CHAPTER 12

STOCKHOLDERS' EQUITY

BRIEF EXERCISES

BE12–1
a. 38.4% of net income was paid in dividends during the year ($1,743/$4,535).

b. The issuance of common stock affected the basic accounting equation by increasing assets (cash) and
increasing stockholders equity by the same amount (common stock and additional paid-in capital).

c. The purchase of treasury stock affected the basic accounting equation by reducing assets (cash) and
reducing stockholders equity (treasury stock) by the same amount.

d. The total dollars distributed to the company’s shareholders during the year totaled $5,743 ($1,743 +
$4,000). This is comprised of dividends paid and the treasury stock that was purchased.

e. The balance in retained earnings as of the end of the year was $20,038. ($17,246 + $4,535 – $1,743).

BE12–2
a. The number of shares outstanding after the split would be 194 million shares (97 million x 2) and the
price per share would be approximately $50 ($100/2).

b. The company’s overall value or market capitalization is $9.7 billion ($50 x 194 million shares). The
company’s overall market should not change simply because of the share split. The number of shares
will double but the price per share will be cut in half. Sometimes companies that announce a share split
see their stock price rise because many investors see a share split as a positive sign from management
but this shareholder action is inferring positive news that has not been announced.

BE12–3
a. During 2010 the company paid an average of $30.21 per share in its repurchase program ($2,961/98).

b. During 2011 the company paid an average of $35.54 per share in its repurchase program ($4,513/127).

c. With no information regarding 2013 treasury purchases, the balance in the treasury stock account will
be $33,809 ($35,009 - $1,200) .

EXERCISES

E12–1
a.,b.,c.
1
 Effect on Effect on Total
Accounts Account Stockholders' Equity
(1) Common Stock Increase Increase
Additional Paid-In Capital, C/S Increase
(2) None N/A No effect
(3) Treasury Stock Increase Decrease
(4) Common Stock Increase No effect
Additional Paid-In Capital, C/S Increase
Retained Earnings Decrease
(5) Treasury Stock Decrease Increase
Additional Paid-In Capital, T/S Increase
(6) None N/A No effect
(7) Retained Earnings Increase Increase

E12–2
a. Debt = Total Liabilities
= $52,000 + $35,000
= $87,000

Contributed Capital = Preferred Stock + Common Stock + Additional Paid-In Capital,

Preferred Stock + Additional Paid-In Capital, Common Stock –
Treasury Stock
= $50,000 + $80,000 + $50,000 + $100,000 – $80,000
= $200,000

Earned Capital = Retained Earnings

= $113,000

The portions of Lamont's assets provided by debt, contributed capital, and earned capital are, therefore,
21.75%, 50%, and 28.25%, respectively.

b. Debt/Equity = Total Liabilities ÷ Stockholders' Equity

= Total Liabilities ÷ (Contributed Capital + Earned Capital)
= $87,000 ÷ ($200,000 + $113,000)
= .278

Debt/Equity = Total Liabilities ÷ Total Stockholders' Equity

= (Total Liabilities + Contributed Preferred Capital) ÷ (Contributed Common
Capital + Earned Capital – Treasury Stock)
= ($87,000 + $50,000 + $50,000) ÷ ($80,000 + $100,000 +
$113,000 – $80,000)
= .878

c. Most states restrict the dollar amount of dividends to either the balance in Retained Earnings or the
balance in Retained Earnings less any treasury stock. So in this case, Lamont Brothers, either would be
restricted to $113,000 or $33,000, depending upon the state.

E12–3
(1) No entry is necessary.
(2) Cash (+A)............................................................................................... 300,000
Common Stock (+SE)..................................................................... 50,000
Additional Paid-In Capital, Common Stock (+SE)........................ 250,000
Issued common stock.

(3) Cash (+A)............................................................................................... 3,750,000

Preferred Stock (+SE)..................................................................... 2,500,000
Additional Paid-In Capital, Preferred Stock (+SE)........................ 1,250,000
Issued preferred stock.

(4) Cash (+A)............................................................................................... 2,500,000

Preferred Stock (+SE)..................................................................... 2,500,000
Issued preferred stock.

Effect of each event on basic accounting equation:

Transaction Assets Liabilities Owner’s Equity

1. NE NE NE
2. + NE +
3. + NE +
4. + NE +

Since par value of a share of stock has no relationship to market value, it has very little economic
significance. At one time, par value was construed to be legal minimum capital to protect creditors in
times of dissolution or bankruptcy, but over time the concept has lost its appeal as creditors have found
better ways to protect themselves.
E12–4
a. Treasury Stock (–SE).................................................................................. 1,000
Cash (–A)............................................................................................. 1,000
Acquired treasury stock. (Dollars in millions)

b. Debt/Equity = Total Liabilities ÷ Total Stockholders' Equity

Before = $1,048 ÷ $2,012

= 0.52

After = $1,048 ÷ ($2,012 – $1,000)

= 1.04

c. Earnings per Share = Net Income ÷ Outstanding Shares

Before = $94 ÷ 125.5 Shares

= $0.75 per Share

After = $94 ÷ (125.5 Shares Issued – 26 Treasury Shares)

= $0.94 per Share

d. A company might choose to purchase treasury stock at year end in order to reduce the number of shares
outstanding as of year-end. A smaller number of shares outstanding will increase the earnings per share
(based on average # of shares outstanding during the year).

E12–5
a.
(1) Cash (+A)................................................................................................. 500,000
Common Stock (+SE)....................................................................... 125,000
Additional Paid-In Capital, Common Stock (+SE).......................... 375,000
Issued common stock.

(2) Cash (+A)................................................................................................. 60,000

Preferred Stock (+SE)...................................................................... 60,000
Issued preferred stock.

(3) Treasury Stock (–SE).............................................................................. 45,000

Cash (–A).......................................................................................... 45,000
Repurchased treasury stock.

(4) Cash (+A)................................................................................................. 18,000

Treasury Stock (+SE)....................................................................... 15,000
Additional Paid-In Capital, Treasury Stock (+SE).......................... 3,000
Reissued treasury stock.

(5) Cash (+A)................................................................................................. 5,000

Additional Paid-In Capital, Treasury Stock (–SE)................................. 3,000
Retained Earnings (–SE)......................................................................... 7,000
Treasury Stock (+SE)....................................................................... 15,000
Reissued treasury stock.
E12–5 Concluded
b. Preferred stock ($8 par value, 5,000 shares outstanding).......................... $ 60,000
Common stock ($5 par value, 25,000 shares issued,
24,000 shares outstanding)....................................................................... 125,000
Additional paid-in capital........................................................................... 375,000
Retained earnings........................................................................................ 493,000
Treasury stock............................................................................................. (15,000)
Total stockholders' equity........................................................................... $ 1,038,000

E12–6
a. (1) Treasury Stock (–SE)...................................................................... 60,000
Cash (–A)................................................................................. 60,000
Purchased treasury stock.

(2) Cash (+A)........................................................................................ 10,000

Retained Earnings (–SE)................................................................. 20,000
Treasury Stock (+SE)............................................................... 30,000
Reissued treasury stock as compensation.

Note: Depending upon the terms of the employees' compensation package, it may be more
appropriate to debit Compensation Expense for $20,000 rather than debiting Retained Earnings
for $20,000.

(3) Cash (+A)........................................................................................ 33,000

Treasury Stock (+SE)............................................................... 30,000
Additional Paid-In Capital, Treasury Stock (+SE).................. 3,000
Reissued treasury stock.

Common stock............................................................................................. $ 80,000

Additional paid-in capital (common and treasury stock)........................... 13,000
Retained earnings ($60,000 - $20,000 +$20,000)...................................... 60,000
Total stockholders' equity........................................................................... $153,000

b. A total of $3,000 of additional paid-in capital is attributable to treasury stock. This amount would be
recorded in the account Additional Paid-In Capital, Treasury Stock. Under the cost method, this amount
represents the amount of proceeds received in excess of the acquisition cost of the treasury stock
reissued.

E12–7
a. Treasury Stock (–SE).................................................................................. 2,850,000
Cash (–A)............................................................................................. 2,850,000
Purchased treasury stock.
E12–7 Concluded
b. Common stock............................................................................................. $ 100,000
Additional paid-in capital, common stock.................................................. 2,400,000
Retained earnings................................($4,500,000 +$350,000 - $50,000) 4,800,000
Treasury stock............................................................................................. (2,850,000)
Total stockholders' equity........................................................................... $ 4,450,000

c. When common stock is initially issued, it is recorded at the value of the assets received. In this case
Stuart Corporation received $25 per share for 100,000 shares of common stock, for a total of
$2,500,000. This $2,500,000 was allocated between the accounts Common Stock and Additional Paid-in
Capital, Common Stock. Under the cost method of accounting for treasury stock, acquiring treasury
stock does not cause the amount recorded for the initial issue of common stock to be adjusted. The
treasury stock is simply recorded at the value of the assets given up. So if the value of the assets given
up to acquire the treasury stock exceeds the value of the assets received when the common stock was
initially issued, then the Treasury Stock balance will exceed contributed capital.

E12–8
a. Book Value per Share = Common Stockholders' Equity ÷ Common Shares Outstanding
= $13,065 ÷ 782 Shares
= $16.71 per Share

b. Book Value per Share = [$13,065 + (50 Shares  $32)] ÷ 832 Shares
= $17.63 per Share

c. Book Value per Share = [$13,065 + (50 Shares  $20)] ÷ 832 Shares
= $16.91 per Share

d. Book Value per Share = [$13,065 – (50 Shares  $32)] ÷ 732 Shares
= $15.66 per Share

e. Book Value per Share = [$13,065 – (50 Shares  $20)] ÷ 732 Shares
= $16.48 per Share

f. Issuing stock can either increase or decrease the book value of a company's common stock. Whether
issuing stock increases or decreases the book value depends upon the issue price of the new stock. If
new stock is issued at a price above the pre-issue book value, then issuing the stock increases the book
value. Alternatively, if new stock is issued at a price below the pre-issue book value, then issuing the
stock decreases the book value.

g. Purchasing treasury stock can either increase or decrease the book value of a company's common stock.
Whether purchasing treasury stock increases or decreases the book value depends upon the acquisition
price of the treasury stock. If treasury stock is acquired at a price above the pre-issue book value, then
purchasing treasury stock decreases the book value. Alternatively, if treasury stock is acquired at a price
below the pre-issue book value, then purchasing the stock increases the book value.
E12–9
a. Cash (+A).................................................................................................... 300
Preferred Stock (+SE).......................................................................... 300
Issued preferred stock.

b. Cash (+A).................................................................................................... 120

Common Stock (+SE).......................................................................... 100
Additional Paid-In Capital, Common Stock (+SE)............................. 20
Issued common stock.

c. Cash (+A).................................................................................................... 30
Treasury Stock (+SE)........................................................................... 20
Additional Paid-In Capital, Treasury Stock (+SE).............................. 10
Reissued treasury stock.

E12–10
Common Sto ck + Ad d itiona l Pa id - in Ca p ita l
a. Issue Price per Share =
Numbe r of Sha re s Is s ue d

$10,000  $25,000
=
2,000 *

= $17.50

*Total Par Value of Par Value Number of Shares

Common Stock ÷ per Share = Issued
$10,000 ÷ $5 = 2,000

Tre a s ury S to ck Ca rrying Va lue on Ba la nc e S he e t

b. Purchase Price of Treasury Stock =
Num b e r o f Tre a s ury S to ck Purc ha s e d

$8,000
=
400

= $20/Share

c. To acquire Timeco, Zielow issued 1,000* shares and the market price of Timeco at the time of
acquisition was $28,000.**

* $5,000 c/s ÷ $5 P/V

** $5,000 c/s + $23,000 AP/C

d. Since the common stock accounts is always credited with total par value of shares issued to stock option
holders, the company issued 200 shares (i.e., $1,000 c/s ÷ $5 a share P/V).
The stock options were exercised at a price of $9* a share. Most certainly the market price of Zielow’s
shares would be more than $9 at that time.

* ($1,000 c/s + $800 AP/C) ÷ 200 shares.

E12–10 Concluded
e. Per Share Dividend Rate = Total Dividends Paid During 2015
Common Stock Outstanding

$3,520
=
2,600 *

= $1.354 per share

* ($16,000 ÷ $5) – [(8,000 + 4,000) ÷ $20]

In this problem it is assumed that during the year 2015, treasury-stock was acquired at $20 a share.

E12–11
Common Sto ck + Ad d itiona l Pa id - in Ca p ita l
a. Issue Price per Share =
Numbe r of Sha re s Is s ue d

$8,000  $32,000
=
8,000 s ha re s *

= $5 a share

Total Par
*Number of Shares Value of Par Value
Issued ÷ Common Stock = per Share of C/S
8,000 ÷ $8,000 = $1

Tre a s ury S to ck Ca rrying Va lue on Ba la nc e S he e t

b. Purchase Price of Treasury Stock =
Num b e r o f Tre a s ury S to ck Purc ha s e d

$18,000
=
1,500 S ha re s

= $12/Share

c. Since $3,000 worth of treasury stock was used to satisfy the stock options, at a price of $12 a share, a
total of 250 shares were issued through stock options.

Since retained earnings is debited at $2,750, it means that stock options were sold at par value or $1 a
share resulting in the following entry.

Cash (+A).................................................................................................... 250

Retained Earnings (–SE)............................................................................. 2,750
Treasury Stock (+SE)........................................................................... 3,000
E12–11 Concluded
Tota l Ca s h Divid e nd s
d. Per Share Cash Dividend Rate =
Numb e r of Co mmon Sha re s Outs ta nding

$3,500
=
6,750 *

= $.519 per share

* 6,750 = 8,000 Shares – 1,500 Treasury Shares Purchased + 250 Treasury Reissued

E12–12
a. Only those shares that are both issued and outstanding are eligible to receive dividends. Since Enerson
has 375,000 shares of common stock issued, but 50,000 of those shares are held in treasury, the total
number of common shares outstanding and, hence, eligible for a dividend are 325,000 shares.

b. Date of declaration
Cash Dividend (–SE) ................................................................................. 3,900,000
Dividend Payable (+L)......................................................................... 3,900,000
Declared cash dividend.

Date of record
No journal entry is necessary.

Date of payment
Dividend Payable (–L)................................................................................ 3,900,000
Cash (–A)............................................................................................. 3,900,000
Paid cash dividend.

E12–13
a. Each year the preferred stockholders are entitled to $5 for each share of preferred stock outstanding.
Since 5,000 shares are outstanding, total dividends to preferred stockholders should be $25,000 per
year.

Year Dividends Declared Dividends to Preferred Dividends to Common

2011 $ 0 $ 0 $ 0
2012 30,000 25,000 (for 2011) 0
5,000 (for 2012)
2013 80,000 20,000 (for 2012) 35,000
25,000 (for 2013)
2014 15,000 15,000 (for 2014) 0
2015 40,000 10,000 (for 2014) 5,000
25,000 (for 2015)
E12–13 Concluded
b. Dividends in arrears are the dividends preferred stockholders are entitled to if and when the company's
board of directors declares a dividend. The amount of dividends in arrears equals the cumulative total of
dividends not declared and not paid to preferred stockholders in the current and past years. The amount
of dividends in arrears at the end of each year would be as follows.

December 31, 2011 $25,000

December 31, 2012 $20,000
December 31, 2013 $0
December 31, 2014 $10,000
December 31, 2015 $0

c. Dividends in arrears should not be considered a liability. A liability represents the probable future
sacrifice of assets. A company may choose to reinvest its profits back into the company, or the company
may not be financially secure enough to pay a dividend. This uncertainty is only resolved when the
company's board of directors actually declares a dividend. Preferred stockholders are only entitled to
receive their dividend when the company declares a dividend. If the board of directors never declares a
dividend, then the preferred stockholders are not entitled to receive one; thus, no liability exists until the
dividend is actually declared.

E12–14
a. Stock Dividend (–SE)................................................................................. 11,200*
Common Stock (+SE).......................................................................... 960
Additional Paid-In Capital, Common Stock (+SE)............................. 10,240
Declared and issued 2% stock dividend.

* $11,200 = (10,000 shares issued – 2,000 shares in treasury)  2%  $70 per share

b. No journal entry is necessary. However, the company should prepare a memorandum entry stating that
the par value has decreased from $6 to $4 per share and that there are now 15,000 shares issued and
12,000 shares outstanding.

c. Stock Dividend (–SE)................................................................................. 64,000*

Common Stock (+SE).......................................................................... 4,800
Additional Paid-In Capital, Common Stock (+SE)............................. 59,200
Declared and issued 10% stock dividend.

* $64,000 = (10,000 shares issued – 2,000 shares in treasury)  10%  $80

d. No journal entry is necessary. However, the company should prepare a memorandum entry stating that
the par value has decreased from $6 to $3 per share and that there are now 20,000 shares issued and
16,000 shares outstanding.
E12–14 Concluded
e. Ratio = (Common Stk. + Additional Paid-In Capital – Treasury Stock) ÷ Retained Earnings

Prior to entries
($60,000 + $100,000 – $24,000) ÷ $60,000 = 2.27

After (a)
[($60,000 + $960) + ($100,000 + $10,240) – $24,000] ÷ ($60,000 – $11,200) = 3.02

After (b)
($60,000 + $100,000 – $24,000) ÷ $60,000 = 2.27

After (c)
[($60,000 + $4,800) + ($100,000 + $59,200) – $24,000] ÷ ($60,000 – $64,000) = .00*

After (d)
($60,000 + $100,000 – $24,000) ÷ $60,000 = 2.27

* Since retained earnings account is –$4,000, no ratio can be computed.

In a stock split the number of outstanding shares is simply “split” into smaller units, which require the
corporation to distribute additional shares. However, in a stock dividend additional shares, usually
expressed as a percentage of the outstanding shares, are issued to stockholders. Large stock dividends
have essentially the same effect as stock splits.

E12–15
a. Option 1
Stock Dividend (–SE)................................................................................. 42,500
Common Stock (+SE).......................................................................... 5,000
Additional Paid-In Capital, Common Stock (+SE)............................. 37,500
Declared and issued 10% stock dividend.

Option 2
Stock Dividend (–SE)................................................................................. 85,000
Common Stock (+SE).......................................................................... 10,000
Additional Paid-In Capital, Common Stock (+SE)............................. 75,000
Declared and issued 20% stock dividend.

When a company declares an ordinary stock dividend, the fair market value of the new shares issued is
transferred from Retained Earnings, via the Stock Dividend account, to the contributed capital accounts.
Since in most states dividends are restricted to the balance in Retained Earnings (or Retained Earnings
less Treasury Stock), any decrease in its account balance decreases the amount of potential dividends.
So from the stockholders' viewpoint a stock dividend is not attractive because it decreases potential
future dividends. The primary reason that a company would declare an ordinary stock dividend is as a
publicity gesture. Some companies take great pride in being able to "promote" the company's dividend-
paying history. If a company finds itself short of cash and still wants to be able to claim that it paid a
dividend, then the company can maintain its dividend-paying streak by declaring a stock dividend.
E12–15 Concluded
b. Option 3 would have no effect on any of the account balances reported in the financial statements
because a stock split does not affect a company's financial position. However, a stock split does affect
both the par value per share of the company's common stock and the number of shares outstanding, and
as a result earnings per share. In this particular case, the 2-for-1 stock split would result in the par value
per share of Railway Shippers' common stock decreasing from $10 to $5 and in the number of common
shares outstanding increasing from 5,000 shares to 10,000 shares.

c. Declaring a stock split does not inherently increase or decrease a company's value. After a stock split, a
company's value is allocated over a larger number of shares, so each share is worth less. If each share is
worth less, then each share should sell for a lower price. If a company's stock is trading at too high a
price, the average investor will not be able to invest in the company. If the price of the company's stock
was lowered, trading in the company's stock would be stimulated. Consequently, a company can lower
the price of its stock and stimulate trading in its stock by declaring a stock split.

E12–16
a. Appropriating retained earnings serves to restrict a portion of retained earnings from the payment of
future dividends. Appropriations of retained earnings usually arise for two reasons. First, a creditor may
require the borrower to appropriate retained earnings. Such appropriations prevent the borrower from
paying "excessive" dividends to the stockholders, thereby reducing the amount of cash available to
repay creditors. Second, a company may decide to restrict future dividends and use the cash that would
have otherwise been used to pay dividends to finance plant expansion and so forth. In this particular
case, the company appropriated retained earnings for both of these reasons.

Auditors would require that appropriations of retained earnings be disclosed in the financial statements
because they affect the magnitude of a company's future dividends. The magnitude of future dividends
is information that current and potential investors desire. Failure to adequately disclose such
information could cause investors to lose money on their investments and, consequently, to sue the
auditor.

b. Common stock............................................................................................. XX
Additional paid-in capital........................................................................... XX
Retained earnings
Restricted.............................................................................................. 350,000
Unrestricted.......................................................................................... 450,000
Total stockholders' equity........................................................................... $ XX

c. The company can only declare a dividend equal only to the portion of retained earnings which exceed
$500,000. Since the debt covenant requires a minimum balance of $500,000 in the retained earnings
account, the board is constrained by that clause and could possibly declare dividends up to a maximum
of $300,000.
 PROBLEMS
P12–1
a. Cash (+A).................................................................................................... 100,000
Preferred Stock (+SE).......................................................................... 100,000
Issued preferred stock.

Debt/Equity = Total Liabilities ÷ Stockholders' Equity

= $250,000 ÷ ($330,000 + $100,000)
= .58

b. Debt/Equity = ($250,000 + $100,000) ÷ $330,000

= 1.06

c. If management classifies the stock as stockholders' equity, then the company will not be in violation of
its debt agreement. However, if management classifies the stock as debt, then the company will be in
violation of its debt agreement. Since violating debt agreements can be quite costly to both the company
and managers, managers have incentives to classify the stock as stockholders' equity.
The terms of the preferred stock make it appear to be more similar to debt than to equity. For example,
the stock has a specified rate, does not participate in the benefits of ownership (i.e., does not vote and
does not participate in profits), and has a fixed life. Based upon these factors, it appears that the stock is
in substance actually debt and should be classified as such.
Auditors will typically be guided by generally accepted accounting principles (GAAP) in deciding how
to report an item. However, in most cases, GAAP does not provide clear-cut guidance, and auditors
must apply their judgment. In applying their judgment, auditors are likely to consider the costs and
benefits of alternative reporting options to themselves, the financial statement users, and the company in
deciding how to classify the item. Auditors are normally better off by having events recorded in the
most conservative manner. In this case, the most conservative manner of recording the stock would be
to classify it as debt. Classifying the stock in this way decreases the probability that financial statement
users will suffer out-of-pocket losses and be able to sue the auditors. Consequently, the auditors would
probably prefer that the stock be classified as debt. It should be noted that some securities are such a
hybrid of debt and equity that GAAP requires such securities to be reported as neither debt nor equity.
Instead, GAAP requires such securities to be reported on the balance sheet in a special section between
long-term debt and stockholders' equity.

P12–2
a. The balance in the Common Stock account represents the number of shares of common stock issued
times the par value per share. Since the balance of $300,000 represents 50,000 shares, the par value per
share must be $6.

b. Book Value = (Total Stockholders' Equity – Contributed Capital from Preferred

Stockholders) ÷ Number of Common Shares Outstanding
= [($840,000 – $300,000) - $50,000] ÷ 45,000 Shares
= $10.89
P12–2 Concluded
c. Since 50,000 shares have been issued, and only 45,000 shares are outstanding, 5,000 shares are held in
treasury. The balance of $40,000 in treasury stock represents the cost of these 5,000 shares.
Consequently, the average price of the treasury stock was $8.

d. If the company reissues the treasury stock at $10 per share, stockholders' equity would increase by
$50,000 and the company would make the following entry.

Cash (+A).................................................................................................... 50,000

Treasury Stock (+SE)........................................................................... 40,000
Additional Paid-In Capital, Treasury Stock (+SE).............................. 10,000
Reissued treasury stock.

Debt/equity ratio
The company's debt/equity ratio is calculated as Total Debt ÷ Total Stockholders' Equity. This ratio
would decrease, because the numerator would be unchanged, while the denominator would increase.

Book value
The book value is calculated as Total Common Stockholders' Equity ÷ Number of Common Shares
Outstanding. In this case, the numerator would increase by $50,000, and the denominator would
increase by the 5,000 shares reissued. The book value would now be $10.80 [($540,000 – $50,000 +
$50,000) ÷ (45,000 + 5,000)]. Since the book value prior to the reissue was $10.89 (see part b), the
company's book value would decrease.

Earnings per share

Earnings per share is calculated as Net Income ÷ Number of Common Shares Outstanding. If the
company did not reissue the stock, its EPS would be $1 per share ($45,000 ÷ 45,000 shares).
The reissue of treasury stock has no effect on net income, but it does increase the number of common
shares outstanding. So the company's EPS would decrease. Its EPS would now be $0.90 per share
[$45,000 ÷ (45,000 + 5,000)].

P12–3
(1) Cash (+A)................................................................................................. 500,000
Common Stock (+SE)....................................................................... 500,000
Issued common stock.

(2) Cash (+A)................................................................................................. 400,000

Common Stock (+SE)....................................................................... 10,000
Additional Paid-in Capital, Common Stock (+SE).......................... 390,000
Issued common stock.

(3) Cash (+A)................................................................................................. 300,000

Common Stock (+SE)....................................................................... 100,000
Additional Paid-in Capital, Common Stock (+SE).......................... 200,000
Issued common stock.

P12–3 Concluded
(4) Cash (+A)................................................................................................. 400,000
 Preferred Stock (+SE)...................................................................... 400,000
Issued preferred stock.

b. Par value has accounting significance only in that it is used to determine the amount that is allocated
to the paid-in capital accounts associated with common stock or preferred stock accounts when stock
is issued. Economically, par value has little significance. Par values were initially established to
protect creditors. Par value represents the amount that stockholders are liable to creditors. However,
because par values are usually very small amounts, such as $1.00 or even $0.01 and because debt
covenants now exist to protect creditors, par value no longer has much economic significance.

P12–4
a. Dividends are paid only on the shares that are both issued and outstanding. In this case, 55,000 shares
have been issued, but 8,000 of these shares are held as treasury stock. Thus, only 47,000 shares are
eligible to receive a dividend.

b. Date of declaration
Cash Dividend (–SE).................................................................................. 705,000
Dividend Payable (+L)......................................................................... 705,000
Declared divided.

Date of record
No journal entry is necessary.

Date of payment
Dividend Payable (–L)................................................................................ 705,000
Cash (–A)............................................................................................. 705,000
Paid dividend.

c. Stock Dividend (–SE)................................................................................. 235,000a

Common Stock (+SE).......................................................................... 47,000b
Additional Paid-in Capital, Common Stock (+SE)............................. 188,000
Declared and issued stock dividend.

a $235,000 is calculated as follows:

1. Number of Shares to Be Distributed = Number of Shares Outstanding  10%
= 47,000  10% = 4,700 Shares
2. Value of Dividend = $50 Fair Market per Share  4,700 Shares to Be Distributed
b $47,000 = 4,700 shares to be distributed  par value of $10 per share

d. The overall impact of cash dividends is a decline in the Retained Earnings account. Since retained
earnings is a part of equity, the debt/equity ratio will increase. Issuance of stock dividends results in no
change in the overall stockholders’ equity of the company. However, the balance in the retained
earnings account goes down and common stock and additional paid-in capital account balances go up.
Thus, the debt/equity ratio remains unchanged after the issuance of stock dividends.
P12–4 Concluded
e. Stockholders would generally prefer a cash dividend over a stock dividend. Assume that you own 1,300
shares of Royal Company's common stock prior to any dividend. Since there are 47,000 shares
outstanding, you own 3% of the company. In addition, since each share is worth $50, the total value of
your investment is $65,000. Since the company's financial position would not be expected to improve or
worsen simply from declaring a stock dividend, the total value of your investment should still be worth
$65,000. Thus, it appears that receiving a stock dividend has not improved your wealth. To the extent
that Royal Company cannot declare and pay dividends in excess of its balance in Retained Earnings, a
stock dividend may even decrease your wealth. By declaring a stock dividend, Royal Company has
capitalized part of Retained Earnings, which means that it will never be available for cash dividends.
Alternatively, with a cash dividend you would receive something of value, namely cash, while still
maintaining a 3% ownership interest in the company. The trade-off, however, is that the value of the
company would decrease by the value of the cash dividend.

P12–5

a. Each preferred stockholder is entitled to 10% of the par value, or $5.00. Thus, the 15,000 preferred
stockholders are entitled to a total of $75,000 in any particular year.

Total Preferred Common Preferred Common

Year Dividends Dividends Dividends per Share per Share
2009 $ 65,000 $65,000 $ 0 $4.33 $0.00
2010 100,000 75,000 25,000 5.00 0.50
2011 70,000 70,000 0 4.67 0.00
2012 50,000 50,000 0 3.33 0.00
2013 125,000 75,000 50,000 5.00 1.00
2014 110,000 75,000 35,000 5.00 0.70
2015 99,000 75,000 24,000 5.00 0.48

b. Total Common Preferred Common

Year Dividends Preferred Dividends Dividends per Share per Share
2009 $ 65,000 $65,000 (for 2009) $ 0 $4.33 $0.00
2010 100,000 10,000 (for 2009) 15,000 5.67 0.30
75,000 (for 2010)
2011 70,000 70,000 (for 2011) 0 4.67 0.00
2012 50,000 5,000 (for 2011) 0 3.33 0.00
45,000 (for 2012)
2013 125,000 30,000 (for 2012) 20,000 7.00 0.40
75,000 (for 2013)
2014 110,000 75,000 (for 2014) 35,000 5.00 0.70
2015 99,000 75,000 (for 2015) 24,000 5.00 0.48
P12–6
a. The maximum cash dividend that Cotter Company could declare given its current financial position is
$25,000. This amount represents the cash that the company currently has on hand. If the company wants
to declare a larger cash dividend, it would either have to sell some of its assets or borrow cash, thereby
changing its financial position.

b. In most states a company can not legally declare a dividend that exceeds the balance in Retained
Earnings. Since Cotter Company has a balance in Retained Earnings (after closing entries) of $288,000,
this amount is the maximum amount that the company could legally declare as a stock dividend. To be
considered an ordinary stock dividend, however, the stock dividend cannot exceed 20% to 25% of the
common shares already outstanding. The company's common stock is currently selling for $40 per
share, which means that the company could distribute an additional 7,200 common shares ($288,000 ÷
$40 per share) in a stock dividend. Since the 7,200 shares represent only 14.4% of the 50,000 shares
already outstanding, the distribution of the 7,200 shares would be considered an ordinary stock
dividend.

c. Cash Dividend
Cash Dividend (–E).................................................................................... 25,000
Cash (–)................................................................................................ 25,000
Declared and paid cash dividend.

Stock Dividend
Stock Dividend (–E).................................................................................... 288,000
Common Stock (+SE).......................................................................... 72,000
Additional Paid-In Capital, Common Stock (+SE)............................. 216,000
Declared and issued stock dividend.

d. If Cotter Company sold its marketable securities, it would receive the market value of $50 per share.
Since Cotter Company owns 2,500 shares, it would receive $125,000. Combining this $125,000 with the
$25,000 of cash already on hand would allow Cotter Company to declare and pay a cash dividend of
$150,000.

P12–7
a. Stevenson Enterprises would make the following journal entry for the stock dividend.

Stock Dividend (–SE)................................................................................. 150,000*

Common Stock (+SE).......................................................................... 36,000
Additional Paid-In Capital, Common Stock (+SE)............................. 114,000
Declared and issued 10% stock dividend.

* $150,000 = (60,000 shares outstanding  10%)  $25 per share

P12–7 Continued
 Stockholders’ equity:
Common stock ($6 par value, 650,000 shares authorized,
76,000 shares issued, 66,000 shares outstanding, and
10,000 shares held as treasury stock).................................................. $ 456,000
Additional paid-in capital (C/S).................................................................. 639,000
Retained earnings........................................................................................ 545,000
Treasury stock............................................................................................. (100,000)
Total stockholders' equity........................................................................... $ 1,540,000

b. If Stevenson Enterprises declares a 2-for-1 stock split, no journal entry is necessary.

Stockholders’ equity:
Common stock ($3 par value, 1,300,000 shares authorized,
140,000 shares issued, 120,000 shares outstanding, and
20,000 shares held as treasury stock).................................................. $ 420,000
Additional paid-in capital (C/S).................................................................. 525,000
Retained earnings........................................................................................ 695,000
Treasury stock............................................................................................. (100,000)
Total stockholders' equity........................................................................... $ 1,540,000

c. If Stevenson Enterprises declares the stock dividend and then a stock split, the only journal entry the
company would have to make would be the journal entry given in Part (a).

Stockholders’ equity:
Common stock ($3 par value, 1,300,000 shares authorized,
152,000 shares issued, 132,000 shares outstanding, and
20,000 shares held as treasury stock).................................................. $ 456,000
Additional paid-in capital (C/S).................................................................. 639,000
Retained earnings........................................................................................ 545,000
Treasury stock............................................................................................. (100,000)
Total stockholders' equity........................................................................... $ 1,540,000

d. Stevenson Enterprises does not need to prepare any journal entry for the stock split. If Stevenson
Enterprises subsequently declares and pays a 10% stock dividend, the company would have to make the
following entry.

Stock Dividend (–SE)................................................................................. 150,000a

Common Stock (+SE).......................................................................... 36,000b
Additional Paid-In Capital, Common Stock (+SE)............................. 114,000
Declared and issued 10% stock dividend.

a $150,000 = [(60,000 shares initially outstanding + 60,000 shares issued in stock

split)  10%]  $12.50 per share
b $36,000 = 12,000 new shares issued  $3 par value per share

P12–7 Concluded
 Stockholders’ equity:
Common stock ($3 par value, 1,300,000 shares authorized,
152,000 shares issued, 132,000 shares outstanding, and
20,000 shares held as treasury stock).................................................. $ 456,000
Additional paid-in capital (C/S).................................................................. 639,000
Retained earnings........................................................................................ 545,000
Treasury stock............................................................................................. (100,000)
Total stockholders' equity........................................................................... $ 1,540,000

P12–8

a. 2011 Dollar Amount / Shares = Average price

Exercised stock options $312.5 17.3 $ 18.06

Sale of common stock 19.1 0.5 $ 38.20

Repurchase of stock 555.9 15.6 $ 35.63

$887.5 33.4 $ 26.57

2012

Exercised stock options $ 326.1 16.5 $ 19.76

Sale of common stock 19.5 0.3 $ 65.00

Repurchase of stock 501.9 12.3 $ 40.80

$847.5 29.1 $ 29.12

b. The common stock shares were issued at a higher price than the options. Stock options typically have a
life of 5-10 years. So it is very likely that the stock options that were exercised this year were granted
in previous years. If the stock price has risen over the last few years then the options would have been
granted at lower prices in previous years.

The trend in the stock price from 2011 to 2012 has been up rather significantly.

P12–9
a. (1) Treasury Stock (–SE)...................................................................... 1,000
Cash (–A)................................................................................. 1,000
Purchased treasury stock.

(2) Cash (+A)........................................................................................ 3,800

Preferred Stock (10%) (+SE)................................................... 2,000
Additional Paid-In Capital, 10% Preferred Stock (+SE)........ 1,800
Issued preferred stock.

(3) Cash (+A)........................................................................................ 660

Treasury Stock (+SE)............................................................... 360
Additional Paid-In Capital, Treasury Stock (+SE).................. 300
Reissued treasury stock.

(4) 10% Preferred Cash Dividend (–SE).............................................. 400a

12% Preferred Cash Dividend (–SE).............................................. 180
Common Stock Cash Dividend (–SE)............................................ 170
Dividends Payable (+L)........................................................... 750
Declared cash and stock dividend.

a Cumulative preferred dividends are paid first. Since no dividends have been paid since 2013,
dividends in arrears in the amount of $200 (2 years of 10% of par value) on the 10% cumulative
Preferred stock must be paid before any dividends can be paid on any other shares. The new shares
of the 10% issue also receive dividends on a priority basis. The $750 payment goes to the cumulative
shares first, with the remainder spread over the other preferred issue and then the common shares.

(5) Dividends Payable (–L).................................................................. 750

Cash (–A)................................................................................. 750
Paid and issued dividend.

(6) No journal entry is needed. A memorandum entry should be made stating that the company's
common stock now has a par value of $.50 per share and that 7,000 shares are now issued and
840 shares [after the events underlying entries (1) and (3)] are held in treasury.
P12–9 Concluded

b. Preferred stock (10%, $10 par value, cumulative)..................................... $ 3,000

Preferred stock (12%, $10 par value, noncumulative)............................... 1,500
Common stock ($0.50 par value, 10,000 shares authorized,
7,000 shares issued, and 840 shares held in treasury)......................... 3,500
Additional paid-in capital:
Preferred stock (10%).......................................................................... 2,850
Preferred stock (12%).......................................................................... 1,275
Common stock...................................................................................... 2,345
Treasury stock...................................................................................... 300
Retained earnings........................................................................................ 4,405*
Treasury stock ($5,750 + $1,000 - $360)................................................... (6,390)
Total stockholders' equity........................................................................... $ 12,785

* $4,405 = $4,256 – $750 (dividends declared) + $899 (net income)

P12–10
a. Number of Shares Issued = Increase in Par Value ÷ Par Value per Share
= ($200,000 – $110,000) ÷ $100 per Share
= 900 Shares

Average Issue Price = Increase in Contributed Capital ÷ Number of Shares

= (Increase in Par Value + Increase in Additional Paid-in Capital) ÷
900 Shares
= [($200,000 – $110,000) + ($150,000 – $35,000)] ÷ 900
Shares
= $227.78 per Share

b. Number of Shares Issued = ($900,000 – $750,000) ÷ $10 per Share

= 15,000 Shares

Average Issue Price = [($900,000 – $750,000) + ($465,000 – $298,000)] ÷

15,000 Shares
= $21.13 per Share

c. Treasury Stock (–SE).................................................................................. 110,000

Cash (–A)............................................................................................. 110,000
Purchased treasury stock.

Average Repurchase Price = Total Repurchase Price ÷ Number of Shares Held in Treasury
= $110,000 ÷ 5,000 Shares Held in Treasury
= $22.00 per Share
P12–10 Concluded
d. Book value equals total common stockholders' equity divided by the total number of common shares
outstanding. To determine total common stockholders' equity prior to the acquisition of the treasury
stock, the value of the 5,000 shares of treasury stock must be added back to total stockholders' equity,
and the 5,000 shares of treasury stock must be considered to be outstanding. Thus, prior to the
acquisition of the treasury stock, the book value of outstanding common shares was:

Total Common Stockholders Equity ÷ Number of Common Shares Outstanding

= [(Total Stockholders' Equity + Treasury Stock) – Preferred Stock – Additional Paid-In Capital,
Preferred Stock] ÷ Number of Common Shares Outstanding
= ($2,180,000 + $110,000) – $200,000 – $150,000) ÷ 90,000 Shares
= $21.56 per Share

After the repurchase of the treasury stock, the book value of outstanding shares was $21.53 per share
($1,830,000 ÷ 85,000 shares outstanding). Thus, repurchasing the treasury stock decreased book value
per share by $0.03.

P12–11
a. Number of Shares Issued = Change in Total Par Value ÷ Par Value per Share
= ($110,000 – $70,000) ÷ $10 per Share
= 4,000 Shares

b. Average Issue Price = Cash Received ÷ Number of Shares Issued

= [Change in Total Par Value + Change in Additional Paid-In Capital,
Common Stock] ÷ 4,000 Shares [from part (a)]
= [($110,000 – $70,000) + ($625,000 – $500,000)] ÷ 4,000
Shares
= $41.25 per Share

c. Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

Declared – Treasury Stock Adjustments
$975,000 = $250,000 + $2,000,000 – Dividends Declared – 0*
Dividends declared = $1,275,000

* Since Additional Paid-in Capital, Treasury Stock increased during 2014, we know that, on average,
Tracey Corporation reissued the treasury stock for more than what it paid for the stock. Since
Retained Earnings is adjusted for treasury stock transactions only when the stock is reissued for less
than its acquisition cost, there is no treasury stock adjustment to Retained Earnings during 2014.

d. Total dividends declared = $1,275,000 [from Part (c)]

Dividends to Preferred Stockholders = Dividends in Arrears + Current Dividends =

Dividends for 2013 + Dividends for 2014
= ($400,000  10%) + ($400,000  10%)
= $80,000

Dividends to Common Stockholders = Total Dividends – Dividends to Preferred

= $1,275,000 – $80,000
= $1,195,000
P12–11 Concluded
e. Treasury Stock (–SE).................................................................................. 105,000
Cash (–A)............................................................................................. 105,000
Purchased treasury stock.

f. Cash (+A).................................................................................................... 90,000

Treasury Stock (+SE)........................................................................... 21,000
Additional Paid-in Capital, Treasury Stock (+SE).............................. 69,000
Reissued treasury stock.

g. Reissue Price per Share = Cash Received ÷ Number of Shares Reissued

= $90,000 [from part (f)] ÷ 300 Shares*
= $300.00 per Share

* The 300 shares reissued is computed as follows:

1. Cost of shares = $105,000 ÷ 1,500 shares = $70 per share
2. Number of shares reissued = Change in treasury stock balance ÷ $70 per share
= ($105,000 – $84,000) ÷ $70 per share
= 300 shares

P12–12
a. (1) Cash (+A)........................................................................................ 750,000
Common Stock (+SE).............................................................. 300,000
Additional Paid-in Capital, Common Stock (+SE)................. 450,000
Issued common stock.

(2) Stock Dividend (–SE)..................................................................... 90,000*

Common Stock (+SE).............................................................. 30,000
Additional Paid-in Capital, Common Stock (+SE)................. 60,000
Declared and issued 10% stock dividend.

* $90,000 = 50,000 shares outstanding  10%  $18 per share

(3) Cash (+A)........................................................................................ 1,320,000

Common Stock (+SE).............................................................. 360,000
Additional Paid-in Capital, Common Stock (+SE)................. 960,000
Issued common stock.

(4) Treasury Stock (–SE)...................................................................... 375,000

Cash (–A)................................................................................. 375,000
Purchased treasury stock.

(5) Cash (+A)........................................................................................ 135,000

Treasury Stock (+SE)............................................................... 125,000
Additional Paid-in Capital, Treasury Stock (+SE).................. 10,000
Reissued treasury stock.

(6) The company should make a memorandum entry stating that par value is now $2 per share and
the total number of shares issued is now 345,000 shares, of which 315,000 shares are
outstanding and 30,000 shares are held in treasury at an adjusted cost of $8.33 per share.
P12–12 Concluded
(7) Cash (+A)........................................................................................ 80,000
Treasury Stock (+SE)............................................................... 66,640*
Additional Paid-In Capital, Treasury Stock (+SE).................. 13,360
Reissued treasury stock.

* $66,640 = 8,000 shares  Adjusted acquisition price of $8.33 per share

(8) Cash Dividend (–SE)...................................................................... 50,000

Dividend Payable (+L)............................................................. 50,000
Declared a cash dividend.

(9) Dividend Payable (–L).................................................................... 50,000

Cash (–A)................................................................................. 50,000
Paid cash dividend.

(10) Cash (+A)........................................................................................ 30,000

Treasury Stock (+SE)............................................................... 16,660*
Additional Paid-In Capital, Treasury Stock (+SE).................. 13,340
Reissued treasury stock.

* $16,660 = 2,000 shares  Adjusted acquisition price of $8.33 per share

b. Common stock ($2 par value, 1,000,000 shares authorized,

345,000 shares issued, and 20,000 shares held in treasury)............... $690,000
Additional paid-in capital:
Common stock...................................................................................... 1,470,000
Treasury stock...................................................................................... 36,700
Retained earnings........................................................................................ 480,000a
Treasury stock............................................................................................. (166,700)b
Total stockholders' equity........................................................................... $ 2,510,000

a $480,000 = Cumulative net income – Cumulative declared dividends

= ($400,000 + $100,000 + $100,000 + $20,000) – [$90,000 from
entry (2) + $50,000 from entry (8)]
b $166,700 = $375,000 [from entry (4)] – $125,000 [from entry (5)] – $66,640
[from entry (7)] – $16,660 [from entry (10)]

P12–13
a. Only investors of shares that are both issued and outstanding are eligible to vote to elect a board of
directors. If the current board could reduce the number of shares held by investors other than
themselves, then they would control a greater proportion of the shares outstanding and could decrease
the probability that Vadar, Inc., would take over Edmonds. One way that the board could consolidate its
ownership position is to reacquire the company's common stock from other investors.
P12–13 Concluded
If the current board could consolidate its ownership so that it controlled 50% plus one share of the
outstanding shares, they could completely block Vadar, Inc.'s takeover attempt. In this particular case,
the current board members own 140,000 shares (35%  400,000 shares outstanding). To allow the
board to completely control the company without the board members personally acquiring any
additional shares, the total number of shares outstanding could not exceed 279,999 [(140,000 shares 
2) – 1 share]. Since 260,000 shares are currently held by non-board investors, and the non-board
members can control a total of only 139,999 shares (279,999 shares – 140,000 shares held by board
members), the company would have to repurchase 120,001 shares of the company's stock.

b. The company will need to pay $50 per share for 120,001 shares [from part (a)]. Consequently, the
company will need at least $6,000,050 in cash. Edmonds currently has insufficient cash to repurchase
all 120,001 shares. If the board wants to block Vadar's takeover attempt by repurchasing some of its
common stock, the company will have to borrow additional cash.

c. Assets Liabilities and Stockholders' Equity

Cash $ 1,149,950* Liabilities $ 5,250,000
Other current assets 4,200,000 Common stock 8,000,000
Noncurrent assets 8,220,000 Retained earnings 6,320,000
Less: Treasury stock (6,000,050)
Total liabilities and
Total assets $ 13,569,950 stockholders' equity $ 13,569,950

* $1,149,950 = $3,150,000 cash on hand + $4,000,000 cash borrowed –$6,000,050 cash paid out for
stock

d. Debt/Equity Ratio = Total Liabilities ÷ Total Stockholders' Equity

Before
$1,250,000 ÷ ($8,000,000 in Common Stock + $6,320,000 in Retained Earnings) = .087

After
$5,250,000 ÷ ($8,000,000 in Common Stock + $6,320,000 in Retained Earnings – $6,000,050 in
Treasury Stock) = .631

The purchase of the treasury stock had a large effect on the company's financial position, as evidenced
by the large increase in the company's debt/equity ratio. The actual purchase of the treasury stock
reduced Edmonds' stockholders' equity by the value of the stock purchased. Since Edmonds financed
the purchase by issuing debt, the purchase directly increased Edmonds' long-term debt by the
$4,000,000 borrowed.
P12–14
a. Loss on Write-Down of Fixed Assets (Lo, –SE)....................................... 50,000
Fixed Assets (–A)................................................................................. 50,000
Wrote down obsolete fixed assets.

b. Alternative 1
Cash (+A).................................................................................................... 650,000
Current Assets (–A)............................................................................. 200,000
Fixed Assets (–A)................................................................................. 450,000
Liquidated assets.

Cash Dividends (–SE)................................................................................ 250,000

Cash (–A)............................................................................................. 250,000
Declared and paid cash dividend.

Liabilities (–L)............................................................................................ 400,000

Cash (–A)............................................................................................. 400,000
Repaid liabilities.

Alternative 2
Cash (+A).................................................................................................... 650,000
Current Assets (–A)............................................................................. 200,000
Fixed Assets (–A)................................................................................. 450,000
Liquidated assets.

Cash Dividends (–SE)................................................................................ 400,000

Cash (–A)............................................................................................. 400,000
Declared and paid cash dividend.

Liabilities (–L)........................................................................................... 250,000

Cash (–A)............................................................................................. 250,000
Repaid liabilities.

Alternative 3
Cash (+A).................................................................................................... 650,000
Current Assets (–A)............................................................................. 200,000
Fixed Assets (–A)................................................................................. 450,000
Liquidated assets.

Treasury Stock (–SE).................................................................................. 250,000

Cash (–A)............................................................................................. 250,000
Purchased treasury stock.

Liabilities (–L)............................................................................................ 400,000

Cash (–A)............................................................................................. 400,000
Repaid liabilities.
P12–14 Concluded
Alternative 4
Cash (+A).................................................................................................... 650,000
Current Assets (–A)............................................................................. 200,000
Fixed Assets (–A)................................................................................. 450,000
Liquidated assets.

Treasury Stock (–SE).................................................................................. 650,000

Cash (–A)............................................................................................. 650,000
Purchased treasury stock.

c. In the event of a liquidation, creditors have the first claim on the company's assets. Consequently,
obligations to creditors should be settled in full before the stockholders receive any residual assets. In
alternatives (2) and (4), the board of directors has proposed circumventing the law and has planned to
distribute assets to the stockholders first and then distribute the residual assets, if any, to the creditors.
The creditors could sue the company and probably force the stockholders to return the "excess"
dividends, which would then be used to satisfy the creditors' claims.
 ISSUES FOR DISCUSSION

ID12–1
a. A 100% stock dividend effectively means that the number of shares will be doubled. Therefore, if
149.5 million shares were outstanding before the stock dividend, then 299 million shares were
outstanding after the dividend.

b. Stock Dividend (–SE).............................................................................. 149,500a

Common Stock (+SE)....................................................................... 149,500
Declared and issued stock dividend.

a Because the stock dividend can be considered a 2:1 stock split par value for the 149.5 million
shares is used.

c. Total Value of Hershey = Number of Shares Outstanding  Market Value per Share
= 149.5 Million Shares  $46 per share = $6.877 Billion

Post dividend Value/Share = Total Value of Hershey ÷ Number of Shares Outstanding

= $6.877 Billion ÷ 299 Million Shares = $23 per Share

d. Prior to the stock dividend, Mr. Jones owned .669% of Hershey (1 million shares ÷ 149.5 million shares
outstanding), and Mr. Jones' investment was worth $46 million (1 million shares  $46 market value per
share). After the stock dividend, Mr. Jones would own 2,000,000 shares, and the total number of shares
outstanding would increase to 299 million shares. Thus, Mr. Jones would still own .669% of Hershey (2
million ÷ 299 million shares outstanding). Because the market price would be expected to drop to $23
per share [see part (c)], Mr. Jones' investment would still be worth approximately $46 million. Thus,
neither the percentage of shares owned nor the total value of an equity investment would be expected to
be affected by a stock dividend, provided that the market price decreases proportionately to the increase
in the number of shares outstanding.

e. As demonstrated in part d, a stock dividend does not represent an economic exchange between a
corporation and its shareholders. A stock dividend merely splits the shareholders’ interests into smaller
pieces. The total value of the company and its assets and liabilities remain unchanged.

f. A company may issue a stock dividend for several reasons. These reasons could include wanting to give
the appearance of paying a dividend when there is limited cash on hand, wanting to decrease the market
price of the shares outstanding, or wanting to expand the number of shares outstanding without selling
new stock.

ID12–2
There are two general situations that would lead a company to cut its dividend. The first scenario is when a
company is no longer able to generate enough cash to pay the dividend that it has been paying in the past.
This usually reflects a downturn in the company’s business and the stock price does not act well after this
announcement. The second scenario is when a company has been paying a dividend and is still generating
enough cash to pay the dividend but decides not to. This is usually because the company feels that it has
very good investment opportunities and wants to use the money to pursue them. This is usually a positive
sign and the stock price may rise.
ID12–3
Since the stock price of a company is affected by the expected future cash inflows due to dividend payments
and capital appreciation, the price of Philip Morris (now known as Altria Group) stock rose in response.
After the $6 billion stock buy-back is completed, the company will have fewer shares outstanding in the
market, and it will increase the future EPS and the book value of the company’s stock.

Further, the company is raising the quarterly dividend by almost 20%, which means higher-cash inflow to
the existing shareholders. All of these are positive signs and would lead to an increase in the price of Philip
Morris’s common stock.

However, the company’s credit rating will go down, primarily due to the fact that after paying an increased
dividend and executing a $6 billion stock buy-back plan, Philip Morris may be low on cash, which could
affect its short-term solvency position. Therefore, the rating agencies would perceive Philip Morris as a
risky company. The higher the risk, the lower the credit rating.

ID12–4
a. Companies could use their cash to invest in the latest technology to improve the productivity of their
manufacturing operations. Companies could use their excess cash to perform research and development
to find new products for their markets. Companies could use their excess cash to acquire other
companies to take advantage of economies of scale as a larger entity with less competition. Companies
could use their cash to repay debt to lower interest costs and improve their performance during cyclical
downturns.

If any of the above alternate uses of cash increase the profitability and cash flow of the company, the
shareholders benefit through capital appreciation (an increased stock price, for example), as well as the
potential increase in dividend payments made possible by the improved performance of the company.
If the alternate use of cash also improves the company’s standing in its industry, and positions it for
future success, the shareholders benefit from the improve long term prospects of the company.

b. Fewer shares in the market would imply that the market capitalization per share is higher, driving up the
stock price. If the company’s performance (profitability, cash flow, leverage, etc.) is not changed but
there are fewer shares of ownership, then each share would command a higher price as the total value
of the company is divided among the equity providers. Driving up the share price strictly by reducing
the number of shares outstanding is an artificial change as the company itself is no different.

c. A company purchasing its own stock is in essence no different than an investor purchasing stock in the
company. “Buy low, sell high” makes sense for any investor. If, due to current market levels, the stock
price is high, there is always the risk that the buyer—the company in this case—would be buying high
with the possibility that a market correction could drive the stock price down to low levels. The
company, similar to any investor, would then be holding a stock with a market value below the cost paid
to acquire the stock. If a company’s stock is at a historically low point, repurchasing stock does not
pose the same risk. However, if the stock price is very high, the possibility exists that the company
would be purchasing an asset that will drop in value.

ID12–5

a. A hybrid security carries some of the properties of debt and some of the properties of equity. A
determination must be made as to which properties dominate the characteristics of the security. If it
is determined that the hybrid carries mainly equity characteritists, then it should be reported in the
 Stockholders’ Equity section of the Balance Sheet and should not affect the Income Statement. In
either case, the hybrid security will be treated in the Financing Activities section of the Statement of
Cash Flow. On the other hand, if the debt characteristics dominate, then the security should be
classified as a liability on the Balance Sheet and will affect the Income Statement.

b. Equity securities typically carry more risk than debt securities but consequently offer higher rates of
return. If an investor was interested in accepting more risk than offered by a debt security, but
required more of a return to justify that risk, then the investor might have an interest in a hybrid
security. If the risk profile of a pure equity security was too great for the investor, but the returns
offered by debt securities insufficient for the investor’s needs, then a hybrid security would offer a
perfect compromise. A company might be interested in offering a hybrid security if it did not want
to give up all that would be required by a traditional equity security or if it had no additional
capacity to raise funds through traditional debt securities. An issue of preferred stock, for example,
would allow the company to raise financing without giving up the voting rights associated with
common stock; further, if the company could borrow no additional money from its banks and the
capital markets, the preferred stock issue might be marketable as it would not carry the interest
payments required each year under a debt issue.

c. Characteristics associated with debt include a higher priority toward receiving payments in case of a
company liquidation and some type of fixed requirement of periodic payments. Characteristics
associated with equity include a vote for the directors of the company and no fixed maturity date for the
financial arrangement.

ID12–6
The case describes a typical scenario that usually occurs while enforcing the debt covenant restrictions.
Many times such agreements or decrees explicitly specify how changes in the key performance indicators
will be treated due to an unanticipated change in the accounting standards. In the current case it is not clear
whether any such clause exists that deals with the effect of change in net worth due to an unforeseen
accounting standard.

From the perspective of an executive of Westinghouse, the company should not be forced to place the $325
million in the escrow account due to the following reasons: (1) Westinghouse’s net worth dipped below $1.9
billion due to a new method of accounting mandated by FASB. The decline was entirely due to factors
beyond Westinghouse’s control. (2) The new method of accounting merely creates an additional expense
and an additional liability on the books of the company. It does not impact the current cash flow situation.
Therefore, there is no change in the economic situation of Westinghouse. Therefore, it should not be
subjected to setting aside $325 million in an escrow account.
From the perspective of a representative of the federal government, Westinghouse should place $325
million in an escrow account. The terms of the decree are very clear, which say that if the company’s net
worth falls below $1.9 billion, it should place $325 million in an escrow account. As

P12–6 Concluded

a federal government representative, he has to ensure that the terms of the decree are complied with.
From the perspective of a resident of Bloomington, Indiana, Westinghouse should place $325 million in an
escrow account to build the incinerator to destroy the PCB-Contaminated materials. As a resident, one must
be very concerned about the impact of PCB-contaminated materials on the health and safety of the town’s
residents as well as the impact on the town’s environment. Several unanticipated factors may occur that may
be out of the company’s control. These risks are inherent in doing business. The company has no right to
transfer those risks to the community by not complying with the decree.
Further, technically, the company was always liable for employee retirement costs, but it ignored that
liability by adopting a liberal accounting policy of a pay-as-you-go basis. It is only fair that Bloomington,
Indiana wants to ensure that the company pays for the hazardous waste cleanup, irrespective of the games
that the company can play with the accounting numbers.

ID12–7
c. An investor can make a return through 1) capital appreciation (the stock moving up in value), 2) receipt
of cash dividends from the company, or 3) both capital appreciation and dividends.

d. Companies that pay dividends are not necessarily under the same pressure to improve earnings and cash
flow as companies who opt not to pay dividends. Investors who are confident they can rely on a steady
stream of dividends are less likely to pressure management to take steps to continually boost future cash
flows to drive the stock price ever higher. Companies, on the other hand, who reinvest all earnings in
their operations must provide a return to their shareholders in the form of higher stock prices; these
companies will be under the gun to continually improve operations, grow their businesses, and improve
cash flow and earnings in order to move the stock price.

e. Investors will monitor sales, profits and earnings-per-share on the income statement, as well as cash
flow from operations on the statement of cash flows. In addition to financial statement clues, investors
can look for industry information, such as market share and consumer surveys to predict future financial
results for the company.

ID12–8
a. Book value of a stock is simply the equity on the balance sheet divided by the number of equity shares
outstanding. This figure is driven by Generally Accepted Accounting Principles. Market value is the
value placed on a share of stock by all the buyers and sellers in the free market. This figure is driven by
company results, but it is also influenced by factors such as general macroeconomic trends, stock
market trends, and very often the subjective mood of investors.
b. The price-to-book ratio is the market price (per share) divided by the book value (per share). Prior to
the buyout offer, the price-to-book ratio of Dow Jones was 6.0 ($36 per share divided by $6 per share).
After the buyout offer, the ratio jumped to 9.8 ($58.60 per share divided by $6 per share).

ID12–8 Concluded
c. Two reasons might explain the high offer for Dow Jones. First, News Corporation might see some
specific synergies of operation between its media businesses and those of Dow Jones (including the
Wall Street Journal and the popular WSJ website); the combined businesses might be worth more to
News Corporation than they would be to other investors. Other investors might only see $36 in value
based on the projected cash flow of Dow Jones, but News Corporation might see $60 in value because
of future business plans combining and growing the two companies together. Secondly, many market
watchers speculated that News Corporation offered such a premium for Dow Jones simply to scare off
other potential buyers in order to make the deal close faster. And, in retrospect, since no other bidders
emerged, the $60 strategy may have been a sound approach to the acquisition.
d. External events (such as technological change) can cloud the future for companies and, since stock
prices are driven by valuing a company’s future, affect the stock valuation. When events beyond the
control of management change the prospects for a business, the market will react by pricing in those
expected changes. If the internet will drive advertisers away from traditional newspapers, the future
cash flow of those newspapers will drop; the market reacts by simply pricing the stock today in
anticipation of those lowered expectations.

ID12–9
a. “Net” proceeds mean the actual cash received by the company after commissions to underwriters
and expenses are paid. “Gross” proceeds would equal all the cash paid by investors buying the
offered shares.

b. Dividing the proceeds by the number of shares issued indicates that the stock price has been
climbing rapidly. The proceeds per share issued climbed from $68.29 to $287.72 and then leveled
off at $268.05 for the three years shown.

c. Google has been one of the major success stories for companies going public in the last decade. As
internet traffic has increased, Google has captured a dominant share in search engine activity. The
company’s business model sells advertising to companies, allowing the advertiser to directly target
internet users based on search requests. More searches will mean more advertising dollars to
Google. Technological changes and a very profitable business model have brightened the future for
Google. The stock market has reacted to those heightened expectations for cash flow and profits by
driving the stock price higher.

ID12–10
a. Both Rhodia and Segway issued equity because of losses that would be evident on the Income
Statement. The influx of funds would be evident in the Financing Activities section of the Statement of
Cash Flows. The Balance Sheet would also show an immediate increase in the Cash asset, but that
would soon be converted to other assets as the company employed the funds.

b. When companies issue new stock, the concept of ownership dilution must always be considered. If
Aventis wants to maintain its 15.3 percent ownership of Rhodia, it must purchase 15.3 percent of the
new shares issued. A large equity stake in another company, such as what Aventis has with Rhodia, is
purchased for strategic control reasons. If Aventis wants to continue to significantly influence the
operations of Rhodia, it must maintain its large ownership share in the company. If new shares are sold
to the public, and if Aventis does not purchase its pro rata share, its 15.3 percent ownership stake will
be diluted to something lower and Aventis’ influence might follow suit.
The original equity providers of Segway might have a similar interest in maintaining their control
position of that company. If they do, they will have to purchase the percentage of the $31 million
offering that matches their current ownership percentage in the company. However, if the investors are
not concerned with maintaining the amount of influence in the company, they do not need to buy into
the new offering.
c. Since both companies are experiencing profitability problems, before purchasing additional equity in
the companies, a sound investor would need to understand the steps taken by management to correct the
profitability problems. To assure that “good money was not chasing bad money”, a sound investor
would meet with management, discuss the causes of past problems, and come to a firm understanding of
and agreement with the remediation steps taken to restore the companies to profitability. Without
 sustained profits, no business can remain viable. A sound investor would need to believe that the
companies will soon be in a position to show that revenues exceed operating expenses.

ID12–11
a. A 4:1 stock split means that the corporation will replace every share of outstanding stock with 4 shares
of the stock. Because the corporation is simply splitting the ownership shares into smaller pieces,
declaring or issuing a stock split does not affect the dollar amounts Walt Disney would report in its
financial statements. However, a 4:1 stock split would result in (1) the number of shares of common
stock Disney had outstanding to increase by a factor of four and (2) the par value per share to drop to
25% of its pre-stock split value.

b. The stock market often views the declaration of a stock split as a positive signal about the corporation.
For example, the market often perceives a stock split as a signal from management that they believe that
they can maintain the price of the stock despite the stock split. In addition, some companies increase
their dividend per share soon after splitting their stock. Such positive signals, in turn, increase demand
for the company's stock, which drives up the price of the stock. In addition, stock splits would be
expected to cause the market price per share to drop once the stock split actually takes place to reflect
the additional shares of stock outstanding. The lower market price would make the stock more
affordable to more investors, which should increase demand for the stock and drive up the price.

c. Theoretically, the value of a company's stock equals the present value of the cash flows the stock
market expects an investor to generate from an equity investment in the company. Any information that
would cause the stock market to change its expectations--either positively or negatively—about the
future cash flows that would be realized from an investment would result in a change in the price of the
company's stock. Thus, if the market perceives the declaration of a stock split as positive new
information about the company's future prospects, as suggested by the quote from The Wall Street
Journal, then the market would be expected to use this information and increase the price of the
company's stock.

ID12–12

a. When a stock price is discussed in terms of a multiple of earnings, say 45 times, it simply means
that the market price per share is 45 times the size of the earnings per share. Or, every penny of
earnings is currently valued by the market at 45 cents. This “multiple” is often cited as a basis for
how over- or under-priced a stock is by the market. When stock markets highly value a stock, its
multiple will be very high (say 45 times), but when markets turn cold to a stock, that multiple drops,
meaning every penny of earnings is worth less to investors in the market.
b. A volatile market will challenge a company that is intent on repurchasing its own shares. As with
any investor, companies buying their own shares do not wish to overpay for their purchases. If a
volatile market exists and stock prices are jumping all around, the company with a committed
buyback program will be paying many different prices (some high, some low) for the shares it
repurchases.

c. Stock repurchases will reduce the company’s cash balances (affecting both liquidity and solvency)
and will lower the company’s equity base (increasing leverage). Subsequent stock re-issuances will
increase cash balances and equity levels, but the reissue price will determine if those equity levels will be
fully restored. If the stock is reissued for a lower price than the acquisition price, a permanent hit to equity
will occur (adjusted through Additional Paid In Capital, assuming APIC balances are sufficient). If, on the
other hand, the stock is re-issued for a higher price, then an increase in equity balances will occur.

d. Borrowing to repurchase shares has a double effect on a company’s leverage. The borrowing, of
course, increases the companies liabilities, while the Treasury Stock accounting decreases the
company’s equity levels. Both treatments (+L, -SE) increase a company’s leverage.
e. Reissuing Treasury Stock is considered to be a capital transaction and, as such, does not affect a
company’s income statement and its level of profitability.

ID12–13

a. Stock-based compensation expense is the expense related to the granting (and subsequent exercise)
of stock options to employees. If an employee is given the option to purchase shares of company
stock from the company, the cost of those shares to the company has to be included as a form of
compensation expense, just as cash paid to an employee for services rendered is considered
compensation expense. The calculation of the actual cost of the shares to the company is still
subject of much debate and controversy, but the fact that options are a form of compensation is
generally accepted.

b. As the shares are issued (or re-issued from treasury), the statement of stockholders’ equity must
reflect the change in shares outstanding. Since the options are now considered an expense, the
income statement is also affected, as is the statement of cash flows (and balance sheet) for any cash
received by the company when the options are exercised by the employee.

c. If the options were not considered an expense, Microsoft’s net income would have been
considerably higher in the years shown, so the expense is definitely material to the company. Net
income would have been higher by 11.6%, 8.5% and 11.4% for 2009, 2008 and 2007, respectively,
if the cost of the options had not been expensed.

d. Many companies resisted the expensing of options due to the negative effect the move would have
on earnings. Many start-up and technology companies relied heavily on stock options for employee
compensation. These companies knew that the large amount of options exercised by their
employees would dramatically increase expenses and reduce earnings.

ID12–14
The Statement of Stockholders’ Equity for Emerson Electric for three years is shown at the end of Chapter
12 in the textbook. Under the Retained Earnings section, the dividend history for 2010 – 2012 can be seen.
The company has consistently paid cash dividends in each of the years. On a per share basis, the dividend
payment is rising from 2010’s $1.34 per share to 2011’s $1.38 per share to 2012’s $1.60 per share. As a
percentage of net income, dividends represented 46.6% (2010), 41.9% (2011), and 59.5% (2012). The large
increase in percentage of earnings paid out in dividends in 2012 is driven by a slight increase in dividend
dollars but more so by the drop in dollar profits (from $2.48 billion to $1.97 billion).

In 2010, $100 million of shares were repurchased, but that amount grew to $958 million in 2011; in the
latest year the amount fell to $787 million. Even though the company is reissuing shares annually, due to
stock option plans, due to the size discrepancy of repurchases versus re-issues, the net effect is to remove
shares from the marketplace.

ID12–15
a. Companies can spend their cash balances on a number of areas: they can expand physical capacity,
they can acquire other businesses, they can invest in new technologies, they can pay cash dividends,
 or they can use their cash to repurchase their own shares. Companies that repurchase shares are
saying that the best use of cash to build value for the shareholder is to use that cash to reduce the
number of shares in the market. Companies that do not repurchase their shares feel that there is a
better use for cash balances, a better way to build value for the shareholder.

b. HP and Apple have been very successful companies, using cash balances to acquire other
businesses (HP) and to reinvest in new product launches (Apple). Bear Stearns, on the other hand,
was forced into a fire sale, selling itself to another financial services firm in order to avoid a
bankruptcy filing.

c. Companies can create wealth for shareholders by building and running successful businesses
(leading to higher share value), by paying cash dividends from strong earnings, and by repurchasing
stock from shareholders.

ID12–16
a. Net income is the difference between revenue and expenses for a given time period.
Comprehensive income includes net income but also includes any other changes to shareholders’
equity (such as unrealized gains/losses on available-for-sale securities and changes to currency
exchange rates).

b. Comprehensive income is for a given time period, such as a year, while accumulated other
comprehensive income is a running total of past comprehensive incomes. The difference between
comprehensive income and accumulated other comprehensive income can be thought of as the
difference between the income statement and the balance sheet: one is for a period of time while
the other is an accumulation as of a point in time.

c. Under U.S. GAAP, the information must be provided as either a separate statement or part of the
Statement of Shareholders’ Equity. Under IFRS, the information must be provided as a separate
statement or an extension of the Income Statement.

ID12–17
a.
As of 12/31/2012:
Liabilities ÷ Total Assets = 23.5%
Contributed Capital ÷ Total Assets = 9.1%
Retained Earnings ÷ Total Assets = 67.4%

b. Common Stock: 21 billion shares authorized and 654.874 million shares issued and outstanding.

c. Other than shares repurchased in an acquisition, the company spent no cash over the last three years on
either dividends or share buybacks.

f. Although preferred stock has been authorized, no shares have been issued.

g. For the year ending 12/31/2012 Google added back stock-based compensation expense of $2.7 billion.
This expense reduced earnings but has not yet cost the company cash, so the amount is added back in
the computation of cash from operations.

h. Over the time period, Google’s stock has traded from $474.88 per share to $768.05 per share.
i. The Statement of Cash Flows indicates that the company has issued debt in the last three years but not
equity. Footnote #12 indicates that shares granted in stock option plans have been exercised at an
average price of $305.81 in 2012.

j. Google’s accumulated other comprehensive income as of 12/31/2012 was $538 million. This balance
consists primarily of unrealized gains on available-for-sale securities. Comprehensive Income was
$10,999 million (slightly higher than net income of $10,737 million).