Ch.15 Equity Exam Prep

Chapter 15

Multiple Choice

• • • 1. For a compensatory stock option plan for which the date of grant and measurement date are the same, compensation cost should be recognized in the income statement

1. At the date of retirement
2. Of each period in which services are rendered
3. At the exercise date
4. At the adoption date of the plan
   • • 1. In a corporate form of business organization, legal capital is best defined as
5. The amount of capital the state of incorporation allows the company to accumulate
   over its existence.
6. The amount of net assets that cannot be distributed to stockholder
7. The amount of capital the federal government allows a corporation to generate.
8. The total capital raised by a corporation within the limits set by the Securities and
   Exchange Commission.

3. Payment of a dividend in stock

a. Increases the current ratio

b. Decreases the amount of working capital

c. Increases total stockholders’ equity

d. Decreases book value per share of stock outstanding

4. The pre-emptive right of a common stockholder is the right to

a. Share proportionately in corporate assets upon liquidation.

b. Share proportionately in any new issues of stock of the same class.

c. Receive cash dividends before they are distributed to preferred stockholders.

d. Exclude preferred stockholders from voting rights.

5. The directors of Corel Corporation, whose $40 par value common stock is currently selling at $50 per share, have decided to issue a stock dividend. The corporation has an authorization for 200,000 shares of common, has issued 110,000 shares of which 10,000 shares are now held as treasury stock, and desires to capitalize $400,000 of the retained earnings balance. To accomplish this, the percentage of stock dividend that the directors should declare is

a. 10

b. 8

c. 5

d. 2

1. When a stock dividend is small, for example a 10% stock dividend,
2. Retained earnings is not reduced because the dividend is immaterial.
3. Retained earnings is reduced by the fair value of the stock.
4. Retained earnings is reduced to the par value of the stock.
5. Paid-in capital in excess of par value is unaffected.
6. The par value method of reporting a treasury stock transaction
7. Will be reported in the balance sheet as a reduction of total stockholders’ equity.
8. Results in no change to total stockholders’ equity.
9. Results in a reduction in the number of shares that are available to be sold to prospective investors.
10. Assumes constructive retirement of the treasury shares.
11. On December 31, 2017, when the Conn Company’s stock was selling at $36 per share, its capital accounts were as follows:

Capital stock (par value $20, 100,000 shares issued) $2,000,000

Premium on capital stock 800,000

Retained Earnings 4,550,000

If a 100 percent stock dividend were declared and the par value per share remained at

$20

1. No entry would need to be made to record the dividend
2. Capital stock would increase to $5,600,000
3. Capital stock would increase to $4,000,000
4. Total capital would decrease
5. A company has not paid dividends on its cumulative nonvoting preferred stock for 20 years. Healthy earnings have been reported each year, but they have been retained to support the growth of the company. The board of directors appropriately authorized management to offer the preferred shareholders an exchange of bonds and common stock for all the preferred stock. The exchange is about to be consummated. Which of the following best describes the effect of the exchange on the company?
6. The statute of limitations applies; hence, cumulative dividends of only seven years need to be paid on the preferred stock exchanged.
7. The company should record a gain for income determination purposes to the extent that dividends in arrears do not have to be paid in the exchange transaction.
8. Gain or loss should be recognized on the exchange by the company, and the exchange would have to be approved by the Securities and Exchange Commission.
9. Regardless of the market value of the bonds and common stock, no gain or loss should be recognized by the company on the exchange, and no dividends need to be paid on the preferred stock exchanged.

10. A primary source of stockholders' equity is

a. Income retained by the corporation.

b. Appropriated retained earnings.

c. Contributions by stockholders.

d. Both income retained by the corporation, and contributions by stockholders.

1. Stockholders' equity is generally classified into two major categories:
   1. Contributed capital and appropriated capital.
   2. Appropriated capital and retained earnings.
   3. Retained earnings and unappropriated capital.
   4. Earned capital and contributed capital.
2. Which of the following represents the total number of shares that a corporation may issue under the terms of its charter?
   1. Authorized shares
   2. Issued shares
   3. Unissued shares
   4. Outstanding shares
3. Stock that has a fixed per-share amount printed on each stock certificate is called
   • • • 1. Stated value stock.
         2. Fixed value stock.
         3. Uniform value stock.
         4. Par value stock.
4. Treasury shares are

Shares held as an investment by the treasurer of the corporation.

Shares held as an investment of the corporation.

Issued and outstanding shares.

Issued but not outstanding shares.

1. Which of the following features of preferred stock makes the security more like debt than

an equity instrument?

• 1. Participating
  2. Voting
  3. Redeemable
  4. Noncumulative

1. The cumulative feature of preferred stock
   • • • 1. Limits the amount of cumulative dividends to the par value of the preferred stock.
         2. Requires that dividends not paid in any year must be made up in a later year before dividends are distributed to common shareholders.
         3. Means that the shareholder can accumulate preferred stock until it is equal to the par value of common stock at which time it can be converted into common stock.
         4. Enables a preferred stockholder to accumulate dividends until they equal the par value of the stock and receive the stock in place of the cash dividends.

17. A restriction of retained earnings is most likely to be required by the

a. Exhaustion of potential benefits of the investment credit

b. Purchase of treasury stock

c. Payment of last maturing series of a serial bond issue

d. Amortization of past service costs related to a pension plan

1. According to the FASB ASC, redeemable preferred stock should be

Included in the common stock section.

Included as a liability.

Excluded from the stockholders' equity section.

Included as a contra item in the stockholders' equity section.

1. At the date of the financial statements, common stock shares issued would exceed

common stock shares outstanding as a result of the

• • • • 1. Declaration of a stock split.
        2. Declaration of a stock dividend.
        3. Purchase of treasury stock.
        4. Payment in full of subscribed stock.

1. A feature common to both stock splits and stock dividends is

A transfer to earned capital of a corporation.

No impact on total stockholders' equity.

An increase in total liabilities of a corporation.

A reduction in the contributed capital of a corporation.

1. The rate of return on common stock equity is calculated by dividing
   • • • 1. Net income less preferred dividends by average common stockholders' equity.
         2. Net income by average common stockholders' equity.
         3. Net income less preferred dividends by ending common stockholders' equity.
         4. Net income by ending common stockholders' equity.

22. A feature common to both stock splits and stock dividends is

a. A reduction in total capital of a corporation

b. A transfer from earned capital to paid-in capital

c. A reduction in book value per share

d. Inclusion in conventional statement of source and application of funds

23. Assuming the issuing company has only one class of stock, a transfer from retained earnings to capital stock equal to the market value of the shares issued is ordinarily a characteristic of

1. Either a stock dividend or a stock split
2. Neither a stock dividend nor a stock split
3. A stock split but not a stock dividend
4. A stock dividend but not a stock split
5. When a stock option plan for employees is compensatory, the measurement date for determining compensation cost is the
   1. Date the option plan is adopted, provided it precedes the date on which the options may first be exercised by less than one operating cycle
   2. Date on which the options may first be exercised (if the first actual exercise is within the same operating period) or the date on which a recipient first exercises any of his options
   3. First date on which are known both the number of shares than an individual employee is entitled to receive and the option or purchase price, if any
   4. Date each option is granted
6. As a minimum, how large in relation to total outstanding shares may a stock distribution be before it should be accounted for as a stock split instead of a stock dividend?
   1. No less than 2 to 5 percent
   2. No less than 10 to 15 percent
   3. No less than 20 to 25 percent
   4. No less than 45 to 50 percent
7. The dollar amount of total stockholders’ equity remains the same when there is a (an)
   1. Issuance of preferred stock in exchange for convertible debentures
   2. Issuance of nonconvertible bonds with detachable stock purchase warrants
   3. Declaration of a stock dividend
   4. Declaration of a cash dividend
8. A company with a substantial deficit undertakes a quasi-reorganization. Certain assets will be written down to their present fair market value. Liabilities will remain the same. How would the entries to record the quasi-reorganization affect each of the following?

Contributed Capital Retained Earnings

• 1. Increase Decrease
  2. Decrease No effect
  3. Decrease Increase
  4. No effect Increase

1. What is the most likely effect of a stock split on the par value per share and the number of shares outstanding?

Par Value Number of shares

Per share outstanding

1. Decrease Increase
2. Decrease No effect
3. Increase Increase
4. No effect No effect
5. Gilbert Corporation issued a 40-percent stock dividend of its common stock that had a par value of $10 before and after the dividend. At what amount should retained earnings be capitalized for the additional shares issued?
   1. There should be no capitalization of retained earnings
   2. Par value
   3. Market value on the declaration date
   4. Market value on the payment date
6. How would the declaration and subsequent issuance of a 10 percent stock dividend by the issuer affect each of the following when the market value of the shares exceeds the par value of the stock?

Common Stock Additional Paid-in Capital

• 1. No effect No effect
  2. No effect Increase
  3. Increase No effect
  4. Increase Increase

1. A company with a $2,000,000 deficit undertakes a quasi-reorganization on November 1, 2020. Certain assets will be written down by $400, 000 to their present fair market value. Liabilities will remain the same. Capital stock was $3,000,000 and additional paid-in capital was $1,000,000 before the quasi-reorganization. How would the entries to accomplish these changes on November 1, 2020, affect each of the following?

Capital Stock Total Stockholders’ Equity

• 1. No effect No effect
  2. No effect Decrease
  3. Decrease Decrease
  4. Decrease No effect

1. How would a stock split affect each of the following?

Total Stockholders’ Additional

Assets Equity Paid-in Capital

1. Increase Increase No effect
2. No effect No effect No effect
3. No effect No effect Increase
4. Decrease Decrease Decrease
5. The purchase of treasury stock
   1. Decreases common stock authorized
   2. Decreases common stock issued
   3. Decreases common stock outstanding
   4. Has no effect on common stock outstanding
6. The equation, assets = equities, expresses which of the following theories of equity?
7. Proprietary theory.
8. Commander theory.
9. Entity theory.
10. Enterprise theory.
11. Under the residual equity theory
12. A business is viewed as a social institution.
13. Management is responsible for maximizing the wealth of common stockholders.
14. A manager’s goals are considered as important as those of the common stockholders.
15. Equities are viewed as restrictions on assets.

1. Under which of the theories of equity is a manager’s goals considered as important as those of the common stockholder.
2. Proprietary theory.
3. Commander theory.
4. Entity theory.
5. Enterprise theory.
6. Which of the theories of equity is consistent with the definition of equity that is found in Statement of Financial Accounting Concepts No. 6?
7. Proprietary theory.
8. Commander theory.
9. Entity theory.
10. Enterprise theory.

1. Which of the following securities must be reported as a liability because they have the characteristics of both liabilities and equity, but the liability characteristic is dominant?
2. Redeemable preferred stock.
3. Stock options issued with a debt security.
4. Detachable stock options.
5. Mandatorily redeemable preferred stock.
6. When a dividend paid to stockholders who own mandatorily redeemable preferred stock, the company must report the dividend
7. As an adjustment to retained earnings in its statement of owners’ equity.
8. As interest expense in the income statement.
9. As a reduction to other comprehensive income.
10. In the financing activities section of the statement of cash flows.
11. When preferred stock is converted to common stock
12. The debt-to-equity ratio decreases.
13. The debt-to-equity ratio increases.
14. The debt-to-equity ratio is unchanged.
15. A gain or loss is reported in earnings for the difference between the fair value of the common stock and the book value of the preferred stock that was converted.
16. When employees are granted options as part of a compensatory stock option plan,
17. Total compensation is measured using a fair value method.
18. Total compensation is measured using the intrinsic method.
19. Total compensation is measured when the options are in the money.
20. Total compensation is measured using the difference between the strike price and the fair value of the options on the grant date.

Essay

1. Discuss the following theories of equity:
   1. Proprietary
   2. Entity
   3. Fund
2. Fund. —an area of attention defined by the activities and operations surrounding any one set of accounting records and for which a self-balancing set of accounts is created.
3. Assets. —economic services and potentials.
4. Restrictions. —limitations on the use of assets.
   1. Commander
   2. Enterprise
   3. Residual equity
5. What is mandatorily redeemable preferred stock and how is it accounted for under the provisions of SFAS No. 150 (FASB ASC 480-10)?
6. List and discuss four advantages of the corporate form of organization.
7. Limited liability. —A stockholder’s loss on his or her investment is limited to the amount of the amount invested (unless on the date of acquisition, the purchase price of the shares acquired was less than their par value). Creditors may not look to the assets of individual owners for debt repayments in the event of a liquidation, as is possible in the case of sole proprietorships and partnerships.
8. Continuity. —The corporation’s life is not affected by the death or resignation of owners.
9. Investment liquidity. —Corporate shares may be freely exchanged on the open market. Many shares are listed on national security exchanges, thereby improving their marketability.
10. Variety of ownership interest. —Shares of corporate stock usually contain four basic rights: the right to vote for members of the board of directors of the corporation and thereby participate in management, the right to receive dividends, the right to receive assets on the liquidation of the corporation, and the preemptive right to purchase additional shares in the same proportion to current ownership interest if new issues of stock are marketed. Shareholders may sacrifice any or all of these rights in return for special privileges. This results in an additional class of stock termed preferred stock, which may have either or both of the following features:
    1. Preference as to dividends.
    2. Preference as to assets in liquidation.
11. Discuss the components of a corporation’s balance sheet capital section.
12. Paid-in capital (contributed capital)
    1. Legal capital-par, stated value, or entire proceeds if no par or stated value accompanies the stock issue
    2. Additional paid-in capital—amounts received in excess of par or stated value
13. Earned capital
    1. Appropriated
    2. Unappropriated
14. Other comprehensive income
15. Discuss the following special features of preferred stock:
    1. Convertible
    2. Call
    3. Cumulative
    4. Participating
    5. Redemption
16. Distinguish between noncompensitory and compensatory stock option plans.
17. How did SFAS No. 123R change accounting for stock options?
18. Define and discuss accounting for stock warrants.
19. As evidence of the preemptive right of current shareholders to purchase additional shares of common stock from new stock issues in proportion to their current ownership percentage.
20. As an inducement originally attached to debt or preferred shares to increase the marketability of these securities.
21. Discuss the difference between a stock dividend and a stock split. Include in your discussion, the reasons a company might issue either a stock dividend or a stock split.
22. Define and discuss the two methods of accounting for treasury stock.
23. Obtain the financial statements of a company and ask the students to compute the:
    1. Return on common stockholders’ equity.
    2. Financial structure ratio