accounting chapter 10 solutions guide

Chapter 15 Leases

Chapter 10 - Stockholders' EquityChapter 10 - Stockholders' EquityChapter 10Stockholders Equity

Questions

Question 10-1Most corporations first raise money by selling stock to the founders of the business and their friends and family. As the equity financing needs of the corporation grow, companies prepare a business plan and seek outside investment from angel investors and venture capital firms. Angel investors are wealthy individuals in the business community willing to risk investment funds on a promising business venture. Venture capital firms provide additional financing, often in the millions, for a percentage ownership in the company. Many venture capital firms look to invest in promising companies to which they can add value through business contacts, financial expertise, or marketing channels. Most corporations do not consider issuing stock to the general public (going public) until their equity financing needs exceed $20 million dollars. Question 10-2The stock of a publicly held corporation trades on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), National Association of Securities Dealers Automated Quotations (NASDAQ), or by over-the-counter (OTC) trading. Examples include Wal-Mart, General Motors, and General Electric.A privately held corporation does not allow investment by the general public and normally has fewer stockholders. Three of the largest private corporations in the United States are Cargill (agricultural commodities), Koch Industries (oil and gas), and Mars (candy). Question 10-3The four basic ownership rights of common stockholders are (1) the right to vote, (2) the right to receive dividends, (3) the right to share in the distribution of assets, and (4) the preemptive right. The preemptive right allows a stockholder to maintain his or her percentage share of ownership when new shares are issued.Question 10-4Sole-proprietorships are the most common form of business. However, corporations are larger in terms of total sales, total assets, earnings, or number of employees. Question 10-5A corporation offers three primary advantages over sole-proprietorships and partnerships. These are (1) limited liability, (2) ability to raise capital, and (3) lack of mutual agency. Because of limited liability, even in the event of bankruptcy, stockholders in a corporation can lose no more than the amount they invested in the company. Because corporations sell ownership interest in the form of shares of stock, ownership rights are easily transferred. An investor can sell his or her ownership interest (shares of stock) at any time and without affecting the structure of the corporation or its

operations. Finally, a lack of mutual agency means that individual shareholders cannot legally bind the corporation to a contract.A corporation has two primary disadvantages relative to sole-proprietorships and partnerships. These are (1) additional taxes and (2) more paperwork. Corporations have double taxation. Corporate income is taxed once on earnings at the corporate level and again on dividends at the individual level. Corporations also have more paperwork as federal and state governments impose expensive reporting requirements on the company. Question 10-6An LLC or an S Corporation allows a company to enjoy limited liability as a corporation, but avoid the double taxation of traditional corporations.Question 10-7Authorized stock is the total number of shares available to sell, stated in the companys articles of incorporation. Issued stock is the number of shares that have been sold to investors. A company usually does not issue all its authorized stock. Outstanding stock is the number of shares held by investors. Issued and outstanding are the same amounts as long as the corporation has not repurchased any of its shares. Repurchased shares, called treasury stock, are included as part of shares issued, but excluded from shares outstanding.Question 10-81 million shares are authorized, 100,000 shares are issued, and 90,000 shares are outstanding. Question 10-9Par value is the legal capital per share of stock thats assigned when the corporation is first established. Par value has no relationship to the market value of the common stock. We credit the common stock account for the number of shares issued times the par value per share and we credit additional paid-in capital for the portion of the cash proceeds above par value.Question 10-10The three potential features of preferred stock are convertible, redeemable, and cumulative. Convertible makes it appear more like stockholders equity, while redeemable and cumulative make it appear more like long-term liabilities. Question 10-11Investors in common stock are the owners of the corporation. Investors in bonds are creditors who have loaned money to the corporation. Preferred stock fits somewhere between common stock and bonds. For example, the risk and expected return are greatest for investments in common stock followed by preferred stock and then bonds. In contrast, preference for payments of interest and dividends are given first to bonds, then preferred stock, and then common stock. Illustration 10-8 provides a summary. Question 10-12A company may buy back its own stock to boost under-priced stock. When a companys management feels the market price of its stock is too low, it may attempt to support the price by decreasing the supply of stock in the marketplace. Other reasons why a company might buy back its

own stock are to distribute surplus cash in the company without paying dividends, to boost earnings per share, and to offset issuance of shares under stock-based compensation plans. Question 10-13When a corporation repurchases its own stock, it increases, or debits treasury stock reported in the balance sheet as a reduction in stockholders equity. When a corporation purchases stock in another corporation, it increases, or debits an investment account reported in the balance sheet as an increase in assets. Question 10-14Some companies are unprofitable and therefore unable to pay cash dividends. However, many profitable companies choose not to pay cash dividends. Companies with large expansion plans, called growth companies, prefer to reinvest earnings in the growth of the company rather than distribute earnings back to investors in the form of cash dividends.Investors purchase stock in companies that do not pay dividends because they expect share prices to increase. Profitable companies that reinvest earnings, rather than pay dividends, should see their share price increase.

Question 10-15The declaration date is when the board of directors declares the cash dividend to be paid. The date of record is the cutoff date. All registered owners on the date of record will be entitled to the dividend. Finally, the payment date is the date of the actual cash distribution.

Question 10-16Total assets, total liabilities, and total stockholders equity do not change as a result of a 100% stock dividend or a 2-for-1 stock split.

Question 10-17Declaration and payment of a cash dividend reduces total assets and total stockholders equity. Declaration and payment of a stock dividend has no effect on total assets, total liabilities, and total stockholders equity.

Question 10-18In a 2-for-1 stock split the number of shares outstanding doubles, while the par value and share price drop by one-half.

Question 10-19The correct order in the stockholders equity section of the balance sheet is preferred stock, common stock, additional paid-in capital, retained earnings, and treasury stock.

Question 10-20The stockholders equity section of the balance sheet shows the balance in each equity account at a point in time. In contrast, the statement of stockholders equity summarizes the changes in the balance in each stockholders equity account over a period of time..

Question 10-21Total stockholders equity is equal to assets minus liabilities. An asset usually equals its market value on the date its purchased. However, the two arent necessarily the same after that. For instance, many buildings increase in value over time, but continue to be reported in the balance sheet at historical cost minus accumulated depreciation. Nike creates brand awareness and increases market value through advertising, but under accounting rules, it expenses all its advertising costs as it incurs them. This causes the true market value of assets and stockholders equity to be greater than the amount recorded for assets and stockholders equity in the accounting records. Question 10-22The return on equity tends to be larger. The return on equity is net income divided by average stockholders equity. The return on the market value of equity is net income divided by the market value of equity. Average stockholders equity tends to be smaller than the market value of equity. Dividing by a smaller number results in a larger ratio. Question 10-23PE stands for price-earnings. Investors use the PE ratio to evaluate the price of a stock in relation to the current earnings generated. A high PE ratio indicates that the market has high hopes for a companys stock and has bid up the price. They are priced high in relationship to current earnings because investors expect future earnings to be higher. On the other hand, a low PE ratio might indicate a lack of confidence by the market, or it might suggest an underpriced sleeper or value stock.

BRIEF ExercisesBrief Exercise 10-1 ADVANTAGES OF A CORPORATION Limited Liability- Even in the event of bankruptcy, stockholders in a corporation can lose no more than the amount they invested in the company. In contrast, owners in a sole proprietorship or a partnership can be held personally liable for debts the company has incurred, over and beyond the investment they have made. Raising Capital- A corporation is better suited to raising capital than is a sole proprietorship or a partnership. Lack of Mutual Agency- Individual partners in a partnership each have the power to bind the business to a contract. DISADVANTAGES OF A CORPORATION Additional Taxes- Owners of sole-proprietorships and partnerships are taxed once, when they include their share of earnings in their personal income tax returns. However, corporations have double taxation. More Paperwork- To protect the rights of those who buy a corporations stock or who loan money to a corporation, the state and federal governments impose expensive reporting requirements on the company.

Brief Exercise 10-2 An S Corporation allows a company to enjoy limited liability as a corporation, but tax treatment as a partnership. Because of these benefits, many companies that qualify choose to incorporate as an S Corporation. One of the major restrictions is that the corporation cannot have more than 100 stockholders, so S Corporations appeal more to smaller, less widely held businesses.

Brief Exercise 10-3Cash (2,000 shares x $12)24,000

Common Stock (2,000 shares x $0.01) 20

Additional Paid-in Capital (difference)23,980

(Issue common stock above par)

Brief Exercise 10-4 Cash (1,000 shares x $20)20,000

Common Stock (1,000 shares x $1.00) 1,000



Cash (1,000 shares x $20)20,000

Common Stock 20,000

(Issue no-par value common stock)

Brief Exercise 10-5Cash (1,000 shares x $22)22,000

Preferred Stock (1,000 shares x $0.01) 10


(Issue preferred stock above par)

Brief Exercise 10-6Preferred Stock FeaturesDescription

__c___ 1. Convertiblea. Shares receive dividend priority, if dividend not paid.

__b___ 2. Redeemableb. Shares can be sold at a predetermined price.

__a___ 3. Cumulativec. Shares can be exchanged for common stock.

Brief Exercise 10-7Preferred dividends for 2012 (1,000 shares x 6% x $50 par value)$3,000

Preferred dividends in arrears for 2010 and 2011($3,000 x 2 years)6,000

Remaining dividends to common stockholders1,000

Total dividends$10,000

Brief Exercise 10-8Treasury Stock (100 shares x $28)2,800

Cash 2,800

(Repurchase treasury stock)

Brief Exercise 10-9Cash (100 shares x $30)3,000

Treasury Stock (100 shares x $28) 2,800

Additional Paid-in Capital (100 shares x $2)200

(Reissue treasury stock above cost)

Cash (100 shares x $26)2,600



(Sell treasury stock below cost)

Brief Exercise 10-10October 1

Dividends (3,000 shares x $0.50)1,500

Dividends Payable1,500

(Declare cash dividends)

October 15

No Entry

October 31

Dividends Payable (3,000 shares x $0.50)1,500

Cash1,500

(Pay cash dividends)

Brief Exercise 10-11June 30

Stock Dividends (20,000 shares x $1.00)20,000

Common Stock 20,000

(100% stock dividend, large stock dividend)

Brief Exercise 10-12 No Entry is recorded for a 2-for-1 stock split since the balance in all of the accounts remain the same before and after a stock split. Number of shares: 20,000 x 2 = 40,000 Par value per share: $1.00 2 = $0.50 Market price per share: $25.00 2 = $12.50

Brief Exercise 10-13

TransactionTotalAssetsTotal LiabilitiesTotalStockholdersEquity

Issue common stock+NE+

Issue preferred stock+NE+

Purchase treasury stockNE

Sale of treasury stock+NE+

Brief Exercise 10-14Silk StationBalance Sheet(Stockholders Equity Section)December 31

Stockholders equity:

Common stock, $1.00 par value $ 1,000,000

Additional paid-in capital17,000,000

Total paid-in capital18,000,000

Retained earnings10,000,000

Treasury stock, 50,000 shares (1,100,000)

Total stockholders equity$26,900,000

Brief Exercise 10-15($ in millions)Net IncomeAverageStockholders Equity=Return on Equity

Limited Brands$220($2,219 + 1,874) / 2=10.8%

EXERCISESExercise 10-1Terms

__f___1. Publicly held corporation

__d___2. Model Business Corporation Act

__h___3. Articles of Incorporation

__a___4. Limited liability

__g___5. Mutual agency

__b___6. Double taxation

__e___7. S Corporation

__c___ 8. Limited liability corporation

Definitionsa. Shareholders can lose no more than the amount they invested in the company. b.Corporate earnings are taxed twice - at the corporate level and individual shareholder level.c.Like an S corporation, but there are no limitations on the number of owners as in an S corporation. d.Designed to serve as a guide to states in the development of their corporate statutes. e.Allows for legal treatment as a corporation, but tax treatment as a partnership. f.Has stock traded on a stock exchange such as the New York Stock Exchange (NYSE).g.Individual partners in a partnership have the power to bind the business to a contract. h. Describe (a) the nature of the firms business activities, (b) the shares to be issued, and (c) the composition of the initial board of directors.

Exercise 10-2Authorized stock is the number of shares the company is authorized to sell, stated in the companys articles of incorporation.Issued stock is the number of shares that have been sold to investors.Outstanding stock is the number of shares held by investors. Issued and outstanding are the same amounts as long as the corporation has not repurchased any of its shares.Preferred stock is preferred over common stock in two ways. Preferred stockholders usually have first rights to a specified amount of dividend and receive preference over common stockholders in the distribution of assets in the event the corporation is dissolved. Treasury stock is the corporations own stock that it reacquired. Exercise 10-3Requirement 1January 1, 2012

Cash (600 shares x $40)24,000

Common Stock 24,000


April 1, 2012

Cash (100 shares x $44)4,400

Common Stock 4,400


Exercise 10-3 (Continued)Requirement 2January 1, 2012

Cash (600 shares x $40)24,000

Common Stock (600 shares x $1.00) 600



April 1, 2012

Cash (100 shares x $44)4,400




Requirement 3January 1, 2012

Cash (600 shares x $40)24,000



(Issue common stock above stated value)

April 1, 2012

Cash (100 shares x $44)4,400



(Issue common stock above stated value)

Exercise 10-4Requirement 1Preferred dividends for 2012 (1,000 shares x 7% x $100 par value)$7,000

Preferred dividends in arrears for 20117,000



Requirement 2 Preferred dividends for 2012 (1,000 shares x 7% x $100 par value)$7,000

Preferred dividends in arrears for 20110



Exercise 10-5February 1DebitCredit

Cash (5,000 x $15)75,000

Common Stock (5,000 x $15) 75,000

(Issue common stock no-par value))

May 15

Cash (500 x $12)6,000

Preferred Stock (500 x $10) 5,000



October 1




October 15

No Entry

October 31


Cash4,125


Exercise 10-6January 2, 2012DebitCredit

Cash (100,000 x $25)2,500,000

Common Stock (100,000 x $1) 100,000

Additional Paid-in Capital (difference) 2,400,000


February 6, 2012

Cash (2,000 x $12)24,000

Preferred Stock (2,000 x $10) 20,000



September 10, 2012

Treasury Stock (10,000 shares x $30)300,000

Cash 300,000

(Purchase treasury stock)

December 15, 2012

Cash (5,000 shares x $35)175,000

Treasury Stock (5,000 shares x $30) 150,000

Additional Paid-in Capital (5,000 x $5)25,000


Exercise 10-7Finishing TouchesBalance Sheet(Stockholders Equity Section)December 31, 2012


Preferred stock, $10 par value $ 20,000

Common stock, $1.00 par value 100,000



Retained earnings53,400 *

Treasury stock, 5,000 shares (150,000)


* 150,000 - (95,000 + 1,600)

Exercise 10-8

March 15 DebitCredit

Dividends (220,000,000 shares x $0.075)16,500,000

Dividends Payable16,500,000


March 30 - No Entry

April 13

Dividends Payable (220,000,000 shares x $0.075)16,500,000

Cash16,500,000


Exercise 10-9

March 1, 2012DebitCredit

Cash (55,000 x $52)2,860,000

Common Stock (55,000 x $1) 55,000

Additional Paid-in Capital (difference) 2,805,000


May 10, 2012


Cash 275,000


June 1, 2012




July 1, 2012


Cash225,000


October 21, 2012

Cash (2,500 shares x $60)150,000


Additional Paid-in Capital (2,500 x $5)(Reissue treasury stock)12,500

Exercise 10-10Power Drive CorporationBalance Sheet(Stockholders Equity Section)December 31, 2012


Common stock, $1.00 par value $ 155,000



Retained earnings2,375,000 *



* $2,000,000+$600,000-$225,000 Exercise 10-11Power Drive CorporationStatement of Stockholders EquityFor the Year Ended December 31, 2012

Common StockAdditionalPaid-inCapitalRetainedEarningsTreasuryStockTotalStockholdersEquity

Balance, January 1$100,0004,500,0002,000,000-0-$6,600,000

Issued common stock55,0002,805,0002,860,000

Purchase treasury stock (275,000)(275,000)

Cash dividends(225,000)(225,000)

Sale of treasury stock12,500137,500150,000

Net income600,000600,000

Balance, December 31$155,0007,317,5002,375,000(137,500)$9,710,000

Exercise 10-12




Purchase treasury stockNE

Sale of treasury stock+NE+

Declare cash dividendNE+

Pay cash dividendNE

100% stock dividendNENENE

2-for-1 stock splitNENENE

Exercise 10-13United ApparelBalance Sheet(Stockholders Equity Section)December 31, 2012


Preferred stock $ 2,600,000

Common stock 500,000



Retained earnings1,700,000

Treasury stock (750,000)


Exercise 10-14Requirement 1

($ in millions)

Net IncomeAverageStockholders Equity=Return onEquity

Limited Brands$220($2,219 + 1,874) / 2=10.8%

Limited Brands has a lower return on equity than Deckers Outdoor, but a higher return on equity than Timberland. Requirement 2

($ in millions)

Net IncomeMarket Valueof Equity=Return on the Market Value of Equity

Limited Brands$220($7.92 x 321)=8.7%

Limited Brands also has a lower return on the market value of equity than Deckers Outdoor, but a higher return on the market value of equity than Timberland..Requirement 3 ($ in millions)Net IncomeShares Outstanding=Earnings per Share

Limited Brands$220321=$0.69

Limited Brands has earnings per share of $0.69. Earnings per share is not useful for comparing earnings performance between companies because of wide differences in the number of shares outstanding. It is useful in comparing earnings for one company over time. Requirement 4($ in millions)Stock PriceEarnings Per Share=Price-Earnings Ratio

Limited Brands$7.92$0.69=11.5

Limited Brands has a slightly higher price-earnings ratio than Deckers Outdoor and a much lower price-earnings ratio than Timberland.

Exercise 10-15Requirement 1 ($ in millions)Net Income Dividends on Preferred Stock

Shares Outstanding=Earnings per Share

2011($180 - $20)220=$0.73

2012($210 - $25)240=$0.77

Earnings per share increased from $0.73 per share to $0.77 per share. Requirement 2($ in millions)Stock PriceEarnings Per Share=Price-Earnings Ratio

2011$10.47$0.73=14.3

2012$11.52$0.77=15.0

The stock is priced lower in relation to reported earnings in 2011.

PROBLEMS: SET AProblem 10-1A

Terms

__f___1. Cumulative

__d__2. Retained earnings

__g__3. Outstanding stock

__h__4. Limited liability

__j__5. Treasury stock

__e__6. Issued stock

__i__ 7. Angel investors

__a__ 8. Paid-in capital

__b__9. Authorized stock

__c__ 10. Redeemable

Definitionsa. The amount invested by stockholders. b.Shares available to sell.c.Shares can be returned to the corporation at a predetermined price.d.The earnings not paid out in dividends.e.Shares actually sold.f.Shares receive priority for future dividends if dividends are not paid in a given year. g.Shares held by investors.h.Shareholders can lose no more than the amount they invested in the company.i.Wealthy individuals in the business community willing to risk investment funds on a promising business venture.j.The corporations own stock that it reacquired.

Problem 10-2ARequirement 1March 1, 2012DebitCredit

Cash (1,000 x $32)32,000

Common Stock (1,000 x $0.01) 10


(Issue common stock)

May 15, 2012

Treasury Stock (600 shares x $25)15,000

Cash 15,000


July 10, 2012

Cash (100 shares x $30)3,000


Additional Paid-in Capital (100 x $5)500


October 15, 2012

Cash (100 x $35)3,500

Preferred Stock (100 x $1) 100


(Issue preferred stock)

December 1, 2012




December 31. 2012


Cash2,850


Requirement 2



Purchase treasury stock-NE-

Reissue treasury stock+NE+


Declare cash dividendsNE+-

Pay cash dividends--NE

Problem 10-3ARequirement 1BeforeAfter 100%Stock DividendAfter 2-for-1 Stock Split

Common stock, $1 par value$ 1,000$ 2,000$ 1,000

Additional paid-in capital49,00049,00049,000

Total paid-in capital50,00051,00050,000

Retained Earnings22,85021,85022,850

Total stockholders equity$72,850$72,850$72,850

Shares outstanding1,0002,0002,000

Par value per share$1.00$1.00$0.50

Share price$110$55$55

Requirement 2 The primary reason companies declare a large stock dividend or a stock split is to lower the trading price of the stock to a more acceptable trading range, making it attractive to a larger number of potential investors.

Problem 10-4ARequirement 1 5,000,000 shares = ($5,000 / $1 par value per share) in thousands (x 1,000).Requirement 2 20,000,000 shares = ($20,000 / $1 par value per share) in thousands (x 1,000).Requirement 3 $40 per share. The total paid-in capital for common stock is $400,000 (20,000 x $20). Therefore, the total paid-in capital for preferred stock must be $200,000 ($600,000 - $400,000). $200,000 divided by 5,000 shares indicates an issue price of $40 per share.Requirement 4 (in millions)

Retained Earnings, Beginning$240

+ Net Income?

- Dividends(20)

= Retained Earnings, Ending$278

Net income for the year was $58 million.Requirement 5 $22 per share. ($220,000 / 10,000 shares)

Problem 10-5ARequirement 1Donnie HilfigerBalance Sheet(Stockholders Equity Section)December 31, 2012


Preferred stock, $1 par value $300

Common stock, $0.01 par value 40

Additional paid-in capital101,890

Total paid-in capital102,230

Retained earnings32,450


Total stockholders equity$122,180

Requirement 2Donnie HilfigerStatement of Stockholders EquityFor the Year Ended December 31, 2012

PreferredStockCommon StockAdditionalPaid-inCapitalRetainedEarningsTreasuryStockTotalStockholdersEquity

Balance, January 12003066,00025,500-0-91,730

Issued common stock1031,99032,000

Purchase of treasury stock (15,000)(15,000)

Sale of treasury stock5002,5003,000

Issued preferred stock1003,4003,500


Net income9,8009,800

Balance, December 31$30040101,89032,450(12,500)$122,180

Requirement 3 Items 1 and 2 are similar in that item 1 shows the equity balances in a column format and item 2 shows these same balances across the bottom row. However, items 1 and 2 serve different purposes. The stockholders equity section of the balance sheet in item 1 presents the balance of each equity account at a point in time. The statement of stockholders equity in item 2 shows the change in each equity account balance over time.

Problem 10-6ARequirement 1January 2, 2012DebitCredit

Cash (100,000 x $60)6,000,000

Common Stock (100,000 x $1) 100,000

Additional Paid-in Capital (difference)5,900,000


February 14, 2012

Cash (50,000 x $11)550,000

Preferred Stock (50,000 x $10) 500,000



May 8, 2012


Cash 500,000


May 31, 2012

Cash (5,000 shares x $55)275,000




December 1, 2012

Dividends (95,000 shares x $0.50 + $25,000)72,500



December 30, 2012


Cash72,500


Requirement 2Major League ApparelBalance Sheet(Stockholders Equity Section)December 31, 2012



Common stock, $1 par value 100,000



Retained earnings407,500*



*$480,000 net income minus $72,500 in dividends.

Problem 10-7ARequirement 1($ in millions)Net IncomeAverageStockholders Equity=Return onEquity

Abercrombie$272($1,619 + 1,845) / 2=15.7%

Abercrombie has a lower return on equity than Deckers Outdoor, but a higher return on equity than Timberland.Requirement 2

($ in millions)Net IncomeMarket Valueof Equity=Return on the Market Value of Equity

Abercrombie$272($29.00 x 103)=9.1%

Abercrombie has a higher return on market value of equity than either Deckers Outdoor (8.9%) or Timberland (3.7%). Requirement 3 The return on the market value of equity is much lower than the return on equity for these companies because the market value of equity is much higher than average stockholders equity recorded on the balance sheet. For some companies the return on equity is a meaningful measure of earnings performance; but for others, the return on the market value of equity is a better measure, especially when the recorded balance in stockholders equity and the market value of equity differ greatly.Requirement 4($ in millions)Stock PriceEarnings Per Share=Price-Earnings Ratio

Abercrombie$29.00($272 / 103)=11.0

Abercrombie has a slightly lower price-earnings ratio than Deckers Outdoor and a much lower price-earnings ratio than Timberland. Abercrombie is trading at a lower price per dollar of earnings. Problems: Set BProblem 10-1BTerms

__e___1. PE ratio

__i___2. Stockholders equity section of the balance sheet

__a___ 3. Accumulated deficit

__b___ 4. Growth stocks

__c___ 5. 100% stock dividend

__f___ 6. Statement of stockholders equity

__j___7. Treasury stock

__g___8. Value stocks

__h___9. Return on equity

__d___ 10. Retained earnings

Definitionsa. A debit balance in retained earnings.b.Priced high in relation to current earnings as investors expect future earnings to be higher. c.Effectively the same as a 2-for-1 stock split.d.The earnings not paid out in dividends.e.The stock price divided by earnings per share.f.Summarizes the changes in the balance in each stockholders equity account over a period of time.g.Priced low in relation to current earnings. h.Measures the ability of company management to generate earnings from the resources that owners provide. i.Shows the balance in each equity account at a point in time. j.The corporations own stock that it reacquired.

Problem 10-2BRequirement 1March 1, 2012DebitCredit

Cash (2,000 x $15)30,000

Common Stock (2,000 x $1.00) 2,000


(Issue common stock)

April 1, 2012

Cash (200 shares x $30)6,000

Preferred Stock (200 shares x $10) 2,000


(Issue preferred stock)

June 1, 2012




June 30, 2012


Cash2,150


August 1, 2012


Cash2,400

(Repurchase treasury stock)

October 1, 2012

Cash (100 shares x $14) 1,400




Requirement 2




Declare cash dividendsNE+-

Pay cash dividends--NE

Purchase treasury stock-NE-

Reissue treasury stock+NE+

Problem 10-3B

BeforeAfter 100%Stock DividendAfter 2-for-1 Stock Split

Common stock, $0.01 par value$ 10$ 20$ 10

Additional paid-in capital24,99024,99024,990

Total paid-in capital25,00025,01025,000

Retained Earnings15,00014,99015,000

Total stockholders equity$40,000$40,000$40,000

Shares outstanding1,0002,0002,000

Par value per share$0.01$0.01$0.005

Share price$82$41$41

Problem 10-4B Requirement 1 No preferred stock has been issued. Requirement 2 3,000,000 shares = ($15,000 / $5 par value per share) in thousands (x 1,000).Requirement 3 $20 per share. The total paid-in capital for common stock is $60,000. $60,000 divided by 3,000 shares indicates an issue price of $20 per share.Requirement 4 Retained Earnings, Beginning$40,000,000

+ Net Income10,850,000

- Dividends ?

= Retained Earnings, Ending$48,000,000

Dividends paid for the year were $2,850,000. Requirement 5 150,000 shares = ($2,700 / $18 per share) in thousands (x 1,000).

Requirement 6 $2,850,000 / (3,000,000 150,000) = $1.00 dividend per share.

Problem 10-5BRequirement 1NauticalBalance Sheet(Stockholders Equity Section)December 31, 2012



Common stock, $1.00 par value 4,000

Additional paid-in capital50,700

Total paid-in capital57,700

Retained earnings15,500

Treasury stock, 100 shares (1,200)

Total stockholders equity$72,000

Requirement 2NauticalStatement of Stockholders EquityFor the Year Ended December 31, 2012

PreferredStockCommon StockAdditionalPaid-inCapitalRetainedEarningsTreasuryStockTotalStockholdersEquity

Balance, January 1$1,000$2,000$18,500$10,500$ -0-$32,000

Issued common stock2,00028,00030,000

Issued preferred stock 2,0004,0006,000


Purchase treasury stock(2,400)(2,400)

Reissue treasury stock2001,2001,400

Net income7,1507,150

Balance, December 31$3,000$4,000$50,700$15,500$(1,200)$72,000

Requirement 3 Items 1 and 2 are similar in that item 1 shows the equity balances in a column format and item 2 shows these same balances across the bottom row. However, items 1 and 2 serve different purposes. The stockholders equity section of the balance sheet in item 1 presents the balance of each equity account at a point in time. The statement of stockholders equity in item 2 shows the change in each equity account balance over time.

Problem 10-6BRequirement 1 February 2, 2012DebitCredit

Cash (1,000,000 x $25)25,000,000

Common Stock (1,000,000 x $5) 5,000,000



February 4, 2012

Cash (500,000 x $22)11,000,000

Preferred Stock (500,000 x $20) 10,000,000



June 15, 2012

Treasury Stock (100,000 shares x $20)2,000,000

Cash 2,000,000


August 15, 2012

Cash (75,000 shares x $35)2,625,000

Treasury Stock (75,000 shares x $20) 1,500,000

Additional Paid-in Capital (75,000 x $15)1,125,000


November 1, 2012

Dividends (975,000 shares x $1.00 + $600,000)1,575,000



November 30, 2012


Cash1,575,000


Problem 10-6B (Continued)Requirement 2National League GearBalance Sheet(Stockholders Equity Section)December 31, 2012


Preferred stock, $20 par value $10,000,000

Common stock, $5 par value 5,000,000



Retained earnings*3,225,000



* $4,800,000 net income minus $1,575,000 in dividends.

Problem 10-7BRequirement 1

($ in millions)Net IncomeAverageStockholders Equity=Return on Equity

Gap$967($4,274 + 4,387) / 2=22.3%

Gap has a lower return on equity than Deckers Outdoor, but a higher return on equity than Timberland.Requirement 2

($ in millions)Net IncomeMarket Valueof Equity=Return on the Market Value of Equity

Gap$967($16.00 x 694)=8.7%

Gap also has a lower return on the market value of equity than Deckers Outdoor, but a higher return on the market value of equity than Timberland.Requirement 3 The return on the market value of equity is much lower than the return on equity for these companies because the market value of equity is much higher than average stockholders equity recorded on the balance sheet. For some companies the return on equity is a meaningful measure of earnings performance; but for others, the return on the market value of equity is a better measure, especially when the recorded balance in stockholders equity and the market value of equity differ greatly.Requirement 4($ in millions)Stock PriceEarnings Per Share=Price-Earnings Ratio

Gap$16.00($967 / 694)=11.5

Gap has a slightly higher price-earnings ratio than Deckers Outdoor and a much lower price-earnings ratio than Timberland. Deckers Outdoor is trading at a lower price per dollar of earnings.

ADDITIONAL PERSPECTIVESContinuing Problem: Great AdventuresAP10-1

Requirement 1July 2, 2014DebitCredit

Cash (100,000 x $12)1,200,000

Common Stock (100,000 x $1) 100,000



September 10, 2014


Cash 150,000


November 15, 2014

Cash (5,000 shares x $16)80,000




December 1, 2014

Dividends 115,000



December 31, 2014


Cash115,000


Requirement 2Great Adventures, Inc.Balance Sheet(Stockholders Equity Section)December 31, 2014


Common stock, $1 par value $120,000



Retained earnings*175,000



* $140,000 beginning balance in retained earnings plus $150,000 net income minus $115,000 in dividends.

Financial Analysis: American EagleAP10-2Requirement 1 $0.01 par value per share. The par value per share is listed in the stockholders equity section of the balance sheet.Requirement 2 249,561,000 shares. The number of shares issued (in thousands) is listed in the stockholders equity section of the balance sheet.Requirement 3 Yes, 41,737,000 shares. The number of shares of treasury stock (in thousands) is listed in the stockholders equity section of the balance sheet.Requirement 4 $83,906,000. The cash dividends paid (in thousands) is listed in the retained earnings column near the bottom of the statement of stockholders equity.

Financial Analysis: The BuckleAP10-3Requirement 1 $0.01 par value per share. The par value per share is listed in the stockholders equity section of the balance sheet.Requirement 2 46,381,263 shares. The number of shares issued (in thousands) is listed in the stockholders equity section of the balance sheet.Requirement 3 No. There is no treasury stock reported in the stockholders equity section of the balance sheet.Requirement 4 $120,341,000. The cash dividends paid ($37,011 + $83,330 in thousands) is listed in the retained earnings column of the statement of stockholders equity. Requirement 5 Yes, the company had a 3-for-2 stock split in the year ended January 31, 2009 according to the statement of stockholders equity. Additional details are provided in footnote A regarding the summary of significant accounting policies. Specifically, On September 15, 2008, the Companys Board of Directors approved a 3-for-2 stock split payable in the form of a stock dividend for shareholders of record as of October 15, 2008, with a distribution date of October 30, 2008.

Comparative Analysis: American Eagle vs. The BuckleAP10-4Requirement 1

($ in thousands)NetIncomeAverage Stockholders Equity=Return on Equity

American Eagle $169,022$1,493,774*=11.3%

The Buckle $127,303$345,741**=36.8%

*($1,409,031 + $1,578,517) / 2**($337,222 + $354,259) / 2The Buckle has a higher return on equity than American Eagle.Requirement 2

($ in thousands)

Net IncomeMarket Valueof Equity=Return on the Market Value of Equity

American Eagle $169,022$15.89 x 206,832=5.1%

The Buckle $127,303$30.34 x 46,381=9.0%

The Buckle also has a higher return on market value of equity than American Eagle. Note that since net income amounts are in thousands, the number of shares outstanding used in calculating the market value of equity also needs to be in thousands.Requirement 3 The return on the market value of equity is much lower than the return on equity for both companies because the market value of equity is much higher than average stockholders equity recorded on the balance sheet. For some companies the return on equity is a meaningful measure of earnings performance; but for others, the return on the market value of equity is a better measure, especially when the recorded balance in stockholders equity and the market value of equity differ greatly.

Requirement 4($ in thousands)Stock PriceEarnings Per Share=Price-Earnings Ratio

American Eagle$15.89($169,022 / 206,832)=19.4

The Buckle$30.34(127,303 / 46,381)=11.1

The Buckle is trading at a lower price per dollar of earnings than American Eagle.

EthicsAP10-5Answers regarding the allocation of the additional $5 million in operating cash flows will vary. Other areas to spend the money, not specifically mentioned in the case, include increasing employee benefits such as retirement and healthcare, investing in research and development to continue the successful launch of new products, investing in other companies to gain access to resources or technology, and giving to charity. It is common for executives to be compensated based on the companys performance each year. This in itself is not unethical and often is a good business practice. However, when executive compensation is related to company performance, users need to be aware that this increases the risk of earnings management to meet management incentives.

Internet ResearchAP10-6This case provides an opportunity for students to learn more about Form 10-K, containing the annual report for publicly traded companies. It also introduces students to EDGAR, one of the largest sources of accounting information available on the internet. Finally, students gain an understanding of transactions that affect the statement of stockholders equity. Answers to the assignment will vary depending on the 10-K filing chosen. Written CommunicationAP10-7

Requirement 1Liabilities are the creditors claims to resources. Stockholders equity are the owners claim to resources.

Requirement 2The balance sheet has always distinguished between liabilities and stockholders equity. Financial accounting information is designed to provide information useful to its two primary user groups, investors and creditors. Therefore, it makes sense to separate the owners claim to resources from the creditors claim to resources.

Requirement 3Arguments in support of eliminating the distinction relate to the difficulty, in certain cases, in distinguishing between liabilities and stockholders equity. For instance, preferred stock can be structured so that it is nearly identical to common stock by giving preferred stock voting rights and making it convertible to common stock at the option of the investor. On the other hand, preferred stock can also be structured so that it is like a bond with a fixed dividend payment and a mandatory redemption date similar to the interest payment and maturity date on bonds payable. Since preferred stock can fall anywhere along the line between common stock and bonds, it becomes difficult to maintain a distinction between liabilities and stockholders equity.

Requirement 4While answers to this question will vary, students should be able to defend their position.

Earnings ManagementAP10-8

Requirement 1

Net Income

Shares outstanding=Earnings Per Share

Before Repurchase$878,000950,000=$0.92

Net IncomeAverageStockholders Equity=Return on Equity

Before Repurchase$878,000($4,425,000 + 4,000,000) / 2=20.8%

Requirement 2

Net Income

Shares outstanding=Earnings Per Share

After Repurchase$878,000(950,000 + 850,000) / 2=$0.98

Net IncomeAverageStockholders Equity=Return on Equity

After Repurchase$878,000($4,425,000 + 3,000,000) / 2=23.6%

Requirement 3The repurchase of stock near year-end improves earnings per share by reducing the number of outstanding shares used to calculate earnings per share. It also improves the return on equity by reducing the ending balance in stockholders equity. Note that it will be difficult to maintain next year as the reduction in shares outstanding and average stockholders equity comes at a cost the increase in interest expense beginning next year due to the $1 million loan at year-end. The loan also increases company risk.

10-210-1

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