DISCUSSION QUESTIONSQ11-1. 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 issuance of stock. The remainder of the issue 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.
Capital + Earned Capital Revenues - Expenses = Net
Income
Issue 18,000 shares of $10 par value preferred stock at $48 per share.
+864,000Cash
=
+180,000Preferred
Stock
+684,000Additional
Paid-in Capital
- =
Issue 120,000 shares of $2 par value common.
+4,440,000Cash
=
+240,000Common
Stock
+4,200,000Additional
Paid-in Capital
- =
M11-21. (10 minutes)
Common stock........................................ $ 5.298a
Additional paid in capital......................... 39,265.702Total........................................................ $39,271.000a 5,298 million shares issued $0.001 par value, rounded.
M11-22. (15 minutes)
a.1/1 Cash (+A) 1,250,000
Preferred stock (+SE) 500,000Additional paid-in capital (+SE) 750,000
Issue 5,000 shares of $100 par value preferred stock at $250 per share.
+1,250,000Cash
=
+500,000Preferred
Stock
+750,000Additional
Paid-inCapital
- - =
Repurchase 5,000 shares of $1 par value common stock at $83 per share.
-415,000Cash
= -+415,000Treasury
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.
b. If the stock repurchase took place on March 31, 2011, two months after the end of the previous fiscal year, the denominator of the basic EPS calculation would decrease by 17,662,000 x 10/12. That is, the weighted average shares outstanding would be 103,300,000 – [17,662,000 x (10/12)] = 88,581,667 shares.
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 toPreferred Common
a. $1,000,000 6%......................................................... $60,000Balance to common..................................................... $100,000Per share
b. $1,000,000 6% 2 years....................................... $120,000Balance to common..................................................... $40,000Per share
For the Year Ended December 31, 2014Retained earnings, December 31, 2013................................................. $347,000Add: Net income.................................................................................... 94,000
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:
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 = 12,66748,000 x 4/12 = 16,00049,000 x 4/12 = 16,333
45,000
b. Basic EPS: [$234,000 – (6,000 x $50 x 6%)] / 45,000 = $4.80
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 adjusts for dilutive securities (such as convertible securities or employee stock options) by including the securities in the denominator and also adjusting for any effect on the numerator. Consequently, diluted earnings per share is always less than or equal to basic earnings per share.
b. In the case of 3M, it has 708.5 million weighted average common shares outstanding, and an additional 10.5 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 708.5 million shares and a basic EPS of $6.05, the implied earnings number is $4,286.425 million, computed as 708.5 million $6.05. For diluted EPS, 719.0 million times $5.96 implies earnings of $4,285.24 million, a difference of $1.185 million. This difference is likely due to the interest/dividends on convertible securities.)
c. While diluted EPS are favored over basic EPS by analysts, the data reflect events that have not and may never occur. In addition, the dilution is assumed to be made at the year’s start.
M11-35. (15 minutes)
a. No entry is required when the options are granted. The compensation expense is recognized ratably over the vesting period. As the options vest, the following entry is required (assume one-third vested in 2011):
Compensation expense (+E, -SE) 14,749Additional paid in capital (+SE) 14,749
b. Granted stock options (whether vested or not) are included in the denominator of diluted EPS whenever the stock price is greater than the exercise price. These options would reduce diluted EPS but have no effect on basic EPS.
c.
Cash (+A) 321,000
Contributed capital (+SE) 321,000
d. When options are exercised, the number of outstanding shares increases. This would reduce basic EPS. It might also lower diluted EPS, though most likely to a lesser degree. This is because the dilutive effect may already be reflected in diluted EPS prior to exercise.
Income1 ….. 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 shares
b. $10 = $6,000,000 / 600,000 shares
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 diluted EPS calculation is made to reflect a worst-case scenario (conservative) EPS figure.
b. $86/278.689 = $0.309 or $0.31 per share
c. $98/346.467 = $0.283 or $0.28 per share
d. Options that are “under water” (the stock price is below the exercise price) are not included in the calculation of diluted EPS. This is because diluted EPS is supposed to be the most conservative possible outcome. Including under water options would actually increase EPS. Thus these options are anti-dilutive.
a. 103.3 million - 17.662 million = 85.638 million shares outstanding.
b. ($1.033 million + $369.171 million) / 103.3 million shares = $3.58 per share.
c. $834.774 million / 17.662 million shares = $47.26 per share.
d. EPS is computed based on the number of shares outstanding. The number of shares in treasury stock is subtracted from shares issued to get the number of shares outstanding. Thus, the number of treasury shares is subtracted from the denominator in computing EPS.
e. $6.455 million – $(6.516) million = 12.971 million.
a. Basic EPS: [$230,000 – (5,000 x $4)] / 30,000 = $7.00
Calculation of weighted average shares outstanding:25,000 x 4/12 = 8,33334,000 x 2/12 = 5,66728,000 x 2/12 = 4,66734,000 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 toPreferred Common
a. Year 1 $ 0 $ 0
Year 2: Arrearage from Year 1($750,000 8%) $ 60,000Current year dividend($750,000 8%) 60,000Balance 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
Year 2: Current year dividend($750,000 8%) $ 60,000Balance to common $220,000
Year 3: Current year dividend($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.
a. 2,805,961,317 $0.331/3 = $935,320,439 rounded to $935 million
b. ($935 million + $5,674 million) / 2,806 million shares = $2.36 per share
c. 2,805,961,317 shares issued – 761,542,032 shares in treasury = 2,044,419,285 shares outstanding
d. $24,625 million / 761.542 million = $32.34 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 CommonPreferred per Share
Common per Share
2013Current year on preferred [6% (18,000 $50)] $54,000Remainder to common $9,000Per share Preferred ($54,000/18,000) $3.00 Common ($9,000/90,000) $0 .10
2014Preferred $0 $0.00Common $0 $0 .00
2015Arrearage on preferred [6% (18,000 $50)] $54,000Current year on preferred [6% (18,000 $50)] 54,000Remainder to common $270,000 Total distribution $108,000 $270,000Per share Preferred ($108,000/18,000) $6.00 Common ($270,000/90,000) $3 .00
Capital + Earned Capital Revenues - Expenses = Net
Income
Declared and paid cash dividend.
-47,500Cash
=-47,5001
Retained Earnings
- =
Declared and issued stock dividend. =
+10,000Common
Stock+25,000
AdditionalPaid-in Capital
-35,0002
Retained Earnings
- =
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) 56,000Additional paid-in capital (+SE) 44,800
Capital + Earned Capital Revenues - Expenses = Net
Income
Declared and paid stock dividend.
=
+56,000Common
Stock+44,800
AdditionalPaid-in Cap
-100,8001
Retained Earnings
- =
Declared and issued cash dividend.
-64,200Cash
=-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 EarningsFor the Year Ended December 31, 2014
Capital + Earned Capital Revenues - Expenses = Net
Income
Declared and paid 100% stock dividend.
=+250,000Common
Stock
-250,0001
Retained Earnings
- =
Declared and paid 3% stock dividend.
+15,000Common
Stock+27,000
AdditionalPaid-inCaptal
-42,0002
Retained Earnings
Declared and issued cash dividend.
-102,400Cash
=-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.
Statement of Retained EarningsFor the Year Ended December 31, 2014
Retained earnings, December 31, 2010 $656,000
Add: Net income 253,000
909,000
Less: Cash dividends declared $102,400
Stock dividends declared 292,000 394,400
Retained earnings, December 31, 2011 $514,600
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.
a. 814,894,624 – 167,361,280 = 647,533,344 shares outstanding.
b. “Paid-in amount” is the total paid-in capital, including the amount specified as the par value and included in the Common Stock and the amount that would be included in the account as Additional Paid-in Capital.
c. $10,281 million / 167.361 million = $61.43 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. Because the number of shares outstanding is in the denominator of the EPS calculation, repurchasing common shares increases basic and diluted EPS.
E11-52. (20 minutes)
a. Shares issued Par value = Common Stock amount3,576.948 million shares $0.50 = $1,788.5 million
b. (Common Stock + Other Paid-In Capital)/Shares issued = Average Issue price($1,788 million + $40,633 million) / 3,576.948 million = $11.86 per share
c. Treasury Stock / Treasury shares = Treasury cost per share$23,792 million / 536.11 million = $44.38 per treasury share
a. No. If the firm had a gain (loss) from an extraordinary item, there would have been an additional line in their report showing the EPS figures for extraordinary items separately.
b. $0.01 x 587.3 = $5.873 million loss based on basic EPS. $0.02 x 594.3 = $11.886 million loss based on diluted EPS. The actual amount (from Viacom’s 10-K) was $10.0 million. Because of rounding, the numbers based on basic EPS and diluted EPS reflect approximations and can be interpreted as high and low values of an estimated range. All such losses (and/or gains) are reported net of tax.
c. $2,136 million - $5.9 million = $2,130.1 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 $0.05 per share is minimal.
E11-54. (20 minutes)
a. No. The Euro amounts for ordinary shares (i.e. common stock) and preferred shares (preferred stock) did not change either year. Neither did the capital reserve (additional paid-in capital).
b. Net income + other comprehensive income = total comprehensive income.€1,253 million + €(297) million = €956 million.
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).
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 capital8% Preferred stock, $25 par value,
50,000 shares authorized; 10,000 sharesissued and outstanding $ 250,000
Common stock, $10 par value, 200,000shares authorized; 78,000 shares issued,of which 3,000 shares are in treasury 780,000 $1,030,000
Additional paid-in capitalPaid-in capital in excess of par
value—Preferred stock 116,000
Paid-in capital in excess of parvalue—Common stock 396,000
Paid-in capital from Treasury stock 13,000 525,000Total paid-in capital 1,555,000
Retained earnings 329,0001,884,000
Less: Treasury stock (3,000 commonshares) at cost 57,000
c. continuedNotes: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 EPS9/1: purchase treasury stock – increase basic EPS10/12: sold treasury stock – decrease basic EPS11/21: issued common stock – decrease basic EPS12/28: sold treasury stock – decrease basic EPS
e.Stockholders’ Equity
Paid-in capital7% Preferred stock, $100 par value,
20,000 shares authorized; 5,000shares issued and outstanding $500,000
Common stock, $5 par value, 300,000shares authorized; 125,000 sharesissued, of which 7,300 shares are inthe treasury 625,000 $1,125,000
Additional paid-in capitalPaid-in capital in excess of par value—Preferred stock 24,000Paid-in capital in excess of par value—Common stock 390,000
Paid-in capital from treasury stock 1,800 415,800Total paid-in capital 1,540,800Retained earnings 408,000
1,948,800Less: Treasury stock (7,300 common
shares) at cost 73,000Total stockholders' equity $1,875,800
f. Because Sougiannis did not pay the 7% dividend on its preferred stock, ROCE is computed as follows:
$83,000 / [($1,875,800+$1,809,000)/2 -$500,000] = 0.062 or 6.2%
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).
50,000 shares authorized, 5,000shares issued and outstanding $125,000
Common stock, $5 par value, 350,000shares authorized; 160,000 sharesissued; 2,500 shares in treasury 800,000 $ 925,000
Additional paid-in capitalPaid-in capital in excess of par
value—Preferred stock 50,000Paid-in capital in excess of par
value—Common stock 670,000Paid-in capital from Treasury stock 2,500 722,500Total paid-in capital 1,647,500
Retained earnings 418,5002,066,000
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.
Preferred stock (+SE) 50,000Additional 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).
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
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.
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).
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).
a. 2012: 4,008 – 1,260.4 = 2,747.6 million 2011: 4,008 – 1,242.2 = 2,765.8 millionEstimated average shares outstanding: (2,747.6 + 2,765.8)/2 = 2,756.7 million.Average shares outstanding is slightly greater than the number of shares outstanding at year-end because P&G has more shares in treasury stock in 2012 that at the end of 2011.
b. 2012: $69,604/1,260.4 = $55.22; 2011: $67,278/1,242.2 = $54.16
c.Preferred stock (-SE) ……………………………………… 39Additional paid-in capital (-SE) 2,073
Treasury stock (-XSE, +SE) 2,112
The reported 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 $1,195 million is assumed to be the stated value, the number of issued shares exceeds the number authorized. Therefore, the $1,195 million figure must include additional paid-in capital of at least $595 million and the additional paid-in capital account refers only to common stock. The debit to preferred stock in this entry includes only the stated value. Technically, P&G should transfer a portion of the additional paid-in capital from the preferred stock amount to additional paid-in capital-common stock.
d. P&G’s diluted EPS reflects the effects of convertible preferred stock and, most likely, outstanding stock options.
e. 2012 ($millions): ($10,756 - $256) / [($64,035-$1,195+$68,001-$1,234)/2] = 0.162 or 16.2%
a. Class A and B common shares are identical except for voting rights. Class A shares have 1 vote per share while class B shares have 10 votes per share. This means that class B shareholders have greater control in the governance of the corporation. Presumably, class B shares were retained by the original owners of the firm when the class A shares were offered.
b. 718,091 x $210.07 per share = $150,849,376.
c. Options vest over 4 years; $150,849,376/4 = $37,712,344Compensation expense (+E, -SE) ……………… 37,712,344
Additional paid-in capital (+SE) …………… 37,712,344
d. Intrinsic value refers to the difference between the current stock price and the exercise price of the options. It is always less than or equal to the fair value of the options. The aggregate intrinsic value of the options granted in 2011 is:
($645.90 - $584.80) x 718,091 = $43,875,360
e. $6,520 / $20.62 = 316.2 million shares.
Google had 321.3 million shares outstanding at the end of 2010 and 324.9 million shares outstanding at the end of 2011.
f. If all outstanding stock options were exercised, basic EPS would decrease. Google had 9.8 million options outstanding at the end of 2011. If all of these options had been exercised and added to shares outstanding, basic EPS would have been $6,520 / (316.2 + 9.8) = $20.00 per share (compared to $20.62).
g. The diluted EPS figure includes an adjustment for outstanding options. Typically, this adjustment is smaller than the effect of including all options in outstanding shares. This is due to two factors:
1. Some options may be under water (exercise price exceeds the stock price). If this is true, the options are anti-dilutive and would not be exercised by the option holder.
2. When options are exercised, the shareholder pays the exercise price to the firm. The calculation in question f made no assumption about what happens to this cash (it would total about $3,508 million = 9.8 million x $357.92). Presumably, this cash could be invested to increase earnings and EPS. The calculation of diluted EPS adjusts for this cash by assuming that the cash is used to purchase treasury shares. Given the current stock price of $645.90 per share, Google could repurchase 5.4 million shares ($3,507 million/$645.90). Thus, the actual increase in shares outstanding if all options were exercised would be 9.8 million – 5.4 million = 4.4 million shares.
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.
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. 2013: $9,450,000 / 250,000 = $37.80 per share2014: $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 2014. Your percentage ownership in Pillar has remained the same. The market value of your shares at the end of 2014 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.
