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Chapter 13 Corporations Review Questions 1.

A corporation is a separate legal entity organized independently of its owners.

2.

Corporations can raise more money than a proprietorship or partnership. A corporation has a continuous life. The transfer of corporate ownership is easy. However, ownership and management are often separated. Corporations pay business income tax, and their shareholders pay income tax on the dividends, thus getting taxed twice.. Government regulation is also expensive

3. Authorized stock is the maximum number of shares of stock that the corporate charter allows for the corporation to issue. Outstanding stock is issued stock in the hands of the stockholders. 4.

Issued Stock is stock that has been issued but may or may not be held by stockholders while Capital stock represents the individual’s ownership of the corporation’s capital.

5.

Stock that is held by the stockholders is said to be outstanding stock. The outstanding stock of a corporation represents 100% of its ownership

6.

Stockholders have a preemptive right to maintain their proportionate ownership in the corporation. Other stockholder rights include the right to vote, the right to receive dividends, and the right to receive their proportionate share of the company’s assets in case of liquidation. These rights can be withheld by contract.

7.

A firm that handles the issuance of a company’s stock to the public, usually assuming some of the risk by agreeing to buy the stock if the firm cannot sell all of the stock to its clients is an underwriter. Brokerage firms like Morgan Stanley are underwriters.

8.

The par value is an amount assigned by a company to a share of its stock. The price that the corporation receives from issuing stock is called the issue price. Usually, the issue price exceeds par value because par value is normally set quite low

9. A premium is the amount above par at which a stock is issued, while a discount is the amount below par at which a stock is issued. 10. A preferred stock dividend is in arrears if the cumulative dividend has not been paid for the year.

11. The three relevant dates involving cash dividends are the declaration date, date of record, and payment date. a. On the declaration date the board of directors announces the intention to pay the dividend. The declaration of a cash dividend creates an obligation (liability) for the corporation. b. Date of record is the date the corporation records which stockholders get dividend checks. Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

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c. Payment of the dividend usually follows the record date by a week or two. 12.A stock dividend of less than 20% to 25% of the issued and outstanding stock is a small stock dividend while one greater than that is a large stock dividend.

13. A stock dividend is a distribution of a corporation’s own stock to its stockholders. 14. When a stock dividend is declared, there is no change to the accounting equation because it does not create a liability. The make-up of stockholders’ equity does, however, change. When the dividend is distributed, the accounting equation stays the same, but the stockholder’s equity will just be rearranged. For a small stock dividend, common stock and paid-in capital in excess of par increase and retained earnings decrease. For a large stock dividend, common stock increases and retained earnings decrease. 15. A company issues stock dividends for several reasons: a. To continue dividends but conserve cash b. To reduce the market price per share of its stock c. To reward investors 16. A stock split is an increase in the number of issued and outstanding shares of stock coupled with a proportionate reduction in the par value of the stock. 17. Treasury stock is a corporation’s own stock that it has previously issued and later reacquired. Its normal balance is a debit. 18. Treasury stock is reported beneath retained earnings on the balance sheet as a reduction to total stockholders’ equity. 19. The statement of retained earnings reports how the company’s retained earnings balance changed from the beginning of the period to the end of the period. 20. A prior-period adjustment is a correction to retained earnings for an error in an earlier period.

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Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

21. The statement of stockholders’ equity is another option for reporting the changes in stockholders’ equity of a corporation. This statement has more information than the statement of retained earnings in that it reports the changes in all stockholders’ equity accounts, not just retained earnings. 22. Earnings per share reports the amount of net income (loss) for each share of the company’s outstanding common stock. It is calculated by taking net income minus preferred dividends divided by the weighted average number of common shares outstanding. 23. The price/earnings ratio is the ratio of the market price of a share of common stock to the company’s earnings per share. It is calculated by taking the market price per share of common stock and dividing it by earnings per share. 24. The rate of return on common stock shows the relationship between net income available to common stockholders and their average common equity invested in the company. It is calculated by taking net income minus preferred dividends and then dividing that number by average common stockholders’ equity.

Short Exercises S13-1 Requirement 1 Stockholders are not personally liable for the debts of the corporation. Other advantages of the corporate entity form include the following. A corporation:  Does not allow stockholders to bind the business to a contract; lack of mutual agency  Has an indefinite life  Can raise more money than sole proprietorships and partnerships  Makes transfer of ownership easy  Attaches no personal liability for corporation debts to owners (stockholders)  Attaches limited liability for corporation debts to stockholders Requirement 2 Some disadvantages of organizing as a corporation are:  Ownership and management are often separated.  Earnings of the corporation are subject to double taxation.  Government regulation is expensive.  Start-up costs are higher than other business forms.

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

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S13-2 Requirement 1 Date

Accounts and Explanation Cash ($11 per share × 2,000 shares) Common Stock—$2 Par Value ($2 per share × 2,000 shares) Paid-In Capital in Excess of Par—Common ($9 per share × 2,000 shares) Issued common stock at a premium.

Debit 22,000

Credit 4,000 18,000

Requirement 2 Date

Accounts and Explanation Cash Preferred Stock—$10 Par Value ($10 per share × 2,000 shares) Issued preferred stock at par.

Debit

Credit

20,000 20,000

S13-3 Date Mar. 13

Accounts and Explanation Cash Common Stock—No-Par Value ($2 per share × 5,000 shares) Issued no-par common stock.

Debit 10,000

Credit 10,000

S13-4 Date July 7

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Accounts and Explanation Cash ($10 per share × 8,000 shares) Common Stock—$2 Stated Value ($2 per share × 8,000 shares) Paid-In Capital in Excess of Stated—Common ($8 per share × 8,000 shares) Issued common stock at a premium.

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

Debit 80,000

Credit

16,000 64,000

S13-5 Date

Accounts and Explanation

Debit

Building Common Stock—$3 Par Value ($3 per share × 40,000 shares) Paid-In Capital in Excess of Par—Common ($180,000 – $120,000) Issued common stock in exchange for a building.

Credit

180,000 120,000 60,000

S13-6 Requirement 1 Date 2014 Dec. 15

Accounts and Explanation

Debit

Retained Earnings ($5,750 + $27,500) Dividends Payable—Preferred (5% × $115,000) Dividends Payable—Common ($0.50 per share × 55,000) Declared a cash dividend.

Credit

33,250 5,750 27,500

Requirement 2 Date 2015 Jan. 4

Accounts and Explanation

Debit

Dividends Payable—Preferred Dividends Payable—Common Cash Payment of cash dividend.

Credit

5,750 27,500 33,250

S13-7 Requirement 1 Total Dividend Dividend to Preferred Stockholders Dividend to Common Stockholders

5% × $15 × 5,500 shares

$ 25,000 (4,125) $ 20,875

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

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S13-7, cont. Requirement 2 Total Dividend Dividend to Preferred Stockholders Dividends in Arrears (2012) Dividends in Arrears (2013) Current Year Dividend (2014) Dividend to Common Stockholders

$ 35,000 5% × $15 × 5,500 shares $ 4,125 4,125 4,125

(12,375) $ 22,625

Requirement 3 Total Dividend Dividend to Preferred Stockholders (2014) Dividend to Common Stockholders

5% × $15 × 5,500 shares

$ 35,000 (4,125) $ 30,875

S13-8 Requirement 1 Date Aug. 15

Aug. 31

Accounts and Explanation Retained Earnings ($22 per share × 12,000 × 0.05) Common Stock Dividend Distributable ($2 per share × 12,000 × 0.05) Paid-In Capital in Excess of Par—Common ($13,200 − $1,200) Declared a 5% stock dividend. Common Stock Dividend Distributable ($2 per share × 12,000 × 0.05) Common Stock—$2 Par Value Issued 5% stock dividend.

Debit

Credit

13,200 1,200 12,000

1,200

Requirement 2 The overall effect of the stock dividend on Supreme’s total assets is zero. Requirement 3 The dividend merely rearranges the balance in the stockholders’ equity accounts, leaving total stockholders’ equity unchanged.

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Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

1,200

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

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S13-9 Requirement 1 Date Dec. 15

Dec. 30

Accounts and Explanation Retained Earnings ($1 per share × 310,000 shares × 0.45) Common Stock Dividend Distributable ($1 per share × 310,000 shares × 0.45) Declared a 45% stock dividend.

Debit 139,500

Common Stock Dividend Distributable Common Stock—$1 Par Value Issued 45% stock dividend.

139,500

139,500

Requirement 2 Shares before dividend New shares from 45% dividend Total shares after dividend

310,000 139,500 449,500

S13-10 Requirement 1 Stockholders’ Equity

Paid-In Capital: Common Stock—$0.50 Par Value; 480,000,000 shares authorized, 228,000,000 shares issued and outstanding Paid-In Capital in Excess of Par—Common Total Paid-In Capital Retained Earnings Total Stockholders’ Equity

$ 114,000,000 140,000,000 254,000,000 650,000,000 $ 904,000,000

Requirement 2 The account balances would be unchanged after the stock split.

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Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

Credit

139,500

S13-11 Requirement 1 Date 2014 Dec. 1 Dec. 15

Dec. 20

Accounts and Explanation

Debit

Treasury Stock—Common ($5 per share × 1,400 shares) Cash

7,000

Cash ($8 per share × 400 shares) Treasury Stock—Common ($5 per share × 400 shares) Paid-In Capital from Treasury Stock Transactions ($3 × 400 shares)

3,200

Cash ($2 per share × 800 shares) Paid-In Capital from Treasury Stock Transactions Retained Earnings Treasury Stock—Common ($5 per share × 800 shares)

1,600 2,000 400

Credit 7,000 2,000 1,200

4,000

Requirement 2 Discount Center Furniture, Inc. will report treasury stock beneath retained earnings on the balance sheet as a reduction to total stockholders’ equity. S13-12 MCDONALD, INC. Statement of Retained Earnings Year Ended December 31, 2014 Retained Earnings, January 1, 2014 Net income for the year Dividends Declared Retained Earnings, December 31, 2014

$ 110,000 60,000 170,000 (80,000) $ 90,000

S13-13 Requirement 1 In 2014, the error overstated utilities expense by $20,000 and understated net income by $20,000. In 2014, total stockholders’ equity (retained earnings) would be understated $20,000.

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

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S13-13, cont. Requirement 2 The error would be reported as an adjustment to the beginning balance in the retained earnings account on the Retained Earnings Statement in 2015; it would be designated as a prior-period adjustment. The prior period adjustment would be an addition of $20,000. S13-14 Earnings per share

(Net income − Preferred dividends) ($40,000 − $3,000) $37,000

=

$2.69 per share 2 S13-15 Price/earnings ratio $5.95 per share

= =

/ / /

Average number of common shares outstanding (13,500 shares + 14,000 shares) / 2 13,750

=

Market price per share of common stock

/

Earnings per share

=

$16

/

$2.69

S13-16 Rate of return on common stockholders’ equity

=

(Net income − Preferred dividends)

/

Average common stockholders’ equity

0.25 = 25%

= =

($3,890 − 0) $3,890

/ /

($16,438 + $14,600) / 2 $15,519

Exercises E13-17 a. b. c. d. e. f. g.

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Disadvantage Advantage Advantage Advantage Disadvantage Advantage Disadvantage

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

E13-18 Paid-in capital = 150,000 shares × (25 – 5) = $3,000,000 E13-19 (a) Cash (2,000 × $20)........................................................................... Common Stock....................................................................... Paid-in Capital in Excess of Par – Common Stock................

40,000 20,000 20,000

(b) Land (5,000 × $16)........................................................................... Common Stock....................................................................... Paid-in Capital in Excess of Par – Common Stock................

80,000

(c) Cash (1,000 × $120)......................................................................... Preferred Stock....................................................................... Paid-in Capital in Excess of Par – Preferred Stock

120,000

50,000 30,000

100,000 20,000

E13-20 Requirement 1 Date a.

b.

Accounts and Explanation

Debit

Credit

Cash ($9.00 per share × 4,000 shares) Common Stock Issued no-par stock.

36,000

Cash ($9.00 per share × 4,000 shares) Common Stock—$2 Stated Value ($2 per share × 4,000 shares) Paid-In Capital in Excess of Stated—Common ($36,000 − $8,000) Issued $2 stated value common stock.

36,000

36,000

8,000 28,000

E13-20, cont. Requirement 2 Both types of stock result in the same paid-in capital balance. E13-21 (a) June 1

July 1

Cash................................................................................... Preferred Stock........................................................ Paid-in Capital in Excess of Par—Preferred Stock.......................................................................

258,000

Cash................................................................................... Preferred Stock........................................................ Paid-in Capital in Excess of Par—Preferred

135,000

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

60,000 198,000 30,000

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Stock.......................................................................

105,000

(b) (1) Preferred stock: $60,000 + $30,000 = $90,000. (2) Paid-in Capital in Excess of Par—Preferred Stock: $198,000 + $105,000 = $303,000. E13-22 Jan 10

Cash (400 × $8)...................................................................... Common Stock............................................................ Paid-in Capital in Excess of Par – Common Stock.....

3,200

July 12

Land (100 × $8.25)................................................................ Common Stock............................................................ Paid-in Capital in Excess of Par – Common Stock.....

825

Sep 15

Cash (100 × $15).................................................................... Preferred Stock........................................................... Paid-in Capital in Excess of Par – Preferred Stock....

1,500

(b) Stockholders' equity Paid-in capital Capital stock Preferred stock, $10 par value 500 shares authorized, 100 shares issued and outstanding Common stock, $5 par value, 1,000 shares authorized, 500 shares issued and outstanding Total capital stock Additional paid-in capital In excess of par—preferred stock $ 500 In excess of par—common stock 1,525 Total additional paid-in capital Total paid-in capital Retained Earnings Total stockholder’s Equity

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Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

2,000 1,200 500 325

1,000 500

$1,000 2,500 3,500

2,025 5,525 2,000 $7,525

E13-23 Requirement 1 Total Dividend—2014 Dividend to Preferred Stockholders Current Year Dividend (2014) Dividend to Common Stockholders

$ 12,200 6% × $11 × 20,000 shares

$ 13,200 $

Total Dividend—2015 Dividend to Preferred Stockholders Dividends in Arrears (2014) Current Year Dividend (2015) Dividend to Common Stockholders

(12,200) 0

$ 55,000 6% × $11 × 20,000 shares $13,200 – $12,200

$ 1,000 13,200

(14,200) $ 40,800

Requirement 2 Date 2014 Dec. 1

Accounts and Explanation

Debit

Retained Earnings Dividends Payable—Preferred

Credit

12,200 12,200

Declared a cash dividend. Dec. 20

Dividends Payable—Preferred Cash Payment of cash dividend.

12,200 12,200

E13-24 Requirement 1 Total Dividend—2014 Dividend to Preferred Stockholders Current Year Dividend (2014) Dividend to Common Stockholders

$ 195,000 7% × $2 × 75,000 shares

Hor ngr en’ sAcc ount i ng 10/ e Sol ut i onsManual

$ 10,500 (10,500) $ 184,500

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E13-24, cont. Requirement 2 Date 2014 July 1

July 31

Accounts and Explanation

Debit

Retained Earnings Dividends Payable—Preferred Dividends Payable—Common Declared a cash dividend.

195,000

Dividends Payable—Preferred Dividends Payable—Common Cash Payment of cash dividend.

10,500 184,500

Credit

10,500 184,500

195,000

E13-25 Requirement 1 Date Accounts and Explanation Apr. 30 Retained Earnings ($11 per share × 530 × 0.10) Common Stock Dividend Distributable ($1 per share × 530 × 0.10) Paid-In Capital in Excess of Par—Common ($583 − $53) Declared a 10% stock dividend. May 15

Common Stock Dividend Distributable ($1 per share × 530 × 0.10) Common Stock—$1 Par Value Issued 10% stock dividend.

Debit 583

53 530<...