Chapter thirteen
Equities
Questions
1. What is a corporate charter?
2. What are the three important rights of owners of a corporation?
3. What are shareholder resolutions?
4. Name two rights of preferred stockholders.
5. Describe the four features that distinguish debt from equity.
6. Explain why preferred stock is often described as a “hybrid” security.
7. What is meant by redeemable preferred stock?
8. What is meant by cumulative preferred stock?
9. What is a stock warrant?
10. Explain the meaning of the terms authorized, issued, and outstanding as they relate to common stock.
11. Explain why the accounts “unearned compensation ESOP” and “accumulated other comprehensive income” appear in the stockholders’ equity section of the balance sheet.
12. What is treasury stock?
13. Is the purchase of treasury stock like the retirement of shares? Why or why not?
14. Explain why treasury stock is not an asset.
15. How are gains or losses on the sale of treasury stock accounted for?
16. When do dividends become a liability of a corporation?
17. Give the entry to record the declaration of $100 of cash dividends.
18. Give the entry to record the payment of $100 of cash dividends previously declared.
19. What accounting entry would be made to record a 3-for-1 stock split?
20. How does a 3-for-1 stock split affect a company’s income statement and balance sheet?
21. What is a stock dividend?
22. What effect does a 10% stock dividend have on a company’s income statement and balance sheet?
23. Explain the difference between basic earnings per share and diluted earnings per share.
24. Explain why preferred dividends are deducted from net income in the computation of earnings per share.
25. What is meant by dilution?
26. What are anti-dilutive securities?
Exercises
E13-1 A note in the Management’s Discussion and Analysis section of the 2000 annual report of the Yankee Candle Company stated:
Partnerships affiliated with Forstmann Little & Co. own approximately 63% of the company’s common stock and control the Company.
What are the implications of this disclosure to other stockholders and interested investors of Yankee Candle Company?
E13-2 Gemminger Corporation reported the following stockholders’ equity section in its balance sheet at December 31, 2000:
Gemminger Corporation
Stockholders’ Equity
December 31, 2000
4% Cumulative preferred stock, $50 par value $1,600,000
Common stock, 400,000 shares authorized, 300,000 shares issued 4,500,000
Additional paid-in capital: common 900,000
Retained earnings 6,800,000
Less: treasury stock at cost, 10,000 common shares (250,000)
Total Stockholders’ Equity $13,550,000
Required
a. Determine the number of shares Gemminger had outstanding at December 31, 2000.
b. Determine the average issue price of Gemminger’s common stock.
E13-3 Refer to E13-2. Assume that Gemminger declares a cash dividend of $934,000. Determine the amount that an owner of one share of Gemminger’s common stock will receive.
E13-4 Refer to E13-2. Assume that Gemminger reissues 1,000 shares of the treasury stock at $28 per share.
Required
a. Prepare the journal entry made for the reissuance of the treasury stock.
b. Determine the impact of the reissuance on Gemminger’s total assets and total equity.
E13-5 During 2000, Janney Corp. had $2,000,000 of 5% convertible bonds outstanding. The bonds may be converted into a total of 40,000 shares of common stock. The common stock is currently selling for $30 per share. The company’s average tax rate is 40%. What is the numerator and denominator effect of the convertible bonds when computing diluted earnings per share?
E13-6 During 2000, Bunneymen Echo Chambers Inc. had 2000 common stock options outstanding. Each option may be used to purchase one share of common stock at $15 per share. The common stock sold at an average price of $25 per share during 2000. What will be the effect of the stock options on the company’s basic and diluted earnings per share during 2000?
E13-7 On December 31, 1999, Case, Inc. had 300,000 shares of common stock issued and outstanding. Case issued a 10% stock dividend on July 1, 2000. On October 1, 2000, Case purchased 24,000 shares of its common stock for the treasury, and recorded the purchase by the cost method. What is the number of shares that should be used in computing earnings per share for the year ended December 31, 2000?
E13-8 On May 10, 2001, the Wall Street Journal reported:
Verizon Communications sagged $1.78 to 53.82. The telecommunications service concern unveiled one of the largest convertible debt issues ever, a $3 billion offering of zero-coupon notes.
Explain why the stock market would have such a negative reaction to Verizon’s ability to raise $3 billion in financing.
E13-9 South Company had 1,000,000 shares of $5 par value common stock issued and outstanding on January 1, 2001. The following events took place during 2001:
March 15, 2001: Purchased 100,000 shares of treasury stock for $20 per share
June 30, 2001: Reissued 50,000 shares of treasury stock for $23 per share
December 15, 2001: Reissued 10,000 shares of treasury stock for $19 per share
Required
Prepare journal entries for each of the three transactions.
Problems
P13-1 At December 31, 1999, Volleyballs ‘R Us Corp. reported the following in its balance sheet:
Common stock, $10 par value, 200,000 shares issued and outstanding
During 2000, the following equity transactions occurred:
April 1 Issued 400,000 shares of common stock at $40 per share.
May 1 Declared and issued a 10% stock dividend. Market price on the date of issue was $42 per share.
September 1 Declared and issued a 4-1 stock split
October 1 Purchased 50,000 shares at $45 per share of common stock and placed them in the treasury.
Required
a. Prepare journal entries where required for all 2000 transactions.
b. Complete the following table. Indicate the impact of each of the transactions on the company’s assets, liabilities, and equity. Use I for Increase, D for Decrease, and NE for No effect.
Transaction Assets Liabilities Equity
April 1
May 1
September 1
October 1
c. Determine the number of shares that will be outstanding on December 31, 2000.
P13-2 The following was extracted from the balance of Bledsoe Corp. at December 31, 1999:
Stockholders’ equity:
8% Cumulative preferred stock, $100 par,
500,000 shares authorized, 300,000 shares issued $ 30,000,000
Common stock, $10 par value, 2,000,000
shares authorized, 1,500,000 shares issued 15,000,000
Additional paid-in capital 40,000,000
Retained earnings 58,000,000
143,000,000
Less common treasury shares, 300,000 shares at cost (1,500,000)
Total stockholders’ equity $ 141,500,000
Required
a. Assume Bledsoe issued the cumulative preferred at the beginning of 1999 and declared total dividends of $2,000,000 in 1999. How much of a total dividend (both preferred and common) would Bledsoe need to declare in 2000 to be able to pay the common shareholders a $2 per share dividend?
b. What would be the effect on the following balance sheet items if Bledsoe declares a 25% common stock dividend on the outstanding shares at a time when the stock is selling at $60 per share?
Common stock:
Additional paid-in capital:
Retained earnings:
Total stockholders’ equity:
c. What would be the effect on the following balance sheet items if Bledsoe declares a 2-1 stock split at a time when the stock is selling at $60 per share?
Common stock:
Additional paid-in capital:
Retained earnings:
Treasury stock:
Total stockholders’ equity:
P13-3 Lyons, Inc. had 1,000,000 authorized shares of $10 par value common stock, of which 400,000 shares were issued and outstanding. The stockholders’ equity accounts at December 31, 1999, had the following balances:
Common stock $4,000,000
Additional paid in capital-common 840,000
Retained earnings 3,800,000
Accumulated other comprehensive income 120,000
Transactions during 2000 and other information relating to the stockholders’ equity accounts were as follows:
a. On January 8, 2000, Lyons issued 30,000 shares of $100 par, 7% cumulative preferred stock at $105 per share. Lyons had 30,000 authorized shares of preferred stock.
b. On March 1, 2000, Lyons reacquired 10,000 shares of its common stock at a price of $12 per share. Lyons uses the cost method of accounting for treasury stock.
c. On April 8, 2000, Lyons issued 50,000 shares of previously unissued common stock for $600,000.
d. On November 10, 2000, Lyons sold 4,000 shares of treasury stock for $10 per share.
e. Net income for the year ended December 31, 2000 was $748,000.
f. The company experienced a holding loss of $45,000 on its available for sale securities during 2000.
g. On December 31, 2000, the Board of Directors declared the yearly cash dividend on the preferred stock, payable on January 15, 2001 to stockholders of record as of December 31, 2000. The Board of Directors also declared a cash dividend of $.20 per share on the common stock, payable on January 15, 2001 to stockholders of record as of December 31, 2000.
Required
a. Prepare a statement of changes in stockholders’ equity for the year ended December 31, 2000 in good form.
b. Prepare the stockholders’ equity section of the balance sheet at December 31, 2000 in good form.
P13-4 The following information relates to Morse Inc. at December 31, 2000:
Net income $5,000,000
Preferred dividend requirement $ 600,000
Weighted average shares outstanding 400,000
The following analysis has been performed in anticipation of computing earnings per share:
Numerator effect Denominator effect
Convertible preferred $600,000 100,000
Convertible bonds $48,000 4,000
Stock options — 1,000
Required
a. Compute basic earnings per share.
b. Compute diluted earnings per share.
P13-5 The stockholders equity section of the balance sheet of Papillardo Corporation at December 31, 2000 appears as follows:
Stockholders’ equity:
7 % preferred stock, $100 par 100,000 shares
authorized, 40,000 shares issued $4,000,000
Common stock, $1 par, 1,000,000 shares authorized,
600,000 shares issued, of which 50,000 are held
in treasury 600,000
Additional paid in capital:
From issuance of preferred stock 480,000
From issuance of common stock 1,410,000
From treasury stock transactions 25,000
Retained earnings 4,500,000
Less treasury stock (at cost: 50,000 common shares) (300,000)
Total stockholders’ equity $10,715,000
Required
Answer the following questions related to Papillardo Corporation.
a. What was the average issue price of the preferred stock as of December 31, 2000?
b. How many shares of common stock are outstanding?
c. What journal entry was made when the common stock was issued?
d. If all of the treasury stock was reissued for $400,000, what journal entry would the company make?
e. What is the amount of the total dividend requirement on preferred stock annually?
f. Assuming that there are no dividends in arrears, if the company declared a total cash dividend of $580,000, what would be the dividend per share for the preferred and common stock?
g. Assume the company’s common stock is selling for $80 per share. What journal entry would be made if the company issues a 10% common stock dividend?
h. Compute basic earnings per share if the company’s net income was $1,560,000 during 2000. Assume no new shares were issued during the year.
i. Refer to the original data. Assume the company declares a 3-for-2 stock split. How many shares of common stock would be outstanding after the split?
j. Refer to the previous requirement. What effect would the stock split have on the company’s income statement, balance sheet, and statement of cash flows?
k. If the stock market reacts rationally to the stock split, what would you expect the stock to be selling for after the split? Assume the stock was selling for $80 per share before the split.
P13-6 At December 31, 2000, Sorena Corp. reported the following in its balance sheet:
Common stock, $5 par value, 400,000 shares issued and outstanding
During 2001, the following equity transactions occurred:
April 1 Issued 600,000 shares of common stock at $40 per share
May 1 Declared and issued a 10% stock dividend
September 1 Declared and issued a 2-1 stock split
October 1 Purchased 100,000 shares of common stock and placed them in the treasury
Required
a. Determine the number of shares outstanding at December 31, 2000.
b. Compute the weighted average shares of common outstanding to be used in the calculation of basic earnings per share calculation for 2000.
Cases and Projects
C13-1 The balance sheets for Coldwater Creek at 2/27/99 and 2/26/00 are as follows on page 148:
Coldwater Creek Inc.
Balance Sheets
(000’s)
For the years ended
02/26/00 02/27/99
ASSETS
Current Assets:
Cash and cash equivalents $7,533 $149
Receivables 5,741 2,683
Inventories 60,203 56,474
Prepaid expenses 1,319 1,234
Prepaid catalog costs 3,994 4,274
Deferred income taxes 915 —
Total Current Assets 79,705 64,814
Deferred catalog costs 2,817 3,195
Property and equipment, net 38,895 31,236
Executive loans 1,453 1,376
Total Assets $122,870 $100,621
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Revolving line of credit — $9,938
Accounts payable 30,098 17,086
Accrued liabilities 13,549 7,668
Income taxes payable 2,140 4,445
Deferred income taxes — 1,080
Total Current Liabilities 45,787 40,217
Deferred income taxes 513 298
Total Liabilities 46,300 40,515
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value, 1,000,000 shares
authorized, none issued and outstanding — —
Common stock, $.01 par value, 15,000,000 shares
authorized, 10,319,345 and 10,183,117 issued
and outstanding, respectively 103 102
Additional paid-in capital 41,579 39,287
Retained earnings 34,888 20,717
Total Stockholders’ Equity 76,570 60,106
Total Liabilities and Stockholders’ Equity $122,870 $100,621
Required
Answer the following questions related to Coldwater Creek’s Stockholders’ Equity:
a. The company has 1,000,000 shares of preferred stock authorized. What would be a possible explanation as to why the company has not issued any preferred stock?
b. Assuming that the changes in the common stock account were related to sales in the open market during 2000, prepare the journal entry the company made when the shares were issued.
c. Again, assuming that all changes in the common stock account were related to sales in the open market, what was the average market price of new shares issued during 2000?
d. The closing market price per share of Coldwater Creek’s common stock on February 26, 2000 was $18.125. What entry would have been made on that date if the company had purchased 600,000 shares of treasury stock in the open market?
e. If the company had purchased 600,000 shares of treasury stock in the open market, what would have been the effect on Coldwater Creek’s net income, earnings per share, assets, equity, and cash flows?
f. Assume that Coldwater Creek split its common stock 3-for-1 on February 26, 2000. How would the split have changed the equity section of the balance sheet on February 26, 2000? Would this split affect the balance sheet at February 27, 1999? Explain.
g. How would a 3-for-1 stock split have affected the market value of Coldwater Creek’s common stock on February 26, 2000, assuming rational markets?