SM ch10

CHAPTER 10
10-1 The preemptive privilege gives present shareholders the

opportunity to purchase additional shares directly from the
corporation before new shares can be sold to the general public.
In this way, the shareholders are able to maintain their
percentage ownership.
10-2 Unlike individual proprietors or partners, stockholders' personal

assets cannot be claimed by creditors to satisfy the debts of an
incorporated entity.
10-3 No. Before a share of common stock can be outstanding, it must

be duly authorized and issued.
10-4 No. Treasury stock is issued stock that has been repurchased
by the issuer and is no longer outstanding.
10-5 Dividends are never liabilities unless declared. Here liabilities is

used in the strict accounting sense. Cumulative dividends are
conditional obligations as the statement implies.
10-6 No. Liquidating value is the dollar measurement of the

preference to receive assets in the event of corporate liquidation.
10-7 Convertible securities are bonds and stocks that can be

transformed into common shares at the option of the holder.
500
10-8 Preferred stock and debt both have fixed payment rates. A
payment on preferred stock is called a dividend while the
payment on debt is called interest. While interest is a legal
obligation on the periodic payment date, dividends on preferred
and common stock are not an obligation of the company until
declared by the board of directors. A final, very important issue,
is that interest is an expense and reduces net income while
preferred and common dividends do not reduce net income.
10-9 Bonds are riskier for the corporation because interest and
principal payments are legal responsibilities. Preferred stock is
riskier for the investor because the corporation has no legal
obligation to pay dividends and most preferred stocks have an
infinite life.
10-10 When a company grants a stock option to an executive, it is
giving something of value for services rendered. When the
company grants other items of value to employees, they record
an expense. Many accountants think the same should happen
for stock options. The FASB required expensing as of mid-2005.
10-11 Stock options reward the employees only if the stock
appreciates in value. Stock options create incentives for
employees to work hard in the best interests of the
shareholders. There can also be tax advantages to options.
10-12 Cash dividends are real in the sense that they require the
disbursement of assets, whereas stock dividends do not.
10-13 No. It is impossible to increase every shareholders' fractional

portion of the company. A stock dividend does not affect
stockholders' fractional ownership.
Chapter 10 Stockholders' Equity 501

10-14 The use of high-percentage stock dividends (20% or more) is
merely another way of obtaining a stock split. Sometimes such
transactions are called a "stock split effected in the form of a
stock dividend." While the economic values are the same for
large stock dividends and splits, different stockholders’ equity
accounts may be involved in the accounting.
10-15 If shares are repurchased and permanently retired, the purchase
price is charged against common stock, additional paid-in
capital, and retained earnings. If the shares are to be held only
temporarily, they are listed as treasury stock and deducted from
stockholders’ equity in total; individual parts of stockholders’
equity are not reduced.
10-16 No. To retire shares, a company must pay the market price per
share.
10-17 There are many reasons a company might buy back its own
stock. It might be the most efficient way to distribute excess
cash to shareholders, especially after considering tax
consequences. It also allows more flexibility in timing and
amount of payment than does the payment of dividends.
Further, it may not create an expectation of higher dividends in
the future. Finally, it can demonstrate management’s
confidence in the prospects for the company.
10-18 Treasury stock is not an asset because it is a reduction of
stockholders' equity. Treasury stock is acquired by distributing
cash or other assets to shareholders. It arises from a return of
assets previously contributed by shareholders.
502
10-19 Although the specific accounting for transactions in the
company's own stock may vary from company to company, one
rule is paramount. Any differences between the acquisition
price and resale price of treasury stock must never be reported
as losses, expenses, revenues, or gains in the income
statement. Why? A corporation's own capital stock is part of its
capital structure. It is not an asset of the corporation. Nor is
stock intended to be treated like merchandise for sale to
customers at a profit. Therefore, changes in a corporation's
capitalization should produce no gain or loss, but should merely
require direct adjustments to the stockholders' equity.
10-20 The proper amount is the "fair value" of either the issued
securities or the incoming assets, whichever is more objectively
determinable. That amount should be used by both parties to
the exchange.
10-21 A conversion option allows an investor to participate in a
company’s success by converting to common shares.
Meanwhile, the investor can receive the interest on bonds or
dividends on preferred stock, and they do not bear the risk of
declines in the price of the common stock. These options are
valuable, so they make the bond or preferred stock more
valuable to an investor.
10-22 A voluntary restriction on dividend-declaring power may take
the form of a reserve for contingencies (also called an
appropriation of retained earnings for contingencies); an
involuntary restriction may be required by bond covenants.

10-23 Restrictions on dividend-declaring power protect the rights of
creditors. Such restrictions may be necessary to borrow
money. They may also reduce the interest rate lenders would
require. Finally, the choice to adopt the restriction may inform
investors about the intentions of the board.
10-24 ROE provides information about the returns investors in general
get from the cumulative investments they have made in the
company. However, most investors do not buy shares directly
from the company, they buy them from other investors in the
market. Thus, what a shareholder pays is often quite different
from his or her share of stockholders’ equity (book value per
share). An individual investor’s return is best measured by
dividends plus price increase divided by the price paid for the
shares.
10-25 A common stock with a market price of less than book value
may not necessarily be an attractive investment. The forecasted
earnings of the company may be too low to justify a higher
market price. The book value may not recognize a large
contingent liability from a law suit, for example. For example, a
major uncertainty for tobacco companies relates to the
possibility that lawsuits by former smokers will be successful.
While the risk is real, the outcome is far too uncertain to record
on the books. Further, book value includes the original costs of
assets, which may be far below or above their current values.
504
10-26 This is a reasonable argument if companies were allowed to
repurchase shares without investors knowing what they were
doing. However, in the United States, companies must
announce programs to repurchase shares and are restricted
from trading around certain information events such as
earnings releases. So, as long as the company announces that
they will be repurchasing before doing so, it does not seem
there is much of a problem. As pointed out in the text, everyone
is better off with repurchases than with dividends. Repurchases
allow those who desire cash to obtain it at lower tax cost than if
it were received as a dividend and protects those who do not
want cash from receiving a dividend, paying taxes, and
reinvesting the remaining money.
10-27 The notion of gains or losses in the income statement that arise
from transactions in the companies own stock is problematic for
two reasons. First, it suggests that the company is in the
business of buying and selling its own stock. This is false. The
company should never seek to make gains or losses in
transactions with its shareholders. So if it is not an activity that
is part of the ongoing profit-making intention of the company, it
should not be shown in the income statement. Moreover,
companies announce their intentions to buy shares of their
stock. It is basically a transaction that is an alternative to issuing
dividends. If the goal is to facilitate stockholder’s in their desires
to enhance their cash positions without committing to cash
dividends every quarter going forward, it is not a source of
operating gains and losses.

10-28 Your friend is onto something. Par value and the related
concept of stated value both have some legal significance in
various states. However, the truth is that the number of states
and individual companies for whom it matters is small. For
practical purposes, this text would probably not cover the topic
if it were not so common in published financial statements.
10-29 Strictly speaking, this plan does not make sense. If a stock is
split or a large stock dividend is issued (more than 25%), the
price per share should usually decline in proportion with the
new issue. The company has no more resources than it had
before and if each of our shares represents a smaller percentage
of ownership, we should expect the value of a share to drop
proportionately.
However, practically speaking, over the recent past, this has
been a reasonable strategy. It is hard to explain why. Perhaps it
suggests that management’s decision provides new
information. If management did not expect things to keep going
well, they would not undertake this step. Thus, the act of issuing
a split or dividend says, “I am rather sure things will keep going
well, as they have been.”
506
10-30 (5 min.)
There were 1,850,000 shares issued and outstanding, and
900,000 unissued shares:
Issued and outstanding: 2,100,000 – 250,000 = 1,850,000
Unissued: 3,000,000 – 2,100,000 = 900,000
Summary (not required) Number of Shares
Authorized 3,000,000
Unissued 900,000
Issued 2,100,000
Deduct: Shares held in treasury 250,000
Issued and outstanding 1,850,000
10-31 (5 min.) (Amounts in millions.)

Issued and outstanding: 1,921 – 199 = 1,722 shares
Unissued: 4,688 – 1,921 = 2,767 shares
Summary (not required): (in millions)

Number of Shares
Authorized 4,688
Unissued – 2,767
Issued 1,921
Deduct: Shares held in treasury – 199
Issued and outstanding 1,722
10-32 (20 min.)
See Exhibit 10-32 on the following page.

EXHIBIT 10-32
Liquidation of Claims Under Various Alternatives

(In Thousands)
Total Cash Proceeds to be Distributed

Account
Balances $1,400 $1,000 $800 $600 $500 $200
Accounts payable $ 300 $ 300 $ 300 $300 $300 $300 $120*
Unsubordinated debentures 200 200 200 200 200 200 80*
Subordinated debentures 300 300 300 300 100
Preferred stock
($20 par value and $24
liquidating value per share) 100 120 120
Common stock and retained earnings 300 480 80
Total liabilities and
shareholders' equity $1,200
Total cash proceeds distributed $1,400 $1,000 $800 $600 $500 $200
* Ratio of 60:40 because of claims of $300,000 and $200,000, respectively.
508
10-33 (5-10 min.) Amounts are in millions of yen.
1. Cash ($69,530 + $36,579) 106,109
Common stock 69,530
Capital surplus 36,579
To account for ¥50 par value shares issues at
¥76.30 per share.
2. In the United States, par value is usually small in relation to the
issue price of common shares. For Kawasaki Heavy Industries,
the par value is ¥50 ÷ ¥76.30 = 66% of the issue price.
10-34 (15-20 min.)
1. Preferred Dividends Common

Dividends
Net Income Declared In Arrears Declared
20X1 $(5,000,000) – $5,000,000 –

20X2 (4,000,000) – 10,000,000 –
20X3 15,000,000 $ 6,000,000** 9,000,000* –
20X4 20,000,000 14,000,000*** – $6,000,000 ***
20X5 13,000,000 5,000,000 – 8,000,000
Total $39,000,000 $25,000,000 $14,000,000
* $5 million per year times 3 years, less $6 million paid in 20X3.

** Available to declare = $(5) + $(4) + $15 = $6 million. All goes to preferred.
*** Available to declare = $20 million, preferred receives $9 million arrearage plus
$5 million for 20X4, balance to common.

10-34 (continued)
The board of directors is not legally obligated to declare

dividends at any time. Whether these amounts would be
declared and paid at the indicated times would depend on the
cash position, liabilities, and general financial plans. Indeed, the
likelihood of these large dividends being paid so soon is small.
Nonetheless, as long as the balance of retained earnings is
positive, in most states, the board could legally declare dividends
that would decrease the balance to zero.
Holders of cumulative stock would receive accumulated

dividends before the holders of common shares received any
dividends. Failure to pay dividends at the specific dates results
in arrearages, which is a word commonly used to describe
accumulated unpaid preferred dividends. The amount of
dividends in arrears is not a liability. Why? Because no
dividends are liabilities until declared.
2. Net Income Dividends Declared

Preferred Common
19X1 $(5,000,000) – –
19X2 (4,000,000) – –
19X3 15,000,000 $5,000,000 $1,000,000
19X4 20,000,000 5,000,000 15,000,000
19X5 13,000,000 5,000,000 8,000,000
$39,000,000 $15,000,000 $24,000,000
If the preferred is not cumulative, preferred shareholders get only

$15,000,000 compared to $25,000,000 otherwise.
510
10-35 (5-10 min.)
This preferred stock is cumulative, so all missed preferred stock

dividends must be paid before paying any common stock dividends.
Preferred dividends for 20X5, 20X6, and 20X7 are:
.07 x $4,000,000 x 3 = $840,000
After paying $840,000 in preferred dividends, $160,000 is left for

common stock dividends: $1,000,000 – $840,000 = $160,000
10-36 (10 min.) Amounts are in thousands.

November 15: Dividends declared 52,710
Dividends payable 52,710
To record dividends of $.07
per share.
December 15: Dividends payable 52,710
Cash 52,710
To record payment of cash dividends.
10-37 (10 min.)
Cash 80,000
Common stock 4,000
Additional paid-in capital 76,000
To record issue of 4,000 shares upon
exercise of options to acquire them @
$20 per share.

10-37 (continued)
Executives sometimes let their options lapse. For example, the

options expire worthless if the price of the common stock is
below $20 per share during the time they may be exercised. In
such a case, no journal entry is made.
Many observers have severely criticized the above practice

because no compensation (the value of the options) is ever
recorded as salary expense. For example, if the options were
required to be valued at the date they are granted at, say, $5 each,
or $25,000, the following entry is logical but is not required:
Salary or bonus expense 25,000

To record the value of 5,000 options
issued to buy 5,000 shares of common
stock at $20 per share.
In the early 1990’s the FASB contemplated a requirement to

recognize expense when options are granted. In the face of extreme
opposition, especially from high growth companies and Congress, the
FASB withdrew the proposal. Instead it required footnote disclosure
while allowing voluntary expense recognition. Following the major
examples of corporate misconduct, misleading and obscure
disclosures, and excessive compensation in the subsequent decade,
many companies have begun to expense option grants at the time of
the grant. The FASB has now decided that companies should
expense stock options beginning on June 15, 2005.
512
10-38 (15 min.)
The classic idea of a stock split has been to issue a number of
shares in exchange for each share of stock now outstanding. Thus a
3-for-2 split of a $30-par stock would mean that a shareholder would
receive three $20-par shares for each two $30-par shares exchanged.
This entails no formal change in the total dollar balance of common
stock.
As a practical matter, companies often accomplish such a split

via a 50% "stock dividend." Dean Foods used the 50% stock dividend
device, thereby automatically issuing one additional share for each
two shares outstanding. This necessitated charging retained earnings
at par for the total additional shares issued because the par value was
not reduced as it often is for a stock split. This way of obtaining a split
has a great attraction because it does not involve the bother and
expense of exchanging certificates.
"Stock dividends" of 25% or more are essentially stock splits and

should be accounted for as such. However, even though a stock
dividend requires a reduction of the balance in Retained Earnings and
an increase in Common Stock, total stockholders' equity is unaffected.
In substance, there is no important difference between the two ways of
accomplishing stock splits.

10-39 (5-10 min.)
1. A reverse stock split, like a regular stock split, does not affect any
of the account balances. Only the number of shares and the par
value (which is not shown by QED) are changed.
QED EXPLORATION, INC.
Stockholders' equity:
Common stock,
3,000,000 shares authorized
2,353,000 shares issued $ 287,637
Additional paid-in capital 3,437,547
Retained earnings 2,220,895
Less treasury stock, at cost,
101,755 shares (305,250)
Total stockholders' equity $5,640,829
2. Since the number of shares is reduced by a factor of ten, the

value of each share should be ten times higher. This is one
motivation for the reverse split, to increase the market value of
each share. These issues are not discussed at length in the text,
but the subsequent discussion could ask, why is this desirable?
Two reasons may be worth discussing. Some investors avoid,
or are prohibited from trading in shares valued below some
threshold, for example, $1. Some stock exchanges, such as the
NYSE, require minimum prices to remain listed for trading.
A more subtle point relates to the transactions costs investors
face. Brokers’ commissions may be based on a combination of
number of shares and price per shares. Higher priced shares
may produce lower commissions for a given percentage
ownership of the firm. In a similar vein, the bid/ask spread is
often an eighth or a quarter of a point. This cost is incurred per
share. A reverse split reduces the number of shares involved in
a $5,000 or $10,000 investment and thus may reduce transaction
costs.
514
10-40 (10 min.)
Common stock 73,726
To record 10% stock dividend.
10% X (7,397,133 – 24,529) x $45.00
=$33,176,718
10-41 (5-10 min.)

1. Treasury stock 3,532,117
Cash 3,532,117
Purchase treasury stock for
$42.53 × 83,050 = 3,532,116.50
2.
Beginning Balance $ 466,000
Additions 3,532,117
Balance $3,998,117
3.
Common Stock 8,305
Paid-in-capital 3,523,812
Cash 3,532,117

10-42 (15 min.)
1. Book value per common share
Total stockholders' equity - Book value of preferred stock
=
Number of common shares outstanding
$118,000,0 00 − $15,000,00 0
= = $51.50
2,000,000
2. Rate of return on common equity

Net income - Preferred dividends
Average common equity
$11,000,00 0 - (8% x $15,000,00 0))

=
1/2[($112, 000,000 - $15,000,00 0) + ($118,000, 000 - $15,000,00 0)]
$9,800,000
= = 9 .8 %
$100,000,000
3. Beginning Net Preferred Common Ending

retained + Income – Dividends – Dividends = retained
earnings earnings
$65,200,000 + $11,000,000 – $1,200,000 – Common dividends = $69,000,000
Common dividends = $6,000,000
Using a T-account, let X = Common dividends
Retained Earnings
1,200,000 Balance 65,200,000
X 11,000,000
Balance 69,000,000
X = $6,000,000
516
10-43 (10 min.)
Rate of return on common equity:

Net income - Preferred dividends
=
Average of (total stockholders' equity - Liquidating value of preferred equity)
$2,400,000 − $400,000
=
1 / 2 [($18,400,000 − 4,400,000) + ($20,000,000 − 4,400,000)]
$2,000,000
=
1 / 2 ($14,000,000 + 15,600,000)
$2,000,000
= = 13.5%
$14,800,000
Earnings per share of common stock:
Net income − Pr eferred dividends

=
Average number of shares outs tan ding
$2,000,000
= = $0.50
4,000,000
Price-earnings ratio:
Market price per share of common stock

=
Earnings per share of common stock
$10.00
= = 20
$0.50

10-43 (continued)
Common dividends per share

Dividend − payout ratio =
Common earnings per share
$.20
= = 4 0%
$.50
Dividend-yield ratio:
Common dividends per share

=
Market price per share of common stock
$.20
= = 2. 0%
$10.00
Book value per share of common stock
Stockholders' equity − Liquidating value of preferred stock

=
Number of common shares outs tan ding
$20,000,000 − $4,400,000
= = 3.90
4,000,000
Note that the book value is lower than the market value. This is typical.
The shareholders are paying for earning power rather than for assets.
518
10-44 (15-25 min.)
The dividends payable item is not part of stockholders' equity.
ROSELLI CORPORATION
Statement of Stockholders' Equity
December 31, 20X8
6% cumulative preferred stock, $40 par value,

callable at $42, authorized 100,000 shares,
issued and outstanding,100,000 shares $4,000,000
Common stock, $2.50 par value, authorized

1.8 million shares, issued 1.2 million shares
of which 60,000 shares are in the treasury 3,000,000
Additional paid-in capital:

Preferred $2,000,000
Common 9,000,000 11,000,000a

Subtotal $30,000,000
Deduct: Cost of 60,000 shares of

common stock reacquired and held
in treasury 4,000,000
a Many presentations would not show the detailed breakdown into preferred and
common stocks. Preferred stock would be shown as the sum of par and
additional paid-in capital of $6,000,000. Similarly, common would be
$12,000,000.

10-45 (10-15 min.)
You may wish to use a balance sheet equation to show the

overall effects of each item.
1. 0 5. 0 8. – $1,000
2. 0 6. – $50,000 9. + $1,200
3. – $800,000 7. 0 10. + $ 800
4. 0
10-46 (15 min.)
1. 20X7 and 20X8 preferred dividends must be paid before any

common dividends can be paid. Dividends are not paid on
treasury stock.
Preferred dividends = .06 x $10 x (52,136 – 11,528) x 2

= 48,730
Common dividends = $.04 x (1,322,850 – 93,091)
= $49,190
Retained earnings 48,730

Cash 48,730
To record the declaration and payment
of preferred dividends for 20X7 and 20X8.

Cash 49,190
of common dividends of $.04 per share.
520
10-46 (continued)
2. Ending balance = Beginning balance + Net income – Dividends

= $2,463,951 + $440,000 – $48,730 – $49,190
= $2,806,031
Retained Earnings
48,730 Balance 2,463,951
49,190 440,000
Balance 2, 806,031
10-47 (15-20 min.)
1. Note that a dividend reinvestment is not the same as a typical

stock dividend.

Dividends payable 494,195,827
Declaration of dividends,
$.20 x (3,490,818,627 − 1,019,839,490)
shares.
Dividends payable 494,195,827

Cash 444,776,244
Common stock 308,872
Capital surplus 49,110,711
To record payment of cash
(90% of $494,195,827) and issuance
of 1,235,490 additional shares under
automatic dividend reinvestment program.

10-47 (continued)
Amount of reinvestment:
10% ($494,195,827) $49,419,583
Price per share ÷ $ 40
Number of shares 1,235,490
Par value, 1,235,490 x $.25 = $ 308,872
Remainder: $49,419,583– $308,872 = $49,110,711
2. These automatic plans save brokerage fees and are a convenient

way for a company to raise additional capital. The letter writer
misses the point. The shareholder can have cash if desired
(unlike stock dividends). Therefore, the amount is justifiably
subject to personal income taxes because the cash is
"constructively received."
Different corporations are at different stages in their growth

cycles. Investors who do not desire dividends may prefer to
invest in growth stocks that do not pay dividends. These
investors can meet their periodic needs for cash by selling
shares.
522
10-48 (20-30 min.)
1. Cash 10,000,000
Common stock 2,000,000
To record the issuance of 400,000
shares of $5 par value for an average
price of $25 per share.
2. Retained earnings 400,000

Cash 400,000
of cash dividends of $1 per share on
March 31, 20X2.
3. Retained earnings 1,000,000

To record a 5% common stock dividend,
resulting in the issuance of 20,000 shares.
Retained earnings is reduced at the rate
of the market value of $50 per share at
date of issuance.

10-48 (continued)
Before 5% After 5%
Stock Stock
Dividend Changes Dividend
Common stock, 400,000 $ 2,000,000 + (20,000 shares $ 2,100,000

shares @ $5par @ $5 par)
= +100,000
Additional paid-in capital 8,000,000 + [20,000 shares 8,900,000
@ ($50 – $5)]
= +900,000
Retained earnings 9,000,000 – (20,000 @ $50) 8,000,000
= –1,000,000
Stockholders' equity $19,000,000 $19,000,000
Overall market value of stock
@ assumed $50 $20,000,000 @ assumed $47.62* $20,000,000*
Total shares outstanding 400,000 420,000
Individual shareholder:
Assumed ownership of shares 5,000 5,250
Percentage ownership interest 1.25% Still 1.25%
* Many simultaneous events affect the level of stock prices, including expectations
regarding the general economy, the industry, and the specific company. Thus,
the market price of a stock may move in either direction when a stock dividend is
declared. Theory and complicated case studies indicate that a stock dividend
should, on average, have zero effect on the total market value of the firm.
Accordingly, the new market price per share should be $20,000,000 ÷ 420,000
shares = $47.62.
First, note that individual shareholders receive no assets from

the corporation. Moreover, their fractional interests are
unchanged; if they sell their dividend shares, their proportionate
ownership interests in the company will decrease.
524
10-48 (continued)
Second, the company records the transaction by transferring the

market value of the additional shares from retained earnings to
common stock and "paid-in capital in excess of par." This entry
is often referred to as the "capitalization of retained earnings."
4. Investment in common stock of

Minneapolis Co. 125,000
Cash 125,000
To record investment in 5,000 shares
of an original issue of Minneapolis'
common stock at $25 per share.
The par value is $5 per share.
Cash 5,000
Dividend income 5,000
To record receipt of cash dividends
at $1 per share.
Stock dividends: No journal entry, but a memorandum would

be made in the investment account to show
that 5,250 shares are now owned at an
average cost of $125,000 ÷ 5,250 or $23.81 per
share.
5. Cash* 11,600
Investment in common stock** 4,762
Gain on sale of investment*** 6,838
* 200 ($58.00) = $11,600

* * 200 ($23.81) = $4,762
*** 200 ($58.00 – $23.81) = 200 x $34.19 = $6,838

10-49 (20-30 min.)
1. Cash 5,400,000
Common stock (at par) 600,000
shares of $1 par value for an average
price of $9 per share.

Cash 300,000
of cash dividends of $.50 per share on
December 31, 20X6.

Common stock 12,000
To record a 2% common stock dividend,
resulting in the issuance of 12,000 shares.
Retained earnings is reduced at the rate of
the market value of $30 per share at date
of issuance.
526
10-49 (continued)
Before 2% After 2%
Stock Stock
Common stock, 600,000 shares $ 600,000 + (12,000 shares $ 612,000
@ $1 par (612,000 after @ $1 par)
dividend) = +12,000
Additional paid-in capital 4,800,000 + [12,000 shares 5,148,000
@ ($30 – $1)]
= +348,000
Retained earnings 7,000,000 – (12,000 @ $30) 6,640,000
= –360,000
Overall market value of
stock @ assumed $30 $18,000,000 @ $29.412* $18,000,000*
Total shares outstanding 600,000 612,000
Individual shareholder:
Assumed ownership of shares 6,000 6,120
Percentage ownership interest 1% Still 1%
* Many simultaneous events affect the level of stock prices, including

expectations regarding the general economy, the industry, and the specific
company. Thus, the market price of a stock may move in either direction when
a stock dividend is declared. Theory and complicated case studies indicate that
a stock dividend should, on average, have zero effect on the total market value
of the firm. Accordingly, the new market price per share should be $18,000,000
÷ 612,000 shares = $29.412.
First, note that individual shareholders receive no assets from

the corporation. Moreover, their fractional interests are
unchanged; if they sell their dividend shares, their proportionate
ownership interests in the company will decrease.

10-49 (continued)
Second, the company records the transaction by transferring

the market value of the additional shares from retained earnings
to common stock and "additional paid-in capital." This entry is
often referred to as the "capitalization of retained earnings."
Garcia Company 36,000
Cash 36,000
To record investment in 4,000 shares of
an original issue of Garcia Company
common stock at $9 per share. The
par value is $1 per share.
Cash 2,000
Dividend income 2,000
To record receipt of cash dividends
at $.50 per share.
Stock dividends: No journal entry, but a memorandum would
be made in the investment account to show
that 4,080 shares are now owned at an
average cost of $36,000 ÷ 4,080 or $8.82 per
share.
5. Cash* 6,600
Investment in common stock of
Garcia Company** 1,764
Gain on sale of investment*** 4,836
* 200 ($33.00) = $6,600

** 200 ($8.82) = $1,764; $8.82 = original cost divided by number of shares
($36,000 ÷ 4,080)
*** 200 ($33.00 – $8.82) = 200 x $24.18 = $4,836
528
10-50 (15-20 min.) Amounts are in millions of Yen (¥).
1. (a) Cash 9,529

Tracking stock 3,917
(b) Treasury Stock 468

Cash 468
Cash 395
Treasury stock 373
Additional paid-in capital 22
2. The following statement differs from Sony’s actual statement

because the problem introduces items that are different from Sony’s
actual results.
Sony
Statement of Stockholders' Equity
End of Year, 2002
Tracking Stock (a) ¥ 3,917

Common stock (b) 471,815
Additional Paid-in capital (c) 967,847
Retained earnings (d) 1,209,262
Accumulated other comprehensive loss (e) (275,593)
Treasury stock (f) (7,588)
Total stockholders' equity ¥2,369,660
(a) see 1(a)

(b) 472,002 - 187
(c) 962,401 - 188 + 5,612 + 22
(d) 1,217,110 + 15,310 - 166 – 22,992
(e) (328,567) + 52,974
(f) (7,493) + (468) + 373

10-51 (15-20 min.)
1. The letter should contain the following points:
a) A stock split is a change of form but not substance. Why is

it considered "good news"?
b) A 5-for-4 stock split accomplishes little. It has only a small

effect on the trading range of the stock's price. For
example, a $40 stock becomes a $32 stock. It is unlikely
that such a small change will affect the marketability of the
stock.
2. The firm is doing well financially and we are therefore able to

increase cash dividends. We increased the number of shares
you own and also increased the cash dividend rate per share. As
a result, a shareholder owning 100 shares will have a 12%
increase in dividend payments per share and have 25% more
shares. The total cash dividend increase is 40%. (1.12 x 1.25) –
1.00 = 40%.
Teaching Note: Some students may interpret the increase of 12

percent as applied to total dividends. The following illustrates the
alternatives.
530
10-51 (continued)
What cash dividends per share will be paid after the split?
Will the current rate per share, including the 12% increase,
be maintained on the new shares? If so, the stock split
increases dividends another 25%, for a total cash dividend
increase of (1.12 x 1.25) – 1.00 = 40%. On the other hand, to
maintain only the 12% total dividend increase, the cash
dividends per share must fall after the split. The cash
dividend rate per share that maintains cash dividends at the
pre-split level (that is 12% above last year's level) is 1.00 ÷
1.25 = 80% of the pre-split cash dividends per share and
1.12 ÷ 1.25 = 89.6% of last year's cash dividend rate.
Consider an example where last year's cash dividends

were $10.00 per share. The 12% increase raises the cash
dividend rate to $11.20 per share. An owner of 4 shares
receives dividends of $44.80 compared to the previous
amount of $40. If the stock splits 5-for-4 and the $11.20 rate
is maintained, cash dividends for the stockholder are 5 x
$11.20 = $56, an increase of ($56 ÷ 40) – 1 = 40%. If the cash
dividends per share fall to .8 x 11.20 = $8.96 per share, the
owner would receive 5 x $8.96 = $44.80, the same amount
as just before the stock split.
You may wish to use this problem to discuss the benefits of a

share repurchase plan rather than dividend increases. If the
additional cash payments were used to repurchase shares rather
than to pay dividends, two benefits accrue. The firm “buys out”
its least enthusiastic owners. Furthermore, less of the payments
go to taxes. If dividends are paid, they are 100% taxable to the
recipient. In a repurchase, only the seller’s gain is taxed.

10-51 (continued)
3. The stockholder will still receive $4,200. The offer price per
share was changed in proportion to the increase in the number
of shares. Note that 100 x $42 = $4,200 and 125 x $33.60 =
$4,200. The change in form, the stock split, did not affect the
substance of the offer, the total price offered for United Financial.
10-52 (15-20 min.)
1. Retained earnings 5,000,000

Common stock, $1 par 497,000
Cash 30,000
To record 5% stock dividend. Total
additional shares were 5% x 10,000,000
= 500,000. Cash of $30,000 was
paid in lieu of 3,000 shares; therefore
497,000 new shares were issued.
2. SODERSTROM COMPANY
Stockholders' Equity
Common stock, 10,497,000 shares, $1 par $10,497,000

Additional paid-in capital* 44,473,000
Retained earnings** 45,000,000
* 40,000,000 + 4,473,000
** 50,000,000 – 5,000,000
532
10-52 (continued)
3. The stockholders' equity decreased by the amount of cash paid

in lieu of fractional shares. If all new shares had been issued,
total stockholders' equity would have been unaffected by the
stock dividend.
Except for the effect of fractional shares, each shareholder owns

the same proportion of the company as he or she did before the
stock dividend. The effect of paying cash in lieu of fractional
shares is to reduce by $30,000 the size of the company.
Shareholders who received no cash would have a slightly
increased proportional ownership interest. Suppose A owned
1% of the company before the stock dividend and received no
cash in lieu of fractional shares. A's ownership share after the
stock dividend would be (1% x $100,000,000) ÷ $99,970,000 =
1.0003%.

10-53 (15 min.)
1. 1/2/X1
Cash 100,000
Common stock 10,000
To record the issuance of 10,000 $1
par common stock for $10 per share.
12/27/X1
To record the declaration of
dividends of $.20 per share.
1/15/X2
Cash 2,000
To record the payment of dividends.
1/30/X2
Common stock 1,000
Cash 8,000
To record the retirement of 1,000
shares purchased for $8.00 per share.
534
10-53 (continued)
2. CHIPPEWA INVESTMENT COMPANY

Balance Sheet
As of December 31, 20X1
Assets Liabilities and Stockholders' Equity

Cash $110,000* Liabilities:
Total assets $110,000 Dividends payable $ 2,000
Stockholders' equity:
Common stock $ 10,000
Additional paid-in capital $ 90,000
Total Stockholders' Equity $108,000
Total liabilities and stock-
holders’ equity $110,000
* $114,000 – $4,000

10-54 (20-30 min.)
1. Cash 3,600,000
shares of $5 par value stock for an
average price of $36 per share.
An alternate journal entry follows:

Cash 3,600,000
Paid-in capital, common stock 3,600,000
2. Before After
2-for-1 2-for-1
Split Changes Split
– 100,000
@ $5 par
Common stock, 100,000 shares +200,000
@ $5 par $ 500,000 @ $2.50 par $ 500,000
Additional paid-in capital 3,100,000 3,100,000
Total paid-in capital 3,600,000 3,600,000
Retained earnings 4,000,000 4,000,000
There is no effect on the reported amount of the total

stockholders' equity. Although no formal journal entry is
required, the underlying stockholder records will be changed to
indicate the number of shares held by each shareholder.
536
10-54 (continued)
3. Before After
100% Stock 100% Stock
Common stock, 100,000 + (100,000 shares
shares @ $5 par $ 500,000 @ $5) = $500,000 $1,000,000
Additional paid-in capital 3,100,000 3,100,000
Total paid-in capital $3,600,000 $4,100,000
Retained earnings 4,000,000 – $500,000 par 3,500,000
_________ value of "dividend" _________
The journal entry would be:

To record stock split in the form of a
100% stock dividend, necessitating a
transfer from Retained Earnings to
Common Stock of the par value of
the additional shares issued,
100,000 x $5 = $500,000.
Lopez Company 72,000
Cash 72,000
To record investment in 2,000 shares of
an original issue of Lopez Company
common stock at $36 per share. The
par value is $5 per share.
The stock split at 2 for 1 (or receipt of a 100% "dividend") would
call for no journal entry. A memorandum would be made to
show that 4,000 shares are now held at a cost of $18.00 each
instead of 2,000 shares at a cost of $36 each.

10-55 (20-30 min.) Dollar amounts are in millions.
1. Cash 2,800
Common stock at 200
To record the issuance of 200 million shares
of $1 par value common stock for an
average price of $14 per share.
An alternate journal entry follows:

Cash 2,800
Paid-in capital, common stock 2,800
2. Before After
2-for-1 Split Changes 2-for-1 Split
Common stock, 200 – 200 @ $1 par

million shares @ $1 par $ 200 + 400 @ $.50 par $ 200
Additional paid-in capital 2,600 2,600
Total paid-in capital 2,800 2,800
Retained earnings 5,000 5,000
Stockholders' equity $7,800 $7,800
There is no effect on the reported amount of the total

stockholders' equity. Although no formal journal entry is
required, the underlying stockholder records will be changed to
indicate the number of shares held by each shareholder.
538
10-55 (continued)
3. Before 100% After 100%

Stock Stock
Common stock, 200 $ 200 + (200 @ $1) = $ 400

million shares @ $1 200
par
Additional paid-in capital 2,600 2,600
Total paid-in capital 2,800 3,000
Retained earnings 5,000 – 200 par value of 4,800
"dividend"
Stockholders' equity $7,800 $7,800

Retained earnings 200
Common stock 200
To record stock split in the form of a 100%
stock dividend, necessitating a transfer
from Retained Earnings to Common
Stock of the par value of the additional
shares issued, 200 million x $1 = $200 million.
4. (Amounts not in millions)

Investment in common stock of AT&T 28,000
Cash 28,000
To record investment in 2,000 shares
of an original issue of AT&T common
Stock at $14 per share.
The stock split at 2 for 1 (or if received as a 100% "dividend")

would call for no journal entry. A memorandum would be made
to show that 4,000 shares are now held at a cost of $7.00 each
instead of 2,000 shares at a cost of $14 each.

10-56 (10-15 min.)
1. There are two possible ways to account for the stock split. The
first requires no journal entry. The par value per share is simply
changed from $1 to $.50, and the number of shares outstanding
is changed from 300,000 to 600,000. Physically the issuing
company must exchange shares with its shareholders. The
second way would entail no change in par value and the
following journal entry:
Additional paid in capital 300,000


Common stock, $1 par 300,000
To record a 100% stock dividend.
3. There is no difference in substance. In form, the stock split

results in a halving of the par value per share but the 100% stock
dividend does not affect par value per share. The 100% stock
dividend requires a decrease in retained earnings and an
increase in common stock in the amount of the par value of the
new shares, $300,000, but no equity balances are affected by a
stock split.
540
10-57 (15-20 min.) Account balances and entries in millions.
1. Treasury stock 942

Cash 942
To acquire 7.9 million shares
2. $4,633 million + $942 million – $4,767 million = $808 million.
3. Treasury stock 6.5

Cash 6.5
1/1/03 Stockholders’ equity = $5,993 – $6.5 = $5,986.5
4. Cash 9.0
Treasury stock 6.5
Capital in excess of par 2.5
3M might maintain an internal separation of its paid-in-capital and

distinguish this as capital from a treasury stock transaction. The
journal entry assumes this is not true.
Many companies adopt a LIFO or FIFO cost flow assumption for

treasury shares, most often FIFO. The problem could be read to
imply specific identification, but this is rare.

10-57 (continued)
5. Cash 5.0
Capital in excess of par 1.5
Treasury stock 6.5
Some companies divide Additional Paid-in Capital into several

separate accounts that identify different sources of capital, for
example:
Additional paid-in capital -- preferred stock

Additional paid-in capital -- common stock
Additional paid-in capital -- treasury stock
transactions
A consistent accounting treatment would call for debiting only

Additional Paid-in Capital-Treasury Stock Transactions (and no
other paid-in capital account) for the excess of the cost over the
resale price of treasury shares. If there is no balance in such a
paid-in capital account, the debit should be made to Retained
Earnings.
542
10-58 (25 min.) Dollar amounts are in millions.
1. The change in outstanding common shares must be due to the
issuance of new shares and the purchase or reissue of treasury
stock. The number of shares of treasury stock reissued is
43,956,000 and this is equal to the change in outstanding shares.
No new shares were issued.
Shares outstanding, beginning of year 9,969,894,000
Shares outstanding, end of year 9,925,938,000
Change (increase) in shares outstanding 43,956,000
Treasury shares, beginning of year 1,219,274,000

Treasury shares, end of year 1,175,318,000
Shares reissued 43,956,000
2. Reduction in cost of treasury shares ($26,627 - $26,619) $289
Proceeds above cost of treasury shares 595
Net proceeds from treasury shares sold $884
3. Increase in retained earnings ($75,553 − $68,701) $ 6,852

Cash dividends 7,266
Net income $14,118

10-58 (continued)
4. In 2002 GE was a net issuer of Treasury shares, but in most years
it is a net purchaser. In 1999, for example, General Electric
returned $7,488 million to shareholders by purchasing its own
shares and returned $4,786 by paying cash dividends.
The dividends are part of a stable pattern of dividend increases.
Many companies believe that a steadily increasing cash dividend
is better than the same total dividends across time paid in an
erratically fluctuating pattern. Thus, General Electric would not
want to greatly increase its dividend in one year and possibly be
faced with a subsequent dividend cut. In addition, purchasing
shares returns money to those shareholders who most want the
cash, that is, those who elect to sell their shares. Those
shareholders also get a tax advantage because gains in the value
of the shares are taxed at the capital gains tax rate, while
dividends are taxed at the ordinary income rate.
In 2002 the net reissuance of shares may have been associated
with acquisitions of other firms or share issuance associated
with stock options.
544
10-59(15-25 min.) Amounts are in millions of CHF.
1. Stockholders’ equity:
Common stock, par value CHF 404
Additional paid-in capital and retained earnings 36,993
Less: Treasury stock 2,578
Total stockholders’ equity CHF 34,819
2. Treasury stock 606
Cash 606
To record the purchase of 1,837,972 shares.
3. The cost of the reissued shares was CHF606,000,000 ÷ 1,837,972
= CHF329.71 per share. The journal entry for reissue is (not in
millions):
Cash 55,000
Share premium and reserves 35,670
Treasury stock 90,670
To record the reissue of treasury
shares on the exercise of stock options.
4. From requirement 3, we know that the price of the shares

purchased during the year was CHF329.71 per share. Shares were
sold for CHF392,000,000 / 1,103,167 = CHF355.34 per share. Nestle
footnotes not included in the problem reveal that only a small portion
of reissued shares (91,535) were issued to satisfy option exercise.

10-60 (15 min.)
1. $4,480,000,000 ÷ $37.70 = 118,832,891 shares
2. Book value = $74,597 million ÷ 6,700 million = $ 11.13
3. Book value = ($74,597 million + 4,480 million) ÷
($6,700 million + 119 million) =
79,077 ÷ 6,819 = 11.60
The purchase of treasury shares occurred at above book value

and reduced the book value of the remaining shares.
546
10-61 (15-20 min.)
Before After
Repurchase of Repurchase of
Outstanding Changes Because of Outstanding
Shares Retirement Shares
Common Stock, 6,000,000 $12,000,000 – (200,000 shares @$2) $ 11,600,000

shares @ $2 par = –$400,000
Paid-in capital in excess of par 48,000,000 – (200,000 shares @ $8) 46,400,000

= –$1,600,000
Total paid-in capital $60,000,000 $58,000,000
Retained earnings 10,000,000 – (200,000 shares @ 4,000,000
$30) = –$6,000,000
Average initial paid-in-capital is $8 calculated as $48,000,000 ÷

6,000,000. The journal entry would reverse the original average
paid-in capital per share and would charge any additional
amount to retained earnings. The additional $30 is sometimes
described as being tantamount to a special cash dividend paid to
the 200,000 shares:

Paid-in capital in excess of par 1,600,000
Cash 8,000,000
To record retirement of 200,000 shares
of stock for $40 cash per share. The
original paid-in capital was $10 per
share, so the additional $30 per share is
debited to Retained Earnings.
10-62 (15 min.)

1. Cash 60,000
To record sale of 5,000 shares of
treasury stock for $12 per share.
Cost was $10 per share.
2. Cash 45,000
To record sale of 5,000 shares
of treasury stock for $9 per
share. Cost was $10 per share.
3. Cash 35,000
To record sale of 5,000 shares
of treasury stock for $7 per share.
Cost was $10 per share.
Note that the maximum amount that could be deducted from

additional paid-in capital was the $10,000 added to additional
paid-in capital when the first 5,000 shares of treasury stock were
sold. The extra $5,000 had to be deducted from retained
earnings.
4. No. Buying or selling treasury stock never results in recognizing

gains or losses on the income statement. Treasury stock
transactions are changes in a corporation's capitalization, not
part of its profit generation activities.
548
10-63 (10 min.)
1. (In Millions of Dollars)

After Dividend
Before Payments of
Dividends $4 $1
Paid-in capital $24 $24 $24
Retained earnings 9 5 8
Total 33 29 32
Deduct:
Cost of treasury stock 6 6 6
Stockholders' equity $27 $23 $26
2. Typically states do not permit dividends if retained earnings does

not exceed the cost of any treasury stock on hand. A lack of this
restriction could jeopardize the position of the creditors. Without
a $6 million restriction of retained earnings (the cost of the
treasury shares), the corporation could pay a dividend of $4
million and thus reduce the stockholders' equity below the paid-
in capital of $24 million. In our example, this restriction of $6
million would leave unrestricted retained earnings (and
maximum legal payment of dividends) of $9 – $6, or $3 million.
Thus, the largest dividend allowed would be $3 million.

10-64 (10-20 min.)
1. The stockholders' equity section would be affected as follows:
Before After
Repurchase Changes Repurchase
of 100,000 Because of of 100,000
Outstanding Treasury Outstanding
Shares Stock Shares
Common stock, 2,000,000
shares @ R3 par R 6,000,000 R 6,000,000
Paid-in capital in excess of par 34,000,000 34,000,000
Total paid-in capital R40,000,000 R40,000,000
Retained earnings 18,000,000 18,000,000
Total R58,000,000 R58,000,000
Deduct:
Cost of treasury stock – – 4,000,000 4,000,000
Stockholders' equity R58,000,000 R54,000,000
Treasury stock 4,000,000
Cash 4,000,000
To record acquisition of 100,000
shares of common stock @ R40 (to
be held as treasury stock).
Note that the treasury stock account does not represent an asset
but a negative element of stockholders' equity.
2. Cash 5,000,000
To record sale of treasury stock,
100,000 shares @ R50. Cost was
R40 per share.
550
10-64 (continued)
3. Cash 3,000,000
To record sale of treasury stock,
100,000 shares @ R30. Cost
was R40 per share.
If the treasury shares are resold below their cost, accountants
tend to debit Additional Paid-in Capital for the difference, $10 per
share in this case.
Additional Paid-in Capital is sometimes divided into several
separate accounts that identify different sources of capital, for
example:
Additional paid-in capital -- preferred stock
Additional paid-in capital -- common stock
Additional paid-in capital -- treasury stock
transactions
A consistent accounting treatment would call for debiting only
Additional Paid-in Capital-Treasury Stock Transaction (and no
other paid-in capital account) for the excess of the cost over the
resale price of treasury shares. If there is no balance in such a
Paid-in Capital account, the debit should be made to Retained
Earnings.
The accounting illustrated here assumes on-going transactions
in treasury stock. As illustrated in the text, when shares are
purchased in the open market and retired, paid-in capital
accounts are reduced proportionately and retained earnings is
also typically reduced.

10-64 (continued)
4. Book value is calculated on outstanding shares. The original

book value per share was R29. The new book values will be:
(1) R54,000,000/1,900,000 shares = R28.42

(2) R59,000,000/2,000,000 shares = R29.50
(3) R57,000,000/2,000,000 shares = R28.50
10-65 (20-25 min.)
Cumulative preferred stock 4,000

Additional capital 160,000
To reissue 6,000 shares of treasury
stock with an average cost of
$27.33 in exchange for shares
of cumulative preferred stock.
Cash 8,593,000
Additional capital 838,000
To reissue 311,000 shares of
treasury stock with an average
cost of $24.94 in conjunction
with the exercise of stock options
at an average price of
$8,593,000 ÷ 311,000 = $27.63.
552
10-65 (continued)
Note: A journal entry for the final "transaction" for "other, net"
was not required. It is a mixture of items with
approximately the following effect.
Cash, etc. 33,032,000

Additional capital 27,259,000
10-66 (10-15 min.) See Exhibit 10-66 on the following page.

EXHIBIT 10-66
1.
Assets = Liabilities + Stockholders' Equity
Additional Additional
Paid-in Paid-in
Preferred Capital, Common Capital,
Cash Stock Preferred Stock Common
Hartford Company Books
Issuance of preferred +150,000 = +50,000 +100,000

Conversion of preferred = –50,000 –100,000 +10,000 +140,000
Investment Investment
in Hartford in Hartford
Cash Preferred Common
Boston Company Books
Acquisition of preferred –150,000 +150,000 =

Conversion of preferred –150,000 +150,000 =
554
10-66 (continued)
2. On issuer's books (Hartford):
Cash 150,000
Preferred stock, convertible 50,000
Additional paid-in capital, preferred 100,000
To record issuance of 10,000 shares of
$5 par preferred stock convertible into
one common share for one preferred
share.
Preferred stock, convertible 50,000

Additional paid-in capital, preferred 100,000
Common stock 10,000
Additional paid-in capital, common 140,000
To record the conversion of 10,000
preferred shares to 10,000 common
shares.
On investor's books (Boston):
Investment in Hartford Company
convertible preferred stock 150,000
Cash 150,000
To record acquisition of 10,000 shares
convertible into common at the rate of
two common shares for one preferred.

common stock 150,000
preferred stock 150,000
To record conversion of 10,000 preferred
shares into 10,000 common shares.

10-67 (15 min.)
1. a. Cash 10,765,977
b. Cash 218,093
Common stock 10,140
c. Cash 355,275
Common stock 52,970
2. Stockholders' equity:
Common stock: authorized 10,000,000
shares with 60¢ par value; issued
and outstanding 5,396,091 shares $ 3,237,655
2,706,545+ 468,000 + 10,140 + 52,970 = 3,237,655

4,603,092 +10,297,977+207,953 + 302,305 = 15,411,327
8,128,230+4,008,991 = 12,137,221
10-68 (10-15 min.)
See Exhibit 10-68 on the following page.
556
EXHIBIT 10-68
1. The proper amount is the "fair value" of either the issued securities or the incoming assets, whichever is more
objectively determinable. That amount should be used by both the investor and the issuer of the securities.
In this case, the market value of Cartier’s common stock would be regarded as a more objectively determinable
fair value than the book value (undepreciated) of Marseilles’s equipment. Thus, the transaction value would be
10,000 shares x €50 = €500,000. The accounts would be affected as follows (in euros):
Assets = Liabilities + Stockholders' Equity
Additional
Common Paid-in
Equipment Stock Capital
Issuance of stock +500,000 = + 10,000 + 490,000
by Cartier
Investment
in Common Accumulated
Stock Equipment Depreciation Retained earnings
Disposal of equipt. ⎡ Gain on ⎤
by Marseilles +500,000 –520,000 +100,000 = +80,000 ⎢disposal of ⎥
⎢⎣ equipment ⎥⎦
2. On issuer's books: Equipment 500,000

(Cartier) Common stock 10,000
On investor's books: Investment in Marseilles stock 500,000
(Marseilles) Accumulated depreciation, equipment 100,000
Equipment 520,000
Gain on disposal of equipment 80,000

10-69 (10-15 min.)
1. Since one restricted ratio is the asset value to debt ratio, entering
a capital lease would increase both the numerator and
denominator equally but the ratio would be reduced because
total assets are greater then total debt. Thus, Mitchell would be
more likely to use operating leases if it is near the covenant
levels. The leasing choice would not affect consolidated
shareholder's equity except as it related to the future effect on
earnings.
2. Covenants provide assurance to investors. Without covenants

investors face more risk and require higher returns so the issue
price of the debt would fall or the interest rate would rise.
3. Cash $248 million

Common Stock $248 million
4. 1,000 shares @ $53 per share was $53,000.

In the merger the investor will receive 1,000 X $31 = $31,000 in
cash. The investor will receive .585 X 1,000 = 585 shares of
Devon valued at $50.76 per share or $29,695.
Total proceeds = $31,000 + $29,695 = $60,695.
With a cost basis of $53,000 this is a profit of $7,695.
558
10-70 (15-20 min.)
1. Number of shares, Adobe: $191,000,000 ÷ $.96 = 198,958,333
Number of shares, Empire: $28,300,000 ÷ $1.29 = 21,937,985
Book value per share, Adobe: ($1,052 million - $378 million = 674
million) ÷ 198,958,333 = $3.39
Book value per share, Empire: ($653 million – 391 million = 262
million) ÷ 21,937,985 = $11.94
Market to book, Adobe: $39 ÷ $3.39 = 11.5
Market to book, Empire: $21 ÷ $11.94 = 1.76
Because we do not have beginning stockholders' equity, we

must use ending rather than average stockholders' equity to
compute ROE.
Return on stockholders’ equity, Adobe: $191,000 ÷ $674,000 =

28.3%
Return on stockholders’ equity, Empire: $28,300 ÷ $262,000 =
10.8%
2. Adobe is a young, fast-growing company in a dynamic industry.
Many of the assets of a company such as Adobe are “intellectual
capital” and thus do not appear on the balance sheet. On the
other hand, Empire District has primarily tangible fixed assets.
Therefore, the denominator for both ratios is likely to be
understated for Adobe compared to Empire District, making both
ratios larger for Adobe.

10-71 (15 - 20 min.) Amounts are in millions.
1. ENRON CORPORATION
Shareholders’ Equity
December 31, 1999
Preferred stock, cumulative, no par value,
1,370,000 shares authorized, 1,296,184
shares issued $ 130
Common stock, no par value,
1,200,000,000 shares authorized,
716,865,081 shares issued 6,637
Common stock held in treasury, 1,337,714 shares (49)
Accumulated other comprehensive income (loss) (741)
Other 895
Total stockholders’ equity $9,570
2. Increase in retained earnings ($2,698 − $2,226) $472

Cash dividends ($355 + $66) 421
Net income $893
3. The number of treasury shares decreased by, 9,333,322 −

1,337,714 = 7,995,608 shares. The average cost of the shares sold
was ($195,000,000 − $49,000,000) ÷ 7,995,608 = $18.26 per share.
The remaining shares have an average cost of $49,000,000 ÷
1,337,714 = $36.63 per share.
4. ($9,570 million - $130 million) ÷ 715,527,367* = $13.19 book value

per share. Market-to-book ratio is $45 ÷ $13.19 = 3.41.
* (716,865,081 – 1,337,714)
5. $91 X 716 million = $65,156.0 million

$.04 X 716 million = 28.6 million
Loss $65,127.4 million
560
10-72 (10-15 min.)
1. No expense would be recorded. Footnotes indicated that
earnings would drop from $2 billion to $1.8 billion if expensed.
2. Many executives would say that there was no value because the
option was issued for the market price. Nevertheless, holding
the option allows the executive to participate in any increase in
stock price without making an investment in the stock and
without bearing the risk of decreases in stock price. Independent
investors were apparently willing to pay $12 per share for a
privilege similar (though not identical) to the stock options.
However, the warrant holders have fewer constraints on
exercising their warrants, so they get more value for them than
the executives receive from their options. Therefore, the options
were worth less than $12 to the executives. There are
mathematical models that predict the value of such options, but
everyone is not convinced of the accuracy of such models.
Footnotes show a Black-Scholes value of $11.12 for the options.
3. The amount the firm gives up in issuing the option is the amount
it could have received for a warrant with identical restrictions.
This would also be slightly under $12. This is an opportunity
cost, not a cash outlay.
4. An advantage often cited for stock options is that they align the
interests of executives and stockholders. To a great extent this is
true; increases in stock prices provide benefits to both.
Nevertheless, there are incentives regarding dividends that may
not be aligned. Executives who hold stock options want the
stock price to grow, and one way to speed the growth of stock
price is to pay no dividends. If this dividend policy is not in the
stockholders’ best interest, executives may face an ethical
dilemma. This may be mitigated by the fact that the board of
directors, not management, declares dividends. Nevertheless,
management often has a large influence on the board's dividend
decisions.

10-73 (50 min. or more)
The purpose of this exercise is to develop an understanding of
how market-to-book and return on stockholders’ equity ratios might
differ across companies in different industries. Both ratios have
stockholders’ equity in the denominator, so industry characteristics
that affect stockholders’ equity will affect both ratios similarly. For
example, industries with large amounts of intellectual capital (which
does not appear on the balance sheet) rather than physical capital, will
tend to have large values for both ratios. Prospects for earnings
growth will affect mainly the market-to-book ratio because the market
price will reflect such prospects.
The individual research will develop the students’
understanding of the stockholders’ equity section of the balance sheet
as well as their interpretation of the ratios. The group session will pool
more information than an individual student has time to gather in order
to develop generalizations about the ratios across industries and firm
characteristics.
10-74 (30-45 min.)
Each solution will be unique and will change each year. The
purpose of this problem is to examine transactions that affect
stockholders' equity.
562
10-75 (40-50 min.) Amounts are in millions.
1. Starbucks paid no dividends. If they had, they would be shown

in the financing activities section of the statement of cash flows and in
the retained earnings column of the statement of shareholders’ equity.
2. Cash 129,108,000
Common stock 8,000
To record the issue of 8,019,604
shares of common stock on the
exercise of stock options.
Cash 14,665,000
Common stock 1,000
To record the sale of 743,340
shares of common stock.
3. For stock options: $129,108,000 ÷ 8,019,604 = $16.10

For stock sold: $14,665,000 ÷ 743,340 = $19.73.

10-76 (30-60 min.)
NOTE TO INSTRUCTOR. This solution is based on the web site as it

was in late 2004. Be sure to examine the current web site before
assigning this problem, as the information there may have changed.
1. According to the 2003 annual report, UPS had the following

stock authorized: 1) preferred stock, no par value, authorized 200
million shares, none issued, 2) class A common stock, $0.01 par value,
authorized 4,600 million shares, issued 571 million shares, 3) class B
common stock, $0.01 par value, authorized 5,600 million shares,
issued 560 million shares. Only the preferred stock has not been
issued. There is an Additional Paid-in Capital account, which indicates
that the common stock was sold for more than par value. This is also
evident from stock issues listed on the Statement of Stockholders’
Equity.
2. Number of shares UPS can issue:

200 million preferred shares
4,600 million – 571 million = 4,029 million class A shares
5,600 million – 560 million = 5,040 million class B shares
If all these shares were issued both cash and stockholders’ equity
would increase.
UPS does have treasury stock, which is a deduction from

Stockholders’ Equity.
564
3. Changes in the common stock accounts are due to: 1)
common stock purchases, 2) stock award plans, 3) common stock
issues, and 4) conversion of class A stock to class B stock. This is
seen most easily in the Statements of Consolidates Shareowners’
Equity.
4. UPS did not declare any stock splits or stock dividends during
2002 or 2003. UPS may want to declare a stock split to lower the
market price of its stock.
5. UPS has a stock option plan. UPS adopted the fair value
measurement provisions of FASB Statement No. 123 on January 1,
2003. In years prior to 2003, it used the intrinsic value method
prescribed by APB Opinion #25. It did not recognize compensation
expense for stock

SM ch10

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

SM ch10

Uploaded by

Copyright:

Available Formats

CHAPTER 10

10-1 The preemptive privilege gives present shareholders the

10-2 Unlike individual proprietors or partners, stockholders' personal

10-3 No. Before a share of common stock can be outstanding, it must

10-5 Dividends are never liabilities unless declared. Here liabilities is

10-6 No. Liquidating value is the dollar measurement of the

10-7 Convertible securities are bonds and stocks that can be

10-13 No. It is impossible to increase every shareholders' fractional

Chapter 10 Stockholders' Equity 501

Chapter 10 Stockholders' Equity 503

Chapter 10 Stockholders' Equity 505

10-31 (5 min.) (Amounts in millions.)

Summary (not required): (in millions)

10-32 (20 min.)

See Exhibit 10-32 on the following page.

Chapter 10 Stockholders' Equity 507

Liquidation of Claims Under Various Alternatives

Total Cash Proceeds to be Distributed

* Ratio of 60:40 because of claims of $300,000 and $200,000, respectively.

10-34 (15-20 min.)

1. Preferred Dividends Common

20X1 $(5,000,000) – $5,000,000 –

* $5 million per year times 3 years, less $6 million paid in 20X3.

Chapter 10 Stockholders' Equity 509

The board of directors is not legally obligated to declare

Holders of cumulative stock would receive accumulated

2. Net Income Dividends Declared

If the preferred is not cumulative, preferred shareholders get only

This preferred stock is cumulative, so all missed preferred stock

.07 x $4,000,000 x 3 = $840,000

After paying $840,000 in preferred dividends, $160,000 is left for

10-36 (10 min.) Amounts are in thousands.

10-37 (10 min.)

Chapter 10 Stockholders' Equity 511

Executives sometimes let their options lapse. For example, the

Many observers have severely criticized the above practice

Salary or bonus expense 25,000

In the early 1990’s the FASB contemplated a requirement to

As a practical matter, companies often accomplish such a split

"Stock dividends" of 25% or more are essentially stock splits and

Chapter 10 Stockholders' Equity 513

2. Since the number of shares is reduced by a factor of ten, the

10-41 (5-10 min.)

Chapter 10 Stockholders' Equity 515

2. Rate of return on common equity

$11,000,00 0 - (8% x $15,000,00 0))

3. Beginning Net Preferred Common Ending

Using a T-account, let X = Common dividends

Rate of return on common equity:

Earnings per share of common stock:

Net income − Pr eferred dividends

Market price per share of common stock

Chapter 10 Stockholders' Equity 517

Common dividends per share

Common dividends per share

Book value per share of common stock

Stockholders' equity − Liquidating value of preferred stock

The dividends payable item is not part of stockholders' equity.

6% cumulative preferred stock, $40 par value,

Common stock, $2.50 par value, authorized

Additional paid-in capital:

Retained earnings 12,000,000

Deduct: Cost of 60,000 shares of