CHAPTER 11 CORPORATIONS: ORGANIZATION, SHARE TRANSACTIONS, AND...

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1. No. ordinary share with a higher par is not necessarily a better investment than ordinary sharewith a lower par because par is an amount assigned to the shares.

2. The broker is not correct. Corporations are not legally liable to pay dividends until the dividends are declared. If the company that issued the preference share has operating losses,it could omit dividends first on its ordinary share, and later on its preference share.

3. The company may not have had enough cash on hand to pay a dividend on the ordinary shareor resources may be needed for plant expansion, replacement of facilities, payment of liabilities, etc.

4. a. No change.b. Total equity is the same.

5. a. Current liabilityb. Equity

6. a. It has no effect on revenue or expense.b. It reduces equity by $3,000,000.

7. a. It has no effect on revenue.b. It increases equity by $3,750,000.

8. The three classifications of restrictions on retained earnings are legal, contractual, and discretionary. Restrictions are normally reported in the notes to the financial statements.

9. Such prior period adjustments should be reported as an adjustment to the beginning balance of retained earnings.

10. The primary purpose of a stock split is to bring about a reduction in the market price per share and thus to encourage more investors to buy the company’s shares.

CHAPTER 11CORPORATIONS: ORGANIZATION, SHARE

DISCUSSION QUESTIONS

TRANSACTIONS, AND DIVIDENDS

CHAPTER 11 Corporations: Organization, Stock Transactions, and Dividends


11. Fund Sources U.S. GAAP IFRSCommon/Preferred Stock Ordinary/Preference ShareCapital stock—Common/Preferred Share capital—Ordinary/PreferencePaid-in-capital in excess of par or Additional paid-in capital Share premium—Ordinary/Preference

Earned Capitalor Reserves Retained earnings or Reinvested earnings Retained earnings or retained profits or accumulated

profits and lossReserves Accumulated other comprehensive income General reserves and other reserves accounts

12. Not apply. It is the IFRS presentaton.

13. The term “reserves” refers to all equity accounts other than contributed capital.Retained earnings is generally the primary component of a firm’s reserves. Other reserve accounts reflectcomponents of other comprehensive income (e.g. revaluation of assets and certain foreign exchange differences).

14. For share repurchase transactions, IFRS provides only the principle that the cost of treasury shares shouldbe accounted for and presented as a reduction of equity. Other than that, IFRS provides nospecific guidance on the allocation of the purchase cost to individual accounts. Therefore, it is up to companies’decision to debit the cost of the transaction to those accounts such as treasury share, share capitaland premium, retained earnings, reverses, or some combination of the above.

Contributed/Issued/Paid-inCapital



15. (Note: Revised as Ex 11-9)March 4Treasure Shares $2772000 Cash $2772000Buy back company's own shares.August 27Cash $2250000 Teasure Shares $2100000 Capital Surplus 150000Reissue treasure shares.November 11Cash $640,000Capital Surplus 32,000 Treasure Shares $672,000Reissue treasure shares.



Ex. 11–1

a. Total dividend declared………………… $24,000 $81,000 $92,000 $139,000

Preference dividend (current)………… $24,000 $51,000 $54,000 $ 54,000

Preference dividend in arrears………… — 30,000 3,000 —

b. Total preference dividends……………… $24,000 $81,000 $57,000 $ 54,000

Preference shares outstanding………… ÷ 30,000 ÷ 30,000 ÷ 30,000 ÷ 30,000

Preference dividend per share………… $ 0.80 $ 2.70 $ 1.90 $ 1.80

* $51,000 = $81,000 – $30,000

Dividend for ordinary shares(a. – b.)…………………………………… $ — $ — 35,000$ 85,000$

Ordinary shares outstanding…………… ÷ 125,000 ÷ 125,000Ordinary dividend per share…………… 0.28$ 0.68$

EXERCISES

2nd Year 3rd Year 4th Year1st Year

*



Ex. 11–2

a. Feb. 25 Cash (120,000 shares × $40) 4,800,000Share Capital—Ordinary (120,000 shares × $36) 4,320,000Share Premium—Ordinary [120,000 shares × ($40 – $36)] 480,000

June 3 Cash (50,000 shares × $9) 450,000Share Capital—Preference (50,000 shares × $8) 400,000Share Premium—Preference[50,000 shares × ($9 – $8)] 50,000

b. $5,250,000 ($4,800,000 + $450,000)

Ex. 11–3

May 10 Land (3,600 shares × $28) 100,800Share Capital—Ordinary (3,600 shares × $4) 14,400Share Premium—Ordinary[3,600 shares × ($28 – $4)] 86,400



Ex. 11–4

a. Cash 900,000Share Capital—Ordinary (45,000 shares × $20) 900,000

b. Organizational Expenses 8,000Share Capital—Ordinary (400 shares × $20) 8,000

Cash 1,200,000Share Capital—Ordinary (60,000 shares × $20) 1,200,000

c. Land 150,000Building 600,000

Interest Payable* 1,500Mortgage Note Payable 450,000Share Capital—Ordinary (14,925 shares × $20) 298,500

* An acceptable alternative would be to credit Interest Expense.

Ex. 11–5

Oct. 1 Cash (120,000 shares × $31.50) 3,780,000Share Capital—Ordinary (120,000 shares × $30.00) 3,600,000Share Premium—Ordinary[120,000 shares × ($31.50 – $30.00)] 180,000

Oct. 1 Buildings 2,380,000Land 840,000

Share Capital—Preference (35,000 shares × $80) 2,800,000Share Premium—Preference[35,000 shares × ($92 – $80)] 420,000



Ex. 11–6

1 Cash 4,500,000Share Capital—Ordinary (180,000 shares × $25) 4,500,000

1 Organizational Expenses 10,000Share Capital—Ordinary (400 shares × $25) 10,000

9 Land 200,000Buildings 550,000Equipment 135,000

Share Capital—Ordinary (30,000 shares × $25.00) 750,000Share Premium—Ordinary[30,000 shares × ($29.50 – $25.00)] 135,000

13 Cash (8,500 shares × $131) 1,113,500Share Capital—Preference (8,500 shares × $120) 1,020,000Share Premium—Preference[8,500 shares × ($131 – $120)] 93,500

Feb.

Mar.

Apr.



Ex. 11–7

10 Cash Dividends 187,500Cash Dividends Payable 187,500

9 No entry required.

18 Cash Dividends Payable 187,500Cash 187,500

Ex. 11–8

a. (1) Stock Dividends [(300,000 shares × 5%) × $40] 600,000Stock Dividends Distributable (15,000 shares × $18) 270,000Share Premium—Ordinary[15,000 shares × ($40 – $18)] 330,000

(2) Stock Dividends Distributable 270,000Share Capital—Ordinary 270,000

b. (1) $6,900,000 ($5,400,000 + $1,500,000)(2)(3) $84,900,000 ($6,900,000 + $78,000,000)

c. (1) $7,500,000 ($5,400,000 + $1,500,000 + $270,000 + $330,000)(2) $77,400,000 ($78,000,000 – $600,000)(3) $84,900,000 ($7,500,000 + $77,400,000)

$78,000,000

Sept.

July

Aug.



Ex. 11–9

a. 4 Treasury Share (33,000 shares × $84) 2,772,000Cash 2,772,000

27 Cash (25,000 shares × $90) 2,250,000Treasury Share (25,000 shares × $84) 2,100,000Share Premium from Sale of TreasuryShare [25,000 shares × ($90 – $84)] 150,000

11 Cash (8,000 shares × $80) 640,000Share Premium from Sale of TreasuryShare [8,000 shares × ($84 – $80)] 32,000

Treasury Share (8,000 shares × $84) 672,000

b. $118,000 ($150,000 – $32,000) credit

c. Crystal Lake may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or for reissuance to employees as a bonus according to stock purchase agreements.

Ex. 11–10

a. 17 Treasury Share (50,000 shares × $12) 600,000Cash 600,000

29 Cash (31,000 shares × $15) 465,000Treasury Share (31,000 shares × $12) 372,000Share Premium from Sale of TreasuryShare [31,000 shares × ($15 – $12)] 93,000

31 Cash (12,000 shares × $17) 204,000Treasury Share (12,000 shares × $12) 144,000Share Premium from Sale of TreasuryShare [12,000 shares × ($17 – $12)] 60,000

b. $153,000 ($93,000 + $60,000) credit

c. $84,000 (7,000 shares × $12) debit

d. The balance in the treasury share account is reported as a deduction from the total of the paid-in capital and retained earnings.

Feb.

Aug.

July

Mar.

Nov.

Apr.



Ex. 11–11

a. 14 Treasury Share (23,500 shares × $75) 1,762,500Cash 1,762,500

6 Cash (14,000 shares × $81) 1,134,000Treasury Share (14,000 shares × $75) 1,050,000Share Premium from Sale of TreasuryShare [14,000 shares × ($81 – $75)] 84,000

30 Cash (9,500 shares × $72) 684,000Share Premium from Sale of TreasuryShare [9,500 shares × ($75 – $72)] 28,500


b. $55,500 ($84,000 – $28,500) credit

c. Equity section

d. Biscayne Bay Water Inc. may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or for reissuance to employees as a bonus according to stock purchase agreements.

Sept.

Nov.

May



Ex. 11–12

Share capital:Share ordinary—preference, 2%, $120 par

(85,000 shares authorized,70,000 shares issued) $8,400,000

Share capital—ordinary, no par, $14 statedvalue (375,000 shares authorized,320,000 shares issued) 4,480,000

Share premium 735,000Total paid-in capital $13,615,000

Ex. 11–13

Share capital:Share capital—ordinary, $45 par


Excess of issue price over par 272,000 $ 3,332,000From sale of treasury share 115,000

Total paid-in capital $ 3,447,000Retained earnings 20,553,000

Total $24,000,000Deduct treasury share

(9,000 shares at cost) 324,000Total equity $23,676,000

Equity

Equity



Ex. 11–14

Share capital:Share capital—preference, 1%, $150 par

(50,000 shares authorized,48,000 shares issued) $ 7,200,000

Excess of issue price over par 384,000 $ 7,584,000Share capital—ordinary, $36 par


Excess of issue price over par 420,000 10,500,000From sale of treasury share 340,000

Total paid-in capital $18,424,000Retained earnings 71,684,000

Total $90,108,000Deduct treasury share capital—ordinary

(24,000 shares at cost) 1,008,000Total equity $89,100,000

Ex. 11–15

Retained earnings, February 1, 2013 $48,110,000Net profit $9,330,000Less dividends declared 2,400,000Increase in retained earnings 6,930,000Retained earnings, January 31, 2014 $55,040,000

Equity

ATLAS PUMPS CORPORATIONRetained Earnings Statement

For the Year Ended January 31, 2014



Ex. 11–161. Retained earnings is not part of paid-in capital.

2. The cost of treasury share should be deducted from the total equity.

3. Dividends payable should be included as part of current liabilities and not as part of equity.

4. Ordinary share should be included as part of paid-in capital.

5. The amount of shares of ordinary share issued of 825,000 times the par value pershare of $20 should be extended as $16,500,000, not $17,655,000. The difference,$1,155,000, probably represents share premium.

6. Organizing costs should be expensed as Organizational Expenses when incurred andnot included as a part of equity.

One possible corrected Equity section of the statement of financial position using Method 2of Exhibit 4 is as follows:

Share capital:Share capital—preference 2%, $80 par (125,000

shares authorized and issued) $10,000,000Share capital—ordinary, $20 par (1,000,000 shares

authorized, 825,000 shares issued) 16,500,000Share premium 1,655,000

Total paid-in capital $ 28,155,000Retained earnings* 96,400,000

Total $124,555,000Deduct treasury share (75,000 shares at cost) 1,755,000Total equity $122,800,000

* $96,700,000 – $300,000. Since the organizing costs should have been expensed, the retained earningsshould be $300,000 less.

Equity



Ex. 11–17

Share Capital—Ordinary Share Treasury Retained

$40 par Premium Share Earnings

Balance, Jan. 1, 2014 $4,800,000 $ 960,000 — $11,375,000

Issued 30,000 shares of share capital—ordinary 1,200,000 300,000

Purchased 12,000 shares as treasury

share $(552,000)

Net profit 3,780,000

Dividends (276,000)

Balance, Dec. 31, 2014 $6,000,000 $1,260,000 $(552,000) $14,879,000

Ex. 11–18a. 160,000 shares (40,000 × 4)

b. $75 per share ($300 ÷ 4)

Ex. 11–19

Assets Liabilities(1) Authorizing and issuing stock

certificates in a stock split 0 0(2) Declaring a stock dividend 0 0(3) Issuing stock certificates for

the stock dividend declaredin (2) 0 0

(4) Declaring a cash dividend 0 +(5) Paying the cash dividend

declared in (4) – –

$17,135,000

I-CARDS INC.Statement of Stockholders’Equity

For the Year Ended December 31, 2014

Total

1,500,000

(276,000)

(552,000)

3,780,000

$21,587,000

0

00

0–

Equity



Ex. 11–20

Jan. 8 No entry required. The shareholders’ ledger would be revised to record the increased number of shares held by each stockholder.

Apr. 30 Cash Dividends {[(18,000 shares × $0.75) + (150,000 shares × $0.28)] = $13,500 + $42,000 = $55,500} 55,500

Cash Dividends Payable 55,500

July 1 Cash Dividends Payable 55,500Cash 55,500

Oct. 31 Cash Dividends {[(18,000 shares × $0.75) + (150,000 shares × $0.14)] = $13,500 + $21,000 = $34,500} 34,500


31 Stock Dividends [(150,000 shares × 5% × $52)= $390,000] 390,000

Stock Dividends Distributable (7,500 shares × $40) 300,000Share Premium—Ordinary[7,500 shares × ($52 – $40)] 90,000

Dec. 31 Cash Dividends Payable 34,500Cash 34,500

31 Stock Dividends Distributable 300,000Share Capital—Ordinary 300,000

Ex. 11–21

= $7.30 per share

Net Profit – Preferred DividendsAvg. Number of Ordinary Shares Outstanding

= $316,000 – ($1.60 × 15,000 shares)40,000 shares

Earnings per Share =

Earnings per Share

Earnings per Share



Ex. 11–22

$1,105 – $14382 shares

= $2.86 per share

$1,208 – $14368 shares

= $3.24 per share

$1,312 – $14357 shares

= $3.64 per share

b. Year 3 Year 2 Year 1Earnings per share…………………………………… $2.86 $3.24 $3.64Growth as a percent of Year 1 (base year)………… 79% 89% 100%

Net profit………………………………………………… $1,105 $1,208 $1,312Growth as a percent of Year 1 (base year)………… 84% 92% 100%

Net profit has declined over the three-year period. Year 2 Net profit declined 8%(100% – 92%) of Year 1, while Year 3 earnings declined 16% (100% – 84%) of Year 1.The decline in earnings per share is slightly more than the decline in earnings.Year 2 earnings per share declined 11% (100% – 89%) of Year 1, while Year 3earnings per share declined 21% (100% – 79%) of Year 1.

Avg. Number of Ordinary Shares Outstanding

Year 3Earnings per Share

Year 1Earnings per Share =

=Earnings per Sharea. Net Profit – Preferred Dividends

=

Year 2Earnings per Share =



Ex. 11–23a. OfficeMax:

$71,155,000 – $2,527,00084,908,000 shares

= $0.81 per share

Staples:

$881,948,000715,596,000 shares

= $1.23 per share

b. Staples’ net profit of $881,948,000 is much greater than OfficeMax’s net income of $71,155,0000. This is because Staples is a much larger business thanOfficeMax. Staples also has over 8 times more shares of ordinary share outstanding than does OfficeMax. Regardless of these size differences, however, earnings per share can be used to compare their relative earnings. As shown above, Staples has a better earnings per share of $1.23 than does OfficeMax, which has earnings per share of $0.81.

= Net Profit – Preferred DividendsAvg. Number of Ordinary Shares Outstanding

=

Net Profit – Preferred Dividends

=

Avg. Number of Ordinary Shares Outstanding

Earnings per Share

Earnings per Share

=Earnings per Share

Earnings per Share



Prob. 11–1A1.

Total Per PerDividends Total Share Total Share

2009………… $ 18,000 $18,000 $0.45 $ 0 $0.002010………… 40,000 40,000 1.00 0 0.002011………… 80,000 32,000 0.80 48,000 0.242012………… 120,000 30,000 0.75 90,000 0.452013………… 150,000 30,000 0.75 120,000 0.602014………… 228,000 30,000 0.75 198,000 0.99

$4.50 $2.28

* $32,000 = (2010 dividends in arrears of $2,000) + (2011 current dividend of $30,000)

2. Average annual dividend for preference: $0.75 per share ($4.50 ÷ 6)Average annual dividend for ordinary: $0.38 per share ($2.28 ÷ 6)

3. a. 0.60% ($0.75 ÷ $125)b. 5.0% ($0.38 ÷ $7.60)

PROBLEMS

Year

Preference Dividends Ordinary Dividends

*



Prob. 11–2A

a. Cash (360,000 shares × $22) 7,920,000Share Capital—Ordinary (360,000 shares × $12) 4,320,000Share Premium—Ordinary[360,000 shares × ($22 – $12)] 3,600,000

b. Cash (14,000 shares × $43) 602,000Share Capital—Preference (14,000 shares × $40) 560,000Share Premium—Preference[14,000 shares × ($43 – $40)] 42,000

c. Treasury Share (66,000 shares × $18) 1,188,000Cash 1,188,000

d. Cash (51,000 shares × $21) 1,071,000Treasury Share (51,000 shares × $18) 918,000Share Premium from Sale of Treasury Share[51,000 shares × ($21 – $18)] 153,000

e. Cash (10,000 shares × $16) 160,000Share Premium from Sale of Treasury Share[10,000 shares × ($18 – $16)] 20,000


f. Cash Dividends {(59,000 shares × $0.40) + [(1,250,000shares + 360,000 shares – 66,000 shares + 51,000shares + 10,000 shares) × 0.03]} 71,750


g. Cash Dividends Payable 71,750Cash 71,750



Prob. 11–3A1. and 2.

Jan. 1 Bal. 7,500,000 Apr. 10 1,500,000 Aug. 15 360,000 Dec. 31 Bal. 9,360,000

Jan. 1 Bal. 825,000 Apr. 10 300,000 July 5 90,000 Dec. 31 Bal. 1,215,000

Dec. 31 493,800 Jan. 1 Bal. 33,600,000 Dec. 31 1,125,000 Dec. 31 Bal. 34,231,200

Jan. 1 Bal. 450,000 June 6 450,000Nov. 23 570,000Dec. 31 Bal. 570,000

June 6 200,000

Aug. 15 360,000 July 5 360,000

July 5 450,000 Dec. 31 450,000

Dec. 28 43,800 Dec. 31 43,800

Share Capital—Ordinary

Share Premium—Ordinary

Retained Earnings

Treasury Share

Cash Dividends

Share Premium from Sale of Treasury Share

Stock Dividends Distributable

Stock Dividends



Prob. 11–3A (Continued)2.

Jan. 22 Cash Dividends Payable [(375,000 shares – 25,000shares) × $0.08] 28,000

Cash 28,000

Apr. 10 Cash (75,000 shares × $24) 1,800,000Share Capital—Ordinary (75,000 shares × $20) 1,500,000Share Premium—Ordinary [75,000 shares × ($24 – $20)] 300,000

June 6 Cash (25,000 shares × $26) 650,000Treasury Share (25,000 shares × $18) 450,000Share Premium from Sale of Treasury Share 200,000

[25,000 shares × ($26 – $18)]

July 5 Stock Dividends [(375,000 shares + 75,000 shares)× 4% × $25] 450,000

Stock Dividends Distributable (18,000 shares× $20) 360,000Share Premium—Ordinary [18,000 shares × ($25 – $20)] 90,000

Aug. 15 Stock Dividends Distributable 360,000Share Capital—Ordinary 360,000

Nov. 23 Treasury Share (30,000 shares × $19) 570,000Cash 570,000

Dec. 28 Cash Dividends [(375,000 shares + 75,000 shares + 18,000 shares – 30,000 shares) × $0.10] 43,800


31 Income Summary 1,125,000Retained Earnings 1,125,000

31 Retained Earnings 493,800Stock Dividends 450,000Cash Dividends 43,800



Prob. 11–3A (Concluded)3.

Retained earnings, January 1, 2014 $33,600,000Net profit $1,125,000Less: Cash dividends -43,800

Stock dividends -450,000Increase in retained earnings 631,200Retained earnings, December 31, 2014 $34,231,200

4.

Share Capital:Share Capital—Ordinary , $20 stated value (500,000 shares

authorized, 468,000 shares issued) $9,360,000Excess of issue price over stated value 1,215,000From sale of treasury share 200,000

Total paid-in capital $10,775,000Retained earnings 34,231,200

Total $45,006,200Deduct treasury share (30,000 shares at cost) 570,000Total equity $44,436,200

Equity

MORROW ENTERPRISES INC.Retained Earnings Statement




Prob. 11–4A

Jan. 9 No entry required. The shareholders’ ledger would be revised to record the increased number of shares held by each stockholder and new par value.

Feb. 28 Treasury Share (40,000 shares × $28) 1,120,000Cash 1,120,000

May 1 Cash Dividends {(75,000 shares × $0.80) + [(1,200,000shares – 40,000 shares) + $0.12]} 199,200


July 10 Cash Dividends Payable 199,200Cash 199,200

Sept. 7 Cash (30,000 shares × $34) 1,020,000Treasury Share (30,000 shares × $28) 840,000Share Premium from Sale of Treasury Share[30,000 shares × ($34 – $28)] 180,000

Oct. 1 Cash Dividends {(75,000 shares × $0.80)+ [(1,200,000 shares – 10,000 shares) × $0.12]} 202,800


1 Stock Dividends [(1,200,000 shares – 10,000 shares) × 2% × $36] 856,800

Stock Dividends Distributable (23,800 shares × $25) 595,000Share Premium—Ordinary [23,800 shares × ($36 – $25)] 261,800

Dec. 1 Cash Dividends Payable 202,800Cash 202,800




Prob. 11–1B1.

Total Per PerDividends Total Share Total Share

2009………… $ 24,000 $ 24,000 $ 0.96 $ 0 $0.002010………… 10,000 10,000 0.40 0 0.002011………… 126,000 101,000 4.04 25,000 0.252012………… 100,000 45,000 1.80 55,000 0.552013………… 125,000 45,000 1.80 80,000 0.802014………… 125,000 45,000 1.80 80,000 0.80

$10.80 $2.40

* $101,000 =(2009 dividends in arrears of $11,000) +(2010 dividends in arrears of $45,000) +(2011 current dividend of $45,000)

2. Average annual dividend for preference: $1.80 per share ($10.80 ÷ 6)Average annual dividend for ordinary: $0.40 per share ($2.40 ÷ 6)

3. a. 1.8% ($1.80 ÷ $100)b. 8.0% ($0.40 ÷ $5.00)

Year

Preference Dividends Ordianry Dividends

*



Prob. 11–2B

9 Cash 1,500,000Mortgage Note Payable 1,500,000

17 Cash (20,000 shares × $126) 2,520,000Share Capital—Preference (20,000 shares × $120) 2,400,000Share Premium—Preference [20,000 shares × ($126 – $120)] 120,000

28 Building 4,150,000Land 800,000

Share Capital—Ordinary (300,000 shares × $15) 4,500,000Share Premium—Preference [300,000 shares × ($16.50– $15.00)] 450,000

Oct.



Prob. 11–3B

a. Treasury Share (87,500 shares × $8) 700,000Cash 700,000

b. Cash (55,000 shares × $11) 605,000Treasury Share (55,000 shares × $8) 440,000Share Premium from Sale of Treasury Share[55,000 shares × ($11 – $8)] 165,000

c. Cash (20,000 shares × $84) 1,680,000Share Capital—Preference (20,000 shares × $80) 1,600,000Share Premium—Preference[20,000 shares × ($84 – $80)] 80,000

d. Cash (400,000 shares × $13) 5,200,000Share Capital—Ordinary (400,000 shares × $9) 3,600,000Share Premium—Ordinary[400,000 shares × ($13 – $9)] 1,600,000

e. Cash (18,000 shares × $7.50) 135,000Share Premium from Sale of Treasury Share 9,000[18,000 shares × ($8.00 – $7.50)]


f. Cash Dividends {(80,000 shares × $1.60) + [(1,750,000 shares – 87,500 shares + 55,000 shares + 400,000 shares + 18,000 shares) × $0.05]} 234,775


g. Cash Dividends Payable 234,775Cash 234,775



Prob. 11–4B 1. and 2.

Jan. 1 Bal. 3,100,000 Apr. 13 1,000,000 July 16 123,000 Dec. 31 Bal. 4,223,000

Jan. 1 Bal. 1,240,000 Apr. 13 600,000 June 14 61,500 Dec. 31 Bal. 1,901,500

Dec. 31 248,068 Jan. 1 Bal. 4,875,000 Dec. 31 775,000 Dec. 31 Bal. 5,401,932

Jan. 1 Bal. 288,000 Mar. 15 288,000Oct. 30 300,000Dec. 31 Bal. 300,000

Mar. 15 36,000

July 16 123,000 June 14 123,000

June 14 184,500 Dec. 31 184,500

Dec. 30 63,568 Dec. 31 63,568

Share Capital—Ordinary

Share Premium—Ordinary

Retained Earnings

Treasury Share

Cash Dividends

Share Premium from Sale of Treasury Share

Stock Dividends Distributable

Stock Dividends



Prob. 11–4B (Continued)2.

Jan. 15 Cash Dividends Payable [(620,000 shares – 48,000shares) × $0.06] 34,320

Cash 34,320

Mar. 15 Cash (48,000 shares × $6.75) 324,000Treasury Share (48,000 shares × $6.00) 288,000Share Premium from Sale of Treasury Share[48,000 shares × ($6.75 – $6.00)] 36,000

Apr. 13 Cash (200,000 shares × $8) 1,600,000Share Capital—Ordinary (200,000 shares × $5) 1,000,000Share Premium—Ordinary [200,000 shares × ($8 – $5)] 600,000

June 14 Stock Dividends [(620,000 shares + 200,000 shares)× 3% × $7.50] 184,500

Stock Dividends Distributable (24,600 shares × $5) 123,000Share Premium—Ordinary [24,600 shares × ($7.50 – $5.00)] 61,500

July 16 Stock Dividends Distributable 123,000Share Capital—Ordinary 123,000

Oct. 30 Treasury Share (50,000 shares × $6) 300,000Cash 300,000

Dec. 30 Cash Dividends [(620,000 shares + 200,000shares + 24,600 shares – 50,000 shares) × $0.08] 63,568


31 Income Summary 775,000Retained Earnings 775,000

31 Retained Earnings 248,068Stock Dividends 184,500Cash Dividends 63,568



Prob. 11–4B (Concluded)

Retained earnings, January 1, 2014 $4,875,000Net profit $ 775,000Less: Cash dividends -63,568

Stock dividends -184,500Increase in retained earnings 526,932Retained earnings, December 31, 2014 $5,401,932

4.

Share capital:Share Capital—Ordinary , $5 stated value (900,000 shares

authorized, 844,600 shares issued) $4,223,000Excess of issue price over stated value 1,901,500From sale of treasury share 36,000

Total paid-in capital $ 6,160,500Retained earnings 5,401,932

Total $11,562,432Deduct treasury share (50,000 shares at cost) 300,000Total equity $11,262,432

Equity

NAV-GO ENTERPRISES INC.Retained Earnings Statement




Prob. 11–5B

Jan. 15 No entry required. The shareholders’ ledger would be revised to record the increased number of shares held by each shareholder and new par value.

Mar. 1 Cash Dividends [(100,000 shares × $0.25) + (800,000 shares × $0.07)] 81,000


Apr. 30 Cash Dividends Payable 81,000Cash 81,000

May 31 Treasury Share (60,000 shares × $32) 1,920,000Cash 1,920,000

Aug. 17 Cash (40,000 shares × $38) 1,520,000Treasury Share (40,000 shares × $32) 1,280,000Share Premium from Sale of TreasuryShare [40,000 shares × ($38 – $32)] 240,000

Sept. 1 Cash Dividends {(100,000 shares × $0.25) + [(800,000 shares – 60,000 shares+ 40,000 shares)× $0.09]} 95,200


1 Stock Dividends [(800,000 shares – 60,000 shares+ 40,000 shares) × 1% × $40] 312,000

Stock Dividends Distributable (7,800 shares × $30) 234,000Share Premium—Ordinary [7,800 shares × ($40 – $30)] 78,000

Oct. 31 Cash Dividends Payable 95,200Cash 95,200




CP 11–1At the time of this decision, the WorldCom board had come under intense scrutiny.This was the largest loan by a company to its CEO in history. The SEC began aninvestigation into this loan, and Bernie Ebbers was eventually terminated as the CEO, with this loan being cited as part of the reason. The board indicated that the decision to lend Ebbers this money was to keep him from selling his stock and depressing the share price. Thus, it claimed that it was actually helping shareholders by keeping these shares from being sold. However, this argument wasn’t well received, given that the share price dropped from around $15 per share at the time of the loan to about $2.50 per share when Ebbers was terminated. In addition, critics were scornful of the low “sweetheart” interest rate given to Ebbers for this loan. In addition, many critics viewed the loan as risky, given that it was not supported by any personal assets. WorldCom has since entered bankruptcy proceedings, Ebbers has gone to prison, and the Ebbers loan went uncollected.

Some press comments:

1. When he borrowed money personally, he used his WorldCom stock as collateral. As these loans came due, he was unwilling to sell at “depressed prices” of $10 to $15 (it’s now around $2.50). So WorldCom lent him the money to consolidate his loans, to the tune of $366 million. How a board of directors, representing you and me at the table, allowed this to happen is beyond comprehension. They should resign with Bernie. (Source: Andy Kessler,“Bernie Bites the Dust,” The Wall Street Journal, May 1, 2002, p. A18.)

2. It was astonishing to read the other day that the board of directors of the United States’ second-largest telecommunications company claims to have had its shareholders’ interests in mind when it agreed to grant more than $430 million in low-interest loans to the company’s CEO, mainly to meet margin calls on his stock.

Yet that’s the level to which fiduciary responsibility seems to have sunk on the board of Clinton, Mississippi-based WorldCom, the deeply troubled telecom giant, as it sought to bail Bernard Ebbers out of the folly of speculating in shares of WorldCom itself. Sadly, WorldCom is hardly alone.

“The very essence of why Mr. Ebbers was granted a loan was to protect shareholder value,” said a WorldCom spokesman in mid-March, just as the U.S. Securities & Exchange Commission was unfurling a probe of the loan and 23 other matters related to WorldCom’s finances.

Yes, folks, you read that right. On March 14, 2002, a spokesman for a publicly traded, $20 billion company actually stood up and declared that of all the uses to which the company could have put almost half-a-billion dollars, the

CASES & PROJECTS



CP 11–1 (Concluded)best one by far—at least from the point of view of the shareholders—was to spend it on some sort of stock-parking scheme in order to keep the CEO out of bankruptcy court . (Source: Christopher Byron, “Bernie’s Bad Idea,” RedHerring , April 16, 2002.)

Note to Instructors: Bernie Ebbers is currently serving a 25-year prisonsentence for conspiracy, securities fraud, and making false statements to securities regulators.

CP 11–2Lou and Shirley are behaving in a professional manner as long as full and complete information is provided to potential investors in accordance with federal regulations for the sale of securities to the public. If such information is provided, the marketplace will determine the fair value of the company’s stock.

CP 11–31. This case involves a transaction in which a security has been issued that has

characteristics of both stock and debt. The primary argument for classifying the issuance of the ordinary share as debt is that the investors have a legal right to an amount equal to the purchase price (face value) of the security. This is similar to a note payable or a bond payable. The additional $120 payment could be argued to be equivalent to an interest payment, whose payment has been deferred until a later date.

Arguments against classifying the security as debt include the fact that the investors will not receive fixed “annual” interest payments. In fact, if EpsteinEngineering Inc. does not generate any net sales, the investors do not have a right to receive any payments. One could argue that the payments of 5% of net sales are, in substance, a method of redeeming the stock. As indicated in the case, the shareholders must surrender their stock for $120 per share afterthe $25 million payment has been made. Overall, the arguments would seem tofavor classifying the security as ordinary share.

2. In practice, the $25 million stock issuance would probably be classified as ordinary share. However, full disclosure should be made of the 5% of net sales and $120 per share payment obligations in the notes to the financial statements. In addition, as Epstein Engineering Inc. generates net sales, a current liability should be recorded for the payment to shareholders. Such payments would be classified as dividend payments rather than as interest payments. Dan Fisher should also investigate whether such payments might violate any loan agreements with the banks. Banks often restrict dividend payments in loan agreements. If such an agreement has been violated, Epstein Engineering Inc. should notify the bank immediately and request a waiver of the violation.



CP 11–4a. 500 shares × ($0.80 ÷ 4) = $100

b. (0.4)% = ($31.74 – $31.87) ÷ $31.87

c. 34.8% = ($31.87 – $23.65) ÷ $23.65

d. 500 shares × $31.74 = $15,870 plus brokerage commission

e. The $15,870 paid for 500 shares of Microsoft ordinary share goes to the seller of the ordinary share (another shareholder).

CP 11–51. Before a cash dividend is declared, there must be sufficient retained earnings

and cash. On December 31, 2014, the retained earnings balance of $4,630,000 is available for use in declaring a dividend. This balance is sufficient for the payment of the normal quarterly cash dividend of $0.50 per share, which would amount to $90,000 ($0.50 × 180,000).

Motion Designs Inc.’s cash balance at December 31, 2014, is $250,000, of which $100,000 is committed as the compensating balance under the loan agreement. This leaves only $150,000 to pay the dividend of $90,000 and to finance normal operations in the future. Unless the cash balance can be expected to increase significantly in early 2015, it is questionable whether sufficient cash will be available to pay a cash dividend and to provide for future cash needs.

Other factors that should be considered include the company’s working capital(current assets – current liabilities) position and the loan provision pertaining to the current ratio, resources needed for plant expansion or replacement of facilities, future business prospects of the company, and forecasts for the industry and the economy in general. The working capital is $5,000,000 ($7,000,000 – $2,000,000) on December 31, 2014. The current ratio is therefore 3.5:1 ($7,000,000 ÷ $2,000,000) on December 31, 2014. However, after deducting the $3,000,000 committed to store modernization and product-line expansion, the ratio drops to 2:1 ($4,000,000 ÷ $2,000,000). If the cash dividend were declared and paid and the other current assets and current liabilities remain unchanged, the current ratio would drop to 1.955:1 ($3,910,000 ÷ $2,000,000), and this would violate the loan agreement. Further, working capital commitments for 2015 and any additional funds that might be required, such as funds for the replacement of property, plant, and equipment, would suggest that the declaration of a cash dividend for the fourth quarter of 2014 might not be wise.

2. Given the cash and working capital position of Motion Designs Inc. on December 31, 2014, a stock dividend might be an appropriate alternative to a cash dividend.



CP 11–5 (Concluded)a. From the point of view of a stockholder, the declaration of a stock

dividend would continue the dividend declaration trend of Motion Designs Inc. In addition, although the amount of the equity and proportional interest in the corporation would remain unchanged, the shareholders might benefit from an increase in the fair market value of their total holdings of Motion Designs Inc. stock after distribution of the dividend.

b. From the point of view of the board of directors, a stock dividend would continue the dividend trend, while the cash and working capital position of the company would not be jeopardized. Many corporations use stock dividends as a way to “plow back” retained earnings for use in acquiring new facilities or for expanding their operations. Motion Designs Inc. has sufficient unissued ordinary share to declare a stock dividend without changing the amount authorized.

CP 11–6Note to Instructors: The purpose of this activity is to familiarize students withsources of information about corporations and how that information is useful in evaluating the corporation’s activities.

The following information was prepared for Google Inc. based upon the SEC 10-K filing for the year ending December 31, 2011.

1. Google Inc.

2. Delaware

3. The following is taken from Google’s 10-K:

“Google is a global technology leader focused on improving the ways people connect with information. We aspire to build products that improve the livesof billions of people globally. Our mission is to organize the world’s informationand make it universally accessible and useful. Our innovations in web searchand advertising have made our website a top internet property and our brandone of the most recognized in the world.

We generate revenue primarily by delivering relevant, cost-effective onlineadvertising. Businesses use our AdWords program to promote their productsand services with targeted advertising. In addition, the third parties that comprisethe Google Network use our AdSense program to deliver relevant ads thatgenerate revenue and enhance the user experience.”



CP 11–6 (Continued)

4. $72,574,000,000

5. $37,905,000,000

6. $9,737,000,000

7. Convertible preference share, $0.001 par value, 100,000 shares authorized; no shares issued and outstanding.

Class A and Class B ordinary share and additional paid-in capital, $0.001 par value per share: 9,000,000 shares authorized; 321,301 (Class A 250,413, Class B 70,888) and par value of $321 (Class A $250, Class B $71) and 324,895 (Class A 257,553, Class B 67,342) and par value of $325 (Class A $258, Class B $67) shares issued and outstanding.

Note to Instructors: The rights of Class A and Class B ordinary share are identical except for voting rights. Specifically, each share of Class A ordinary shareis entitled to one vote per share. Each share of Class B ordinary share is entitled to 10 votes per share. Shares of Class B ordinary share may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A ordinary share. The Class A ordinary shareis the stock that is actively traded on the New York Stock Exchange. The Class B ordinary share allows the founders of Google (Sergey Brin and Larry Page) and Executive Chairman (Eric Schmidt) to maintain control of thecorporation. Specifically, the following stated in Google’s 10-K:

“… As of December 31, 2011, Larry, Sergey, and Eric beneficially ownedapproximately 92% of our outstanding Class B ordinary share, representing approximately 66% of the voting power of our outstanding share capital—ordinary. Larry, Sergey, and Eric therefore have significant influence over management andaffairs and over all matters requiring stockholder approval, including the electionof directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future.”

8. $618.39 as of close on February 28, 2012.

9. $642.96 – $473.02



CP 11–6 (Concluded)10. Google Inc. does not pay dividends. In its SEC 10-K filing for the year ending

December 31, 2011, Google states:

“We have never declared or paid any cash dividend on our ordinary share. We intend to retain any future earnings and do not expect to pay any dividends inthe foreseeable future.”

Note to Instructors: The preceding information, which may be updated as needed,can be used as a basis for class discussion. Some issues that you may want to raise in class are (1) the high price of Google’s Class A stock; (2) control of the corporation by the founders, using the voting rights of their Class B stock; (3) the no dividend policy; and (4) future prospects for Google, including appreciation in value of the Class A stock.

CHAPTER 11 CORPORATIONS: ORGANIZATION, SHARE TRANSACTIONS, AND...

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