Owner's Equity

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Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. Par value

a. changes when market value changes
b. is the same as fair market value
c. will never change
d. is determined by the corporation’s charter

Check Your Answer
D.  Par value is determined by the corporate charter and will only change with a stock split.
2. When a cash dividend is declared

a. total owner’s equity does not change
b. total assets decrease
c. retained earnings decreases
d. total assets increase and total owner’s equity increases

Check Your Answer
C.  The declaration of a cash dividend is recorded with a decrease to retained earnings (debit) and an increase to dividend payable (credit).  Retained earning is part of owner’s equity so total owner’s equity decrease (a). Asset does not decrease until the payment date (b).
3. When a company purchases its own stock

a. total owner’s equity increases
b. investments increase
c. total assets increase
d. total owner’s equity decreases

Check Your Answer
D.  The purchase is recorded as an increase to treasury stock.  Treasury stock is negative owner’s equity that is an indirect reduction to issued common stock.  Total assets decrease when cash is used (c). Treasury stock is not considered an investment (asset); it is contra owner’s equity.  
4. Which of the following is a contra-owner’s equity account?

a. additional paid in capital
b. treasury stock
c. common stock issued
d. retained earnings for a profitable company

Check Your Answer
B. Treasury stock is a negative owner’s equity account. All others listed will be reported as positive amounts on the balance sheet.
5. Which of the following is the number of shares that are held by owners other than
the company?

a. authorized
b. issued
c. outstanding
d. treasury

Check Your Answer
C.  Issued less treasury = outstanding which reflects shares owned by other than the company itself.
6. When a company sells treasury stock

a. paid in capital – treasury stock is always increased
b. a gain or loss on sale of stock is recorded
c. paid in capital – treasury stock is recorded when cash received per share is higher than original cost per share
d. retained earnings is always decreased

Check Your Answer
C.  Selling treasury stock is reissuing (selling) it back to outside shareholders. The treasury stock account is always reduced at the historical cost, cash is always increased, and paid in capital – treasury stock is used to record a gain on the transaction.   

Paid in capital – treasury stock is decreased to record a loss up to the amount of paid in capital recorded previously and then retained earnings is decreased to record the rest of the loss.  

Gains and losses are not recorded or reported on the income statement for treasury stock transactions.

7. Paid in capital – common stock is increased when

a. common stock is repurchased from shareholders
b. common stock is purchased from employees
c. common stock is issued for less than par value
d. common stock is issued for more than par value

Check Your Answer
D.  Paid in capital is used when more is received from issuing stock than par value.  Treasury stock transaction never use a common stock account. (a. & b.) are treasury stock transactions.  
8. A small stock dividend

a. increases retained earning for par value x # shares issued
b. decreases retained earnings for par value x # shares issued
c. increases retained earnings for fair market value x # shares issued
d. decreases retained earnings for fair market value x # shares issued

Check Your Answer
D.   Dividends always decrease (debit) retained earnings.  Retained earnings is decreased for the fair market value of the shares issued when the dividend is considered to be a small dividend (< 20-25%).  Large dividends use par value.
9. Paid in Capital – Treasury stock

a. always increases at par amount
b. increases when treasury stock is purchased
c. increases when treasury stock is sold
d. decreases when common stock is sold

Check Your Answer
C.  Additional paid in capital – treasury stock is only recorded when more cash is received from selling treasury shares than was originally paid.   It may also decrease when treasury stock is sold if it is sold at a loss. This account is used to record gains and losses on sales of treasury stock.
10. A stock dividend

a. always increases the number of shares outstanding
b. always increases total owner’s equity
c. always increases retained earnings
d. all of the above

Check Your Answer
A.  A stock dividend gives more shares to shareholders, as a % of what they already own, and always increases the number of shares outstanding.  It is a decrease to retained earnings (c,). Total owner’s equity does not change because retained earnings and common stock offset each other for the same amount.
11.   A company was incorporated at the beginning of the current year.  The corporate charter authorized 100,000 share of $0.01 par value common stock and 10,000 shares of $100 par value preferred stock.  During this year the company issued 50,000 shares of common stock for $500,000 and 3,000 shares of preferred stock for $300,000.

 Record the issuance of common and preferred stock.

Check Your Answer
Cash                                           500,000
       Common Stock                                    500
       Addtl Paid in Capital – CS         499,500

Common stock is always par value x # shares ($0.01 x 50,000)
Additional Paid in Capital – CS is for the difference in par and cash received

Cash                                    300,000
       Preferred Stock                      300,000

Preferred stock is always par value x # shares ($100 x 3,000)
It was issued for par, so paid in capital is not necessary for the difference

12.  At the beginning of the year the company had common stock as follows:

Authorized                       1,000,000 shares    
Issued and outstanding    500,000 shares
Par Value of $0.50

The following transactions occurred in the current year:

April 1:  Purchased 50,000 shares of their own stock for $10 per share

June 30:  Reissued 20,000 shares of their own stock for $12 per share

October 10:  Reissued 30,000 shares of their own stock for $8 per share

Record the transactions related to treasury for the current year

Check Your Answer
4/1

Treasury Stock                   500,000
       Cash                                           500,000

Treasury stock is always increased or decreased for the cost.
The common stock account is not used.
Par value is not used.

6/30

Cash                                        240,000
       Treasury Stock                            200,000
       Addtl Paid in Capital – TS          40,000

First:  record the cash received as a debit.
Treasury stock is always decreased at
original cost x # shares reissued
Cash is what is received, often referred to as
FMV.
Paid in capital is a plug for the difference.

10/10

Retained Earnings                  20,000
Additional PIC – TS                40,000
Cash                                         240,000
       Treasury Stock                             300,000

First: record the cash received as a debit

Second: reduce treasury stock for original cost x # shares with credit (30K x $10)

Third: Determine what you need to have to get the entry in balance, debit or credit.
For a debit, use the Additional PIC – TS for all if you have enough, you can’t use more than you have recorded before, in this case the limit is 40,000.

If you need more debit, use retained earnings to balance the entry.

13.   The company had 100,000 shares of common stock, par value $1, issued and outstanding at the end of the prior year.  In February of the current year the company declared a 2:1 stock split. The fair market value of the common stock when the stock split was declared was $20 per share.

 Record the stock split:

Check Your Answer
A stock split is not recorded with a journal entry.  Total par value is not changed, so the common stock account is not changed either.

Total par before split = 100,000 shares x $1 par = $100,000
Total par after split =  200,000 shares x $0.50 par = $100,000

A split multiplies the number of shares and divides the par value.

The company will reissue new stock certificates changing the number of shares and the par value of each share.

14.  At the end of the prior year the company’s balance sheet reported the following:

Preferred stock, $100 par, 5%, 1,000 shares issued & outstanding $100,000
Common stock, $0.10 par, 100,000 shares issued and 90,000 shares outstanding $10,000
Additional Paid in Capital – Common Stock $1,500,000
Treasury Stock, 10,000 shares $120,000

 

A.  Determine the fair market value of a share of stock when the common stock was issued.

B.  The board of directors declared a $1 per common share cash dividend.  Make the entries to record the cash dividend declared and paid.

C.  The board declared the stated preferred stock dividend.  Make the entries to record the preferred dividend declared and paid.

D.  The board declared a 15% stock dividend when fair market value of each share was $10.  Record the declaration and payment.

E.  The board declared a 40% stock dividend when fair market value of each share was $10.  Record the declaration and payment of the stock dividend given D. has not occurred.

Check Your Answer
A.  The amount of cash received when the shares were issued is the fair market value of the shares.  

Common Stock 10,000
+  Addtl Paid in Capital – CS 1,500,000
=  Total cash received 1,510,000
  / shares issued 100,000
= FMV per share of stock $15.10

B.  The total amount is number of shares outstanding x $ per share declared.  Only outstanding shares receive the dividend; the company does not pay themselves cash on the treasury shares they own.  (Cutting a check to them selves does not make sense)

Retained Earnings               90,000
       Dividends Payable                    90,000

Dividends Payable               90,000
       Cash                                             90,000

C.  The total dividend paid is # shares issued x par value per share x stated %

Retained Earnings               5,000
       Dividends Payable                  5,000

Dividends Payable               5,000
       Cash                                           5,000

D.  A stock dividend is paid on all issued stock.  Stock the company owns also gets the dividend so the company does not lose value.  

Number of shares issued 100,000
x Dividend % x   .15
= Number of shares issued 15,000
x Fair market value per share    $10
= Total decrease to Retained earnings 150,000

Small stock dividend – use FMV for retained earnings

Retained Earnings               150,000
       Stock Dividend Payable             150,000

Stock Dividend Payable      150,000
       Common Stock                                1,500
       Addtl paid in capital – CS         148,500

Common stock always = # shares x par value
Then, the amount that makes the entry balance for Additional paid in capital

E.  A stock dividend is paid on all issued stock.  Stock the company owns also gets the dividend so the company does not lose value.

Number of shares issued 100,000
x Dividend % x   .40
= Number of shares issued 40,000
x Par value per share    $.10
= Total decrease to Ret earnings 4,000

 

Large stock dividend, use par value for retained earnings

Retained Earnings                     4,000
       Stock Dividend Payable             4,000

Stock Dividend Payable            4,000
       Common Stock                             4,000    

The dividend is at par, so there is no need for paid in capital

15.  Refer to the information in problem 14. to answer the following questions:

A.  How much cash was raised by the company when common stock was issued?

B.  Which class of stock would an investor purchase if they were looking for a return of income only?

C.  What was the price per share paid for treasury stock?

Check Your Answer
A.  The amount of cash raised is always equal to common stock plus additional paid in capital.

Common Stock 10,000
+  Additional Paid in Capital – CS 1,500,000
=  Total cash received 1,510,000

 

B.  Preferred stock gives no voting rights and shareholders invest to get the annual dividend payment stated on the stock.  The annual payment is considered annual income. Preferred stock does not increase in value as the company grows.

C. Treasury stock is always reported at cost, (what was paid for it).

Total treasury stock / # shares held = cost per share

$120,000 /10,000 shares = $12 per share historical cost

Number of treasury shares is always equal to the number of common shares issued less the number of common shares outstanding.