Owner's Equity

Hard Test

Hard Test

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

1. During the year the company declared a stock dividend. The company would make an entry in their accounting records

a. only when the stock dividend was declared
b. when the stock dividend was declared and when it was paid
c. only when the stock dividend was paid
d. no entry required since there is no total change in owner’s equity

Check Your Answer
B.  Entries are made to record dividends declared and dividends paid.  An entry is not made on the record date, when the list of names to be paid is compiled.  A cash dividend decreases retained earnings and decreases total owner’s equity. A stock dividend does not change total owner’s equity; however, amounts are moved between equity accounts (d).
2. A shareholder who purchased cumulative preferred stock is

a. guaranteed they will be paid a dividend
b. paid dividends before common shareholders are paid dividends
c. investing in a higher risk security than non-cumulative preferred stock
d. investing in a security whose future return will vary with market rate changes

Check Your Answer
B.  Cumulative means the preferred will be paid before common, if not this year, than in future years.  It is not a guarantee the dividend will be paid. Dividends are only paid if declared by the board of directors.  Cumulative is lower risk than non cumulative because if the dividend is not declared this year it may be declared in the future (which is not the case with non cumulative).   The dividend paid is stated and does not change with market rate changes.
3. Stock dividends

a. have no impact on total owner’s equity
b. increase total owner’s equity
c. decrease total owner’s equity
d. increase retained earnings

Check Your Answer
A.  Stock dividends are recorded with a decrease to retained earnings and an increase to common stock accounts.  Total owner’s equity does not change. Dividends always decrease retained earnings (d).
4. A large stock dividend will

a. increase retained earning for more than a small stock dividend
b. decrease common stock for more than a small stock dividend
c. decrease retained earning for less than a small stock dividend
d. increase common stock for less than a small stock dividend

Check Your Answer
C.  Dividends always decrease retained earnings.  Large stock dividends are recorded at par value x number of shares issued.  Small stock dividends are recorded at FMV x number of shares issued. Par value is almost always lower than FMV.  Recording the dividend at par value will decrease retained earnings for a lower amount than decreasing it for fair market value of shares issued.   Common stock is always increased for number of shares x par value.
5. Generally, a company’s fair market value is

a. equal to total book value of the company
b. equal to total stockholder’s equity of the company
c. equal to the future value of cash flows
d. equal to the current fair market value of assets owned

Check Your Answer
C.  A company is most often valued at total future cash flows.  Book value, which is the same thing as stockholder’s equity, does not reflect fair market value or future cash flows.  (d) does not consider that liabilities are netted with assets.
6. Common stock is decreased when

a. treasury stock is purchased
b. additional stock is issued to investors
c. fair market value of stock decreases
d. never, unless the stock is retired

Check Your Answer
D.  Common stock never decreases, unless it is retired and totally removed from circulation ( a subject not typically discussed in this class).  Treasury stock is used to show the account is temporarily held by the company and not other investors. Issuing stock increases common stock (b).  The common stock account is not an investment and is not adjusted to fair market value (c.).
7. Which of the following statements relative to treasury stock is not correct?

a. total number of shares repurchased changes the number of shares issued
b. the total number of shares purchased as treasury stock does not change the total fair market value of the company
c. gains and losses on the sale of treasury stock are not reported on the income statement
d. the total number of shares authorized does not change when treasury stock is purchased

Check Your Answer
A.  Purchasing treasury stock changes the number of shares outstanding only and does not change the number of shares issued.  All other statements are true.
8. _________ shares will receive a stock dividend when declared.

a. authorized
b. outstanding
c. issued
d. all of the above

Check Your Answer
C.  Stock dividends are paid on all issued stock, including shares owned by the company.  The stock dividend changes the value of the shares as the market price adjusts to more shares issued for the same value of company.  Each share is worth less when there are more shares. If the company does not get more shares also, the total value of the treasury stock will decrease.
9. Which of the following is not true relative to dividends?

a. all dividends paid must first be declared by the board of directors
b. a dividend is a legal liability of the corporation before it is declared by the board of directors
c. The record date is the date the company determines who will be paid
d. No accounting entry is made on the record date

Check Your Answer
B.  The company is not legally bound to pay a dividend until it is declared by the board of directors.  All other statements are true.
10. Retained earnings is either increased or decreased for each of the following except

a. declaration of a stock dividend
b. declaration of a stock split
c. earnings of the corporation
d. the first sale of treasury stock for less than the amount paid

Check Your Answer
B.  No entry is made for a stock split.  Total par value does not change and no additional funds are raised, so there is nothing to record.  Declaring a dividend decreases retained earnings (a.) Earnings become part of retained earnings, increasing retained earnings. (c.)  Selling treasury stock for less than paid is an economic loss that is not recorded as a loss. It is recorded as a reduction to PIC – TS if there were prior gains, and if not, it is a direct reduction to retained earnings. 
11. The company reported the following on the prior year balance sheet:

Common Stock – 1,000,000 shares authorized, 200,000 shares issued, 175,000 shares outstanding $20,000
Additional Paid in Capital – common stock $1,380,000
Treasury Stock, 25,000 shares  $125,000
Retained Earnings $320,000

Record the following transactions that occurred during the current year in the following order and prepare the owner’s equity section of the balance sheet reported at the end of the current year.

  1. Reissued all shares of treasury stock for $200,000
  2. Declared and paid a cash dividend of $0.50 per common share
  3. Declared and paid a 30% stock dividend when the FMV of a share of stock was $10
  4. Declared a 2:1 stock split
  5. Purchased 5,000 shares of treasury stock for $48,000
  6. Sold 5,000 shares of treasury stock for $24,000
  7. The company earned $300,000 in profits for the year.
Check Your Answer
Cash                                    200,000
       Treasury Stock                            125,000
       Paid In Capital – TS                     75,000

Retained Earnings               100,000
       Dividends Payable                     100,000

Dividends Payable                100,000
       Cash                                              100,000

Shares issued: 200,000 x $0.50 = 100,000    

Treasury shares were sold back to other investors and are now issued
Issued now = outstanding 

Retained Earnings            6,000
       Dividends Payable                       6,000

Dividends Payable                 6,000
       Common Stock                             6,000

Shares issued 200,000
x % dividend .30
Total shares issued 60,000
x par (large) $0.10 **
Total to Retained Earnings 6,000

** Total CS $20,000 / shares issued 200,000 = $0.10 par

No journal entry for a stock split.  Total number of shares issued is now
200,000 + 60,000 = 260,000 x 2 = 520,000

Par value per share is now $0.05 
($0.10 / 2)

Treasury Stock                      48,000
       Cash                                                  48,000

Paid In Capital – TS       24,000
Cash                                    24,000
       Treasury Stock                      48,000 (from 5.)

Income Summary               300,000
       Retained Earnings                      300,000

Owner’s Equity section of balance sheet:

Common Stock, $0.05 par value,  2 million authorized 520,000 issued and outstanding $26,000
Additional Paid In Capital – CS $1,380,000
Treasury Stock 0
Retained Earnings $514,000
Total Stockholder’s Equity $1,920,000


12. At the beginning of the year the company had 10,000 shares of treasury stock at a cost of $18 per share. The following transactions occurred in this order during the year.

a. reissued 3,000 shares of treasury stock for $15 per share
b. reissued 2,000 shares of treasury stock for $13 per share
c. repurchased 5,000 shares of treasury stock for $11 per share
d. reissued 3,000 treasury shares for $21 per share

Record the above transactions (given the company uses the FIFO method to account
for treasury shares).

Check Your Answer
Retained Earnings                    9,000
Cash                                            45,000
       Treasury Stock                             54,000

Credit TS for original cost $18 x 3,000

Debit retained earnings because there is no Paid in capital – TS

Retained Earnings                  10,000
Cash                                           26,000
       Treasury                                         36,000

Credit TS for original cost $18 x 2,000
Debit retained earnings because there is no Paid in capital – TS

Treasury Stock                      55,000
       Cash                                             55,000

Cash                                         63,000
       Treasury Stock                            54,000
       Paid In Capital – TS                    9,000

Credit TS for original cost $18 x 3,000 (still left from original 10,000)
Credit to balance to Paid in capital – TS

13. State whether owner’s equity in total will increase, decrease or stay the same when each of the following transactions occur. Explain your answer.

a. common stock is issued
b. preferred stock is issued
c. treasury stock is purchased
d. treasury stock is reissued for more than cost
e. a stock split is declared
f. a 40% stock dividend is declared
g. a 10% stock dividend is declared
h. a cash dividend is declared
i. the company incurs a loss for the year
j. the company earns income for the year

Check Your Answer
a.  increase: common stock & paid in capital increases

b.  increase: preferred stock & paid in capital increases

c.  decrease: treasury stock is a contra equity account

d.  increase: less treasury stock (a negative), more paid in capital TS

e.  no change: no entry

f.   no change: out of retained earnings, into common stock

g.  no change: out of retained earnings, into common stock and PIC – CS

h.  decrease: retained earnings

i.   decrease: retained earnings

j.   increase: retained earnings