Chapter 13

Corporations

Review Questions

1. What is meant by ‘separate legal entity’ with regard to corporations?

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

3. What does authorized stock mean?

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. How does issued stock differ from capital stock?

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. Define outstanding stock.

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. What is meant by preemptive right? List the other three shareholders’ rights.

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. What is an underwriter? Give an example of an underwriter.

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. Briefly define issue price and how it relates to par value.

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. What is the difference between premium and discount?

© 2016 Pearson Education, Ltd. 13-1

 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. What is meant by dividend in arrears?

A preferred stock dividend is in arrears if the cumulative dividend has not been paid for the year.

11. Where and how is treasury stock reported on the balance sheet?

Treasury stock is reported beneath retained earnings on the balance sheet as a reduction to total
stockholders’ equity.

12. How does small stock dividend differ from a large stock dividend?

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. What are the three relevant dates involving cash dividends? Describe each.

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 the names of stockholders that receive dividend
checks.
c. Payment of the dividend usually follows the record date by a week or two.

14. How does cumulative preferred stock differ from noncumulative preferred stock?

With cumulative preferred stock, the owners must receive all dividends in arrears before the
corporation pays dividends to the common stockholders. For noncumulative preferred stock, the
corporation is not required to pay any passed dividends.

15. What is a stock dividend?

A stock dividend is a distribution of a corporation’s own stock to its stockholders.

© 2016 Pearson Education, Ltd. 13-2

16. What is the effect on the accounting equation when a stock dividend is declared? What is the effect
on the accounting equation when a stock dividend is distributed?

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 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.

17. What are some reasons corporations issue stock dividends?

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

18. What is a stock split?

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.

19. What does the statement of retained earnings report?

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. What is a prior-period adjustment?

A prior-period adjustment is a correction to retained earnings for an error in an earlier period.

21. What does the statement of stockholders’ equity report? How does the statement of stockholders’
equity differ from the statement of retained earnings?

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. What does earnings per share report, and how is it calculated?

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. What is the price/earnings ratio, and how is it calculated?

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.

© 2016 Pearson Education, Ltd. 13-3

24. What does the rate of return on common stock show, and how is it calculated?

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 Describing corporation characteristics

Learning Objective 1

Due to recent beef recalls, Southwest Steakhouse is considering incorporating. Bob, the owner, wants to
protect his personal assets in the event the restaurant is sued.

Requirements
1. Which advantage of incorporating is most applicable? What are other advantages of organizing as a
corporate entity?
2. What are some disadvantages of organizing as a corporation?

SOLUTION

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.

© 2016 Pearson Education, Ltd. 13-4

S13-2 Journalizing issuance of stock—at par and at a premium
Learning Objective 2

Guinness Corporation has two classes of stock: common, $1 par value; and preferred, $15 par value.

Requirements
1. Journalize Guinness’ issuance of 5,000 shares of common stock for $14 per share.
2. Journalize Guinness’ issuance of 5,000 shares of preferred stock for a total of $75,000.

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Cash ($14 per share × 5,000 shares) 70,000
Common Stock—$1 Par Value ($1 per share × 5,000 shares) 5,000
Paid-In Capital in Excess of Par—Common ($13 per share ×
5,000 shares) 65,000
Issued common stock at a premium.

Requirement 2

Date Accounts and Explanation Debit Credit

Cash 75,000
Preferred Stock—$15 Par Value ($15 per share × 5,000 shares) 75,000
Issued preferred stock at par.

S13-3 Journalizing issuance of stock—no-par

Learning Objective 2

Ashford Corporation issued 10,000 shares of no-par common stock for $5 per share on March 13.
Record the stock issuance.

SOLUTION

Date Accounts and Explanation Debit Credit

Mar. 13 Cash 50,000
Common Stock—No-Par Value ($5 per share × 10,000
shares) 50,000
Issued no-par common stock.

© 2016 Pearson Education, Ltd. 13-5

S13-4 Journalizing issuance of stock—stated value
Learning Objective 2

Turner Corporation issued 6,500 shares of $3 stated value common stock for $11 per share on July 7.
Record the stock issuance.

SOLUTION

Date Accounts and Explanation Debit Credit

July 7 Cash ($11 per share × 6,500 shares) 71,500
Common Stock—$3 Stated Value ($3 per share × 6,500
shares) 19,500
Paid-In Capital in Excess of Stated—Common ($8 per share ×
6,500 shares) 52,000
Issued common stock at a premium.

S13-5 Journalizing issuance of stock for assets other than cash

Learning Objective 2

Miller Corporation issued 30,000 shares of $1 par value common stock in exchange for a building with a
market value of $160,000. Record the stock issuance.

SOLUTION

Date Accounts and Explanation Debit Credit

Building 160,000
Common Stock—$1 Par Value ($1 per share × 30,000 shares) 30,000
Paid-In Capital in Excess of Par—Common ($160,000 –
$30,000) 130,000
Issued common stock in exchange for a building.

© 2016 Pearson Education, Ltd. 13-6

 S13-6 Accounting for the purchase and sale of treasury stock
Learning Objective 3

Discount World Furniture, Inc. completed the following treasury stock transactions in 2016:

Requirements
1. Journalize these transactions. Explanations are not required.
2. How will Discount World Furniture, Inc. report treasury stock on its balance sheet as of December
31, 2016?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

2016
Dec. 1 Treasury Stock—Common ($7 per share × 1,300 shares) 9,100
Cash 9,100

Dec. 15 Cash ($10 per share × 200 shares) 2,000

Treasury Stock—Common ($7 per share × 200 shares) 1,400
Paid-In Capital from Treasury Stock Transactions ($3 × 200 shares) 600

Dec. 20 Cash ($3 per share × 500 shares) 1,500

Paid-In Capital from Treasury Stock Transactions 1,900
Retained Earnings 100
Treasury Stock—Common ($7 per share × 500 shares) 3,500

Requirement 2

Discount World Furniture, Inc. will report treasury stock beneath retained earnings on the balance sheet
as a reduction to total stockholders’ equity on December 31, 2016.

© 2016 Pearson Education, Ltd. 13-7

S13-7 Accounting for cash dividends
Learning Objective 4

Frenchroast Company earned net income of $95,000 during the year ended December 31, 2016. On
December 15, Frenchroast declared the annual cash dividend on its 2% preferred stock (par value,
$128,000) and a $0.75 per share cash dividend on its common stock (65,000 shares). Frenchroast then
paid the dividends on January 4, 2017.

Requirements
1. Journalize for Frenchroast the entry declaring the cash dividends on December 15, 2016.
2. Journalize for Frenchroast the entry paying the cash dividends on January 4, 2017.

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

2016
Dec. 15 Cash Dividends ($2,560 + $48,750) 51,310
Dividends Payable—Preferred (2% × $128,000) 2,560
Dividends Payable—Common ($0.75 per share × 65,000) 48,750
Declared a cash dividend.

Requirement 2

Date Accounts and Explanation Debit Credit

2017
Jan. 4 Dividends Payable—Preferred 2,560
Dividends Payable—Common 48,750
Cash 51,310
Payment of cash dividend.

© 2016 Pearson Education, Ltd. 13-8

S13-8 Dividing cash dividends between preferred and common stock
Learning Objective 4

Platinum Trust has the following classes of stock:

Requirements
1. Platinum declares cash dividends of $20,000 for 2016. How much of the dividends goes to preferred
stockholders? How much goes to common stockholders?
2. Assume the preferred stock is cumulative and Platinum passed the preferred dividend in 2014 and
2015. In 2016, the company declares cash dividends of $50,000. How much of the dividend goes to
preferred stockholders? How much goes to common stockholders?
3. Assume the preferred stock is noncumulative and Platinum passed the preferred dividend in 2014
and 2015. In 2016, the company declares cash dividends of $50,000. How much of the dividend goes
to preferred stockholders? How much goes to common stockholders?

SOLUTION

Requirement 1

Total Dividend $ 20,000

Dividend to Preferred Stockholders 3% × $14 × 5,500 shares (2,310)
Dividend to Common Stockholders $ 17,690

Requirement 2

Total Dividend $ 50,000

Dividend to Preferred Stockholders 3% × $14 × 5,500 shares
Dividends in Arrears (2014) $ 2,310
Dividends in Arrears (2015) 2,310
Current Year Dividend (2016) 2,310 (6,930)
Dividend to Common Stockholders $ 43,070

Requirement 3

Total Dividend $ 50,000

Dividend to Preferred Stockholders (2016) 3% × $14 × 5,500 shares (2,310)
Dividend to Common Stockholders $ 47,690

© 2016 Pearson Education, Ltd. 13-9

S13-9 Journalizing a small stock dividend
Learning Objective 4

Extreme Water Sports has 17,000 shares of $1 par value common stock outstanding. Extreme distributes
a 15% stock dividend when the market value of its stock is $18 per share.

Requirements
1. Journalize Extreme’s declaration of the stock dividend on August 15 and distribution on August 31.
2. What is the overall effect of the stock dividend on Extreme’s total assets?
3. What is the overall effect on total stockholders’ equity?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Aug.
15 Retained Earnings ($18 per share × 17,000 × 0.15) 45,900
Common Stock Dividend Distributable ($1 per share ×
17,000 × 0.15) 2,550
Paid-In Capital in Excess of Par—Common ($45,900 −
$2,550) 43,350
Declared a 15% stock dividend.

Aug. Common Stock Dividend Distributable ($1 per share × 17,000 2,550
31 × 0.15)
Common Stock—$1 Par Value 2,550
Issued 15% stock dividend.

Requirement 2

The overall effect of the stock dividend on Extreme’s total assets is zero.

Requirement 3

The overall effect of the stock dividend on Extreme’s total stockholders’ equity accounts is zero.

© 2016 Pearson Education, Ltd. 13-10

S13-10 Journalizing a large stock dividend
Learning Objective 4

Billy, Inc. had 270,000 shares of $2 par value common stock issued and outstanding as of December 15,
2016. The company is authorized to issue 1,500,000 common shares. On December 15, 2016, Billy
declared a 40% stock dividend when the market value for Billy’s common stock was $7 per share. The
stock was issued on Dec. 30.

Requirements
1. Journalize the declaration and distribution of the stock dividend.
2. How many shares of common stock are outstanding after the dividend?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Dec. 15 Stock Dividends ($2 per share × 270,000 shares × 0.40) 216,000
Common Stock Dividend Distributable 216,000
Declared a 40% stock dividend.

Dec. 30 Common Stock Dividend Distributable 216,000

Common Stock—$2 Par Value 216,000
Issued 40% stock dividend.

Requirement 2

Shares before dividend 270,000

New shares from 40% dividend 108,000
Total shares after dividend 378,000

© 2016 Pearson Education, Ltd. 13-11

S13-11 Accounting for a stock split
Learning Objective 4

Decor Plus Imports recently reported the following stockholders’ equity:

Suppose Decor Plus split its common stock 2-for-1 in order to decrease the market price per share of its
stock. The company’s stock was trading at $21 per share immediately before the split.

Requirements
1. Prepare the stockholders’ equity section of the Decor Plus Imports balance sheet after the stock split.
2. Were the account balances changed or unchanged after the stock split?

SOLUTION

Requirement 1

Stockholders’ Equity
Paid-In Capital:
Common Stock—$0.50 Par Value; 550,000,000 shares
authorized, 220,000,000 shares issued and outstanding $ 110,000,000
Paid-In Capital in Excess of Par—Common 154,000,000
Total Paid-In Capital 264,000,000
Retained Earnings 645,000,000
Total Stockholders’ Equity $ 909,000,000

Requirement 2

The account balances would be unchanged after the stock split.

© 2016 Pearson Education, Ltd. 13-12

S13-12 Preparing a statement of retained earnings
Learning Objective 5

Tinder, Inc. had beginning retained earnings of $90,000 on January 1, 2016. During the year, Tinder
declared and paid $90,000 of cash dividends and earned $95,000 of net income. Prepare a statement of
retained earnings for Tinder, Inc. for the year ending December 31, 2016.

SOLUTION

TINDER, INC.
Statement of Retained Earnings
Year Ended December 31, 2016

Retained Earnings, January 1, 2016 $ 90,000

Net income for the year 95,000
185,000
Dividends Declared (90,000)
Retained Earnings, December 31, 2016 $ 95,000

S13-13 Analyzing the effect of prior-period adjustments

Learning Objective 5

Taylor Corporation discovered in 2017 that it had incorrectly recorded in 2016 a cash payment of
$50,000 for utilities expense. The correct amount of the utilities expense was $60,000.

Requirements
1. Determine the effect of the error on the accounting equation in 2016.
2. How should this error be reported in the 2017 financial statements?

SOLUTION

Requirement 1

In 2016, the error overstated assets by $10,000, understated utilities expense by $10,000 and overstated
net income by $10,000. In 2016, total stockholders’ equity (retained earnings) would be overstated
$10,000.

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 2017; it would be designated as a prior-period adjustment. The
prior period adjustment would be a deduction of $10,000.

© 2016 Pearson Education, Ltd. 13-13

S13-14 Computing earnings per share
Learning Objective 6

RUT Corporation had net income for 2016 of $36,400. RUT had 2,400 shares of common stock
outstanding at the beginning of the year and 20,000 shares of common stock outstanding as of December
31, 2016. During the year, RUT declared and paid preferred dividends of $5,040. Compute RUT’s
earnings per share.

SOLUTION

Earnings per (Net income − Preferred Average number of common shares

= /
share dividends) outstanding
= ($36,400 − $5,040) / (2,400 shares + 20,000 shares) / 2
$2.80 per share = $31,360 / 11,200

Note: Short Exercise S13-14 must be completed before attempting Short Exercise S13-15.

S13-15 Computing price/earnings ratio

Learning Objective 6

Refer to the RUT data in Short Exercise S13-14. Assume the market price of RUT’s common stock is
$18 per share. Compute RUT’s price/earnings ratio.

SOLUTION

Price/earnings
= Market price per share of common stock / Earnings per share
ratio
$6.43 per share = $18 / $2.80

© 2016 Pearson Education, Ltd. 13-14

S13-16 Computing rate of return on common stockholders’ equity
Learning Objective 6

Tolman, Inc.’s 2016 balance sheet reported the following items—with 2015 figures given for
comparison:

Net income for 2016 was $1,750. Compute Tolman’s rate of return on common stockholders’ equity for
2016.

SOLUTION

Rate of
return on
(Net income − Preferred Average common stockholders’
common = /
dividends) equity
stockholders’
equity
= ($1,750 − 0) / ($11,500 + $13,500) / 2
0.14 = 14% = $1,750 / $12,500

© 2016 Pearson Education, Ltd. 13-15

Exercises
E13-17 Identifying advantages and disadvantages of a corporation
Learning Objective 1

Following is a list of advantages and disadvantages of the corporate form of business. Identify each
quality as either an advantage or a disadvantage.
a. Ownership and management are separated.
b. Entity has continuous life.
c. Transfer of ownership is easy.
d. Stockholders’ liability is limited.
e. Exposure to double taxation is evident.
f. Entity can raise more money than a partnership or sole proprietorship.
g. Government regulation is expensive.

SOLUTION

a. Disadvantage
b. Advantage
c. Advantage
d. Advantage
e. Disadvantage
f. Advantage
g. Disadvantage

E13-18 Determining paid-in capital for a corporation

Learning Objective 2

Moe & Rabie Corporation began business by issuing 150,000 shares of $5 par value common stock for
$25 per share. During its first year, the corporation sustained a net loss of $25,000. Without journalizing,
determine the paid-in capital in excess of par created by this transaction.

SOLUTION

Paid-in capital = 150,000 shares × (25 – 5) = $3,000,000

© 2016 Pearson Education, Ltd. 13-16

E13-19 Journaling issuance of stock
Learning Objective 2

Prepare the necessary journal entry for each of the following transactions for Nadim Corporation.

1. Issued 2,000 shares of its $10 par value common stock for $20 per share.
2. Issued 5,000 shares of its stock for land advertised for sale at $90,000. Nadim’s stock is actively
traded at a market price of $16 per share.
3. Issued 1,000 shares of its $100 par value preferred stock for $120 per share.

Requirements
1. Journalize the transactions. Explanations are not required.
2. How much paid-in capital did these transactions generate for Skylar Systems?

SOLUTION

(a) Cash (2,000 × $20)........................................................................... 40,000

Common Stock....................................................................... 20,000
Paid-in Capital in Excess of Par – Common Stock................ 20,000

(b) Land (5,000 × $16)........................................................................... 80,000

Common Stock....................................................................... 50,000
Paid-in Capital in Excess of Par – Common Stock................ 30,000

(c) Cash (1,000 × $120)......................................................................... 120,000

Preferred Stock....................................................................... 100,000
Paid-in Capital in Excess of Par – Preferred Stock……. 20,000

© 2016 Pearson Education, Ltd. 13-17

 E13-20 Journalizing issuance of no-par stock
Learning Objective 2
1. a. Cash $16,000

Bates Corp. issued 2,000 shares of no-par common stock for $8 per share.

Requirements
1. Record issuance of the stock if the stock:
a. is true no-par stock.
b. has stated value of $2 per share.
2. Which type of stock results in more total paid-in capital?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

a. Cash ($8.00 per share × 2,000 shares) 16,000

Common Stock 16,000
Issued no-par stock.

b. Cash ($8.00 per share × 2,000 shares) 16,000

Common Stock—$2 Stated Value ($2 per share × 2,000 shares) 4,000
Paid-In Capital in Excess of Stated—Common ($16,000 − $4,000) 12,000
Issued $2 stated value common stock.

Requirement 2

Both types of stock result in the same paid-in capital balance.

© 2016 Pearson Education, Ltd. 13-18

E13-21 Journalizing issuance of stock and determining preferred stock and paid-in capital for a
corporation
Learning Objective 2
Preferred Stock $90,000

In its first year of operations, Mira Corporation had the following transactions pertaining to its $10 par
value preferred stock.

Requirements
1. Journalize the transactions.
2. Indicate the amount to be reported for (1) preferred stock, and (2) paid-in capital in excess of par —
preferred stock at the end of the year.

SOLUTION

(a) June 1 Cash................................................................................... 258,000

Preferred Stock........................................................ 60,000
Paid-in Capital in Excess of Par—Preferred
Stock....................................................................... 198,000

July 1 Cash................................................................................... 135,000

Preferred Stock........................................................ 30,000
Paid-in Capital in Excess of Par—Preferred
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.

© 2016 Pearson Education, Ltd. 13-19

E13-22 Journalizing issuance of stock and preparing the stockholders’ equity section of the
balance sheet
Learning Objective 2
Total Stockholders’ Equity $7,525

Daniella Corporation is authorized to issue 1,000 shares of $5 par value common stock and 500 shares
of $10 par value preferred stock. In its first year the corporation has the following stock transactions:

Requirements
1. Journalize the transactions.
2. Prepare the stockholder’s equity section assuming that the company had retained earnings of $2,000
on December 31.

© 2016 Pearson Education, Ltd. 13-20

SOLUTION

Jan 10 Cash (400 × $8)...................................................................... 3,200

Common Stock............................................................ 2,000
Paid-in Capital in Excess of Par – Common Stock..... 1,200

July 12 Land (100 × $8.25)................................................................ 825

Common Stock............................................................ 500
Paid-in Capital in Excess of Par – Common Stock..... 325

Sep 15 Cash (100 × $15).................................................................... 1,500

Preferred Stock........................................................... 1,000
Paid-in Capital in Excess of Par – Preferred Stock.... 500

(b) Stockholders' equity

Paid-in capital
Capital stock
Preferred stock, $10 par value
500 shares authorized, 100 shares issued and outstanding $1,000
Common stock, $5 par value, 1,000
shares authorized, 500 shares issued and
outstanding 2,500
Total capital stock 3,500
Additional paid-in capital
In excess of par—preferred stock $ 500
In excess of par—common stock 1,525
Total additional paid-in capital 2,025
Total paid-in capital 5,525
Retained Earnings 2,000
Total stockholder’s Equity $7,525

© 2016 Pearson Education, Ltd. 13-21

E13-23 Journalizing treasury stock transactions and reporting stockholders’ equity
Learning Objective 3
2. Total Stockholders’ Equity $53,500

Pioneer Amusements Corporation had the following stockholders’ equity on November 30:

On December 30, Pioneer purchased 100 shares of treasury stock at $11 per share.

Requirements
1. Journalize the purchase of the treasury stock.
2. Prepare the stockholders’ equity section of the balance sheet at December 31, 2016. Assume the
balance in retained earnings is unchanged from November 30.
3. How many shares of common stock are outstanding after the purchase of treasury stock?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Dec. 30 Treasury Stock—Common ($11 per share × 100 shares) 1,100

Cash 1,100
Purchased treasury stock.

© 2016 Pearson Education, Ltd. 13-22

E13-23, cont.
Requirement 2

PIONEER AMUSEMENTS CORPORATION

Balance Sheet (Partial)
December 31, 2016

Stockholders’ Equity
Paid-In Capital:
Common Stock, $5 Par Value; 1,300 shares authorized,
130 shares issued, 30 shares outstanding $ 650
Paid-In Capital in Excess of Par—Common 1,950
Total Paid-In Capital 2,600
Retained Earnings 52,000
Treasury Stock—Common; 100 shares at cost (1,100)
Total Stockholders’ Equity $ 53,500

Requirement 3

There are 30 shares outstanding after the purchase of the treasury stock (130 shares − 100 shares).

E13-24 Journalizing issuance of stock and treasury stock transactions

Learning Objectives 2, 3
Sept. 22 Treasury Stock $3,300 CR

Stock transactions for Cautious Driving School, Inc. follow:

Journalize the transactions.

© 2016 Pearson Education, Ltd. 13-23

 SOLUTION

Date Accounts and Explanation Debit Credit

Mar. 4 Cash ($8 per share × 29,000 shares) 232,000

Common Stock ($1 per share × 29,000 shares) 29,000
Paid-In Capital in Excess of Par—Common ($232,000 − $29,000) 203,000
Issued common stock for cash.

May 22 Treasury Stock—Common ($11 per share × 900 shares) 9,900

Cash 9,900
Purchased treasury stock.

Sep. 22 Cash ($25 per share × 300 shares) 7,500

Treasury Stock—Common ($11 cost per share × 300 shares) 3,300
Paid-In Capital from Treasury Stock Transactions ($14 × 300 shares) 4,200
Sold treasury stock with cost of $11 per share.

Oct. 14 Cash ($6 per share × 600 shares) 3,600

Paid-In Capital from Treasury Stock Transactions ($5 × 600 shares) 3,000
Treasury Stock—Common ($11 cost per share × 600 shares) 6,600
Sold treasury stock with cost of $11 per share.

© 2016 Pearson Education, Ltd. 13-24

E13-25 Computing dividends on preferred and common stock and journalizing
Learning Objective 4
1. Preferred Dividend 2016 $7,680

Horizon Communications has the following stockholders’ equity on December 31, 2016:

Requirements
1. Assuming the preferred stock is cumulative, compute the amount of dividends to preferred
stockholders and to common stockholders for 2016 and 2017 if total dividends are $7,680 in 2016
and $49,000 in 2017. Assume no changes in preferred stock and common stock in 2017.
2. Record the journal entries for 2016, assuming that Horizon Communications declared the dividend
on December 1 for stockholders of record on December 10. Horizon Communications paid the
dividend on December 20.

SOLUTION

Requirement 1

Total Dividend—2016 $ 7,680

Dividend to Preferred Stockholders 4% × $11 × 22,000 shares $ 9,680
Current Year Dividend (2016) (7,680)
Dividend to Common Stockholders $ 0

Total Dividend—2017 $ 49,000

Dividend to Preferred Stockholders 4% × $11 × 22,000 shares
Dividends in Arrears (2016) $9,680 – $7,680 $ 2,000
Current Year Dividend (2017) 9,680 (11,680)
Dividend to Common Stockholders $ 37,320

© 2016 Pearson Education, Ltd. 13-25

E13-25, cont.
Requirement 2

Date Accounts and Explanation Debit Credit

2016
Dec. 1 Cash Dividends 7,680
Dividends Payable—Preferred 7,680
Declared a cash dividend.

20 Dividends Payable—Preferred 7,680

Cash 7,680
Payment of cash dividend.

E13-26 Computing dividends on preferred and common stock and journalizing

Learning Objective 4
2. July 1 Cash Dividends $155,000 DR

The following elements of stockholders’ equity are from the balance sheet of Sacchetti Marketing Corp.
at December 31, 2015:

Sacchetti paid no preferred dividends in 2015.

Requirements
1. Compute the dividends to the preferred and common shareholders for 2016 if total dividends are
$155,000 and assuming the preferred stock is noncumulative.
2. Record the journal entries for 2016 assuming that Sacchetti Marketing Corp. declared the dividends
on July 1 for stockholders of record on July 15. Sacchetti paid the dividends on July 31.

© 2016 Pearson Education, Ltd. 13-26

SOLUTION

Requirement 1

Total Dividend—2016 $ 155,000

Dividend to Preferred Stockholders 5% × $2 × 45,000 shares $ 4,500
Current Year Dividend (2016) (4,500)
Dividend to Common Stockholders $ 150,500

Requirement 2

Date Accounts and Explanation Debit Credit

2016
July 1 Cash Dividends 155,000
Dividends Payable—Preferred 4,500
Dividends Payable—Common 150,500
Declared a cash dividend.

31 Dividends Payable—Preferred 4,500

Dividends Payable—Common 150,500
Cash 155,000
Payment of cash dividend.

© 2016 Pearson Education, Ltd. 13-27

E13-29 Reporting stockholders’ equity after a stock split
Learning Objective 4
Total Stockholders’ Equity $4,120

Tour Golf Club Corp. had the following stockholders’ equity at December 31, 2015:

On June 30, 2016, Tour split its common stock 2-for-1. Prepare the stockholders’ equity section of the
balance sheet immediately after the split. Assume the balance in retained earnings is unchanged from
December 31, 2015.

SOLUTION

TOUR GOLF CLUB, CORP.

Balance Sheet (Partial)
June 30, 2106

Stockholders’ Equity
Paid-In Capital:
Common Stock—$1.00 Par Value; 650 shares
authorized, 440 shares issued and outstanding $ 440
Paid-In Capital in Excess of Par—Common 880
Total Paid-In Capital 1,320
Retained Earnings 2,800
Total Stockholders’ Equity $ 4,120

E13-30 Determining the effects of cash dividends, stock dividends, and stock splits
Learning Objective 4

Complete the following chart by inserting a check mark (?) for each statement that is true.

© 2016 Pearson Education, Ltd. 13-28

SOLUTION

Cash dividend Stock dividend Stock split

Decreases retained earnings √ √
Has no effect on a liability √ √ √
Increases paid-in capital by the
same amount that it decreases √
retained earnings
Decreases both total assets and
√
total stockholders’ equity
Has no effect on total
√ √
stockholders’ equity

© 2016 Pearson Education, Ltd. 13-29

E13-31 Determining the effect of stock dividends, stock splits, and treasury stock transactions
Learning Objectives 3, 4

Many types of transactions may affect stockholders’ equity. Identify the effects of the following
transactions on total stockholders’ equity. Each transaction is independent.
a. A 10% stock dividend. Before the dividend, 560,000 shares of $1 par value common stock were
outstanding; market value was $10 per share at the time of the dividend.
b. A 2-for-1 stock split. Prior to the split, 65,000 shares of $1 par value common stock were
outstanding.
c. Purchase of 1,500 shares of $0.50 par treasury stock at $7 per share.
d. Sale of 900 shares of $0.50 par treasury stock for $9 per share. Cost of the treasury stock was $8 per
share.

SOLUTION

a. No effect (increases Paid-In Capital, but decreases Retained Earnings)

b. No effect
c. Decrease stockholders’ equity
d. Increase stockholders’ equity

E13-32 Preparing a statement of retained earnings

Learning Objective 5
Retained Earnings Dec. 31, 2016 $97,000

Susan May Bakery, Inc. reported a prior-period adjustment in 2016. An accounting error caused net
income of prior years to be overstated by $4,000. Retained Earnings at December 31, 2015, as
previously reported, was $42,000. Net income for 2016 was $79,000, and dividends declared were
$20,000. Prepare the company’s statement of retained earnings for the year ended December 31, 2016.

SOLUTION

SUSAN MAY BAKERY, INC.

Statement of Retained Earnings
Year Ended December 31, 2016

Retained Earnings, January 1, 2016, as originally reported $ 42,000

Prior Period Adjustment (4,000)
Retained Earnings, January 1, 2016, as adjusted 38,000
Net income for the year 79,000
117,000
Dividends Declared (20,000)
Retained Earnings, December 31, 2016 $ 97,000

© 2016 Pearson Education, Ltd. 13-30

E13-33 Computing earnings per share and price/earnings ratio
Learning Objective 6

Temple Corp. earned net income of $128,500 and paid the minimum dividend to preferred stockholders
for 2016. Assume that there are no changes in common shares outstanding. Temple’s books include the
following figures:

Requirements
1. Compute Temple’s EPS for the year.
2. Assume Temple’s market price of a share of common stock is $8 per share. Compute Temple’s
price/earnings ratio.

SOLUTION

Requirement 1

Earnings per (Net income − Preferred Average number of common shares

= /
share dividends) outstanding
($128,500 – (5% × $40 ×
= / 50,600
1,000 shares)
($128,500 – $2,000) 50,600
$2.50 per share = $126,500 / 50,600

Requirement 2

Price/earnings
= Market price per share of common stock / Earnings per share
ratio
$3.20 per share = $8 / $2.50

© 2016 Pearson Education, Ltd. 13-31

E13-34 Computing rate of return on common stockholders’ equity
Learning Objective 6

Louisville Exploration Company reported these figures for 2016 and 2015:

Compute rate of return on common stockholders’ equity for 2016 assuming no dividends were paid to
preferred stockholders.

SOLUTION

Rate of
return on Average common stockholders’
(Net income − Preferred
common = / equity = Total equity - preferred
dividends)
stockholders’ equity
equity
($15,500,000 − 0) / (($189,600,000 – $2,600,000) +
=
($179,100,000 − $2,600,000)) / 2
= $15,500,000 / ($187,000,000 + $176,500,000) / 2
0.09 = 9% = $15,500,000 / $181,750,000

© 2016 Pearson Education, Ltd. 13-32

Problems (Group A)
P13-35A Organizing a corporation and issuing stock
Learning Objectives 2

Maury and Joe are opening a couture clothing boutique. There are no competing couture clothing
boutiques in the area. They must decide how to organize the business. They anticipate profits of
$250,000 the first year, with the ability to sell franchises in the future. Although they have enough to
start the business now as a partnership, cash flow will be an issue as they grow. They feel the corporate
form of operation will be best for the long term. They seek your advice.

Requirements
1. What is the main advantage they gain by selecting a corporate form of business now?
2. Would you recommend they initially issue preferred or common stock? Why?
3. If they decide to issue $2 par common stock and anticipate an initial market price of $50 per share,
how many shares will they need to issue to raise $2,000,000?

SOLUTION

Requirement 1

The following are selected advantages of the corporate form of business. In a corporation:
a. Stockholders have limited liability to the extent of capital they have invested, and hence they will
not be held responsible for any personal liabilities.
b. There is a separation between management and ownership; no mutual agency
c. There is an indefinite life
d. More capital can be raised than sole proprietorships and partnerships
e. There is ease of transfer of ownership

Requirement 2

The recommendation would be to issue common stock, because dividends normally must be paid on
preferred stock.

Requirement 3

They need to issue 40,000 shares (cash needed $2,000,000 / market price $50 per share).

© 2016 Pearson Education, Ltd. 13-33

P13-36A Identifying sources of equity, stock issuance, and dividends
Learning Objectives 1, 2, 4
4. Common stock dividends $840,000

Travel Comfort Specialists, Inc. reported the following stockholders’ equity on its balance sheet at June
30, 2016:

Requirements
1. Identify the different classes of stock that Travel has outstanding.
2. What is the par value per share of Travel’s preferred stock?
3. Make two summary journal entries to record issuance of all the Travel stock for cash. Explanations
are not required.
4. No preferred dividends are in arrears. Journalize the declaration of a $900,000 dividend at June 30,
2016, and the payment of the dividend on July 20, 2016. Use separate Dividends Payable accounts
for preferred and common stock. An explanation is not required.

SOLUTION

Requirement 1

Travel has preferred stock and common stock outstanding.

Requirement 2

The par value of the preferred stock is $5 per share (Balance $1,000,000 / 200,000 shares issued and
outstanding = $5 per share)

© 2016 Pearson Education, Ltd. 13-34

P13-36A, cont.
Requirement 3

Date Accounts and Explanation Debit Credit

Cash 1,000,000
Preferred Stock—$5 Par Value 1,000,000

Cash 4,020,000
Common Stock—$1 Par Value 1,320,000
Paid-In Capital in Excess of Par—Common 2,700,000

Requirement 4

Total Dividend—2016 $ 900,000

Dividend to Preferred Stockholders 6% × $5 × 200,000 shares $ 60,000
Current Year Dividend (2016) (60,000)
Dividend to Common Stockholders $ 840,000

Date Accounts and Explanation Debit Credit

2016
June 30 Cash Dividends 900,000
Dividends Payable—Preferred 60,000
Dividends Payable—Common 840,000

July 20 Dividends Payable—Preferred 60,000

Dividends Payable—Common 840,000
Cash 900,000

© 2016 Pearson Education, Ltd. 13-35

P13-37A Journalizing stock issuance and cash dividends and preparing the stockholders’ equity
section of the balance sheet
Learning Objectives 2, 4
2. Total Stockholders’ Equity $323,000

C-C ell Wireless needed additional capital to expand, so the business incorporated. The charter from the
state of Georgia authorizes C-Cell to issue 50,000 shares of 7%, $50 par value cumulative preferred
stock and 120,000 shares of $2 par value common stock. During the first month, C-Cell completed the
following transactions:

Requirements
1. Record the transactions in the general journal.
2. Prepare the stockholders’ equity section of C-Cell’s balance sheet at October 31, 2016. Assume C-
Cell’s net income for the month was $96,000.

© 2016 Pearson Education, Ltd. 13-36

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Oct. 2 Building 120,000

Common Stock—$2 Par Value ($2 per share × 22,000 shares) 44,000
Paid-In Capital in Excess of Par—Common ($120,000 –
$44,000) 76,000
Issued common stock for building

6 Cash ($70 per share × 900 shares) 63,000

Preferred Stock—$50 Par Value ($50 per share × 900 shares) 45,000
Paid-In Capital in Excess of Par—Preferred ($63,000 − $45,000) 18,000
Issued preferred stock for cash

9 Cash 60,000
Common Stock—$2 Par Value ($2 per share × 12,000 shares) 24,000
Paid-In Capital in Excess of Par—Common ($60,000 – $24,000) 36,000
Issued common stock for cash

10 Cash Dividends 16,000

Dividends Payable—Preferred 3,150
Dividends Payable—Common 12,850
Declared cash dividend.*

25 Dividends Payable—Preferred 3,150

Dividends Payable—Common 12,850
Cash 16,000
Paid cash dividend.

*Total Dividend $ 16,000

Dividend to Preferred Stockholders 7% × $50 × 900 shares $ 3,150
Current Year Dividend (3,150)
Dividend to Common Stockholders $ 12,850

© 2016 Pearson Education, Ltd. 13-37

P13-37A, cont.
Requirement 2

C-CELL WIRELESS
Balance Sheet (Partial)
October 31, 2016

Stockholders’ Equity
Paid-In Capital:
Cumulative Preferred Stock—7%, $50 Par Value;
50,000 shares authorized, 900 shares issued and
outstanding $ 45,000
Paid-In Capital in Excess of Par—Preferred 18,000
Common Stock—$2 Par Value; 120,000 shares
authorized, 34,000 shares issued and outstanding 68,000
Paid-In Capital in Excess of Par—Common 112,000
Total Paid-In Capital 243,000
Retained Earnings* 80,000
Total Stockholders’ Equity $ 323,000

*Net income $96,000 – Dividends $16,000 = $80,000

© 2016 Pearson Education, Ltd. 13-38

P13-38A Journalizing dividends and treasury stock transactions and preparing the stockholders’
equity section of the balance sheet
Learning Objectives 3, 4
Nov. 8 Treasury Stock $6,300 CR

Winterborn Manufacturing Co. completed the following transactions during 2016:

Requirements
1. Record the transactions in Winterborn’s general journal.
2. Prepare the Winterborn’s stockholders’ equity section of the balance sheet as of December 31, 2016.
Assume that Winterborn was authorized to issue 2,400 shares of preferred stock and 500,000 shares
of common stock. Both preferred stock and common stock were issued at par. The ending balance of
retained earnings as of December 31, 2016, is $2,080,000.

© 2016 Pearson Education, Ltd. 13-39

SOLUTION

Requirement 1
Date Accounts and Explanation Debit Credit

Jan. 16 Cash Dividends 41,800

Dividends Payable—Preferred (4% × $100 × 950
shares) 3,800
Dividends Payable—Common ($0.40 × 95,000
shares) 38,000
Declared cash dividend.

Feb. 15 Dividends Payable—Preferred 3,800

Dividends Payable—Common 38,000
Cash 41,800
Paid cash dividend.

Jun. 10 No entry

Jul. 30 Stock Dividends ($2 per share × 190,000 shares × 0.50) 190,000
Common Stock Dividend Distributable 190,000
Declared a 50% stock dividend.

Aug. 15 Common Stock Dividend Distributable 190,000

Common Stock—$2 Par Value 190,000
Issued 50% stock dividend.

Oct. 26 Treasury Stock—Common ($9 per share × 1,400

shares) 12,600
Cash 12,600
Purchased treasury stock.

Nov. 8 Cash ($11 per share × 700 shares) 7,700

Treasury Stock—Common ($9 cost per share ×
700 shares) 6,300
Paid-In Capital from Treasury Stock Transactions
($2 × 700 shares) 1,400
Sold treasury stock with cost of $9 per share.

30 Cash ($6 per share × 500 shares) 3,000

Paid-In Capital from Treasury Stock Transactions 1,400
Retained Earnings ($4,500 – $3,000 – $1,400) 100
Treasury Stock—Common ($9 cost per share ×
500 shares) 4,500
Sold treasury stock with cost of $9 per share.

© 2016 Pearson Education, Ltd. 13-40

P13-38A, cont.
Requirement 2

WINTERBORN MANUFACTURING CO.

Balance Sheet (Partial)
December 31, 2016

Stockholders’ Equity
Paid-In Capital:
Noncumulative Preferred Stock—4%, $100 Par Value;
2,400 shares authorized, 950 shares issued and
outstanding $ 95,000
Common Stock—$2 Par Value; 500,000 shares
authorized, 285,000 shares issued and 284,800
outstanding 570,000
Total Paid-In Capital 665,000
Retained Earnings 2,080,000
Treasury Stock (200 shares at cost) (1,800)
Total Stockholders’ Equity $ 2,743,200

Jan. 16 Shares of Common Stock 95,000

Jun. 10 Shares after stock split 190,000
Jul. 30 Shares after stock dividend—50% 285,000

© 2016 Pearson Education, Ltd. 13-41

P13-39A Journalizing dividend and treasury stock transactions, preparing a statement of retained
earnings, and preparing stockholders’ equity
Learning Objectives 3, 4, 5
2. Retained Earnings Dec. 31, 2016 $152,240

The balance sheet of Morrisey Management Consulting, Inc. at December 31, 2015, reported the
following stockholders’ equity:

During 2016, Morrisey completed the following selected transactions:

Requirements
1. Record the transactions in the general journal.
2. Prepare a retained earnings statement for the year ended December 31, 2016. Assume Morrisey’s net
income for the year was $86,000.
3. Prepare the stockholders’ equity section of the balance sheet at December 31, 2016.

© 2016 Pearson Education, Ltd. 13-42

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit

Feb. 6 Stock Dividends ($23 per share × 25,000 × 0.15) 86,250

Common Stock Dividend Distributable ($10 per share ×
25,000 × 0.15) 37,500
Paid-In Capital in Excess of Par—Common ($86,250 −
$37,500) 48,750
Declared a 15% stock dividend.

15 Common Stock Dividend Distributable 37,500

Common Stock—$10 Par Value 37,500
Issued 15% stock dividend.

Jul. 29 Treasury Stock—Common ($23 per share × 2,100 shares) 48,300

Cash 48,300
Purchased treasury stock.

Nov. 27 Cash Dividends 5,330

Dividends Payable—Common ($0.20 × (25,000 shares + 3,750
shares from dividend less treasury stock 2,100 shares)) 5,330
Declared cash dividend.

Requirement 2

MORRISEY MANAGEMENT CONSULTING, INC.

Statement of Retained Earnings
Year Ended December 31, 2016

Retained Earnings, January 1, 2016 $ 158,000

Net income for the year 86,000
244,000
Stock Dividends Declared (86,250)
Cash Dividends Declared (5,330)
Retained Earnings, December 31, 2016 $ 152,420

© 2016 Pearson Education, Ltd. 13-43

P13-39A, cont.
Requirement 3

MORRISEY MANAGEMENT CONSULTING, INC.

Balance Sheet (Partial)
December 31, 2016
Stockholders’ Equity
Paid-In Capital:
Common Stock—$10 Par Value; 300,000 shares authorized,
28,750 shares issued, 26,650 outstanding $ 287,500
Paid-In Capital in Excess of Par—Common 368,750
Total Paid-In Capital 656,250
Retained Earnings 152,420
Treasury Stock (2,100 shares at cost) (48,300)
Total Stockholders’ Equity $ 760,370

P13-40A Computing earnings per share, price/earnings ratio, and rate of return on common
stockholders’ equity
Learning Objective 6

Mendonza Company reported these figures for 2016 and 2015:

Requirements
1. Compute Mendonza Company’s earnings per share for 2016. Assume the company paid the
minimum preferred dividend during 2016.
2. Compute Mendonza Company’s price/earnings ratio for 2016. Assume the company’s market price
per share of common stock is $9.
3. Compute Mendonza Company’s rate of return on common stockholders’ equity for 2016. Assume
the company paid the minimum preferred dividend during 2016.
© 2016 Pearson Education, Ltd. 13-44
SOLUTION

Requirement 1

Earnings per (Net income − Preferred Average number of common shares

= /
share dividends) outstanding
$20,400 – (5% × $6 ×
= / (40,000 + 40,000) / 2
8,000 shares)
($20,400 – $2,400) 40,000
$0.45 per
= $18,000 / 40,000
share

Requirement 2

Price/earnings
= Market price per share of common stock / Earnings per share
ratio
$20.00 per share = $9 / $0.45

Requirement 3

Rate of
return on Average common stockholders’
(Net income − Preferred
common = / equity = Total equity minus
dividends)
stockholders’ preferred equity
equity
$20,400 – (5% × $6 × / (($228,000 – $48,000) + ($228,000
=
8,000 shares) − $48,000)) / 2
= ($20,400 – $2,400) ($180,000 + $180,000) / 2
0.10 = 10% = $18,000 / $180,000

© 2016 Pearson Education, Ltd. 13-45