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Homeworksee handout

Influential (20-50%): Equity Method Recap

1. Record investment at original cost.2. At year-end, the Investor’s proportionate share of Investee’s

net income or loss is recognized by Investor as investment income on IS and offset by an increase or decrease in the equity investment account. [i.e., single line consolidation]

3. Dividends received are recognized as a reduction in the investment account (not as dividend income on IS).

4. The investment is not marked to market; however, the market value is disclosed in the footnotes.

5. If there is goodwill implied by the purchase price, it is not amortized or evaluated for impairment separately from the investment.

6. If more than 20% equity does not result in “significant influence,” the investment should not be accounted for by the equity method, but by the mark-to-market method, if readily marketable.

Long-term Equity Investments

Problems: E8-8, E8-12

Long-Term Equity Investments

Inter-corporate Equity Investments

3 Categories of Equity Investors:

• Passive Investors: Less than 20% of the outstanding voting stock. Use Mark-to-Market method if shares are readily marketable. Otherwise, use Cost method.

• Influential Investors: 20% to 50% of the outstanding voting stock. Use the Equity method.

• Controlling Investors: More than 50% of the outstanding voting stock. Use the Equity method, along with Consolidation.

Passive(<20%): Mark-to-Market Method & Cost Method Recap

1. Record initial investment at cost.2. Dividends received are recognized as income on IS. If no dividends

are received, then no income is recorded.3. At the end of each period, the investment is adjusted to market

value with the increase or decrease in market value reported as an:– Unrealized gain or loss on the IS (and closed to RE) if investments are

held in a trading account, i.e. Trading securities are a current asset).– Unrealized gain or loss not on IS but in a special SHE account for

Unrealized Holding Gains or Losses and reported as part of Comprehensive Income if investments held in an AFS portfolio.

4. If securities are not readily marketable, the Cost Method is used, which includes only Steps 1 &2 above. Under the cost method, investment only written down if there is an other than temporary loss in value, i.e., a permanent write down or the investment is sold.

The Cost Method- Market value hard to determine

E8-8 Cost Method

Mystic Lakes Food Company began investing in equity

securities for the first time in 2011. During 2011, the

company engaged in the following transactions involving

equity securities. Assume that the stock of Thayers

International and Bayhe Enterprises is not considered

marketable that ownership is less than 20 percent of the

equity. Prepare journal entries to record these transactions.

E8-8

1. Purchased 10,000 shares of Thayers International for $26 per share.

2. Purchased 25,000 shares of Bayhe Enterprises for $35 per share.

3. Thayers International declared a $2-per-share dividend to be paid at a later date.

E8-8

4. Sold 4,500 shares of Bayhe Enterprises for $30 per share.

5. Sold 8,000 shares of Thayers International for $32 per share.

The Equity Method

E8-12 Equity Method Inference from FSMainmont Industries uses the equity method for its long-term equity investments from affiliates. The following information from the financial statements of Mainmont refers to an investment in the securities of Tumbleweed Construction, a company owned 30% by Mainmont.

Mainmont neither purchased nor sold any equity securities during 2011.a. How much net income did Tumbleweed Construction earn during

2011?b. What was the dollar amount of the total dividend declared by

Tumbleweed during 2011?c. Provide the journal entries recorded by Mainmont during 2011 with

respect to its investment in Tumbleweed.

2011 2010

Long-term investment in equity securities $29,000 $25,000

Income from equity securities 12,000 7,000

Consolidation MethodControlling investments of more than 50% are accounted for by the Equity method and then the parent and subsidiary financials are consolidated on a spreadsheet at the end of the accounting period.

1. The Investment account balance on the Investor’s balance sheet is replaced with the Investor’s share of the actual assets and liabilities of the Investee plus any goodwill implied by the Investor’s purchase.

2. The assets and liabilities of the investee attributable to the non-controlling shareholders are added to the Investor’s balance sheet along with the non-controlling interest equity in those net assets, based on the fair market value of the non-controlling equity on the acquisition date. Any goodwill implied by such mark to fair value would also be recognized. [Minority Interest liability]

3. The income statement of the investee company is combined with the income statement of the investor. The equity income of the Investee recognized by the Investor is eliminated to avoid double counting this income. The total net income is apportioned between the net income attributable to the controlling shareholders and non-controlling shareholders. [Minority interest income]

4. Goodwill recognized in the consolidated financials is not amortized; however, if goodwill becomes impaired, it is written down. Goodwill must be evaluated each period of possible impairment.

Business Combinations

Two Ways to Obtain Control:

• Asset acquisition-all the company’s “net assets” are acquired directly from the company-the books of acquired company are closed and only one set of books remain.

• Stock acquisition-a controlling interest in another firm’s voting common stock is acquired – two sets of books remain and an Investment in Sub account is carried on the acquirer’s books.

Stock Acquisition and Consolidated Financial Statements

A business acquisition occurs when an investor company

acquires a controlling interest (more than 50 percent of the

voting stock) in another company.

The companies continue as separate legal entities, the

investor company is referred to as the parent company, and

the investee company is called the subsidiary.

A Corp + B Corp = Consolidated A and B

A merger, or business combination, occurs when two or

more companies combine to form a single legal entity.

Asset Acquisition-Purchase Method

• All identifiable net assets (assets less liabilities assumed) are recorded at their FMV, both tangible and intangible (assuming a controlling interest is acquired).

• Goodwill is created when the price paid exceeds the FMV of the net assets acquired.

• A gain is recorded when the price paid is less than the FMV of the net assets acquired.

• Direct acquisition costs (costs paid to consultants) and indirect acquisition costs (internal costs) are expensed.

• A single combined entity exists, no consolidation process is necessary.

Legal Forms of Business Combinations

• Statutory consolidation (100% ownership)

A Corp + B Corp = C Corp (new company)

• Statutory merger (100% ownership)

A Corp + B Corp = A Corp

BUS512MSession 9

Accounting for Financing Decisions:

Long-Term Liabilities and Stockholders Equity

Liabilities

• Current or Short-term Liabilities

• Long-term Debt (borrowed funds)

• Lease Liabilities

• Deferred Taxes

• Contingencies and Commitments

Accounting for liabilities is a subject that can be very technical. There is a tendency for some institutions to create exotic instruments for marketing of funds in recent years. Despite this, there are some basic principles that govern the accounting for liabilities….

Basis for Valuing Liabilities

• Because money has time value, the amount of money needed today to pay a future debt is less than the future obligation.

• Historically, the best basis for valuing a liability was its economic present value (the present value of the future cash flows, i.e., the amount of money that would have to be set aside today to accumulate to the future cash flows required to pay the interest and the principal of the debt).

• Most current liabilities are reported on the BS at their face (or nominal value)—the amount that will be paid.

• Most Long-term liabilities are reported on the BS at their present value (the time-discounted value of the future cash flows).

Basic Definitions and Different Contractual FormsSome contracts, called interest-bearing obligations, require

periodic (annual or semiannual) cash payments (called

interest) that are determined as a percentage of the face,

principal, or maturity value, which must be paid at the end of

the contract period.

Non-interest-bearing obligations, on the other hand, require

no periodic payments, but only a single cash payment at the

end of the contract period.

These contractual forms may contain additional terms that

specify assets pledged as security or collateral in case the

required cash payments are not met (default), as well as

additional provisions (restrictive covenants).

Short-term Liabilities• Report at Face value: Accounts payable, Accrued

expenses, Unearned revenue, Taxes payable, Warranties payable

• Non-interest bearing ST Notes Payable generally are reported at maturity value less any unamortized interest discount. i.e., BS shows either: Note payable $950 or Note payable $1,000 less Unamortized discount $50.

• Interest-bearing ST Notes Payable generally are reported at the maturity (face) value plus any accrued interest. i.e., Note Payable $1,000 and Interest payable $50 on BS.

• Short-term debt which company has no intentions of liquidating, but plans to continually refinance, should be classified as long-term. Also, the current portion (the amount that will be paid within one year) of any long-term debt should be classified on the BS as a current liability.

Long-term Debts

• Since interest accounts for the difference between the amount received and the amount paid back, the interest rate is the basis for computing interest.

• On all long-term debt contracts there are two interest rates: The stated rate and the effective rate, they may not be the same…

• The stated rate is the interest rate on interest-bearing debt that is used to calculate the amount of cash interest payments that will be made to the lender.

• The effective rate is the compounded interest rate that mathematically accounts for the total difference between the amount borrowed and the amount repaid.

Bond Terminology

Key Questions:-Present Value? Issue value or Proceeds

-Future Value? Maturity value or Face value-n= number of periods?-r=effective or market interest rate?-Bond or Note stated rate or face rate?-Single payment or Ordinary annuity (multiple payments)?-Interest bearing or Noninterest bearing? What is the interest payment? How often?

Draw a Timeline and fill in:-Issue date-When pay interest and amortize discount or premium-Maturity date

BE11-2 Bond TermsIn October 1997 HP issued zero-coupon bonds with a face of 1.8 billion, due in 2017, for proceeds of $968 million.

a. What is the life of these bonds?

b. What is the stated rate on these bonds?

c. Estimate the effective interest rate of these bonds. (hint: $PV/$FV = approximate Table value)

d. How many bonds did HP issue?

e. What entry did HP make when the bonds were issued?

The Time Value of Money and Non-Interest bearing

Long-term Debt

Accounting for Non-Interest Bearing Notes Payable Recap

E11-8 Present Value of a Non-interest-bearing Note

Purchased a building 1.1.2012 in exchange for a 3year non-interest-bearing note with a face of $693,000. Building appraisal is $550,125.

a. What amount should this building be capitalized?

E11-8 Present Value of a Non-interest-bearing Note

Purchased a building 1.1.2012 in exchange for a 3 year non-interest-bearing note with a face of $693,000. Building appraisal is $550,125.

b. Compute the present value of the note’s future cash flows, using the following discount rates:

1. 6 percent

2. 8 percent

3. 10 percent

c. What is the effective rate of this note?

E11-5 Discounted Non-interest-bearing Notes

Purchase equipment with a FMV of $11,348 in exchange for a 5 year non-interest-bearing note with a face of $20,000.

d. Explain how one could more quickly compute the effective interest rate on the note.

e. Compute the effective interest rate on the note payable.

f. Prepare entry to record the purchase.

E11-5 Discounted Non-interest-bearing Notes

Purchase equipment with a FMV of $11,348 in exchange for a 5year non-interest-bearing note with a face of $20,000.

g. How much interest expense should be recognized in the first year?

h. What is the BS value of the note at the end of the first year?

i. Will the interest expense recognized in the second year be greater, equal, or less than the interest expense recognized in the first year? Why?

E11-4 Non-interest-bearing Note Payable Proceeds

Compute the proceeds from the following notes payable. Interest payments are made annually.

PV Principal

PV Interest Payments

= Proceeds Stated Rate Effective Rate

Face Value Life

0% 8% $1,000 4 years

0% 6% $5,000 6 years

Sample Non-interest bearing Long-term Notes Payable

• Problem 1: On January 2, 2008, Pearson Company purchases a section of land for its new plant site. Pearson issues a 5 year non-interest bearing note, and promises to pay $50,000 at the end of the 5 year period. What is the cash equivalent price of the land, if a 6 percent discount rate is assumed?

PV1 = 50,000 x ( 0.74726) = $37,363 [ i=6%, n=5]

Journal entry Jan. 2, 2008:

Dr. Land 37,363

Dr. Discount on N/P 12,637

Cr. Notes Payable 50,000

Sample Problem 1 Solution, continued

The Effective Interest Method:

Interest Expense =

Carrying value x Effective interest rate x Time period

(CV) (Per year) (Portion of year)

Where carrying value = face - discount.

For Example 1, CV= 50,000 - 12,637 = 37,363

Interest expense = 37,363 x 6% per year x 1year

= $2,242

Sample Problem 1 Solution, continued

Journal entry, December 31, 2008:

Carrying value on B/S at 12/31/2008:

(Discount = $12,637 - 2,242 = $10,395)

Interest expense 2,242Discount on N/P 2,242

Notes Payable $50,000Discount on N/P (10,395) $39,605

Sample Problem 1 Solution, continued

$50,000

Interest expense at Dec. 31, 2009:39,605 x 6% x 1 = $2,376

Journal entry, December 31, 2009:

Carrying value on B/S at 12/31/2009:

(Discount = 10,395 - 2,376)Carrying value on 12/31/2012 (before retirement)?

Interest expense 2,376Discount on N/P 2,376

Notes Payable $50,000Discount on N/P (8,019) $41,981

Time Value of Money and Interest bearing Long-Term Liabilities: Notes, Bonds, and Leases

• Long-term liabilities are recorded at the present value of the future cash flows.

• Two components determine the “time value” of money:– interest (discount) rate

– number of periods of discounting

• Types of activities that require PV calculations:– notes payable

– bonds payable and bond investments

– capital leases

Interest bearing: Bond Prices

E 11-3 Bond Terms

The stated and effective interest rates for several notes and bonds follow:Is Note or Bond issued a Par, Premium, or Discount?

Bond Stated Interest Rate Effective or Market Interest Rate

1. 10% 10%

2. 7% 8%

3. 9% 8%

4. 11.5% 9%

E11-4 Interest-bearing and Non-interest-bearing Note Payable Proceeds

Compute the proceeds from the following notes payable. Interest payments are made annually.

PV Principal

PV Interest Payments

= Proceeds Stated Rate Effective Rate

Face Value Life

4% 12% $8,000 6 years

8% 8% $3,000 7 years

10% 6% $10,000 10 years

Bonds Payable Issued at a Discount

• If bonds are issued at a discount, the carrying value will be below face value at the date of issue.

• The Discount on B/P account has a normal debit balance and is a contra to B/P (similar to the Discount on N/P).

• The Discount account is amortized with a credit. Note that the difference between Cash Paid and Interest Expense is still the amount of amortization.

• Interest expense for bonds issued at a discount will be greater than cash paid.

• The amortization table will show the bonds amortized up to face value.

E11-13 Bonds issued at a DiscountIssued 500 five-year bonds on 7.1.12. Interest payments are due semiannually at 1.1 and 7.1 at an interest rate of 6%. The effective rate is 8%. The face value of each bond is $1,000.

a. 7.1.12 entry when bonds are issued?

b. 12.31.12 entry at yearend?

E11-13 Bonds issued at a DiscountIssued 500 five-year bonds on 7.1.12. Interest payments are due semiannually at 1.1 and 7.1 at an interest rate of 6%. The effective rate is 8%. The face value of each bond is $1,000.

c. 12.31.12 Balance sheet value?

d. PV of bonds remaining cash flows as of 12.31.12?

Your Turn

E11-14 Bonds issued at a Premium

Issued 100 ten-year bonds on 7.1.12. Interest payments are due semiannually (1.1 and 7.1) at an annual rate of 8%. The effective rate is 6%. The face of each bond is $1,000.

a. 7.1.12 entry to issue bonds?

b. 12.31.12 entry?

E11-14 Bonds issued at a Premium

Issued 100 ten-year bonds on 7.1.12. Interest payments are due semiannually (1.1 and 7.1) at an annual rate of 8%. The effective rate is 6%. The face of each bond is $1,000.

c. 12.31.12 balance sheet value?

d. PV of remaining cash flows as of 12.31.12?

Your Turn

Investor’s Bond Yield= annual cash received/note price

“The yield on a 10 year note, which was hovering at about 2.2% before the release of the non-farm report [on Friday] plummeted to about 2.07% in a matter of minutes. Yields, which move in the opposite direction to prices, continued to move lower, ending the day at 2.056%, compared with 2.173% late Thursday.”

Page B2, The Wall Street Journal, 4.7-8.2012

Sample Problem 2: Bonds Payable issued at Premium, semiannual interest payments

• On July 1, 2007, Mustang Corporation issues $100,000 of its 5-year bonds which have an annual stated rate of 7%, and pay interest semiannually each June 30 and December 31, starting December 31, 2007. The bonds were issued to yield 6% annually.

• Calculate the issue price of the bond:(1) What are the cash flows and factors?

Face value at maturity = $100,000Stated Interest =

Face value x stated rate x time period100,000 x 7% x (1/2) = $3,500

Number of periods = n = 5 years x 2 = 10

Discount rate = 6% / 2 = 3% per period

Sample Problem 2 - calculationsPV of interest annuity:

PVOA Table

PVOA = 3,500 (8.53020) = $29,856 i = 3%, n = 10

PV of face value:

PV1 Table

PV = 100,000 (0.74409)=$74,409 i=3%, n=10

Total issue price = $104,265Issued at a premium of $4,265 because the company was offering an interest rate greater than the market rate, and investors were willing to pay more for the higher interest rate.

Sample Problem 2 - Amortization ScheduleTo recognize interest expense using the effective interest

method, an amortization schedule must be constructed. (This expands the text discussion.)

To calculate the columns (see next slide):Cash interest paid = Face x Stated Rate x Time

= 100,000 x 7% x 1/2 year = $3,500(this is the same amount every period)

Int. Expense = CV x Market Rate x Timeat 12/31/07 = 104,265 x 6% x 1/2 year = 3,128at 6/30/08 = 103,893 x 6% x 1/2 year = 3,117

The difference between cash paid and interest expense is the periodic amortization of premium.

Note that the carrying value is amortized down to face value by maturity.

Sample Problem 2 - Amortization Schedule

Cash Interest CarryingDate Paid Expense Premium Value7/01/07 104,265

12/31/07 3,500 3,128 372 103,8936/30/08 3,500 3,117 383 103,510

12/31/08 3,500 3,105 395 103,1156/30/09 3,500 3,093 407 102,708

12/31/09 3,500 3,081 419 102,2896/30/10 3,500 3,069 431 101,858

12/31/10 3,500 3,056 444 101,4146/30/11 3,500 3,042 458 100,956

12/31/11 3,500 3,029 471 100,4856/30/12 3,500 3,015 485 100,000

Sample Problem 2 - Journal EntriesJE at 7/1/07 to issue the bonds:

JE at 12/31/07 to pay interest:

Note that the numbers for each interest payment come from the lines on the amortization schedule.

Cash 104,265Premium on B/P 4,265Bonds Payable 100,000

Interest Expense 3,128Premium on B/P 372

Cash 3,500

Sample Bonds Issued at Face Value

Sample Bonds Issued at a Discount

Sample Bond Amortization Table

Recap: Non-Interest Bearing Notes and Bonds

>Issue date

>Amortize discount

>Maturity date

Recap: Interest Bearing Notes and Bonds

>Issue date

>Pay interest and amortize discount or premium

>Maturity date

Bond RedemptionsWhen bonds are redeemed at the maturity date,

the issuing company simply pays cash to the

bondholders in the amount of the face value

and removes the bond payable from the

balance sheet. To illustrate the redemption of a bond issuance

prior to maturity at a loss, assume that bonds

with a $100,000 face value and a $5,000

unamortized discount are redeemed for

$102,000. The $7,000 loss on redemption

would decrease net income

P11-10 Callable Bond Redemptions12.31.11 account balances are:

Bond payable $500,000

Premium on bond payable $ 12,600

The bonds have an annual stated rate of 8% and an effective rate of 6%. Interest is paid 6.30 and 12.31.

a. Compute the gain or loss if the bonds are called for 104 on 1.1.2012?

P11-10 Callable Bond Redemptions

12.31.11 account balances are:Bond payable $500,000Premium on bond payable $ 12,600The bonds have an annual stated rate of 8% and an effective rate of 6%. Interest is paid 6.30 and 12.31.

b. Compute the gain or loss if the bonds are called for 108 on 1.1.2012?

c. Compute the gain or loss if the bonds are called for 110 on 7.1.2012?

Bond ConversionsThe Jolly Corporation has $400,000 of 6 percent bonds outstanding. There is $20,000 of unamortized discount remaining on these bonds after the July 1, 2011, semiannual interest payment. The bonds are convertible at the rate of 20 shares of $5 par value common stock for each $1,000 bond. On July 1, 2011, bondholders presented $300,000 of the bonds for conversion. 1. Is there a gain or loss on conversion, and if so, how much is it?

2. How many shares of common stock are issued in exchange for the bonds?

3. In dollar amounts, how does this transaction affect the total liabilities and the total stockholders' equity of the company? In your answer, show the effects on four accounts.

International Perspective • The accounting disclosure requirements in non-U.S. countries

and IFRS are not as comprehensive as those in the United States, partially because the information needs of the major capital providers (i.e., banks) are satisfied in a relatively straightforward way—through personal contact and direct

visits.

• A second way in which the heavy reliance on debt affects non-U.S. accounting systems is that the required disclosures and regulations tend to be designed either to protect the creditor or to help in the assessment of solvency.

Economic Consequences of Reporting Long-Term Liabilities

• Improved credit ratings can lead to

lower borrowing costs

• Management has strong incentive to

manage the balance sheet by using

“off-balance-sheet financing” i.e.,

operating leases

Stockholders Equity

BE12-2, E12-1, E12-3, E12-5, E12-6, E12-13, E12-14, P 12-10

How to Finance the Corporation?

• Borrow– Notes, Bonds, Leases

– The debt holders are legally entitled to repayment of their principal and interest claims

• Issue Equity– Common and Preferred Stock

– The shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assets

• Retained Earnings

Chapter 12: Shareholders’ Equity

Debt versus Equity

Debt Equity

Formal legal contract No legal contractFixed maturity date No fixed maturity dateFixed periodic payments Discretionary dividendsSecurity in case of default Residual asset interestNo voice in management Voting rights - commonInterest expense deductible Dividends not deductible

Double taxation

Interested Party Debt Equity

Investors / Creditors

Lower investment risk Higher investment risk

Management

Fixed cash receipts Variable cash receipts

Contractual futurecash payments

Dividends arediscretionary

Effects on creditrating

Effects of dilution/takeover

Interest is taxdeductible

Dividends are nottax deductible

Accountants/Auditors

Liabilities sectionof the balance sheet

Shareholders’ equityof the balance sheet

Income statement effects from debt

No income statement effects from equity

Distinctions between Debt and Equity

Preferred Stock vs Common Stock

Preferred Stock Common Stock

Advantages Preference over common in

liquidation

Voting Rights

Stated dividend Rights to residual profits

(after preferred)

Preference over common in

dividend payout

Disadvantages Subordinate to debt in liquidation Last in liquidation

Stated dividend can be skipped No guaranteed return

No voting rights (versus common)

Debt or Equity? Components of both

Usually classified as equity

E12-3 Authorizing and Issuing StockPrepare entries for each event:

1. Authorized to issue: (a) 100,000 shares of $100 par value , 8% preferred stock (b) 150,000 shares of no-par, $5 preferred stock; and (c) 250,000 shares of $5 par value common stock.

2. Issued 10,000 shares of $5 par value common stock for $30 per share.

E12-3 Authorizing and Issuing StockPrepare entries for each event:

3. Issued 25,000 shares of the $100 par value preferred stock for $150 per share.

4. Issued 50,000 shares of no-par preferred stock for $50 each.

Treasury Stock

• Created when a company buys back shares of its own common stock.

• Reasons for buyback?

• The debit balance account called “Treasury Stock” is reported in shareholders’ equity as a contra account to SE.

– Note: Treasury Stock is not an asset.

• The stock remains issued, but is no longer outstanding.

– does not have voting rights

– cannot receive cash dividends

• May be reissued (to the market or to employees) or retired.

• No gains or losses are ever recognized from these equity transactions.

E12-5 Treasury StockCompany was incorporated on 4.1.12 and was authorized to issue 100,000 shares of $5 par value common stock and 10,000 shares of $8, no-par preferred stock.

a. T accounts:1. Issued 25,000 shares of common

stock in exchange for $500,000 cash.

2. Issued 5,000 shares of preferred stock in exchange for $60,000 cash.

3. Purchased 3,000 common shares for $15 per share and held them in the treasury.

4. Sold 1,000 treasury shares for $18 per share.

5. Issued 1,000 treasury shares to executives who exercised stock options for a reduced price of $5 per share.

b. Assume company generated $500,000 in net income in 2012 and did not declare any dividends. Prepare the stockholders’ equity section of the balance sheet as of 12.31.2012.

E12-6 Treasury Stock12.31.2011 Shareholders’ section

Common stock $80,000

Additional paid-in capital 10,000

Retained earnings 60,000

Total shareholders’ equity $150,000

During 2012, the company entered into the following transactions:

1. Purchased 1,000 shares of treasury stock for $60 per share.

2. As part of a compensation package, reissued half of the treasury shares to executives who exercised stock options for $20 per share.

3. Reissued the remainder of the treasury stock on the open market for $66 per share.

a. Prepare the shareholders’ equity section of the balance sheet as of 12.31.2012. Company generated $20,000 in net income and did not declare dividends during 2012.

E12-6 Treasury Stock12.31.2011 Shareholders’ section

Common stock $80,000

Additional paid-in capital 10,000

Retained earnings 60,000

Total shareholders’ equity $150,000

b. What portion of the additional paid-in capital account is attributed to treasury stock transactions?

E12-9 Inferring Transactions from SHE

Provide the journal entries for the following:

a. Issuance of preferred stock during 2012.

b. Issuance of common stock during 2012.

c. Sale of treasury stock during 2012.

2012 2011

Preferred stock (no par) $ 700 $ 400

Common stock ($1 par value) 1,000 900

Additional paid-in capital:

Common stockTreasury stock

4010

20---

Less Treasury stock 130 150

Cash Dividends and Stock Dividends: 3 Dates

BE12-2 Stock Splits and Market ValueWhen Tandy (Radio Shack) Corporation announced a 2:1 stock split, it had 97 million shares outstanding, trading at $100 per share.

a. Estimate the number of shares outstanding and market price per share immediately after the split.

b. Estimate the company’s overall market value, and explain whether you expect the company’s overall market value to change due to the split.

E12-1 SHE TransactionsFor each transaction indicate which SHE accounts are affected, whether these accounts increase or decrease, and the transaction’s effect on total SHE.1. Issue common stock above par for

cash.

2. Declare a 3-for-1 stock split.

3. Repurchase 10,000 shares of own stock for cash.

4. Declare and issue a stock dividend. Market>Par

5. Reissue 1,000 treasury shares for $75. Treasury stock had been previously acquired for $60.

6. Pay cash dividend that had been previously declared.

7. Generate net income of $250,000.

E12-13 Dividends in ArrearsThe company paid the following total cash dividends since 2008: 2008:$0; 2009:$30,000; 2010:$80,000; 2011:$15,000; and 2012:$40,000. • Preferred stock-10,000 shares

authorized, 5,000 issued, cumulative, nonparticipating, $5, $10 par.

• Common stock-500,000 shares authorized, 200,000 shares issued, 50,000 held in treasury, no par.

a. Compute the dividends paid to the preferred and common shareholders for each year since 2008. b. Compute the balance of dividends in arrears at yearend. c. Should dividends in arrears be considered a liability?

E12-14 Stock Dividends and Stock Splits

Prepare journal entries for the following independent transactions:a. Declare and distribute a 2% stock dividend when the market price

of the stock was $70.

b. Declare a 3:2 stock split.

c. Declare a 10% stock dividend when the market price of the stock was $80.

d. Declare a 2:1 stock split.

SHE as of 12.31.2012:

Common stock (10,000 shares issued @$6 par) $ 60,000

Additional paid in capital-common stock 100,000

Retained earnings 60,000

Less: Treasury stock (2,000 @ $12) (24,000)

Total shareholders’ equity $196,000

P12-10 Inferring Transactions from BS

a. How many shares of preferred stock were issued during 2012? What was the average issue price?

b. How many shares of common stock were issued during 2012? What was the average issue price?

c. Prepare the entry to record the repurchase of the company’s own stock during 2012? What was the average repurchase price?

2012 2011

Preferred stock (9%, $100 par value) $200,000 $110,000

Common stock ($10 par value, 750,000 authorized, 90,000 issued, and 5,000 held in treasury

900,000 750,000

Additional paid in capital-preferred 150,000 35,000

Additional paid in capital-common 465,000 298,000

Retained earnings 575,000 495,000

Less: Treasury stock (110,000)

Total shareholders’ equity $2,180,000 $1,688,000

Sample Co. Shareholders’ EquityCommon stock, $1 par value, 500,000 shares

authorized, 80,000 shares issued, and75,000 shares outstanding $ 80,000

Common stock dividends distributable 2,000Preferred stock, $100 par value, 1,000 shares

authorized, 100 shares issued and outstanding 10,000

Paid in capital on common $ 20,000Paid in capital on preferred 3,000Paid in capital on treasury stock 2,000 25,000Retained earnings:

Unappropriated $18,000Appropriated 4,000 22,000

Less: Treasury stock, 5,000 shares (at cost) (6,000)Less: Other comprehensive income items

(unrealized loss on AFS securities) (2,000)Total Shareholders’ Equity $131,000

Retained Earnings We will be expanding the basic retained earnings formula in this chapter. Now the Statement of Retained Earnings will include the following:

RE, beginning (unadjusted) xxAdd/Subtract: Prior period adjustment xxRE, beginning (restated) xxAdd: net income xxLess dividends:

Cash dividends-common xxCash dividends - preferred xxStock dividends xxProperty dividends xx

Less: Adjustment for TS transactions xx Appropriation of RE xx

RE, ending xx

Other Comprehensive Income

• “Other Comprehensive Income” includes certain direct equity adjustments that are notpart of the current income statement, but which may have an eventual effect on income.

• We already discussed one of these direct equity adjustments when reviewing Available-for-sale Investments. We found that any unrealized gains/losses from revaluation to market are shown in SE (as “other comprehensive income”) rather than on the income statement.

Stock Option Basics v. Restricted Stock• Granted to employees as part of their compensation.

• Generally not transferable and must either be exercised prior to expiration date or allowed to expire as worthless on expiration day. May have a vesting period.

• When granted, company expenses options for their fair value on grant date [may be a complicated calculation].

• Depending on the type of option granted, the employee may or may not be taxed when granted or exercised.

• Gives employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the exercise price stated in the option, the employee could exercise the option, pay the exercise price and would be issued ordinary shares in the company.

Today we: