Owner's Equity

Medium Test

Medium Test

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

1. A company would buy its own stock if

a. it determined the stock was overvalued
b. it wanted to increase owner’s equity
c. it wanted to give stock to employees without diluting ownership
d. all of the above

Check Your Answer

C. Company’s often give employees stock or sell stock to them at a reduced price as compensation. The company buys the stock first from other shareholders. Issuing additional stock will dilute current ownership and make current shares worth less. Company’s also purchase their stock when they believe it is undervalued (a.). Holding your own stock is treasury stock which is a reduction to owner’s equity (b).

2. Which of the following is a description of “par value”?

a. the maximum total liability of investors
b. total cash received from the original issue of common stock
c. the current fair market value of common stock
d. the projected fair market value of common stock at incorporation

Check Your Answer

A.  Par value is the legal liability of the corporation which is owned by shareholders, so it is also the legal liability of shareholders (investors).  Cash received is at fair market value which is not often par value. Par value is set as low as possible to keep legal liability low.

3. Preferred shareholders are given preference when

a. voting on a sale of the company
b. voting to elect members of the board of directors
c. dividends are paid
d. cash is distributed if liquidation of the company occurs

Check Your Answer

C.  Preferred shareholders get paid dividends before common shareholders are paid dividends.  Preferred shareholders have no voting rights and do not participate in a liquidation of the company.

4. One reason for a company to declare a stock split is

a. to increase earnings per share
b. to decrease the market value of a share of stock
c. to increase total fair market value
d. to decrease the number of voting shares

Check Your Answer

B.   A stock split increases the number of shares available.  It does not change the total fair market value of shares owned.  A 2:1 split, doubles the number of shares owned and cuts the FMV per share in half.  The number of voting shares is increased also (d.). More shares lowers earnings per share (a).

5. The total par value of a company’s stock is equal to

a. total fair market value of the company
b. total book value of the company
c. total earnings this period less dividends paid this period
d. none of the above

Check Your Answer

D.  Total par value is equal to par value per share x number of shares issued.  This is the amount that is reported on the balance sheet. Par value is not related to fair market value in any way.  Book value of the company is equal to total stockholder’s equity, not just common stock. (b) (c) is part of retained earnings.

6. Additional paid in capital changes when

a. treasury stock is repurchased
b. treasury stock is sold for more than original cost
c. common stock is issued for more than par value
d. both b. & c.

Check Your Answer

D.  Additional PIC – CS represents amounts of capital raised from common stock greater than par.  Additional PIC – TS represents net gain from treasury stock transactions. A gain occurs when it is sold for more than original cost.

7. The account that represents corporate profits reinvested in the company is

a. retained earnings
b. dividends paid
c. additional paid in capital
d. common stock

Check Your Answer

A. Retained earnings is cumulative profits and losses less cumulative dividends paid. This is the profits that are kept in the company and not returned to shareholders. (b) is cash returned to shareholders.  (c. & d.) are increased when common stock is issued to raise capital.  

8. A stock split

a. requires no change to be made to the company’s stock
b. requires no entry to be made to the accounting records to change account balances
c. causes total owner’s equity to increase
d. is very common for very low-priced stocks

Check Your Answer

B.  A stock split increases the number of shares and reduces the par value by the same proportion.  Stock certificates are reissued to reflect this (a.). The total par value of common stock does not change and no entry is required.  Owner’s equity does not change because no entry is made. A stock split is common for higher priced stocks to lower the price to the price range of a common investor.

9. The sale of treasury stock for less than original cost is recorded with

a. a decrease to common stock
b. a decrease to retained earnings always
c. a decrease to paid in capital treasury stock if there is a current balance
d. a loss on sale of stock

Check Your Answer

C.  Selling for less causes an economic loss.  Gains and losses related to treasury stock transaction are not reported on the income statement (d).  Gains are recorded using paid in capital – treasury stock. If there were previous gains from treasury stock transactions the gain is reduced when a loss occurs by reducing PIC – TS.  If there were no previous gains (or not enough) retained earnings is directly decreased for the loss. The common stock account is never used to record treasury stock transactions.

10. Shares of stock that receive a cash dividend are shares

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

Check Your Answer

B.  Shares outstanding received cash dividends.  The company does not pay itself a cash dividend on treasury stock owned.  The company does not cut itself a check.  Issued shares less treasury shares = outstanding shares

11. A company was incorporated at the beginning of the current year. The company
was authorized to issue 100,000 shares of $1 par common stock and 10,000 shares of $50 par, 6% preferred stock. During the prior year, the company issued 40,000 shares of common stock for $8 per share and 5,000 shares of preferred stock for $55 per share.

At the beginning of the current year the company purchased 5,000 shares from
shareholders for $6 per share. In June of the current year, the company reissued (sold back to investors) 3,000 treasury shares for $10 per share.

In December of the current year a 2:1 stock split was declared.

Record all of the transactions related to the common and preferred stock during the
prior year and the current year.

Check Your Answer

Authorized stock is not recorded; it is the total number of shares the company can issue. 

Cash                                       320,000
       Common Stock                             40,000
       Additional PIC – CS                  280,000

Cash                                         275,000
       Preferred Stock                        250,000
       Additional PIC – PS                   25,000

Treasury Stock                         30,000
       Cash                                               30,000

Cash                                           30,000
       Treasury Stock                             18,000
       Paid In Capital – TS                    12,000

No entry is made for a stock split.  Par value decreases to $0.50. 

The 40,000 shares issued is changed to 80,000 shares.  

Total par does not change so the account common stock does not change. 

Divide Par Value
Multiply # Shares

12. A company reported the following on the prior year’s balance sheet:

Common Stock, $0.50 par value, 100,000 authorized, 50,000 issued, 45,000 outstanding $25,000
Additional Paid in Capital – common stock $1,175,000
Treasury Stock, 5,000 shares $20,000

The company purchased the treasury stock in one transaction. During the current year,
the following transactions occurred:

2/1 Reissued (sold) 2,000 shares of treasury stock for $20,000
3/1 Repurchased 5,000 shares of treasury stock for $45,000
6/1 Sold 4,000 shares of treasury stock for $24,000

A. Make the entry required to record each treasury stock transaction. The company
uses the first in first out method to determine the cost of treasury shares sold.
B. What will be reported on the balance sheet for treasury stock on June 30 th of the current year?
C. What does the ending balance in paid in capital – treasury stock represent?

Check Your Answer


Cash                                     20,000
       Treasury Stock                        8,000 **
       Paid in Capital – TS              12,000 plug

**Cost per TS share = $20,000 / 5,000 shares = $4 per share

Treasury Stock                   45,000
       Cash                                           45,000

Cash                                      24,000
       Treasury Stock                          21,000
       Paid in Capital – TS                    3,000

3,000 left from original balance x $4 12,000
1,000 from the 3/1 purchase at $9 each 9,000
Total cost of treasury stock 21,000


Beginning TS balance $20,000
less sold (8,000)
plus purchase 45,000
less sold (21,000)
= Ending balance for TS 36,000
Additional Paid in Capital – TS 15,000


C.  Paid in capital – Treasury stock represents the economic gain that occurred from treasury stock transactions.  This gain is NOT reported on the income statement, it directly increases owner’s equity.

13.  A company reported the following on the prior year’s balance sheet:

Common Stock, $0.01 par value, 1,000,000 shares authorized, 200,000 shares issued, 175,000 shares outstanding  $     ??
Additional Paid in Capital – common stock $1,115,000
Treasury Stock, at cost  $   150,000


A.  What amount should be reported for common stock?

B.  What was the average cost of treasury shares?

C.  Make the entries to record the following transactions that occurred this year.  
Record each as if the other has not occurred.

Transactions in the current year:

1)  A 10% stock dividend was declared when the fair market value of each share was $6.  

2)   A 50% stock dividend was declared when the fair market value of a share was $6.

3)   A cash dividend of $0.25 per share was declared and paid.

4)   2,000 shares of treasury stock were reissued for $9 per share.

Check Your Answer

A.  The amount reported for common stock will always be:

# shares issued x par value

200,000 x $0.01 = $2,000 

B.  Treasury stock is always recorded and reported at cost.  To get the cost per share, divide the number of shares held (issued less outstanding) by the $ balance.

$150,000 / 25,000 = $6 per share 

C.   1) 10% stock dividend

Number of shares issued 200,000
x Dividend %   x .10
= Number of shares issued 20,000
x Fair market value per share      $6
= Total decrease to Retained earnings $120,000

Small stock dividend is at FMV

Retained Earnings               120,000
       Stock Dividend Payable        120,000

Stock Dividend Payable        120,000
       Common Stock                               200
       Additional PIC – CS                119,800

C.  2) 50% stock dividend

Number of shares issued 200,000
x Dividend % x .50
= Number of shares issued 100,000
x Par value per share $0.01
= Total decrease to Retained earnings $1,000

Large stock dividend is at par value

Retained Earnings                      1,000
       Stock Dividend Payable               1,000

Stock Dividend Payable             1,000
       Common Stock                              1,000

C.  3) Cash dividend   $0.25 per share   

Cash dividends are paid on 175,000 shares outstanding:  


Retained Earnings                   43,750
      Dividends Payable                         43,750


Dividends Payable                   43,750
      Cash                                                 43,750


C.  4) Reissue Treasury stock

Cash                                           18,000
      Treasury Stock                             12,000
      Paid In Capital – TS                     6,000