Equity | Test Bank - 1st Edition

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Chapter 9

Equity

Test Bank

True/False Questions

1. Equity typically contains three elements: 1) contributed capital, 2) retained earnings and 3) reserves.

Page: p503

1. All limited liability companies have both ordinary shares and preference shares.

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1. There must be at least one class of ordinary shares though additional classes can exist.

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1. An ordinary share is an equity instrument that is superior to all other classes of equity instruments.

Page: p504

1. A pre-emptive right means that shareholders have the first right of refusal when additional shares are issued.

Page: p504

1. Preference shares, like ordinary shares, always have voting rights since they represent an ownership interest in the business.

Page: p505

1. Some preference shares have a convertibility feature which allows the shares to be exchanged for ordinary shares at some point in the future.

Page: p505

1. In a liquidation, preference shareholders have priority over creditors and ordinary shareholders.

Page: p505

1. A preference shareholder receives a stated dividend and can also benefit from any capital appreciation based on increases in share price.

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1. As part of the registration process, a certain number of authorized shares is specified for a limited liability company and this number cannot subsequently be changed.

Page: p506

1. Authorized share capital is the amount of share capital that a share-based business can issue to owners, either by sale or grant.

Page: p506

1. Nominal value is the total amount authorized shares multiplied by the share’s market price.

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1. Nominal value per share is calculated by dividing authorized share capital by the number of shares authorized.

Page: p507

1. A charter is a document that determines how a share-based business is to be governed.

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1. Issued shares are the number of authorized shares less treasury shares.

Page: p507

1. The register of members is the list of shareholders at any point in time.

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1. An allotment is the right a board has to sell shares without further approval from the shareholders between general meeting dates.

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1. Shares can only be sold for cash.

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1. The difference between the nominal value of a share and the amount the investor paid to aquire the share is recorded in the share premium account.

Page: p508

1. The capitalization of a firm refers to the value of the share-based entity as determined by market price.

Page: p509

1. An IPO refers to the first time shares are issued to owners.

Page: p510

1. When a share-based entity’s shares trade in the secondary market after initial public offering.

Page: p510

1. Shares can be sold to managers and employees of the entity at less than their real market value when a grant is made as part of the employee’s compensation.

Page: p511

1. A rights issue allows existing shareholders to purchase shares at a discounted price in proportion to their current shareholdings.

Page: p513

1. When a company makes an investment in own shares, then the shares are removed from the number of shares issued.

Page: p513

1. An investment in own shares is recorded in a contra account that is shown as a deduction to equity.

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1. The number of outstanding shares is calculated by deducting the number of treasury shares from issued shares.

Page: p514

1. A dividend is a distribution of profit to owners.

Page: p516

1. The dividend declaration date is the date the board of directors declares the dividend however the dividend is not recorded until the payment date.

Page: p517

1. The dividend date of record is the date the dividend is declared by the board of directors.

Page: p518

1. A cumulative preference dividend means that all past dividends for both preference and ordinary shares must be paid before a current preference dividend can be paid.

Page: p518

1. Noncumulative preference shares do not provide for payments of dividend in arrears.

Page: p520

1. Participating preference shares receive a share of dividend distributions over and above the preference dividend amount.

Page: p521

1. A scrip issue is a distribution of cash in proportion to current shareholdings.

Page: p521

1. With a scrip dividend, an amount equal to the fair value of the shares is transferred from retained earnings account to the share capital account.

Page: p522

1. With a share split, an amount equal to the fair value of the shares is transferred from retained earnings account to the share capital account.

Page: p522

1. A journal entry must be made for a share split but not for a scrip dividend.

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1. Dividends are not an expense of the business

Page: p524

1. In 2011, Ahmed Chemicals, LLC paid dividends of €300 000 on a total of 1 000 000 ordinary shares. The equity section showed €1 000 000 in the share capital account and €400 000 in the share premium account. The current market price per share is €2. The dividend yield is 15%.

Page: p524

1. Earnings per share is calculated by dividing the average ordinary plus preference shares outstanding into profit less preference dividends.

Page: p527

1. Dilution refers to the effect that conversion of all convertible instruments has on earnings per share.

Page: p528

1. Slemani Life Water, Ltd. paid total dividends of $40 000 or $0.40 per share in 2010. During 2010, its reported profit was $200 000. The market price of each share was $22. The share capital account showed a balance of $1 000 000 and the share premium account had a balance of $100 000. The price earnings ratio is 11.0.

Page: p528

1. Book value per share is calculated by dividing the number of ordinary shares outstanding into equity less preference shares amount.

Page: p530

Multiple Choice Questions

1. Which of the following statements is not true about ordinary shareholders?
   1. Ordinary shareholders receive distributions in liquidation before preference shareholders
   2. Ordinary shareholders receive distributions in liquidation after creditors
   3. Ordinary shares represent the residual interest in the assets of the business entity
   4. Ordinary shareholders receive a distribution of profits from the business only if and when the board declares a dividend

Page: p504

1. Which of the following elements is not included in equity?
   1. Retained earnings
   2. Reserves
   3. Preference shares
   4. Bonds

Page: p503

1. A convertibility feature is described by which of the following statements?
   1. Shareholders have the first right of refusal when new shares are issued
   2. Shareholders have the right to exchange one class of shares for another
   3. Shareholders have the right to receive a dividend each year
   4. Shareholders have the option of exchanging their shares for voting rights

Page: p505

1. Which of the following will receive the first priority distribution in liquidation?
   1. Creditors
   2. Class B ordinary shareholders
   3. Class A ordinary shareholders
   4. Preference shareholders

Page: p505

1. Which of the following describes the shares that the jurisdiction in which a limited liability company is registered permit to be sold?
   1. Treasury shares
   2. Issued shares
   3. Authorized shares
   4. Outstanding shares

Page: p506

1. Which of the following describes the shares owned by investors?
   1. Treasury shares
   2. Issued shares
   3. Authorized shares
   4. Outstanding shares

Page: p507

1. Four individuals register a new limited liability company with the appropriate jurisdiction. The jurisdiction authorizes 10 000 000 shares and total share capital of $25 000 000. Each individual receives 100 000 shares paying $200 000 in cash. Another 500 000 shares are sold to family and friends for a total of $1 500 000. What is the nominal value per share?
   1. $2.56
   2. $2.00
   3. $2.50
   4. $3.00

Page: p507

1. Which of the following describes the shares owned by investors?
   1. Treasury shares
   2. Issued shares
   3. Authorized shares
   4. Outstanding shares

Page: p507

1. Salim Street Sales, Incorporated sells 10 000 preference shares for £72 000 cash. The shares have a nominal value per share of £4. The company’s ordinary shares have a nominal value of £2 each. 50 000 ordinary shares are issued which sold for £3 each. How much is the preference shares premium account?
   1. £50 000
   2. £82 000
   3. £140 000
   4. £32 000

Page: p508

1. On 1 April 2011, Bano Corporation is selling for €3.50 per ordinary share. The company has 400 000 authorized shares of which 150 000 have been issued. The nominal value of each share is €1.50. What is the capitalization of Bano?
   1. €1 400 000
   2. €600 000
   3. €525 000
   4. €225 000

Page: p509

1. On 2 December 2010, Yamada Hanako, KK sells shares in an initial public offering. What can be said about this sale?
   1. The shares were sold through a private placement in the secondary market
   2. The shares were sold through a bourse in the primary market
   3. The shares were sold through a bourse in the secondary market
   4. The shares were sold through a private placement in the primary market

Page: p509

1. Spinner Ltd. owns a patent which is recorded on its statement of financial position for $40 000. The fair value of the patent is $50 000. Spinner transfers the patent to Lurssen, Incorporated in exchange for 1000 Lurssen’s ordinary shares. The nominal value of each Lurssen share is $4. What amount of share premium will Lurssen record as the result of this transaction?
   1. None
   2. $10 000
   3. $40 000
   4. $20 000

Page: p511

1. Which of the following describes the difference between issued shares less treasury shares?
   1. Treasury shares
   2. Issued shares
   3. Authorized shares
   4. Outstanding shares

Page: p507

1. Adalheidis SA purchases 112 000 of its own ordinary shares for €42 each. The nominal value of each share is €30. The shares were originally sold in an initial public offering for €55 each. The journal entry to record the acquisition would credit investment in own shares for what amount?
   1. €336 000
   2. €6 160 000
   3. €4 704 000
   4. None of the above

Page: p513

1. Adalheidis SA purchases 112 000 of its own ordinary shares for €42 each. The nominal value of each share is €30. The shares were originally sold in an initial public offering for €55 each. The journal entry to record the acquisition would debit investment in own shares for what amount?
   1. €336 000
   2. €6 160 000
   3. €4 704 000
   4. None of the above

Page: p513

1. A dividend becomes a legal obligation of the entity on what date?
   1. The date of record
   2. The declaration date
   3. The payment date
   4. It is automatically an obligation once the shares are issued

Page: p517

1. A preference dividend becomes a legal obligation of the entity on what date?
   1. The date of record
   2. The declaration date
   3. The payment date
   4. It is automatically an obligation once the shares are issued

Page: p519

1. Barham Salih Company has 15 000 preference shares outstanding with a nominal value of €20 each. The stated dividend is 5%. In 2009 and 2010 the board did not declare the preference dividend because business was slow. In 2011, the board made €70 000 available for dividends. How much in dividends did the ordinary shareholders receive?
   1. €70 000
   2. €40 000
   3. €25 000
   4. €55 000

Page: p520

1. The board of directors for Geyer Computer Training, Inc. declared a 3-for-1 split on 15 June 2010. At that time, the company had 100 000 shares outstanding. Each share had a nominal value of $7 and was trading for $22 per share. The journal entry to record this transaction would debit retained earnings for how much?
   1. $0
   2. $4 400 000
   3. $1 400 000
   4. $3 000 000

Page: p522

1. The board of directors for Amina Enterprises Ltd. declared a 15% scrip dividend on 1 May 2010. At that time, the company had 300 000 shares outstanding. Each share had a nominal value of £3 and was trading for £31 per share. The journal entry to record this transaction would debit retained earnings for how much?
   1. £0
   2. £135 000
   3. £9 300 000
   4. £1 395 000

Page: p522

Essay Questions

1. Compare and contrast ordinary and preference shares.
2. What is the difference between a private placement and a public sale of shares? What is the difference between the primary and secondary markets?
3. What is an allotment?
4. Briefly describe the process a board of directors undertakes to pay a dividend to shareholders.