CHAPTER 16



CHAPTER 16

STOCKHOLDERS’ EQUITY: RETAINED EARNINGS

Read pages 811-833 and answer the following questions.

1. What is the basic source of Retained Earnings?

2. What are the major types of events/items that affect Retained Earnings? See Illustration 16-1.

3. Why don’t companies pay out all of their retained earnings as dividends?

4. What types of dividends do companies distribute? Briefly describe each.

Example 1

5. On September 12, 2001, the Nickell Corporation’s Board of Directors voted to declare a $.50 per share cash dividend on common stock payable October 15 to stockholders of record on September 30.

a. What is the date of declaration?

b. What is the date of record?

c. What is the date of payment?

6. Assume the Nickell Corporation has 1,000,000 shares of common stock authorized, 500,000 shares issued and 480,000 shares outstanding. Give all the journal entries related to the dividend declared in #5 above.

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Example 2

7. Assume instead that the Nickell Corporation declared a property dividend. Each share of common stock will receive one share of stock in the Ringer Corporation. The Nickell Corporation paid $15 per share for the stock and it is currently worth $20 per share. Record the declaration of the dividend and the payment of the dividend.

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Example 3

8. The Toman Corporation would like to pay a cash dividend to its stockholders but does not have cash available currently. The corporation has decided to issue a $1 per share scrip dividend to its 100,000 shares of outstanding common stock. The date of declaration is September 1, 2001. The date of payment is September 1, 2002 and the scrip bears interest at 6%. Record the declaration of the dividend, the accrual of interest at December 31, 2001 (assume 4 months) and the payment of the dividend on September 1, 2002.

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9. Why do companies issue stock dividends?

10. Why do companies split their stock?

Example 4

11. The Brandt Corporation wants to double the number of shares of common stock it has outstanding. It can do this through a 2-for-1 stock split or a 100% stock dividend. The company has 200,000 shares of $2 par common stock outstanding.

a. How would this affect the selling price of the stock? Is your answer the same for both a stock split and a stock dividend?

b. How would a stock split affect the par value per share of the stock?

c. What would the total legal capital be after the stock split?

d. How would the stock split affect the retained earnings?

e. What journal entry is used to record a stock split?

f. How would a 100% stock dividend affect the par value per share of the stock?

g. What would the total legal capital be after the stock dividend?

h. How would the stock dividend affect retained earnings?

i. Give the journal entry to record the stock dividend if the stock is selling for $100 per share when the dividend is declared.

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j. What factors might influence whether the company chooses a stock split or a stock dividend to double the shares?

Example 5

12. The Conley Company has 100,000 shares of $1 par common stock outstanding. The stock is currently selling for $25 per share. The company declares a 10% stock dividend on September 19, 2001 distributable on October 19 to stockholders of record on October 5. Prepare the journal entries related to this stock dividend.

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Example 6

13. The Conover Company has 100,000 shares of $1 par common and 1,000 shares of $50 par preferred stock outstanding. The preferred stock has a 6% dividend rate and is cumulative. The Conover Company wants to declare dividends totaling $12,000. Determine how much will be paid to preferred stockholders and how much to common, assuming

a. The company has not paid dividends in the two years prior to the current year.

b. The preferred stock is participating up to 8% and there are no dividends in arrears.

14. What is an appropriation of retained earnings? Why do companies appropriate retained earnings?

15. What are the three categories that normally appear on a statement of stockholders’ equity? (Actually, there is a fourth category not mentioned. That is Accumulated Other Comprehensive Income. Three items that normally appear in Accumulated OCI are foreign currency translation gains and losses (ACC 435); minimum pension liability (Ch 21) and unrealized gains/losses on AFS investments (Ch 18)).

16. What does the rate of return on common stock equity measure? What is the formula? Is a higher % better than a lower %?

17. What does the payout ratio measure? What is the formula? How do you interpret this ratio (that is, how do you decide whether the ratio is good or bad)?

18. What is the formula for the price earnings ratio? What information does this ratio give to investors?

19. What is the formula for the book value per share? What information does this ratio give to investors/analysts?

|Account Title |Dr/Cr |Classification |What does the balance in the account represent? |

|Cash Dividends Declared |Debit |Contra equity |A temporary account used to record the amount of cash dividends|

|Or Cash Dividends | | |declared. |

|Dividends Payable |Credit |Current liability |Amount of cash dividends declared but not yet paid. |

|Property Dividends Declared |Debit |Contra equity |A temporary account used to record the fair market value of |

| | | |property dividends declared. |

|Property Dividends Payable |Credit |Current liability |Amount of property dividends declared but not yet paid. |

|Scrip Dividends Declared |Debit |Contra equity |A temporary account used to record the amount of scrip |

| | | |dividends declared. |

|Notes Payable to Stockholders |Credit |Current or long-term |Amount of scrip dividends declared but not yet paid. |

| | |liability | |

|Stock Dividend Declared |Debit |Contra equity |A temporary account used to record the total contributed |

| | | |capital assigned to shares of stock to be issued as a dividend.|

|Common Stock Distributable |Credit |Legal capital |The par or stated value of the shares of stock to be issued as |

| | | |a dividend. |

|Retained Earnings Appropriated for ….. |Credit |Retained Earnings |The amount of retained earnings that are not available for the |

| | | |declaration of dividends due to ……… |

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