of
the extraordinary loss needs to be considered, and its impact on future
operations needs to be evaluated. For example, if the extraordinary loss was
due to a flood that occurred in December that damaged the plant, then
production would most likely be impaired in 2006, resulting in a decrease in
income from continuing operations.

1. Market price = $170 per share (current stock exchange price given)
2. Computation of stock par values

Preferred: Paid-in amount / Number of shares = $100,000 / 1,000 = $100
Common: Paid-in amount / Number of shares = $160,000 / 4,000 = $40
3. Book values with no dividends in arrears

Book value per preferred share = par value (when not callable) = $100
Common stock
Total equity ............................................... $ 560,000
Less equity for preferred......................... (100,000)
Common stock equity.............................. $ 460,000
Number of outstanding shares ............... 4,000
Book value per common share............... $ 115 ($460,000 / 4,000 shares)
4. Book values with two years’ dividends in arrears
Preferred stock
Preferred stock par value ........................ $ 100,000
Plus two years’ dividends in arrears* .... 10,000
Preferred equity........................................ $ 110,000
*2 years’ dividends = 2 x ($100,000 x 5%) = $10,000
Book value per preferred share.............. $ 110 ($110,000 / 1,000 shares)
Common stock
Total equity ............................................... $ 560,000
Less equity for preferred......................... (110,000)
Common stock equity.............................. $ 450,000
Book value per common share............... $ 112.50 ($450,000/4,000 shares)

5. Book values with call price and two years’ dividends in arrears
Preferred stock
Preferred stock call price (1,000 x $110)..... $ 110,000
Plus two years’ dividends in arrears* ......... 10,000
Preferred equity............................................. $ 120,000
Number of outstanding shares .................... 1,000
Book value per preferred share................... $ 120 ($120,000 / 1,000 sh.)
Common stock
Total equity .................................................... $ 560,000
Less equity for preferred.............................. (120,000)
Common stock equity................................... $ 440,000
Book value per common share.................... $ 110 ($440,000 / 4,000 sh.)
6. Dividend allocation in total

Preferred Common Total
2 years’ dividends in arrears ... $10,000 $ 0 $10,000
Current year dividends ............. 5,000 5,000
Remainder to common ............. 5,000 5,000
Totals.......................................... $15,000 $5,000 $20,000
Dividends per share for the common stock

$5,000 / 4,000 shares = $1.25
7. Equity represents the residual interest of owners in the assets of the

business after subtracting claims of creditors. With few exceptions, these
assets and liabilities are reported at historical cost, not market value.
Therefore, the book value of common stock does not normally match its
market value. Also, the book value of common stock is based on past
transactions and events, whereas the market value takes into account
expected future earnings, growth, dividends, and other industry and
economic factors.

PROBLEM SET B
Problem 13-1B (30 minutes)
Part 1
a. To record sale of 1,500 shares of $1 par value common stock for $40
per share.
b. To record issuance of 500 shares of $1 par value common stock to the
company’s promoters for their efforts in organizing the company when
the market value is $40 per share.
c. To record acquisition of assets and liabilities by issuing 400 shares of
$1 par value common stock at $50 per share and issuing a note for
$3,150.
d. To record sale of 600 shares of $1 par value common stock for $50 per
share.
Part 2
Number of outstanding shares
Issued in (a)........................................ 1,500
Issued in (b) ....................................... 500
Issued in (c)........................................ 400
Issued in (d) ....................................... 600
Total .................................................... 3,000
Part 3
Minimum legal capital = Outstanding shares x Par value per share
= 3,000 x $1 = $3,000
Part 4
Total contributed capital from common stockholders
From transaction (a).......................... $60,000
From transaction (b).......................... 20,000
From transaction (c).......................... 20,000
From transaction (d).......................... 30,000
Total contributed capital................... $130,000
Part 5
Book value per common share
Total stockholders’ equity (given) ... $141,500
Outstanding shares (from 2) ............ 3,000
Book value per common share ........ $ 47.17 ($141,500 / 3,000 shares)

Part 1
Jan. 10 Treasury Stock, Common ................................... 240,000
Cash ................................................................ 240,000
Purchased treasury stock (20,000 x $12).
Mar. 2 Retained Earnings ............................................... 120,000

Common Dividend Payable .......................... 120,000
Declared $1.50 dividend on 80,000 outstanding shares.
Mar. 31 Common Dividend Payable ................................ 120,000

Cash ................................................................ 120,000
Paid cash dividend.
Nov. 11 Cash*..................................................................... 156,000

Treasury Stock, Common** .......................... 144,000
Contributed Capital, Treasury Stock*** ....... 12,000
*(12,000 x $13) **(12,000 x $12) ***(12,000 x $1)
Nov. 25 Cash*..................................................................... 76,000

Contributed Capital, Treasury Stock ................. 12,000
Retained Earnings ............................................... 8,000
Treasury Stock, Common** .......................... 96,000
*(8,000 x $9.50) **(8,000 x $12)
Dec. 1 Retained Earnings ............................................... 250,000

Common Dividend Payable .......................... 250,000
Declared $2.50 dividend on 100,000 outstanding shares.
Dec. 31 Income Summary ................................................. 536,000

Retained Earnings ......................................... 536,000
Closed Income Summary account.

Problem 13-2B (Concluded)
Part 2
BAYCORE CORP.
Statement of Retained Earnings
Retained earnings, Dec. 31, 2005..................................... $1,080,000
Plus net income................................................................. 536,000
1,616,000
Less Cash dividends declared ....................................... (370,000)
Treasury stock reissuances .................................. (8,000)
Retained earnings, Dec. 31, 2006..................................... $1,238,000
Part 3
BAYCORE CORP.
Stockholders’ Equity Section of the Balance Sheet
December 31, 2006
authorized, 100,000 shares issued and outstanding .... $ 100,000
Contributed capital in excess of par value,
common stock ..................................................................700,000
Total contributed capital.................................................... 800,000
Retained earnings (from part 2) ............................................. 1,238,000
Total stockholders’ equity................................................. $2,038,000

Part 1
Explanations for each of the journal entries
Jan. 17 Declared a cash dividend of $1 per share of common stock.
($48,000 / 48,000 shares)
Feb. 5 Paid the cash dividend on common stock.
Feb. 28 Declared a 12.5% stock dividend when the market value is $21 per
share. ($60,000 / $10 par = 6,000 shares = 12.5% of 48,000 shares;
$126,000 / 6,000 shares = $21 per share)
Mar. 14 Distributed the common stock dividend.
Mar. 25 Executed a 2-for-1 stock split. ($10 par / $5 par = 2-for-1 ratio)
Mar. 31 Closed the Income Summary account to Retained Earnings.
Part 2
Jan. 17 Feb. 5 Feb. 28 Mar. 14 Mar. 25 Mar. 31
Common stock............. $ 480,000 $ 480,000 $ 480,000 $ 540,000 $ 540,000 $ 540,000

Common stock
dividend distributable.... 0 0 60,000 0 0 0
Contributed capital in
excess of par................ 192,000 192,000 258,000 258,000 258,000 258,000
Retained earnings........ 752,000 752,000 626,000 626,000 626,000 986,000
Total equity..................... $1,424,000 $1,424,000 $1,424,000 $1,424,000 $1,424,000 $1,784,000

Part 1
Outstanding common shares
Feb. 15 May 15 Aug. 15 Nov. 15
Beginning balance ....................... 8,500 8,500 8,500 8,500
Less treasury stock (Mar. 2)........ (500) (500) (500)
Plus dividend shares (Oct. 4)*..... _____ _____ _____ 1,000
Outstanding shares...................... 8,500 8,000 8,000 9,000
*(12.5% x 8,000)
Part 2
Cash dividend amounts
Feb. 15 May 15 Aug. 15 Nov. 15
Outstanding shares...................... 8,500 8,000 8,000 9,000
Dividend per share ....................... $ 0.40 $ 0.40 $ 0.40 $ 0.40
Total dividend ............................... $3,400 $3,200 $3,200 $3,600
Part 3
Capitalization of retained earnings for small stock dividend
Number of shares..................................................... 1,000
Market value per share ............................................ $ 42
Total capitalized ....................................................... $42,000
Part 4
Cost per share of treasury stock
Total amount paid .................................................... $20,000
Shares purchased .................................................... 500
Cost per share .......................................................... $ 40
Part 5
Net income
Retained earnings, beginning balance ................. $135,000
Less dividends: Feb. 15 ........................................ (3,400)
May 15 ........................................ (3,200)
Aug. 15 ....................................... (3,200)
Oct. 4 .......................................... (42,000)
Nov. 15........................................ (3,600)
Total before net income.......................................... $ 79,600
Plus net income....................................................... ?
Retained earnings, ending balance....................... $147,600
Therefore, net income = $68,000

Part 1 Effect of income taxes (debits or losses in parentheses)
25% Tax
Pretax Effect After-Tax
c. Cumulative effect of change in accounting principle...$ 46,000 $ 11,500 $ 34,500
f. Loss on hurricane damage............................................ (32,000) (8,000) (24,000)
m. Loss from operating a discontinued segment............... (60,000) (15,000) (45,000)
o. Correction of overstatement of prior year’s expense... 24,000 6,000 18,000
q. Loss on sale of discontinued segment’s assets........... (90,000) (22,500) (67,500)
Part 2 Income from continuing operations (and its components)
d. Net sales .............................................................. $1,320,000

b. Interest revenue.................................................. 10,000
k. Gain from settling lawsuit.................................. 34,000
Total revenues and gains .................................. 1,364,000
p. Cost of goods sold ............................................. $520,000
i. Depreciation expense—Equipment .................. 50,000
n. Depreciation expense—Buildings .................... 78,000
h. Other operating expenses ................................. 164,000
l. Loss on sale of equipment ................................ 12,000
j. Loss from settling lawsuit ................................. 18,000
Total expenses and losses ................................ 842,000
Income from continuing operations before taxes . 522,000
e. Income taxes expense (25%)............................. (130,500)
Income from continuing operations after taxes .... $ 391,500

Part 3 Income from discontinued segment
m. Loss from operating a discontinued segment (after-tax)......... $ (45,000)

q. Loss on sale of discontinued segment’s assets (after-tax) ..... (67,500)
Loss from discontinued segment....................................... $(112,500)
Part 4 Income before extraordinary items and the cumulative effect of

changes in accounting principle
Income from cont. oper. after taxes (from Part 2)................. $ 391,500
Loss from discontinued segment (from Part 3) .................... (112,500)
cumulative effect of changes in principle ..................... $ 279,000
Part 5 Net income

cumulative effect of changes in principle ...................... $ 279,000
f. Extraordinary item:
Loss on hurricane damage (after-tax)................................ (24,000)
c. Cumulative effect of change in accounting
principle (after-tax)............................................................ 34,500
Net income............................................................................ $ 289,500

Part 1
Yes—generally accepted accounting principles allow the accounting
change to be made as long as the change can be justified as producing
more useful financial statements. Consistency with other companies in the
industry is often a satisfactory justification.
Part 2 Double-declining-balance depreciation (Rate = 40%)

Book Value Expense Book Value
2003 ............................... $200,000 $ 80,000 $120,000
2004 ............................... 120,000 48,000 72,000
2005 ............................... 72,000 28,800 43,200
Total ............................... $156,800
Part 3 Straight-line depreciation

Book Value Expense* Book Value
2003 ............................... $200,000 $ 40,000 $160,000
2004 ............................... 160,000 40,000 120,000
2005 ............................... 120,000 40,000 80,000
Total ............................... $120,000
*Annual amount = ($400,000 - $0) / 5 years = $80,000
Part 4
Pretax cumulative effect of the accounting change

(see book, part 4)........................................................................... $36,800
After-tax cumulative effect of the accounting change

($36,800 x [1-0.25]) ........................................................................ $27,600

Part 5
The cumulative effect should be reported in the lower section of the income
statement after any extraordinary items but before net income. It will increase
income because it results from a retroactive restatement of the asset to a
higher book value.
Part 6
The 2006 income statement will report depreciation expense of $40,000.

This amount is the depreciation expense using the straight-line method.
Part 7
Effect of error on financial statements

On the 2006 income statement, the pre-tax cumulative effect of the change
from double-declining-balance to straight-line depreciation of $36,800 (from
part (4)) less the 2006 straight-line depreciation of $40,000 yields a decrease to
income before taxes of $3,200. Therefore, treating it as a change in an
accounting estimate (accounted for in current and future periods) would result
in an understatement of income before taxes by $18,400 ($21,600 * - $3,200).
This means net income (after-tax) would be understated by $13,800 [computed
as $18,400 x (1 - .25)].
On the 2006 balance sheet, retained earnings would be understated by
$13,800, income taxes payable would be understated by $4,600 ($18,400 x .25),
and assets would be understated by $18,400.
* Supporting computation⎯Depreciation expense for 2006:

If switching depreciation methods is treated as a change in an
accounting estimate, then the straight-line depreciation amount is
computed and reported in 2006 as follows:
Book value, January 1, 2006 ........................................... $43,200
Less salvage value .......................................................... 0
Depreciation expense...................................................... $43,200 / 2 years = $21,600


Outstanding Effect of Fraction Weighted
Time Period Shares Dividend of Year Average
January-June ............ 10,000 x 1.2 x 6/12 = 6,000
July-September ........ 9,000 x 1.2 x 3/12 = 2,700
October-November... 12,500 x 1.2 x 2/12 = 2,500
December .................. 15,000 x 1.0 x 1/12 = 1,250

Income from continuing operations .... $ 90,000 12,450 $7.23
Loss on discontinued segment ........... (26,145) 12,450 (2.10)
Net income ............................................. $ 63,855 12,450 $5.13

January-March.................. 15,000 x 3/12 = 3,750
April-September ............... 19,000 x 6/12 = 9,500
October-December ........... 17,500 x 3/12 = 4,375

Income from continuing operations .... $85,000 17,625 $4.82
Extraordinary gain................................. 14,100 17,625 0.80
Net income ............................................. $99,100 17,625 $5.62


Outstanding Effect Fraction Weighted
Time Period Shares of Split of Year Average
January-June ............... 17,500 x 2 x 6/12 = 17,500
July-September ........... 20,500 x 2 x 3/12 = 10,250
October......................... 18,750 x 2 x 1/12 = 3,125
November-December .. 37,500 x 1 x 2/12 = 6,250

Income from continuing operations .... $130,000 37,125 $3.50
Extraordinary loss................................. (37,125) 37,125 (1.00)
Net income ............................................. $ 92,875 37,125 $2.50
Part 7
Of the three earnings per share figures in part 6, income from continuing
operations is most likely the best predictor of 2006 results. We might also
want to factor in any trend in earnings per share (adjusted for the stock split).
By definition, the 2005 extraordinary loss is both unusual and infrequent and
therefore extremely unlikely to occur again in 2006. However, the nature of
the extraordinary loss needs to be considered, and its impact on future
operations needs to be evaluated. For example, if the extraordinary loss was
due to a fire that occurred in December that damaged the plant, then
production would most likely be impaired in 2006, resulting in a decrease in
income from continuing operations.

1. Market price = $45 per share (current stock exchange price given)
2. Computation of stock par values

Preferred: Paid-in amount / Number of shares = $187,500 / 1,500 = $125
Common: Paid-in amount / Number of shares = $450,000 /18,000 = $ 25
3. Book values with no dividends in arrears
Book value per preferred share = par value (when not callable)
= $125
Common stock
Total equity ........................................... $1,200,000
Less equity for preferred ..................... (187,500)
Common stock equity .......................... $1,012,500
Number of outstanding shares ........... 18,000
Book value per common share ........... $56.25 ($1,012,500 / 18,000)
٤. Book values with two years’ dividends in arrears
Preferred stock
Preferred stock par value ..................... $ 187,500
Plus two years’ dividends in arrears*.. 30,000
Preferred equity ..................................... $ 217,500
Number of outstanding shares ............ 1,500
Book value per preferred share ........... $ 145.00 ($217,500 / 1,500)
Common stock
Total equity ............................................ $1,200,000
Less equity for preferred ...................... (217,500)
Common stock equity ........................... $ 982,500
Number of outstanding shares ............ 18,000
Book value per common share ............ $ 54.58 ($982,500 / 18,000)

5. Book values with call price and two years’ dividends in arrears
Preferred stock
Preferred stock call price (1,500 x $140) $ 210,000
Plus two years’ dividends in arrears*.......... 30,000
Preferred equity ............................................. $ 240,000
Book value per preferred share ................... $ 160.00 ($240,000 / 1,500)
Common stock
Total equity .................................................... $1,200,000
Less equity for preferred .............................. (240,000)
Common stock equity ................................... $ 960,000
Book value per common share .................... $ 53.33 ($960,000 / 18,000)
6. Dividend allocation in total

Preferred Common Total
2 years’ dividends in arrears ... $30,000 $ 0 $30,000
Current year dividends ............. 15,000 — 15,000
Remainder to common ............. — 5,000 5,000
Totals.......................................... $45,000 $5,000 $50,000
Dividends per share for the common stock

$5,000 / 18,000 shares = $0.28
٧. Equity represents the residual interest of owners in the assets of the

business after subtracting claims of creditors. With few exceptions, these
assets and liabilities are valued at historical cost, not market value.
Therefore, the book value of common stock does not normally match its
market value. Also, the book value of common stock is based on past
transactions and events, whereas the market value takes into account
expected future earnings, growth, dividends, and other industry and
economic factors.

SERIAL PROBLEM
Serial Problem, Success Systems (30 minutes)
Part 1
Apr. 1 Kay Breeze, Capital ............................................... 10,000

Common Stock, $1 Par Value......................... 10,000
Exchanged capital for 10,000 shares of $1 par
value common stock (10,000 x $1).
Apr. 1 Kay Breeze, Capital ............................................... 119,034

Contributed Capital in Excess of Par 119,034
Value, Common Stock.................................
Transfer remaining capital to contributed capital
in excess of par.
Note: An April 1 compound entry is acceptable.
Part 2 Corporate Balance Sheet—Equity Section Only

SUCCESS SYSTEMS, INC.
Balance Sheet
April 1, 2005
Equity
Common stock—$1 par value, 25,000 shares authorized,
10,000 shares issued and outstanding ........................................ $ 10,000
Contributed capital in excess of par value, common stock ......... 119,034
Total equity ........................................................................................ $129,034

Reporting in Action — BTN 13-1
1. No. The balance sheet shows that 10,000 shares of no par value,
preferred stock has been authorized, however, none have been issued.
2. As of February 2, 2003, the number of shares of common stock issued
and outstanding are 56,295 (in thousands, see balance sheet). As of
February 3, 2002, the number of shares of common stock issued is
54,271.
The weighted average common shares used in calculating earnings per
share can be found under Krispy Kreme’s “Selected Financial Data”.
For 2003, the weighted average common shares used were 55,093 and
for 2002 were 53,703. Therefore, for both years, the shares outstanding
at year-end were slightly higher than the average shares outstanding
during the year.
3. Total stockholders’ equity as of February 2, 2003........... $273,352,000
Book value of equity applicable to common stock* ........ $273,352,000

* Given that there is only one class of stock, all the equity items listed can be considered to
represent the book value of the common stock.
4. Krispy Kreme has not paid cash dividends on its common shares since
2001; see its statement of cash flows.
5. Krispy Kreme’s income statement reports the following:
2003 2002 2001
Basic earnings per common share.............. $0.61 $0.49 $0.30
Its basic earnings per common share figure is has consistently grown
over this 3-year period. Moreover, the 2003 amount is considerably
larger than the prior two years.
6. Krispy Kreme’s consolidated balance sheet does not list any shares of
treasury stock in 2003 or 2002.
7. No extraordinary gains or losses, nor changes in accounting principle,

are reported for either 2003 or 2002 (see its income statement). Also, no
gains or losses on the disposal of a business segment are reported for
either year.
8. Answer depends on the financial statement information obtained.

Comparative Analysis — BTN 13-2
Equity applicable to common shares

1. Book value per common share =
Common shares outstanding
Krispy Kreme’s book value per common share:

= $273,352/ 55,093 = $4.96
Tastykake’s book value per common share:

= $47,525/ 8,075 = $ 5.89
Net income
2. Earnings per share =
Weighted-average common shares outstanding
Krispy Kreme earnings per share: $33,478 / 55,093 = $0.61
Tastykake earnings per share: $2,000*/ 8,075 = $0.25
* Excluding restructuring charge. If the net loss shown on the income statement is used
then earnings per share is $(0.54).
Annual cash dividends per share

3. Dividend Yield =
Market value per share
Krispy Kreme dividend yield = $0 / 30.41 = 0.00%
Tastykake dividend yield = $0.48 / $9.20 = 5.22%
Analysis: The low dividend yield for Krispy Kreme suggests that it is a
“growth stock.”
Market value per share

4. Price-earnings ratio =
Earnings per share
Krispy Kreme price-earnings ratio: $30.41 / $0.61 = 50

Tastykake price-earnings ratio: $9.20 / $ 0.25 = 37
Interpretation: The price-earnings ratios of the companies are

considerably different. In Krispy Kreme’s case, the market appears
willing to pay a multiple of 50 times its earnings. For Tastykake, that
multiple is considerably less at 37 times its earnings.

Ethics Challenge — BTN 13-3
The auditor’s primary responsibility is to determine whether the financial

statements are fairly stated in all material respects. The auditor in this
situation must decide if the income statement would be materially
misstated (or less useful) by showing a $56,000 increase in net income due
to the change from the double-declining-balance method of depreciation to
the straight-line method.
Notice that with the cumulative effect of the change, the net income is
$1,224,300. Without the change, the net income is $1,168,300. The ratio of
$56,000/$1,168,300 represents a change of close to 5%. This magnitude of
difference results in the need for the auditor to make a judgment call.
Perhaps the difference is not so material that it would affect the decisions
of some users relying on the information presented in the income
statement. Other users, however, may view $56,000 as a material amount.
The auditor must also consider whether generally accepted accounting

principles are being followed. Generally accepted accounting principles
allow a change in accounting method if the new method will present results
in a more useful fashion. In this particular case it does not appear that the
change would improve the financial reporting. The equipment in question
is of a high-tech nature, which often implies that it should be depreciated
using an accelerated method allowing most of the depreciation to be taken
early in the asset’s useful life.
Management’s decision to change also seems to be related to securing a

higher bonus. The $56,000 obviously represents a material amount to the
managers of the company, or they would not have suggested the change.
Given these considerations it seems as though the auditor should ask
management to not change the method of applying depreciation. At a
minimum, management must be required to fully explain the rationale for
this change.
Communicating in Practice — BTN 13-4
There is no set solution to this activity. Solutions will vary based on the
industry and the companies selected.

Taking It to the Net — BTN 13-5
١. The balance sheet of HCA, Inc., shows that the company has only
issued common stock. However, the common stock is divided into
voting and nonvoting shares. In 2002 there were 493,176,000 voting
shares and 21,000,000 nonvoting shares outstanding.
٢. Both the voting and nonvoting common shares have a par value of
$0.01.
٣. The statement of cash flows (financing) shows that in 2002 HCA issued
common stock for proceeds of $267 million.
٤. In 2002, the statement of cash flows (financing) shows that HCA
repurchased common stock shares for $282 million.
٥. In 2002, the statement of cash flows (financing) shows that HCA paid
cash dividends of $40 million.
Teamwork in Action — BTN 13-6
1. The team statement should include the following:

a. When a corporation “buys back” its stock (engages in a treasury
stock acquisition), the effect on financial position is a decrease in
both assets (cash) and equity (treasury stock). Also, treasury stock
is a contra equity account that decreases equity.
b. Reasons for “buybacks”:
• to use shares to acquire another corporation.
• to avoid a hostile takeover by an investor seeking to take control
of the company.
• to reissue shares to employees as compensation.
• to maintain a strong or stable market for the stock.
2. The team should establish the acquisition entry as follows:
Treasury Stock, Common....................................... 13,400

Cash ................................................................... 13,400
Reacquired 100 shares of $100 par value
common stock at a cost of $134 per share.
Each member should prepare one of the following reissue entries:

Teamwork in Action (Continued)
a. Cash ................................................................ 13,400

Treasury Stock, Common........................ 13,400
Received $134 per share for 100 treasury
shares costing $134 per share.
b. Cash ................................................................ 15,000

Contributed Capital, Treasury Stock...... 1,600
c. Cash ................................................................ 12,000

Contributed Capital, Treasury Stock............ 1,400
d. Cash ................................................................ 12,000

Contributed Capital, Treasury Stock............ 1,000
Retained Earnings.......................................... 400
e. Cash ................................................................ 12,000

Retained Earnings.......................................... 1,400
3. When presenting and explaining the above entries to the team, the
following points should be made by the team members:
The similarities in all reissue entries a through e are:

• The net affect of the transaction is to increase assets and equity by
the amount received on reissue.
• Cash (assets) is always increased by the amount received.
• Treasury Stock is always decreased by the full cost regardless of
whether the reissue is at cost, above cost, or below cost.

Teamwork in Action (Concluded)
The differences in reissue entries a through e are:

(b) Reissuing above cost creates additional Contributed Capital.*
(c) Reissuing below cost reduces existing Contributed Capital.*
(d) Reissuing below cost reduces existing Contributed Capital,*
but after this account’s balance has been eliminated, then Retained
Earnings must be reduced by the additional amount below cost.
(e) Reissuing below cost reduces Retained Earnings when Contributed
Capital* does not exist.
*Refers to the Contributed Capital, Treasury Stock account.
Business Week Activity — BTN 13-7
١. Start-up tech companies usually have limited cash. Most small tech
companies argue that they are better off pouring their cash into
research and development or other investments while also retaining a
cushion for any sharp downturns the industry might encounter.
٢. The most prominent large tech companies do not pay cash dividends.
٣. A recent poll of 500 institutional investors showed that investors were

clearly in favor of receiving dividends if the tax law changes so that
distributed dividends will not be taxed as part of the shareholder
personal income.
٤. In the past, tech companies have often purchased treasury shares

(stock buybacks) with their excess cash. The share buybacks have
been popular with tech companies in the past because treasury stock
reduces shares outstanding. Stock options, which are highly utilized by
tech companies, will ultimately result in shares being issued. The tech
companies can manage the total number of shares outstanding by
balancing stock issued due to stock options with share repurchases.
5. CEOs of tech companies tend to hold considerable amounts of their

companys’ stocks. Therefore, the personal (cash) wealth of CEOs may
grow substantially if tech companies start to issue more dividends.

Entrepreneurial Decision — BTN 13-8
1.
Plan A Plan B
Net income.............................................................. $ 45,000 $ 45,000
Less preferred dividends ...................................... 0 (5,000)
Net income for common stockholders ................ $ 45,000 $ 40,000
Chavez’s share of common equity....................... 80% 100%

Chavez’s share of income after any preferred
stock dividends....................................................... $ 36,000 $ 40,000
Chavez’s initial equity ........................................... $250,000 $250,000
Chavez’s return on equity..................................... 14.4% 16.0%
2.
Plan A Plan B
Net income.............................................................. $ 10,500 $ 10,500
Less preferred dividends ...................................... 0 (5,000)
Net income for common stockholders ................ $ 10,500 $ 5,500
Chavez’s share of common equity....................... 80% 100%

Chavez’s share of income after any preferred
stock dividends....................................................... $ 8,400 $ 5,500
Chavez’s initial equity ........................................... $250,000 $250,000
Chavez’s return on equity..................................... 3.4% 2.2%
3. The difference between the answers for parts 1 and 2 arises from the
percent return generated with the assets invested in the corporation.
In part 1, Get Real Girl Inc.’s return on equity is 14.4% ($36,000/$250,000)
for Plan A, which is less than the 16.0% for Plan B. However, the return on
equity is only 3.4% ($8,400/$250,000) in part 2 for Plan A, BUT this is more
than the 2.2% for Plan B.
These results indicate that the 8% dividend rate on the preferred stock is
advantageous to Chavez as long as the rate of return on the assets is
greater than 8% (this is the same as saying net income is over $25,000).
This means Plan B is preferred. Net income over $25,000 yields a return on
assets greater than 8% (i.e., 8% equals $25,000/$312,500). If net income
falls below $25,000 (or less than 8% return on assets), then Plan A is
preferred.

Hitting the Road — BTN 13-9
There is no formal solution for this field activity. Students often find this
assignment interesting as it highlights the relevance of their accounting
studies.
Global Decision — BTN 13-10
١. Earnings per share
2002 2001 2000

$0.83 $1.25 $1.39
The trend in earnings per share is a negative one, showing decreases

for the past two years.
٢. Weighted Average Shares Outstanding (disclosed at the bottom of the

Income Statement)
2002 2001
1,175,821,000 1,321,642,000
Weighted average number of shares outstanding has decreased.
٣. Cash dividends declared for shareholders (see Statement of Financial

Position- (financing)
2002 2001
$303,804 $286,184
Cash dividends paid to shareholders has increased.


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Chapter 13

Accounting for Corporations

©McGraw-Hill Companies, Inc., 2005

©McGraw-Hill Companies, Inc., 2005

Quick Study 13-2 (15 minutes)

(b) Apr. 1 Cash .................................................................... 50,000

(c) Apr. 6 Inventory............................................................. 35,000

Quick Study 13-3 (10 minutes)

Quick Study 13-4 (10 minutes)

May 15 Retained Earnings ............................................. 48,000

July 31 Common Dividend Payable .............................. 48,000

©McGraw-Hill Companies, Inc., 2005

Apr. 2 Retained Earnings....................................................... 375,000

Quick Study 13-6 (10 minutes)

May 3 Treasury Stock (3,000 shares)............................... 27,000

Nov. 4 Cash ......................................................................... 7,080

©McGraw-Hill Companies, Inc., 2005

1. This material error should be reported on the statement of retained

2. This change in the expected useful life is a change in an accounting

Quick Study 13-8 (10 minutes)

Quick Study 13-9 (10 minutes)

Outstanding Fraction of Weighted

©McGraw-Hill Companies, Inc., 2005

Quick Study 13-11 (10 minutes)

Total stockholders' equity ............................................................... $920,000

Quick Study 13-12 (10 minutes)

Annual cash dividends per share $2.10

Analysis: The company’s dividend yield of 7.4% indicates that it should be

Quick Study 13-13 (10 minutes)

Price-earnings ratio = Market value per share = $30.75 = 7.5

©McGraw-Hill Companies, Inc., 2005

Exercise 13-2 (15 minutes)

©McGraw-Hill Companies, Inc., 2005

1. Organization Expenses .................................................. 30,000

2. Organization Expenses .................................................. 30,000

3. Cash ................................................................................. 70,000

4. Cash ................................................................................. 120,000

Exercise 13-4 (10 minutes)

©McGraw-Hill Companies, Inc., 2005

2004 ($24,000 paid)

2005 ($100,000 paid)

2006 ($196,000 paid)

2003-2006 ($330,000 paid) ______ _______

©McGraw-Hill Companies, Inc., 2005

2004 ($24,000 paid)

2005 ($100,000 paid)

2006 ($196,000 paid)

2003-2006 ($330,000 paid) _______ _______

©McGraw-Hill Companies, Inc., 2005

b. Total stockholders’ equity

c. Number of outstanding shares

b. Total stockholders’ equity

c. Number of outstanding shares

3. From a stockholder’s point of view, there is no practical

©McGraw-Hill Companies, Inc., 2005

Feb. 28 Common Stock Dividend Distributable ............... 300,000

Exercise 13-9 (25 minutes)

Nov. 1 Cash (1,200 x $36) ................................................. 43,200

©McGraw-Hill Companies, Inc., 2005

Nov. 25 Cash (3,300 x $25) ................................................. 82,500

2. Changes to the equity section include the following

(ii) The descriptions and dollar amounts for Contributed Capital in

(v) Total stockholders’ equity will change from $900,000 to $765,000.

2003-2006 ($330,000 paid) _

2003-2006 ($330,000 paid) _ _