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©Cambridge Business Publishers, 2011

Solutions Manual, Chapter 11 11-1

Chapter 11

Reporting and Analyzing Stockholders’ Equity

Learning Objectives – coverage by question

Mini-exercises Exercises Problems Cases

LO1 – Describe business financing through stock issuances.

37, 38 41 62, 63

LO2 – Explain and account for the issuance and repurchase of stock.

19, 20, 21, 22,

25, 36, 37, 38

39, 40, 41,

45, 52, 54

55, 56, 57, 58,

59 62, 63, 64

LO3 – Describe how operations increase the equity of a business.

30 41 62, 63, 64

LO4 – Explain and account for dividends and stock splits.

23, 26, 27, 28,

29, 30, 31, 36,

38

42, 44, 46,

47, 48, 49,

50, 51, 54

58

LO5 – Define and illustrate comprehensive income.

59, 60

LO6 – Describe and illustrate basic and diluted earnings per share computations.

23, 24, 25, 32,

33, 34, 36, 37

41, 43, 44,

50, 54 55, 56, 57

LO7 – Appendix 11A: Analyze the accounting for convertible securities, stock rights, and stock options.

35 53 59, 60 61


Financial Accounting, 3rd Edition 11-2

QUESTIONS Q11-1. Par value stock is stock that has a face value printed (identified) on the

stock certificate.

From an accounting standpoint, the par value of the common stock is the amount added to the common stock portion of paid-in-capital upon the sale of stock. The remainder of the sale price is added to the additional paid-in-capital portion of paid-in-capital. There are no analysis implications of the par value of stock.

Q11-2. Preferred stock usually takes priority over common stock in the receipt of a specified amount of dividends and in the distribution of assets if the corporation is ever liquidated. Also, preferred stock does not usually have voting rights.

Typically, preferred stock has the following features: 1) Preferential claim to dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No voting rights.

Q11-3. Preferred stock is similar to debt when

1. Dividends are cumulative. 2. Dividends are nonparticipating. 3. It has a preference to assets in liquidation. Preferred stock is similar to common stock when

1. Dividends are not cumulative. 2. Dividends are fully participating. 3. It is convertible into common stock. 4. It does not have a preference to assets in liquidation.

Q11-4. Dividend arrearage on preferred stock is the aggregate amount of dividends on cumulative preferred stock that has not been declared to date. The amount of dividends in arrears and a current dividend must be paid to preferred stockholders before common stockholders can receive any dividends. In the example, preferred stockholders must receive $90,000 in

dividends ($500,000 0.06 3 years = $90,000) before common stockholders receive any dividends.

Q11-5. A corporation's authorized stock is the maximum number of shares of stock it may issue. The authorized amounts and classes of stock are enumerated in the company's charter when the corporation is formed. A corporation can later amend its charter to change the amount of authorized capital, but such action must have the approval of the company’s shareholders. Shares that have been sold and issued to stockholders are the company's issued stock. Shares that have been sold and issued can be subsequently reacquired by the corporation—called treasury stock. When treasury stock is held, the issued shares exceed the outstanding shares.



Q11-6. Contributed capital represents the total investment that has been paid in to the company by its shareholders as a result of the purchase of stock. Earned capital represents the cumulative net income that has been earned, less the portion of that income that has been paid out to shareholders in the form of dividends.

When profit is earned, shareholders have the option of paying out that profit as a dividend or reinvesting the earnings in order to grow the company. In fact, many companies title the Retained Earnings account as Reinvested Earnings. Earned capital, thus, represents an implicit investment by the shareholders in the form of forgone dividends.

Q11-7. Paid-in capital is divided into two accounts: the common or preferred stock account and additional paid-in capital. The common stock or preferred stock accounts are increased by the par value of the shares issued and the additional paid-in capital account is increased for the balance of the proceeds received from the sale of the shares. The balance of the paid-in capital account is affected by the par value of the stock; the higher (lower) the par value, the lower (higher) the additional paid-in capital. Although paid-in capital will, in general, be higher if the stock price is higher, the breakdown of paid-in capital between the common or preferred stock accounts and additional paid-in capital does not yield any inferences regarding the financial condition of the company.

Q11-8. A stock split refers to the issuance of additional shares of a class of stock to the current stockholders in proportion to their ownership interests, normally accompanied by a proportionate reduction in the par or stated value of the stock. For example, a 2-for-1 stock split doubles the number of shares outstanding and halves the par or stated value of the shares. Consequently, there is no change in the amount of contributed capital associated with that class of stock. The major reason for a stock split is to reduce the per-share market price of the stock. Another possible reason is to influence shareholders’ in believing there has been some distribution of value.

Q11-9. Treasury stock is a corporation's issued stock that has been reacquired by the issuing corporation through purchases of its stock from its shareholders. A corporation often purchases treasury stock for distribution to employees under stock option plans or to offset dilution resulting from such sales. It is also used by management to prop up stock price when management believes its stock is inappropriately underpriced.

On the balance sheet, treasury stock should be carried at its cost and is shown as a deduction in deriving the total stockholders' equity—known as a contra equity account.

Q11-10. The $2,400 increase should not be shown on the income statement as any form of income or gain. The $2,400 is properly treated as additional paid-in capital and is shown as such in the stockholders' equity section of the balance sheet. The latter treatment is justified because treasury stock transactions are considered capital rather than operating transactions.



Q11-11. The book value per share of common stock is the total stockholders' equity divided by the number of shares outstanding, or $4,628,000/260,000 = $17.80.

Q11-12. A stock dividend is the distribution of additional shares of a corporation's stock to its stockholders. A stock dividend does not change a stockholder's relative ownership interest, because each stockholder owns the same fractional share of the corporation before and after the stock dividend. There is empirical evidence, however, suggesting that the stock price does not decline fully for the additional shares issued—various hypotheses, such as signaling theory, have been asserted as explanations of this phenomenon.

Q11-13. The stock dividend transfers capital from retained earnings to contributed capital. For a small stock dividend, this transfer is recorded at the market price of the shares at the time of the dividend. For a large stock dividend, the transfer is made at the par value of the stock.

Q11-14. Many companies repurchase shares (as Treasury Stock) in order to offset the dilutive effects of exercised stock options which increase the number of outstanding shares. This repurchase results in a cash outflow, and has been used by those arguing for the expensing of employee stock options as evidence of the cash effect of these options and linkage to the payment of wages.

Q11-15. The statement of stockholders' equity analyzes and reconciles changes in all major components of stockholders' equity for an accounting period. The statement begins with the beginning balances of those key stockholders' equity components, reports the items causing changes in these components, and ends with the period-end balances.

Q11-16. Other Comprehensive Income (OCI) represents changes in stockholders’ equity that are caused by factors other than profit (loss) and the sale (repurchase) of equity securities. Some examples include unrealized gains (losses) on available-for-sale securities, foreign currency translation adjustments (current-rate method only), unrealized gains (losses) on derivatives, and minimum pension liability adjustments.

Q11-17. A stock option vesting period is a period of time after the grant date that an employee must wait before exercising stock options. For example, a company may grant five-year options that vest in three years. An employee would then be able to exercise the options in Years 4 or 5, but not before. Typically, the vesting period requires that the employee remains employed at the company until the options vest; otherwise he/she forfeits the options.

Q11-18. When a convertible bond is converted, both the face amount and any associated unamortized premium or discount is removed from the balance sheet. The stock is, then, issued considering the “purchase price” to be the book value (face amount ± an unamortized premium or discount) of the bond. This purchase price is, then, allocated to common stock and additional paid-in capital. No gain or loss is reported upon the conversion.



MINI EXERCISES

M11-19 (10 minutes)

Balance Sheet Income Statement

Transaction Cash Asset

+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital

Revenues - Expenses = Net

Income Issue 8,000 shares of

$50 par value preferred stock at $68 cash per share.

+544,000 Cash

=

+400,00 Preferred Stock

+144,000

Additional Paid-in

Capital

-

=

Issue 12,000 shares of $1 par value common stock at $10 cash per share.

+120,000 Cash

=

+12,000 Common Stock

+108,000

Additional Paid-in

Capital

-

=

M11-20 (15 minutes) a. 9/1 Cash (+A) ................................................................................... 864,000 Preferred stock (+SE) ................................................................ 180,000 Additional paid-in capital (+SE) ................................................. 684,000 9/1 Cash (+A) ................................................................................... 4,440,000 Common stock (+SE) ................................................................ 240,000 Additional paid-in capital (+SE) ................................................. 4,200,000 b.

+ Cash (A) - - Preferred Stock (SE) +

9/1 864,000 180,000 9/1 9/1 4,440,000

- Common Stock (SE) + - Additional Paid-in Capital (SE) +

240,000 9/1 684,000 9/1 4,200,000 9/1

c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Issue 18,000

shares of $10 par value preferred stock at $48 per share.

+864,000 Cash

=


+684,000

Additional Paid-in

Capital

-

=

Issue 120,000 shares of $2 par value common. +4,440,000

Cash

=


+4,200,000

Additional Paid-in

Capital

-

=



M11-21 (10 minutes) Common stock ..................................... $ 6.1a Additional paid in capital ..................... 33,498.9 Total ....................................................... $33,505.0

a 6,100 million shares issued $0.001 par value, rounded. M11-22 (15 minutes) a. 1/1 Cash (+A) .................................................................................. 1,250,000 Preferred stock (+SE) ................................................................ 500,000 Additional paid-in capital (+SE) ................................................. 750,000 3/1 Treasury stock (+XSE, -SE) ....................................................... 415,000 Cash (-A) ................................................................................... 415,000 b.


1/1 1,250,000 500,000 1/1 415,000 3/1

+ Treasury Stock (XSE) - - Additional Paid-in Capital (SE) +

3/1 415,000 750,000 1/1

c.



+

Noncash Assets = Liabilities +

Contributed Capital

+ Earned Capital

- Contra Equity

Revenues - Expenses = Net Income

Issue 5,000 shares of $100 par value preferred stock at $250 per share.

+1,250,000 Cash

=


+750,000

Additional Paid-in

Capital

-

-

=

Repurchase 5,000 shares of $1 par value common stock at $83 per share.

-415,000 Cash

=

- +415,000 Treasury

Stock

-

=



M11-23 (10 minutes) A stock split does not result in an accounting transaction and, as a result, does not require an entry into the accounting records. The number of outstanding shares must be changed in the parenthetical note to the common and preferred stock accounts in the stockholders’ equity section of the balance sheet, and the par value of the stock must also be adjusted. In the three-for-one stock split affected by Cigna, each shareholder receives two additional shares for each share owned, thus tripling the outstanding shares, and the par value of the shares is reduced to one-third. The dollar amount of total paid-in capital, thus, remains unchanged, as does the total dollar amount of stockholders’ equity. Only the parenthetical note relating to the number of outstanding shares and their par value is adjusted for all periods presented. Earnings per share is also recomputed for all years presented in the income statement to reflect the additional shares outstanding. M11-24 (15 minutes) a. Basic EPS: [$501,000 – (16,000 x $2)] / 134,000 = $3.50

Calculation of weighted average shares outstanding: 120,000 x 2/12 = 20,000 130,000 x 5/12 = 54,167 146,000 x 3/12 = 36,500 140,000 x 2/12 = 23,333

134,000 b. Diluted EPS: $501,000 / 150,000 = $3.34 c. Given a simple capital structure, only basic EPS need be reported.

M11-25 (10 minutes) a. Treasury shares are deducted from issued shares to yield outstanding shares.

The issued shares are, therefore:

Shares Outstanding + 15,664,385 = 103,300,000. Thus shares outstanding = 87,635,615.

b. If the stock repurchase took place on March 31, 2008, two months after the

end of the previous fiscal year, the denominator of the basic EPS calculation would decrease by 15,664,385 x 10/12. That is, the weighted average shares outstanding would be 103,300,000 – [15,664,385 x (10/12)] = 90,246,346 shares.



M11-26 (15 minutes) a. Preferred dividend:

12/31 Retained earnings (-SE) ............................................................. 18,000 Cash (-A) ................................................................................... 18,000

Common dividend:

12/31 Retained earnings (-SE) ............................................................. 88,000 Cash (-A) ................................................................................... 88,000 b.

+ Cash (A) - - Retained earnings (SE) +

18,000 12/31 12/31 18,000 88,000 12/31 12/31 88,000

c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income

Declared and paid cash dividend on preferred stock.

-18,000 Cash

=

-18,000 Retained Earnings

-

=

Declared and paid cash dividend on common stock.

-88,000 Cash

=


-

=

M11-27 (15 minutes) Because this is a small stock dividend (4%), retained earnings is debited for the market value of the stock (70,000 x 4% x $21). a. 1/1 Retained earnings (-SE) ............................................................. 58,800 Common stock (+SE) ................................................................ 14,000 Additional paid-in capital (+SE) ................................................. 44,800 b.

- Retained Earnings (SE) + - Common Stock (SE) +

12/31 58,800 14,000 12/31

- Additional Paid-in Capital (SE) +

44,800 12/31



c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Declaration and

payment of stock dividend.

=


+44,800 Additional

Paid-in Capital


-

=

M11-28 (10 minutes) a. Immediately after the 3-for-2 stock split, the company has 375,000 shares of

$10 par value common stock [250,000 shares (3/2) = 375,000 shares] issued and outstanding.

b. The dollar balance in the Common Stock account is unchanged by the stock split; the balance remains at $3,750,000 (375,000 shares at the new $10 par value per share).

c. The usual reason for a corporation to split its stock is to reduce the per share market price of the stock and, therefore, improve the stock's marketability. The market price of the common stock prior to the split is $165 per share, which is somewhat high. Splitting the stock would reduce the per-share price (though not the total market value).

M11-29 (15 minutes)

Distribution to Preferred Common

a. $1,000,000 6% ...................................................... $60,000 Balance to common ............................................... $100,000 Per share $60,000/20,000 shares ................................ $3.00 $100,000/80,000 shares .............................. $1.25

b. $1,000,000 6% 2 years ..................................... $120,000 Balance to common ............................................... $40,000 Per share $120,000/20,000 shares .............................. $6.00

$40,000/80,000 shares ................................ $0.50



M11-30 (10 minutes)

BAMBER COMPANY STATEMENT OF RETAINED EARNINGS

FOR YEAR ENDED DECEMBER 31, 2011

Retained earnings, December 31, 2010 ................................................ $347,000

Add: Net income ...................................................................................... 94,000

441,000

Less: Cash dividends declared .............................................. $35,000

Stock dividends declared ............................................. 28,000 63,000

Retained earnings, December 31, 2011 ................................................ $378,000

M11-31 (10 minutes)

a. No entry is made when the dividend is declared; an entry is required only when the additional stock is issued. Because this is a large stock dividend, the dividend is recorded at par value:

Retained earnings (-SE) ............................................................ 400,000 Common stock (+SE) ................................................................ 400,000 b. The stock split would reduce the par value, but no journal entry would be

recorded. As a consequence, neither the common stock nor the retained earnings accounts are affected.

M11-32 (10 minutes)

a. Basic EPS: [$440,000 – (10,000 x $50 x 8%)] / 50,000 = $8.00 per share b. Diluted EPS: $440,000 / (50,000 + 10,000x3) = $5.50 per share



M11-33 (15 minutes) a. Basic EPS: $234,000 / 45,000 = $5.20

Calculation of weighted average shares outstanding: 38,000 x 4/12 = 12,667 48,000 x 4/12 = 16,000 49,000 x 4/12 = 16,333

45,000 b. Basic EPS: [$234,000 – (6,000 x $50 x 6%)] / 45,000 = $4.80 M11-34 (15 minutes) a. Basic earnings per share is computed as net income less any preferred

dividends divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share includes dilutive securities (such as convertible securities or employee stock options) in the denominator (and also adjusting for any numerator impacts). Consequently, diluted earnings per share is always less than or equal to basic earnings per share.

b. In the case of 3M, it has 699.2 million weighted average common shares

outstanding, and an additional 8.0 million weighted average common shares that could potentially be issued (dilutive). These dilutive shares relate to employee stock options and convertible securities, like convertible debt and convertible preferred stock that potentially could be converted into common shares. (Note: With 699.2 million shares and a basic EPS of $4.95, the implied

earnings number is $3,461.04 million, computed as 699.2 million $4.95. For diluted EPS, 707.2 million times $4.89 implies earnings of $3,458.21 million, a difference of $2.84 million. This difference is likely due to the interest/dividends on convertible securities.)

c. While diluted EPS are favored over BEPS by analysts, the data reflect events

that have not and may never occur. In addition, the additions are assumed to be made at the year’s start.



M11-35 (15 minutes) a. Merck included the table to show the comparison of net income in 2006 with

the net income that would have been reported in 2004 and 2005 if the newly required fair value method had been used in those previous years. The words “pro forma” in the last line of the table are the words used to indicate that the data given is meant to allow comparisons with currently reported numbers of the results in prior years computed using current GAAP.

b. The new reporting method would have had the following effects: Cash: No effect Net income: Reduced by $325.9 ($357.1-$31.2) or 7% in 2005 and by $475.1

($491.8-$16.7) or 8% in 2004. c. The accounting change would have caused EPS measures to decline because

lower net income would have been reported. There would have been no change in the denominator of the basic or diluted EPS numbers.

M11-36 (10 minutes)

Year Total

Assets Total

Liabilities

Total Stockholders’

Equity EPS

Operating Income

1 ….. Increase No effect Increase Decrease No effect

2 ….. Decrease No effect Decrease Increase No effect

3 ….. No effect Increase Decrease No effect No effect

M11-37 (15 minutes) a. $30 = $18,000,000/600,000 b. $10. $6,000,000 = 600,000(10) c. $12,000,000 = $18,000,000 - $6,000,000 d. $4,000,000 = $5,000,000 – $1,000,000 e. 50,000 shares = 600,000 – 550,000 f. $8.70 = $5,000,000 ÷ (600,000 + 550,000)/2. 600,000 shares were outstanding for

the first half year but only 550,000 during the second half of the year.



M11-38 (10 minutes) a. The DPS calculation is made to reflect a worst-case scenario (conservative)

EPS figure.

b. $0.34

c. The assumed debt conversation would add the number of common shares that would be then issued for the debt to the denominator of the DEPS calculation. The calculation would not be made if the final result caused an increase in DEPS.

d. One reason, other than the reason discussed in part b above is that the if the bonds are treated as if converted, then the interest on those bonds (net of the tax deduction effect), which would no longer be due holders would need to be added back to the numerator. This interest reduced net income, the basis of the numerator.



EXERCISES E11-39 (15 minutes)

a. 2/20 Cash (+A) ................................................................................... 250,000 Common stock (+SE) ................................................................. 10,000 Additional paid-in capital (+SE) ................................................. 240,000

2/21 Cash (+A) .................................................................................. 4,125,000 Preferred stock (+SE) ................................................................. 1,500,000 Additional paid-in capital (+SE) ................................................. 2,625,000

6/30 Treasury stock (+XSE, -SE) ....................................................... 30,000 Cash (-A) .................................................................................... 30,000

9/25 Cash (+A) .................................................................................. 21,000 Treasury stock (-XSE, +SE) ....................................................... 15,000 Additional paid-in capital (+SE) ................................................. 6,000

b. + Cash (A) - - Preferred Stock (SE) +

2/20 250,000 1,500,000 2/21 2/21 4,125,000

30,000 6/30 - Common Stock (SE) +

9/25 21,000 10,000 2/20


6/30 30,000 240,000 2/20 15,000 9/25 2,625,000 2/21 6,000 9/25

c. Balance Sheet Income Statement


+ Noncash Assets = Liabilities +

Contributed Capital

+ Earned Capital

- Contra Equity

Revenues - Expense

s =

Net Income

Issue 10,000 shares of $1 par value common stock.

+250,000 Cash

=

+10,000 Common

Stock

+240,000 Add’l Paid-in

Capital

-

-

=

Issued 15,000 shares of $100 par preferred stock.

+4,125,000 Cash

=

+1,500,000 Preferred

Stock

+2,625,000 Add’l Paid-in

Capital

-

-

=

Purchased treasury stock. -30,000

Cash

=

- +30,000 Treasury

Stock

-

=

Sold 1,000 shares of treasury stock.

+21,000 Cash

=

+6,000

Add’l Paid-in Capital

- -15,000 Treasury

Stock

-

=



E11-40 (20 minutes)

a. 1/15 Cash (+A) ................................................................................... 425,000 Common stock (+SE) ................................................................. 125,000 Additional paid-in capital (+SE) ................................................. 300,000

1/20 Cash (+A) ................................................................................... 468,000 Preferred stock (+SE) ................................................................ 300,000 Additional paid-in capital (+SE) ................................................. 168,000

3/31 Treasury stock (+XSE, -SE) ....................................................... 60,000 Cash (-A) ................................................................................... 60,000

6/25 Cash (+A) .................................................................................. 52,000 Treasury stock (-XSE, +SE) ....................................................... 40,000 Additional paid-in capital (+SE) ................................................. 12,000 7/15 Cash (+A) .................................................................................. 19,000 Additional paid-in capital (+SE) ................................................. 1,000 Treasury stock (-XSE, +SE) ....................................................... 20,000 b.


1/15 425,000 300,000 1/20 1/20 468,000

60,000 3/31 - Common Stock (SE) +

6/25 52,000 125,000 1/15 7/15 19,000


3/31 60,000 300,000 1/15 40,000 6/25 168,000 1/20 20,000 7/15 12,000 6/25 7/15 1,000





+


Contributed Capital

+ Earned Capital

- Contra Equity

Revenues - Expenses = Net Income

Issue 25,000 shares of $5 par common stock.

+425,000 Cash

=

+125,000 Common

Stock

+300,000 Add. Paid-in

Capital

-

-

=

Issued 6,000 shares of $50 par preferred stock.

+468,000 Cash

=

+300,000 Preferred

Stock


Capital

-

-

=

Repurchased 3,000 shares of treasury stock.

-60,000 Cash

=

- +60,000 Treasury

Stock

-

=


+52,000 Cash

=


Capital

-

-40,000 Treasury

Stock

-

=


+19,000 Cash

=

-1,000 Add. Paid-in

Capital

-

-20,000 Treasury

Stock

-

=

E11-41 (20 minutes) a. 103.3 million - 15.0 million = 88.3 million shares outstanding. b. ($1.033 million + $328.488 million) / 103.3 million shares = $3.19 per share. c. $706.198 million / 15.0 million shares = $47.08 per share. d. Treasury stock is subtracted from shares issued to get the number of shares

outstanding. That is, when we compute EPS, common shares outstanding is equal to the shares issued less the number of shares of treasury stock.



E11-42 (20 minutes) a. Dividend Distribution

Preferred

Common

Preferred per Share

Common per Share

2010 Preferred $0 $0.00 Common $0 $0.00

2011 Arrearage on preferred

[7% (20,000 $60)] $84,000 Current year on preferred

[7% (20,000 $60)] 84,000 Remainder to common $15,000 Total distribution $168,000 $15,000 Per share Preferred ($168,000/20,000) $8.40 Common ($15,000/100,000) $0.15

2012 Current year on preferred

[7% (20,000 $60)] $84,000 Remainder to common $116,000 Per share Preferred ($84,000/ 20,000) $4.20 Common ($116,000/100,000) $1.16

b.



[7% (20,000 $60)] $84,000 Per share Preferred ($84,000/20,000) $4.20 Common $0.00


[7% (20,000 $60)] $ 84,000 Partial current year on preferred 66,000 Total distribution $150,000 Per share Preferred ($150,000/20,000) $7.50 Common $0.00



E 10-43 (15 minutes) a. Basic EPS: [$230,000 – (5,000 x $4)] / 30,000 = $7.00

Calculation of weighted average shares outstanding: 25,000 x 4/12 = 8,333 34,000 x 2/12 = 5,667 28,000 x 2/12 = 4,667 34,000 x 4/12 = 11,333

30,000 b. Diluted EPS: $230,000 / [(30,000 + (5,000 x 2)] = $5.75 c. If Nichols Corporation had a simple capital structure, only basic EPS ($7.00)

would be reported. E11-44 (25 minutes) Distribution to

Preferred Common a. Year 1 $ 0 $ 0

Year 2: Arrearage from Year 1

($750,000 8%) $ 60,000 Current year dividend

($750,000 8%) 60,000 Balance to common _______ $160,000 Total for Year 2 $120,000 $160,000

Year 3: Current year dividend

($750,000 8%) $ 60,000 $ 0

b. Year 1 $ 0 $ 0


($750,000 8%) $ 60,000 Balance to common $220,000


($750,000 8%) $ 60,000 $ 0

c. Because the preferred stock is not convertible, Potter Company has a simple

capital structure and would only report basic EPS. Basic EPS would be reduced in years 2 and 3 when the preferred dividends are subtracted from net income in the numerator.



E11-45 (20 minutes)

a. 2,805,961,317 $0.331/3 = $935,320,439 rounded to $935 million

b. ($935 million + $6,350 million) / 2,806 million shares = $2.60 per share

c. 2,805,961,317 shares issued – 744,589,733 shares in treasury = 2,061,371,584 shares outstanding

d. $24,407 million / 744.59 million = $32.78 per share

e. Companies repurchase stock for a variety of reasons:

1. To offset the dilutive effects of shares issued to employees under stock option plans.

2. To mitigate a takeover threat by concentrating the remaining shares in “friendly hands.”

3. To send a signal to the market that the company feels its shares are undervalued.

E11-46 (30 minutes)

a. Dividend Distribution

Preferred

Common

Preferred per Share

Common per Share

2009 Current year on preferred

[6% (18,000 $50)] $54,000 Remainder to common $9,000 Per share Preferred ($54,000/18,000) $3.00 Common ($9,000/90,000) $0.10



[6% (18,000 $50)] $54,000 Current year on preferred

[6% (18,000 $50)] 54,000 Remainder to common $270,000 Total distribution $108,000 $270,000 Per share Preferred ($108,000/18,000) $6.00 Common ($270,000/90,000) $3.00



E11-46—continued b. Dividend Distribution

Preferred

Common

Preferred per Share

Common per Share

2009 Preferred $0 $0.00 Common $0 $0.00 2010 Arrearage on preferred

[6% (18,000 $50)] $ 54,000 Current year on preferred

[6% (18,000 $50)] 54,000 Common $0 Total distribution $108,000 $0 Per share Preferred ($108,000/18,000) $6.00 Common $0.00 2011 Current year on preferred

[6% (18,000 $50)] $54,000 Remainder to common $135,000 Per share Preferred ($54,000/18,000) $3.00 Common ($135,000/90,000) $1.50

E11-47 (15 minutes)

a. 1) Retained earnings (-SE) ............................................................. 47,500 Cash (-A) .................................................................................... 47,500

2) Retained earnings (-SE) ............................................................. 35,000 Common stock (+SE) ................................................................ 10,000 Additional paid-in capital (+SE) ................................................. 25,000 b.

+ Cash (A) - - Common Stock (SE) +

47,500 1) 10,000 2)

- Retained Earnings (SE) + - Additional Paid-in Capital (SE) +

1) 47,500 25,000 2) 2) 35,000



c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Declared and paid cash dividend.

-47,500 Cash

=

-47,5001

Retained Earnings

-

=

Declared and issued stock dividend.

=


+25,000 Add. Paid-in Cap.


-

=

1 $1.90 25,000 = $47,500.

2 Retained Earnings is reduced by the market price of the shares distributed (25,000 shares 4% $35 market value = $35,000). Common Stock is increased by the par value with the balance of the market price reflected in an increase in Additional Paid-in Capital.

E11-48 (20 minutes) a. 5/12 Retained earnings (-SE) ............................................................. 100,800 Common stock (+SE) ................................................................ 56,000 Additional paid-in capital (+SE) ................................................. 44,800 12/31 Retained earnings (-SE) ............................................................. 64,200 Cash (-A) ................................................................................... 64,200 b.


64,200 12/31 56,000 5/12


5/12 100,800 44,800 5/12 12/31 64,200

c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Declared and paid stock dividend.

=


+44,800 Add. Paid-in Cap

-100,8001

Retained Earnings

-

=

Declared and issued cash dividend.

-64,200 Cash

=

-64,2002

Retained Earnings

-

=

1 The 7% dividend is a small stock dividend and, accordingly, Retained Earnings is reduced by the

market value of the shares distributed (7% 80,000 shares $18 = $100,800). Common Stock is increased by the par value of the shares ($56,000) and Additional Paid-in Capital in increased by the remainder ($44,800).

2 Retained Earnings is reduced by $0.75 per share on 85,600 shares outstanding and Cash is decreased by the payment.



d.

PALEPU COMPANY STATEMENT OF RETAINED EARNINGS


Retained earnings, December 31, 2010 $305,000

Add: Net income 283,000

588,000

Less: Cash dividends declared $ 64,200

Stock dividends declared 100,800 165,000


E11-49 (20 minutes) a. 4/1 Retained earnings (-SE) ............................................................. 250,000 Common stock (+SE) ................................................................ 250,000 12/7 Retained earnings (-SE) ............................................................. 42,000 Common stock (+SE) ................................................................ 15,000 Additional paid-in capital (+SE) ................................................. 27,000 12/20 Retained earnings (-SE) ............................................................. 102,400 Cash (-A) .................................................................................... 102,400 b.


102,400 12/20 250,000 4/1 15,000 12/7


4/1 250,000 27,000 12/7 12/7 42,000

12/20 102,400



c.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Declared and paid 100% stock dividend.

=

+250,000

Common Stock

-250,0001

Retained Earnings

-

=

Declared and paid 3% stock dividend.



-42,0002

Retained Earnings

Declared and issued cash dividend.

-102,400 Cash

=

-102,4003

Retained Earnings

-

=

1 The large stock dividend is reflected as a reduction of Retained Earnings at the par value of the

shares distributed (50,000 shares 100% $5 par value per share = $250,000). Common Stock is increased by the same amount.

2 This is a small stock dividend. As a result, Retained Earnings is decreased by the market value of

the shares to be distributed (3% 100,000 shares $14 per share = $42,000). Common Stock is

increased by the par value of the shares distributed (3% 100,000 $5 = $15,000) and Additional Paid-in Capital is increased by the balance ($27,000).

3 Total dividends are 4,000 $5 = $20,000 for the preferred shares and 103,000 $0.80 = $82,400 for the common shares. Retained Earnings and Cash are reduced to reflect the payment.

d.

KINNEY COMPANY STATEMENT OF RETAINED EARNINGS



Add: Net income 253,000

909,000

Less: Cash dividends declared $102,400

Stock dividends declared 292,000 394,400


E11-50 (15 minutes) a. Immediately after the stock split, 800,000 shares (2 x 400,000 shares) of $10 par

value common stock are issued and outstanding.

b. The stock split does not change the Common Stock account balance. The account balance is $8,000,000 just before and immediately after the stock split.

c. The stock split does not change the Paid-in Capital in Excess of Par Value account. The account balance is $3,400,000 just before and immediately after the stock split.

d. The 2-for-1 split will reduce EPS by half. The EPS numbers currently reported in previous years’ income statements would also be reduced by half for comparison purposes.



E11-51 (20 minutes) a. 814,894,624 – 213,367,983 = 601,526,641 shares outstanding. b. “Paid-in amount” is the total paid-in capital, including the amount reflected as

the par value Common Stock and the amount reflected as Additional Paid-in Capital.

c. $11,217 million / 213.367 million = $52.57 per share d. Generally, companies repurchase shares in order to

Offset the dilutive effects of shares issued to employees under stock option plans.

Mitigate a takeover threat if the remaining shares are concentrated in “friendly hands.”

Send a signal to the market that the company feels its shares are undervalued.

e. Repurchasing common stock (buying stock for treasury stock) reduces the

number of shares outstanding and increases basic and diluted EPS. E11-52 (20 minutes)

a. Shares issued Par value = Common Stock amount

2,983,508,675 $0.01 = $29.8 million ($29,835,086.75 rounded)

b. (Common Stock + Other Paid-In Capital)/Shares issued = Average Issue price

($29.8 million + $8,319.1 million) / 2,983,508,675 = $2.80 per share

c. Treasury Stock / Treasury shares = Treasury cost per share

$30,735.5 million / 875,818,333 = $35.09 per treasury share

d. Shares issued – Treasury shares = Shares outstanding

2,983,508,675 – 875,818,333 = 2,107,690,342 shares outstanding



E11-53 (20 minutes) a. No. If the firm had a change in accounting principle or a gain (loss) from an

extraordinary item, there would have been additional lines in their report showing the EPS figures for each of these items separately.

b. $0.03 x 624.7 = $18.7 million gain. All such gains ( and/or losses) are reported

net of tax. c. $1,251 million - $18.7 million = $1,232.3 million. d. The dilution would be due to potentially dilutive securities. In Viacom’s case

these dilutive securities were primarily in-the-money stock options. However the company also had some restricted stock units. The dilution of $0.01 is minimal.

E11-54 (20 minutes)

a. ($13,436 - $192)/ X = $4.49 per share. So X = 2,950 million shares. b. $1.64/$54.77 = 0.0299 or about 3%. This yield is very low and, therefore, not

attractive to investors requiring cash. The dividend yield assumes that that the $1.64 was paid when the stock price was $54.77. If some dividends were paid at other times in the year when the price was some other value we should average these yields to be precise.

c. Two possibilities include convertible preferred stock and options. P & G has

both, with the larger impact due to the dilution that would occur from converting preferred stock.

d. As shown in the problem, (4,007 – 1,090.3) – (4,002 – 969.1) = $116.2 decrease

in shares outstanding. The par value of the stock is $1 so the dollar amounts given for common stock are also the numbers of shares.



PROBLEMS P11-55 (45 minutes) a. 1/10 Cash (+A) ................................................................................... 476,000 Common stock (+SE) ................................................................. 280,000 Additional paid-in capital (+SE) ................................................. 196,000 1/23 Treasury stock (+XSE, -SE) ....................................................... 152,000 Cash (-A) ................................................................................... 152,000 3/14 Cash (+A) .................................................................................. 84,000 Treasury stock (-XSE, +SE) ....................................................... 76,000 Additional paid-in capital (+SE) ................................................. 8,000 7/15 Cash (+A) ................................................................................... 128,000 Preferred stock (+SE) ................................................................ 80,000 Additional paid-in capital (+SE) ................................................. 48,000 11/15 Cash (+A) .................................................................................. 24,000 Treasury stock (-XSE, +SE) ....................................................... 19,000 Additional paid-in capital (+SE) ................................................. 5,000 b.


1/10 476,000 152,000 1/23 280,000 1/10 3/14 84,000 7/15 128,000 - Preferred Stock (SE) +

11/15 24,000 80,000 7/15 + Treasury Stock (XSE) - - Additional Paid-in Capital (SE) +

1/23 152,000 76,000 3/14 196,000 1/10 19,000 11/15 8,000 3/14 48,000 7/15 5,000 11/15



c.



+ Noncash Assets = Liabilities +

Contributed Capital

+ Earned Capital

- Contra Equity


Income

1/10: Issued common stock.1

+476,000 Cash

=

+280,000 Common stock


-

-

=

1/23: Purchased treasury stock.2

-152,000 Cash

=

- +152,000 Treasury

Stock

-

=

3/14: Sold treasury stock.3

+84,000 Cash

=

+8,000

Add. Paid-in Cap

-

-76,000 Treasury

Stock

-

=

7/15: Issued preferred stock.4

+128,000 Cash

=



-

-

=

11/15: Sold treasury stock.5

+24,000

=

+5,000

Add. Paid-in Cap

-

-19,000 Treasury

Stock

-

=

1 Total proceeds of 28,000 $17 = $476,000 are reflected as an increase in Cash. Common Stock is

increased by the par value of the shares issued (28,000 $10 = $280,000) and Additional Paid-in Capital is increased for the balance (196,000).

2 Cash is decreased and Treasury Stock is increased by the purchase price of 8,000 shares $19 = $152,000. The increase in Treasury Stock reduces contributed capital.

3 Cash received is 4,000 shares $21 = $84,000. Treasury Stock is reduced by the original cost of $19 per share and the remainder of $8,000 is reflected as an increase in Additional Paid-in Capital.

4 Cash received is $128,000. The Preferred Stock account is increased by the par value of the

preferred shares issued (3,200 $25 = $80,000) and Additional Paid-in Capital is increased for the balance.

5 Cash received is 1,000 shares $24 = $24,000. Treasury Stock is reduced by its original cost of

1,000 shares $19 = $19,000, thus increasing contributed capital, and Additional Paid-in Capital is increased for the balance ($5,000).

d. 1/10: Decrease basic EPS

1/23: Increase basic EPS

3/14: Decrease basic EPS

7/15: Decrease basic EPS

11/15 Decrease basic EPS

Note: These answers ignore the effect of cash balances on earnings. Each

transaction changed the cash balance. If cash is invested in operations or in securities to earn a return, net earnings would be affected by each transaction.



e.

Stockholders' Equity

Paid-in capital 8% Preferred stock, $25 par value, 50,000 shares authorized; 10,000 shares issued and outstanding $ 250,000 Common stock, $10 par value, 200,000 shares authorized; 78,000 shares issued, of which 3,000 shares are in treasury 780,000 $1,030,000 Additional paid-in capital Paid-in capital in excess of par value—Preferred stock 116,000 Paid-in capital in excess of par value—Common stock 396,000 Paid-in capital from Treasury stock 13,000 525,000 Total paid-in capital 1,555,000 Retained earnings 329,000 1,884,000 Less: Treasury stock (3,000 common shares) at cost 57,000 Total stockholders’ equity $1,827,000



P11-56 (30 minutes) a. 1/12 No entry is required for the 3-for-1 stock split. 9/1 Treasury stock (+XSE, -SE) ....................................................... 100,000 Cash (-A) ................................................................................... 100,000 10/12 Cash (+A) .................................................................................. 18,000 Treasury stock (-XSE, +SE) ....................................................... 15,000 Additional paid-in capital (+SE) ................................................. 3,000 11/21 Cash (+A) .................................................................................. 55,000 Common stock (+SE) ................................................................ 25,000 Additional paid-in capital (+SE) ................................................. 30,000 12/28 Cash (+A) .................................................................................. 10,800 Additional paid-in capital (-SE) .................................................. 1,200 Treasury stock (-XSE, +SE) ....................................................... 12,000 b.


10/12 18,000 100,000 9/1 25,000 11/21 11/21 55,000 12/28 10,800


9/1 100,000 15,000 10/12 12/28 1,200 3,000 10/12 12,000 12/28 30,000 11/21

c.



+


Contributed Capital

+ Earned Capital

- Contra Equity


Income

Purchased 10,000 shares of treasury stock for cash.

-100,000 Cash

=

- +100,0001

Treasury Stock

-

=


+18,000 Cash

=

+3,000 Add. Paid-in

Cap

- -15,0002 Treasury

Stock

-

=

Issued 5,000 shares of common stock.

+55,000 Cash

=



Cap

-

-

=


+10,800 Cash

=

-1,200

Add. Paid-in Cap

-

-12,0004 Treasury

Stock

-

=



Notes:

1 The stock is acquired for 10,000 shares $10 = $100,000. This is reflected as a reduction in Cash and a corresponding increase in the Treasury Stock account, a contra-equity account which reduces contributed capital.

2 Cash received is 1,500 shares $12 per shares = $18,000. Treasury Stock is reduced by its original cost of $10 per share and the balance ($3,000) is reflected as an increase in Additional Paid-in Capital.

3 Cash received is 5,000 shares $11 per share. Common Stock is increased by the par value of

the shares issued (5,000 $5 = $25,000) and Additional Paid-in Capital is increased by the balance ($30,000).

4 Cash received is 1,200 shares $9 = $10,800. Treasury Stock is reduced by the original cost of

the shares (1,200 shares $10 = $12,000) and Additional Paid-in Capital is reduced by the balance ($10,800 - $12,000 = -$1,200).

d. 1/12: stock split – decrease basic EPS 9/1: purchase treasury stock – increase basic EPS 10/12: sold treasury stock – decrease basic EPS 11/21: issued common stock – decrease basic EPS 12/28: sold treasury stock – decrease basic EPS e.


Paid-in capital

7% Preferred stock, $100 par value, 20,000 shares authorized; 5,000 shares issued and outstanding $500,000 Common stock, $5 par value, 300,000 shares authorized; 125,000 shares issued, of which 7,300 shares are in the treasury 625,000 $1,125,000 Additional paid-in capital Paid-in capital in excess of par value—Preferred stock 24,000 Paid-in capital in excess of par value—Common stock 390,000 Paid-in capital from treasury stock 1,800 415,800 Total paid-in capital 1,540,800

Retained earnings 408,000 1,948,800

Less: Treasury stock (7,300 common shares) at cost 73,000

Total stockholders' equity $1,875,800



P11-57 (45 minutes) a. 1/51 Cash (+A) ................................................................................... 120,000 Common stock (+SE) ................................................................ 50,000 Additional paid-in capital (+SE) ................................................. 70,000 1/182 Treasury stock (+XSE, -SE) ....................................................... 56,000 Cash (-A) ................................................................................... 56,000 3/123 Cash (+A) ................................................................................... 17,000 Treasury stock (-XSE, +SE) ....................................................... 14,000 Additional paid-in capital (+SE) ................................................. 3,000 7/174 Cash (+A) .................................................................................. 6,500 Additional paid-in capital (-SE) .................................................. 500 Treasury stock (-XSE, +SE) ....................................................... 7,000 10/15 Cash (+A) ................................................................................... 175,000 Preferred stock (+SE) ................................................................ 125,000 Additional paid-in capital (+SE) ................................................. 50,000 1 Cash is increased by the proceeds from the stock sale (10,000 shares $12 = $120,000).

Common Stock is increased by the par value (10,000 shares $5) and Additional Paid-in Capital for the balance ($70,000).

2 Cash is reduced by the cost of the Treasury Stock (4,000 shares $14 = $56,000). The Treasury Stock account is increased accordingly. Since this account has a negative balance in stockholders’ equity, contributed capital is reduced.

3 Cash is increased by the proceeds from the sale of the Treasury Stock (1,000 shares $17 =

$17,000). The Treasury Stock account is reduced by the original cost of the shares (1,000 $14 = $14,000) and Additional Paid-in Capital is increased for the balance.

4 Cash is increased by the proceeds from the sale of the Treasury Stock (500 shares $13 =

$6,500). Treasury Stock is reduced by its original cost (500 shares $14 = $7,000) and Additional Paid-in Capital is reduced for the balance.

5 Cash is increased by the proceeds from the sale of the Preferred Stock (5,000 shares $35 per

share = $175,000). Preferred Stock is increased by its par value (5,000 shares $25 = $125,000) and Additional Paid-in Capital is increased for the balance ($50,000).

b.


1/5 120,000 56,000 1/18 50,000 1/5 3/12 17,000 7/17 6,500 - Preferred Stock (SE) +

10/1 175,000 125,000 10/1 + Treasury Stock (XSE) - - Additional Paid-in Capital (SE) +

1/18 56,000 14,000 3/12 70,000 1/5 7,000 7/17 7/17 500 3,000 3/12 50,000 10/1





+

Noncash Assets = Liabilities + Contributed Capital +

Earned Capital

- Contra Equity


Income


+120,000 Cash

=



-

-

=

Purchased 4,000 shares of treasury stock.

-56,000 Cash

=

- +56,000 Treasury

Stock

-

=


+17,000 Cash

=


- -14,000 Treasury

Stock

-

=

Sold 500 shares of treasury stock.

+6,500 Cash

=

-500

Add. Paid-in Cap

-

-7,000

Treasury Stock

-

=

Issued 5,000 shares of preferred stock.

+175,000 Cash

=



-

-

=

d.


Paid-in capital 8% Preferred stock, $25 par value, 50,000 shares authorized, 5,000 shares issued and outstanding $125,000 Common stock, $5 par value, 350,000 shares authorized; 160,000 shares issued; 2,500 shares in treasury 800,000 $ 925,000 Additional paid-in capital Paid-in capital in excess of par value—Preferred stock 50,000 Paid-in capital in excess of par value—Common stock 670,000 Paid-in capital from Treasury stock 2,500 722,500 Total paid-in capital 1,647,500

Retained earnings 418,500 2,066,000

Less: Treasury stock (2,500 shares) at cost 35,000

Total stockholders' equity $2,031,000

e. The transactions on January 5 (stock issue), March 12 and July 17 (both

treasury stock sales), and the transaction on October 1 (issued preferred stock) would decrease basic EPS. The transaction on January 18 (treasury stock purchase) would increase basic EPS.



P11-58 (30 minutes) a. 1/15 Cash (+A) ................................................................................... 62,000 Preferred stock (+SE) ................................................................ 50,000 Additional paid-in capital (+SE) ................................................. 12,000

Cash is increased by the proceeds from the sale of the Preferred Stock (1,000 shares $62 per

share = $62,000). The Preferred Stock account is increased for its par value (1,000 shares $50 par = $50,000) and Additional Paid-in Capital is increased for the balance ($12,000).

1/20 Cash (+A) ................................................................................... 144,000 Common stock (+SE) ................................................................ 80,000 Additional paid-in capital (+SE) ................................................. 64,000

Cash is increased by the proceeds from the sale of the Common Stock (4,000 shares $36 =

$144,000). Common Stock is increased by its par value (4,000 $20 = $80,000) and Additional Paid-in Capital is increased for the remainder ($64,000).

5/18 No entry is required for the 2-for-1 stock split

6/1 Cash (+A) .................................................................................. 60,000 Common stock (+SE) ................................................................ 20,000 Additional paid-in capital (+SE) ................................................ 40,000

Common Stock is increased by its par value (2,000 $10 = $20,000) and Additional Paid-in Capital is increased for the balance ($40,000).

9/1 Treasury stock (+XSE, -SE) ....................................................... 45,000 Cash (-A) ................................................................................... 45,000

Cash is reduced by the cost of the Treasury Stock (2,500 shares $18 per share = $45,000). The Treasury Stock account is increased by its cost, thereby reducing contributed capital.

10/12 Cash (+A) .................................................................................. 18,900 Treasury stock (-XSE, +SE) ....................................................... 16,200 Additional paid-in capital (+SE) ................................................. 2,700

Cash is increased by the proceeds from the sale of the Treasury Stock (900 $21 = $18,900). The

Treasury Stock account is reduced by its cost (900 $18 = $16,200), thereby increasing contributed capital, and Additional Paid-in Capital is increased by the balance ($2,700).

12/22 Cash (+A) .................................................................................. 29,500 Preferred stock (+SE) ................................................................ 25,000 Additional paid-in capital (+SE) ................................................. 4,500

Cash is increased by the proceeds from the sale of the preferred shares (500 $59 = $29,500). The

Preferred Stock account is increased for its par value (500 shares $50 = $25,000) and Additional Paid-in Capital is increased for the balance ($4,500).



b. + Cash (A) - - Common Stock (SE) +

1/15 62,000 80,000 1/20 1/20 144,000 20,000 6/1 6/1 60,000

45,000 9/1 - Preferred Stock (SE) +

10/12 18,900 50,000 1/15 12/22 29,500 25,000 12/22


9/1 45,000 12,000 1/15 16,200 10/12 64,000 1/20 40,000 6/1 2,700 10/12 4,500 12/22

c.



+

Noncash Assets = Liabilities + Contributed Capital +

Earned Capital

- Contra Equity


Income

Issued 1,000 shares of preferred stock.

+62,000

=



-

-

=


+144,000 Cash

=



-

-

=


+60,000 Cash

=



-

-

=

Purchased 2,500 shares of treasury stock.

-45,000 Cash

=

- +45,000 Treasury

Stock

-

=

Sold 900 shares of treasury stock.

+18,900 Cash

=

+2,700

Add. Paid-in Cap -

-16,200 Treasury

Stock

-

=

Issued 500 shares of preferred stock.

+29,500 Cash

=



-

-

=



P11-59 (50 minutes)

a. We cannot tell how many shares of preferred stock were issued because the $1,324 million value for preferred stock includes additional paid-in capital. This fact can be discerned by noting that 600 million of class A preferred shares are authorized and if all 600 million shares were issued, the stated value of $1 per share would yield $600 million of preferred stock. But if the $1,324 million is assumed to be the stated value, the number of issued shares exceeds the number authorized. Therefore, the $1,324 million figure must include additional paid-in capital of at least $806 million.

b. Convertible means the holder of the security has an option to convert (exchange) the security into another security. In the case of P&G Class A preferred, the holder can convert the preferred shares into common shares.

c. 4,007.3 million common shares per equity section $1 stated value per share = $4,007 million (rounded).

d. (Common stock + Add. paid-in capital)/Shares issued = Average issue price

($4,007 million + $61,118 million) / 4,007.3 million shares = $16.25

e. Accumulated Other Comprehensive Income consists of items that affect stockholders’ equity but do not flow through income and into retained earnings. Examples are unrealized gains and losses on available-for-sale securities and gains and losses from foreign currency translations.

f. Included in the $6,332 million is net income ($13,436 million), financial statement (foreign currency) translation adjustments ($6,151 million), net gain on hedging activities ($748 million), and defined retirement plan losses ($1,701 million).

Net income is closed to retained earnings. All other comprehensive income items are added to (subtracted from) accumulated other comprehensive income.

g. Common dividends of $4,852 million and preferred dividends of $192 million were paid in 2009.

h. It is called the Statement of Recognized Income and Expense (SoRIE). It includes all changes to equity except the effect of transactions with owners (e.g., dividends).



P11-60 (50 minutes)

a. The $2.67 is the amount of dividend per year on each share of preferred stock.

b. 234.9 million shares issued $3.125 par value = $734.0 million (rounded).

c. (Common stock + Add. paid-in capital)/Shares issued = Average issue price

($734.0 million + $716.4 million) / 234.9 million shares = $6.17

d. The Accumulated Other Comprehensive Income (or Loss) account typically consists of unrealized accumulated gains and losses from available-for-sale securities, cumulative foreign currency translation adjustments, pension liability adjustments, and unrealized gains and losses from some hedging activities.

Fortune Brands reports cumulative foreign exchange translation adjustments and the pension liability adjustments as part of its other comprehensive income adjustments for 2008.

e. $39.37 = $3,337.7 million / 84.775617 million = $39.37.

Cash dividend payments reduce stockholders’ equity (via retained earnings); they also reduce the cash asset account.



CASES C11-61 (30 minutes)

a. Mandatorily redeemable means that the issuing company can decide to repurchase all of the remaining shares that have not been converted before the redemption date specified in the preferred issue contract. Prior to that date, holders of the preferred shares can convert their shares to common stock. Northrop Grumman preferred holders converted most of their shares and the rest were redeemed by the company. “Convertible” means that the preferred stock can be exchanged for common stock. Usually this option rests with the holder of the preferred stock. Sometimes, companies retain an option to force the conversion. Northrop Grumman did so. This option is spelled out in the preferred stock contract. The issue may also include a “liquidation preference”, which would indicate the amount that will be paid to the preferred shareholders in the event that the company fails. This amount must be paid in full before the common shareholders can be paid anything in the event of the liquidation of the company.

b. $350 million/$3.5 million = $100

c. The conversion option has increased substantially in value since issue. This increase is likely due to an expected new government contract most likely for aircraft.

d. The answer depends on whether the remaining preferred shares are redeemed for cash or converted into common shares. If Northrop Grumman pays for the conversion in cash, cash is reduced, as is preferred stock. If converted into common, the preferred stock is removed from the balance sheet and the common stock is “sold” for the book value of the preferred; that is, the par value and additional paid-in capital accounts increase as if the common were sold for the book value of the preferred.

e. Outstanding convertible preferred shares need to be considered in our analysis of the company, as the potential shares to be issued represent a contingent claim to the future cash flows of the company. Convertible preferred shares are considered in the computation of diluted EPS, which assumes conversion at the earliest possible opportunity. The forgone preferred dividends are removed from (added back to) the numerator, and the additional shares issued are added to the denominator. The net effect is a reduction in the diluted EPS over basic EPS.



C11-62 (15 minutes)

King’s responsibility is to the shareholders of Image, Inc. Hatcher’s offer is beneficial to the shareholders, so, in theory, King should support Hatcher’s efforts. However, since it is likely that King and other managers will lose their jobs if Hatcher’s takeover attempt is successful, King’s inclination may be to resist Hatcher’s move.

It would be unethical to pay Hatcher 50% above current market price to repurchase his stock. This would harm the remaining shareholders in two ways. First, blocking the takeover would deprive shareholders of the opportunity to sell their shares at a price that is substantially higher than current market price. Second, King would be using company funds to purchase Hatcher’s stock, so the other shareholders are essentially paying for King’s job security.

A tactic that would be ethical and beneficial to shareholders is for King, along with other managers and directors, to make a competing offer to shareholders for the outstanding stock. In that way, shareholders benefit by receiving the higher stock price (whether from King or Hatcher) and if King acquires the company, he keeps his job.

C11-63 (30 minutes)

a. There are no cash proceeds from the stock dividend.

b. 2010: $9,450,000 / 250,000 = $37.80 per share

2011: $10,285,000 / 275,000 = $37.40 per share

c. Because of the stock dividend, the number of shares you own increased by 10% to 8,250 in 2011. Your percentage ownership in Pillar has remained the same. The market value of your shares at the end of 2011 is $214,500 (8,250 x $26). At December 14, just prior to the stock dividend, your shares were worth $210,000 (7,500 x $28).

d. Stock dividends, like stock splits, do not increase the book value of stockholders’ equity. Stock dividends are paid to indicate a continued expectation of earnings and earnings growth in periods when cash must be maintained for investment needs. Stock dividends also serve to keep the per share price of the stock at manageable levels during growth periods.

e. Retained earnings are restricted as to the amount of cash dividends that Pillar can pay. Except for this restriction, paying a cash dividend then allowing shareholders to purchase additional shares would have accomplished the same thing as a stock dividend. However, some of the shareholders may have chosen not to purchase the additional shares. If this had happened, the company would have to make a public offering in order to raise the required cash. A public offer that is this small is not economical.

f. The dividend cut is due to the restrictions on retained earnings and the amount of cash needed to fund the plant addition.

g. Retained earnings are not the same as cash. The company is borrowing $500,000 cash because that is how much additional cash will be needed to build the plant addition. The restriction on retained earnings simply prevents the company from using available cash to pay cash dividends.



C11-64 (20 minutes)

The projected 5% decline in net income will reduce net income from $7,800,000 last year to $7,410,000 this year. The proposed stock buyback of 600,000 shares at midyear would reduce the weighted average shares outstanding from 4,000,000 to 3,700,000 (4,000,000 x 6/12 + 3,400,000 x 6/12). The resulting earnings per share would be $7,410,000 / 3,700,000 = $2.00 per share.

Plummer is likely concerned about the proposal because the stock repurchase appears to manipulate EPS in order to achieve the goal of increasing EPS each year, earning management a nice bonus. This raises ethical concerns, since the cash might be better used to make profitable investments or pay a cash dividend to shareholders.

A less obvious question is why Sunlight has so much “excess cash?” If the cash that would be used to repurchase stock (600,000 shares x market price per share) were invested in a profitable investment, management may be able to make up for the expected decline in earnings. It would be hard to believe that no profitable investment opportunities exist. Even a short-term investment in marketable securities might make up for the $390,000 decrease in earnings.

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