Stockholders’ Equity
Self Test
Intermediate Accounting 2
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. A corporation is
a. a group of companies that act like one company
b. a legal entity doing business
c. a company with one owner
d. all of the above
Answer
B. A corporation is a separate legal entity that owns assets and incurs liabilities.
2. Articles of Incorporation
a. specify the general rules for conducting business
b. authorize the corporation to issue ownership in the form of stock
c. are used to register a company in a particular state
d. all of the above
Answer
D. “Articles of Incorporation” are issued that specify the general rules for conducting the business of the corporation. They authorize the issuance of stock and is part of the registration process in a state.
3. Par value of common stock is
a. the legal capital that must be retained by the corporation
b. the fair market value of common stock
c. the book value of common stock
d. the total amount expected to be paid in dividends
Answer
A. The par value is the legal capital that must be retained by the corporation. It is the legal amount that shareholders may be liable for.
4. Common stockholders
a. participate in the day to day operations of the business
b. elect the BOD and vote on only very significant issues of the Company
c. individually own the assets of the company
d. elect preferred shareholders
Answer
B. Common shareholders have voting rights to vote on the election of the board of directors and significant changes to the company’s structure. They do not participate in day to day decision making. The assets of the corporation are owned by the corporation. Preferred shareholders are investors and are not elected.
5. The rights of the common shareholder include
a. attending all stockholder meetings when invited
b. share in dividends not declared by the board
c. share in the proceeds of any liquidation
d. can not sell their investment in shares at any time
Answer
C. The only correct statement is (c.). All common shareholders may attend all stockholder meetings without exception. Dividends must be declared by the board to be paid. Shareholders are investors that may sell their investment at any time there is a willing buyer.
6. Preferred stock is issued by a company primarily to
a. raise capital
b. increase voting ownership in the company
c. increase annual cash flow
d. decrease the amount of dividends paid annually
Answer
A. Preferred stock is issued to raise capital. A stated return is associated with preferred stock. Paying dividends on preferred stock decreases annual cash flow of the company. Preferred shareholders do not have voting rights.
7. The total amount of preferred dividends paid to shareholders, (when declared) is
a. par value x market rate of return
b. par value per share x number of shares issued x stated rate
c. par value per share x number of shares authorized x stated rate
d. number of shares issued x par value per share
Answer
B. The preferred stock dividend is computed as: # shares issued x par value per share = total par value x stated %.
8. A cumulative preferred stock means
a. dividends that were not declared this year will never be paid
b. dividends that were declared this year must be paid by next year
c. dividends not declared this year may be declared next year
d. dividends not declared this year may be declared next year and must be paid before common shareholders received dividends
Answer
D. Cumulative means that if current dividends were not declared this year they may be declared in future years and paid in the future before common shareholders receive dividends. Dividends of any kind are only paid if they are declared by the board of directors.
9. When a company issues stock
a. owner’s equity is increased
b. owner’s equity is decreased when it is issued to the shareholder
c. total owner’s equity remains the same
d. cash is paid to shareholders
Answer
A. The account common stock or preferred stock increases when stock is issued. This increases owner’s equity. Cash is received from shareholders when stock is issued (d).
10. Common stock is always reported on the balance sheet at
a. par value x number of shares issued
b. fair market value x number of shares issued
c. par value x number of shares outstanding
d. fair market value x number of shares outstanding
Answer
A. Common stock is always recorded at par. It increases at (# shares x par value). The ending balance in the common stock account is always # shares x par value.
11. When a company owns its own common stock it is reported as
a. investment in stock
b. treasury stock
c. treasury investment
d. common stock issued
Answer
B. Shares that a company owns of itself is called treasury stock. This occurs when a company repurchases stock back from shareholders after it has been issued to shareholders. Treasury stock is a contra-equity account with a negative balance.
12. The total amount of cash received by the company when issuing stock is reported on the balance sheet as
a. common stock
b. common stock plus treasury stock
c. common stock plus additional paid in capital
d. retained earnings plus common stock
Answer
C. Total cash received from the investor is common stock plus additional paid in capital. Of the total amount received, par value x # shares issued goes to common stock and the difference goes to additional paid it capital. The company must report the par value separately because it is the legal capital required to be maintained by the company.
13. The number of treasury stock shares is always equal to
a. issued shares less outstanding shares
b. outstanding shares less issued shares
c. authorized shares less outstanding shares
d. authorized shares less issued shares
Answer
A. Issued shares are those “sold” originally to investors by the company. Outstanding shares are those still held by anyone except the company. The difference in issued shares and outstanding shares are the ones held by the company after repurchasing them from investors (treasury shares). Authorized is the total shares the company is allowed to issue.
14. Treasury stock is always increased or decreased at
a. current fair market value
b. par value
c. historical cost
d. fair market value at the end of the latest period
Answer
C. Treasury stock is always recorded at what was paid for it (both increases and decreases). Par value is not used with treasury stock. It is not treated as an investment; it is a temporary reduction to issued shares.
15. The difference in what a company pays for treasury stock and what the treasury stock is sold for when more cash is received than was originally paid is recorded as
a. gain on sale of stock
b. gain on sale of treasury stock
c. treasury capital
d. paid in capital – treasury stock
Answer
D. Cash received is more than cash paid indicates a gain. Gains and losses are not recorded on transactions with treasury stock. The gain would have been a credit, so a credit is necessary. The credit that represents the gain is paid in capital – treasury stock. You must put the – treasury stock in the account name.
16. Dividends are payments to shareholders in
a. cash
b. common stock
c. assets of the company
d. all of the above
Answer
D. The board of directors can declare a distribution in any of the listed forms. The most common dividend is a cash dividend, then stock dividend, than asset dividend in the event of liquidation.
17. A cash dividend is authorized by the board of directors on
a. the declaration date
b. the record date
c. the authorized date
d. the payment date
Answer
A. There are 3 dates associated with a dividend: 1) Declaration date – the board authorized the dividend, 2) Record date – the day that those who own the stock on this date will be paid, and 3) Payment date- the date the distribution is actually made.
18. Dividends declared always decrease
a. cash
b. retained earnings
c. paid in capital
d. common stock
Answer
B. Dividends are always charged to retained earnings when declared. A dividend is paid out of the cumulative profits and losses of the company which is part of retained earnings. It is a decrease because it reduces the amount available to the owners in the future. A stock dividend increases (c. & d.). Cash is not decreased with a stock dividend (a.)
19. A stock split
a. does not change total owner’s equity
b. increases par value
c. increases paid in capital
d. decreases the number of outstanding shares
Answer
A. A stock split increases (d) the number of shares and decreases (b) the par value of each share. It does not change total par value and does not change the common stock account balance.
20. A stock dividend
a. does not change total owner’s equity
b. increases par value per share of stock
c. decreases paid in capital
d. decreases the number of outstanding shares
Answer
A. A stock dividend decreases retained earnings and increases common stock and paid in capital (for a small dividend) by the same amount. There is no change to total owner’s equity because no funds are received from shareholders for the additional stock.
21. When a company retires stock
a. treasury stock is reissued
b. common stock is issued to the company
c. the common stock is removed from the issued shares
d. the common stock is removed from the authorized shares
Answer
C. Common stock that is retired is issued shares that the company purchases and makes no longer available for ownership. The company will cancel the shares and they will not be issued (traded or owned) from this point forward. The company can retire treasury shares they are holding; treasury shares are issued shares also.
22. When a company retires common stock, paid in “capital – common stock” is recorded
a. as a credit for the difference in fair market value and par value
b. as a debit for the average paid in capital per share at the time of retirement
c. as a credit for the average paid in capital per share at the time of retirement
d. as a debit for the difference in fair market value and par value
Answer
B. When common stock is retired, common stock is removed (debit) at par value and paid in capital is removed (debit) at the average paid in capital received per share when the common stock was issued.