Solution manual financial accounting 9th harrison ch10

Find more at www.downloadslide.com Chapter 10 Stockholders’ Equity Short Exercises (5 min.) S 10-1 Corporation’s advantages:     Continuous life Transferability of ownership Limited liability of the stockholders Ease of raising capital Corporation’s disadvantages:  Double taxation of distributed profits  Government regulation  Separation of ownership and management (5 min.) S 10-2 The stockholders hold ultimate power in a corporation The chairperson of the board of directors is usually the most powerful person in a corporation The title is also often CEO The president is in charge of day-to-day operations The title is COO The chief financial officer is in charge of accounting and finance The title is CFO Chapter 10 Stockholders’ Equity 10-1 Find more at www.downloadslide.com (5-10 min.) S 10-3 The common stockholders are the real owners of a corporation Preferred stockholders have priority over common stockholders in (1) receipt of dividends and (2) receipt of assets if the corporation liquidates Common stockholders benefit more from a successful corporation because the preferred stockholders’ dividends are limited to a specified amount The common stockholders take more risk so their potential for gains through an increase in the value of the company’s stock is unlimited 10-2 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 10-4 TO: Jessica Johnson and Claudia Stein FROM: Student Name RE: Steps in forming a corporation The first step in organizing a corporation is to obtain a charter from the state The charter authorizes the corporation to issue a certain number of shares of stock to the owners of the business, who are called stockholders The corporation will exist when the incorporators pay fees, sign the charter, file documents with the state, and agree to a set of bylaws to determine how the corporation is to be governed internally Later steps include the stockholders electing a board of directors who in turn appoint officers to manage the corporation on a day-to-day basis These officers consist of the chairperson of the board (the chief executive officer) and the president (the chief operating officer), who lead the chief financial officer, who manages the day to day operations of the controller (accounting officer) and treasurer (finance officer) (5-10 min.) S 10-5 The $47,952,000 was paid-in capital It was not a profit and therefore had no effect on net income The par value of stock has no effect on total paid-in capital Total paid-in capital is the total amount that stockholders have invested in (paid into) a corporation, including the par value of stock issued plus any additional paid-in capital Chapter 10 Stockholders’ Equity 10-3 Find more at www.downloadslide.com (10 min.) S 10-6 Millions Hana Printer: Cash…………………………………………… Common Stock…………………………… Additional Paid-in Capital……………… 17,827 27 17,800 Delightful Doughnuts: Cash…………………………………………… Common Stock…………………………… 298 298 (10 min.) S 10-7 Case A — Issue stock and buy the assets in separate transactions: Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT Cash Common Stock (17,000 × $25) Paid-in Capital in Excess of Par Issued stock 850,000 Building Equipment Cash Purchased plant assets 590,000 260,000 CREDIT 425,000 425,000 850,000 Case B — Issue stock to acquire the assets: Building 590,000 Equipment 260,000 Common Stock (17,000 × $25) Paid-in Capital in Excess of Par Issued stock to acquire building and equipment The balances in all accounts are the same 10-4 Financial Accounting 9/e Solutions Manual 425,000 425,000 Find more at www.downloadslide.com (5-10 min.) S 10-8 Thousands Stockholders’ equity: Common stock, $.01 par, 800 thousand shares issued…………………………………………… $ Paid-in capital in excess of par………………… 193 Retained earnings………………………………… 643 Other stockholders’ equity……………………… (27) Total stockholders’ equity……………………… $817 (10 min.) S 10-9 Amounts In Thousands a b c Total revenues……………………………………… $1,370 Total expenses……………………………………… 812 Net income………………………………….………… $ 558 Accounts payable…………………………………… $ 460 Other current liabilities…………………………… 2,562 Long-term debt………………………………….…… 23 Total liabilities……………………………………… $3,045 Total liabilities (from Req b)……………………… $3,045 Total stockholders’ equity (from S 10-8)………… 817 Total assets…………………………………………… $3,862 d Net profit ratio Net income Total revenues $558 $1,370 Chapter 10 = 407 Stockholders’ Equity 10-5 Find more at www.downloadslide.com (continued) S 10-9 e Asset turnover Total revenues Total assets $1,370 $3,862 = 35 Total assets Total stockholders’ equity $3,862 $817 = 4.72 Net income Total stockholders’ equity $558 $817 = 67 f Leverage ratio g Return on equity Prior year returns from the company and comparative data for competitors would also be helpful to make decisions (5 min.) S 10-10 Journal DATE ACCOUNT TITLES AND EXPLANATION Treasury Stock…………………………… Cash……………………………………… Cash………………………………………… Treasury Stock………………………… Paid-in Capital from Treasury Stock Transactions………………………… DEBIT CREDIT Millions 22 22 15 11 Overall, stockholders’ equity decreased by $7 million ($22 million paid out minus $15 million received) 10-6 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (15-20 min.) S 10-11 Req MEMORANDUM TO: Karen Knox Exports, Inc., Board of Directors FROM: Student Name RE: How the purchase of treasury stock will make it more difficult for outsiders to take over the company Purchasing treasury stock decreases the amount of stock outstanding If Karen Knox Exports holds a sufficient quantity of company stock in the treasury, outsiders, such as the Alberton investor group, may not be able to acquire a controlling interest (50+ percent) of the outstanding stock from the remaining stockholders Because it takes cash to buy treasury stock, the purchase decreases the size of the corporation Reducing the company’s cash position may make the company sufficiently unattractive to cause the outside investors to abandon their takeover plan Req Sales of treasury stock at prices above the purchase price increase company assets because of the greater amount of assets coming in from the sale than went out to buy the stock Treasury stock transactions not affect liabilities, so the sale of treasury stock also increases stockholders’ equity These sales of treasury stock will not affect net income because the company is dealing with its owners Transactions between the corporation and its owners cannot generate a profit or a loss that is reported on the income statement Student responses may vary Chapter 10 Stockholders’ Equity 10-7 Find more at www.downloadslide.com (10 min.) S 10-12 Journal ACCOUNT TITLES AND EXPLANATION DATE 2012 Dec 15 Retained Earnings ($200,000 × 08) + (40,000 × $.15)……… Dividends Payable…………………… Declared a cash dividend 2013 Jan Dividends Payable……………………… Cash…………………………………… Paid the cash dividend DEBIT CREDIT 22,000 22,000 22,000 22,000 During 2012, Retained Earnings increased by $63,000 (net income of $85,000 − dividends of $22,000) (5-10 min.) S 10-13 $121,500 (90,000 shares × $1.35 per share) Preferred: $121,500 Common: $428,500 Cumulative, because it is not specifically designated as noncumulative Preferred: $364,500 ($121,500 × 3) Common: $1,235,500 ($1,600,000 − $364,500) 10-8 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 10-14 Req Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT May 11 Retained Earnings (18,000 × 08 × $20)……… 28,800 Common Stock (18,000 × 08 × $4)……… 5,760 Paid-in Capital in Excess of Par-Common 23,040 Req No effect on total assets No effect on total liabilities No effect on total stockholders’ equity Chapter 10 Stockholders’ Equity 10-9 Find more at www.downloadslide.com (10 min.) S 10-15 Total stockholders’ equity……………………………… Less: $4,877,000 Preferred stock………………………………… (450,000) Preferred dividends in arrears (35,000 × 01 × $12 x 3)…………………… Common equity………………………………………… (12,600) $4,414,400 Number of common shares outstanding (67,000 − 1,400)……………………………………… Book value per share of common stock…………… 10-10 Financial Accounting 9/e Solutions Manual ÷ 65,600 $ 67.29 Find more at www.downloadslide.com (continued) Decision Case Req Plan 1: Stockholders’ Equity Preferred stock, 6%, $100 par, nonvoting, 10,000 shares authorized, 800 shares issued… $ 80,000 Common stock, $1 par, 500,000 shares authorized, 50,000 shares issued……………………………… 50,000 Retained earnings ($120,000 − $30,000)…………… 90,000 Total stockholders’ equity………………………… $220,000 Plan 2: Stockholders’ Equity Preferred stock, $5, no-par, 5,000 shares authorized, 500 shares issued…………………………………… $ 55,000 Common stock, $1 par, 500,000 shares authorized, 85,000 shares issued……………………………… 85,000 Retained earnings ($120,000 − $30,000)…………… 90,000 Total stockholders’ equity………………………… $230,000 10-74 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Decision Case Req Plan appears to fit the plans of Smith and Jones better than Plan because:  Their primary goal is to raise as much capital as possible without giving up control of the business Under Plan 2, the outside stockholders would have 60,000 votes [35,000 common votes + 25,000 preferred votes (500 shares × 50 votes per share)] Smith and Jones would lose control of the business because they would have only 50,000 votes  Under Plan preferred stockholders have no votes Smith and Jones would have complete control since they would hold all the voting shares  Plan would raise only $10,000 more than Plan Chapter 10 Stockholders’ Equity 10-75 Find more at www.downloadslide.com (15-20 min.) Decision Case Req The stock dividend does not affect your proportionate ownership in the company because all the stockholders receive 10% new shares All stockholders are in the same relative position after the dividends as they were before Req Cash dividends received last year were $7,150 (10,000 shares × $0.715 per share) Cash dividends after the dividend will be $7,150 (11,000 shares × $0.65 per share) Thus, there is no change in cash dividends Req You incur no loss in value because the market value of your investment after the stock dividend — $610,203 (11,000 shares × $55.473) — is the same as it was before the dividend — 10,000 shares × $61.02 The increase in the number of shares you own at $55.473 per share offsets the decrease in the market price per share Any difference here is due to rounding Req If the company continues paying the $0.715 cash dividend per share, after issuing the 10% stock dividend, total cash dividends will increase (Your annual dividends will rise to $7,865 [11,000 shares × $0.715].) The increase in dividends might attract new investors, who view the increased cash dividends as an indication that the business is operating quite well This investor interest may result in an increase in the market value of UPS stock, or at least keep the value higher than it would be without the increase in cash dividends 10-76 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (20-30 min.) Decision Case Req Millions a Net income, as reported for 2000………………… $979 b Net income after new developments [$979 − $130 − ($2,000 × 12)]…………… $609 c The trend of net income is down The reasons for the downward trend are (a) inclusion of the money-losing companies and (b) the interest expense on the new debt Req (amounts in millions) As reported…………… Adjustments for 2001: Inclusion of companies………… Exchange of notes payable for stock……… Interest expense on new debt…… As adjusted…………… Assets $65,503 = = Liabilities $54,033 + + Equity $11,470 5,700 = 5,600 + 100 = 2,000 – 2,000 $71,203 = = 240 $61,873 – + 240 $9,330 Chapter 10 Stockholders’ Equity 10-77 Find more at www.downloadslide.com (continued) Decision Case Req As Reported As Adjusted Dollars in millions Debt ratio = Total liabilities Total assets = $54,033 $65,503 $61,873 $71,203 = 0.82 = 0.87 Req I would recommend downgrading Enron’s debt for two reasons: Downturn in net income due to (a) inclusion of the money-losing companies, and (b) the added interest expense on the new debt Increase in the debt ratio due to the same two factors 10-78 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Ethical Issue Req The ethical issue is, ―What is the correct amount at which to record and disclose the value of the franchise on Campbell’s balance sheet?‖ Req and Req.3 The stakeholders in the transaction include Campbell, the potential buyers of the franchises, and potential lenders who loan them the money to buy the franchises in the future Campbell and the corporation are effectively the same entity The third party serves no purpose other than as an accomplice to overvalue the franchise Analysis of the decision to overvalue the franchise: (a) Economic: Campbell is better off temporarily, unless potential buyers sue him for damages, in which case he could be worse off Potential buyers of the individual-language franchises can be harmed Campbell’s balance sheet overstates his assets If outsiders believe his balance sheet, they may be induced to pay Campbell more than the individual-language franchises are worth Lenders can also be harmed by loaning money to Campbell on more favorable terms than his financial position warrants (b) Legal: If potential buyers are damaged by Campbell’s actions, they might sue him for recovery of those damages In this situation, the public is also defrauded if Campbell amortizes the cost of the franchise for income tax purposes Basing amortization on $500,000 overstates tax deductions and understates Campbell’s income As a result, his tax Chapter 10 Stockholders’ Equity 10-79 Find more at www.downloadslide.com (continued) Ethical Issue payments are lower than they should be This could expose Campbell to future investigations from the IRS (c) Ethical: This type of scheme is harmful to everyone involved It is not truthful, and it violates the rights of individuals and business entities to full and complete disclosure of the proper valuation of a business It is an example of the type of transaction that meets the letter of the law without meeting the spirit of the law Req The franchise should be valued at its true value, which is $50,000 Campbell should focus his time and energy on ways to make the business profitable in the long run in other ways, rather than focusing on turning a quick buck and playing legal games that could well get him into trouble with a lot of other parties Note: 10-80 One of the authors experienced this actual situation in his first job after college Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Ethical Issue Req The ethical issue is whether the company acted properly in purchasing their shares on the open market based on inside information known only to them Req and Req Stakeholders include the company, its officers and directors, the shareholders from whom the stock was purchased, and the general public (a) Economic analysis: The company, and likely its officers and directors, benefitted temporarily at the other shareholders’ expense The managers purchased the stock at $6 and could sell it for $27 Thus, the managers enriched themselves at the expense of the stockholders who sold company stock at $6 Had the stockholders known of the oil discovery, those stockholders who sold shares probably would have held their St Genevieve stock Stockholders wanting to sell company stock would have demanded a price based on all relevant information about the company, including news of the discovery (b) Legal analysis: If St Genevieve is a public company, their actions are illegal The Securities Exchange Act of 1934 prohibits insider trading It imposes stiff penalties for unethical conduct of this type The SEC will prosecute them for insider trading, probably fine them, and possibly send the officers and directors responsible for the decision to Chapter 10 Stockholders’ Equity 10-81 Find more at www.downloadslide.com (continued) Ethical Issue prison In addition, actions such as these have been the basis for numerous civil stockholder lawsuits, to recover monetary damages suffered because of the actions of the company (c) Ethical analysis: The managers clearly did not behave ethically, violating the rights of existing shareholders as well as the good faith of the investing public Managers defrauded the stockholders by withholding important information prior to buying company stock Req The correct way to handle this transaction is never to have proposed it in the first place However, if it did happen, the disclosure principle is relevant to the situation The transaction should be disclosed in the footnotes to the financial statements, and if potential liability to the SEC or others is probable and can be estimated, a loss be disclosed in the income statement and a liability should be accrued on the balance sheet 10-82 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Focus on Financials: Amazon.com, Inc (20-30 min.) Req Amazon.com, Inc has two classes of stock authorized at December 31, 2010: Preferred stock, $.01 par value, 500 million shares authorized, no shares issued and outstanding Common stock, $.01 par value, billion shares authorized, 445 million shares issued, 468 million shares issues, 451 million shares outstanding Req Purchase of treasury stock during 2010 $ Cost of treasury stock 600 600 ÷ number of shares in treasury (468 – 451) 17 = Average cost per share $35.29 Req The company earned and reported net income of $1,152 million appears first in the Consolidated Statements of Operations It It also appears as a reduction of the accumulated deficit in the Consolidated Statements of Stockholders’ Equity, and as the opening line of the Consolidated Statements of Cash Flows Net income is a good thing Chapter 10 Stockholders’ Equity 10-83 Find more at www.downloadslide.com (continued) Amazon.com, Inc Req Amazon.com Wal-Mart Profit margin $1,152 $34,201 Asset turnover $34,201 ($18,797+ $13,813)/2 $34,201 = $16,305 = ROA 3.4% x 2.1 = Leverage ratio $16,305 ($6,864 + $5,257) / = $16,305 = $6,060.5 2.7 ROE 7.1% x 2.7 = 192 = 034 2.1 071 $16,380 $421,849 = 039 $421,849 (180,663 + 170,407) = /2 3.9% x 2.4 = 094 $175,535 = ($71,247 + $72, 648) /2 9.4% x 2.4 2.4 2.4 = 225 Both companies have a relatively low profit margin Wal-Mart has the higher return on equity because its profit margin and asset turnover are higher and leverage is lower Wal-Mart has less debt relative to its equity Student answers may vary if another company is chosen for comparison 10-84 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Focus on Analysis: RadioShack Corporation (20-30 min.) Req RadioShack, Corp has 650,000,000 shares of common stock authorized, 146,033,000 shares issued and 105,773,000 shares outstanding (146,033,000 – 40,260,000) Req RadioShack, Corp purchased 19,800,000 shares of treasury stock for $398,800,000 This represents an average price of $20.14 per share The price of Radio Shack Stock peaked at $22.85 in October 2010 and has steadily decreased Recently, the stock was selling for around $12 Based on this price, RadioShack probably paid too much too much for its treasury stock The reasons why RadioShack purchased treasury might include:  Reducing the number of outstanding shares to improve ratios such as ROE and EPS  Reduce the likelihood of a hostile takeover  Return cash to shareholders  To make a profit on the purchase and subsequent sale of treasury stock Chapter 10 Stockholders’ Equity 10-85 Find more at www.downloadslide.com (continued) RadioShack Req RadioShack Corporation retired 45 million treasury shares which effectively reduced both the number of issued shares and the number of treasury shares RadioShack held Req RadioShack issued 100,000 shares as a result of its equity compensation plan Additionally, RadioShack issued 200,000 shares as a result of the exercise of stock options Req Retained Earnings 2,323.9 Retirement of Treasury stock 1,001.0 Cash Dividends 206.1 Net Income 26.5 1,502.5 10-86 Beg Balance Financial Accounting 9/e Solutions Manual End Balance Find more at www.downloadslide.com Group Project in Ethics (1-3 hours, including discussion) Req Stakeholders in a corporation vary widely with the nature of the corporation In the case of the corporations included in this case (GM, Chrysler, AIG, Citibank, Bank of America) because of their size and the scope of their operations, stakeholders include the shareholders, bondholders, other creditors, employees, suppliers, customers, local, regional, national and international economies, federal, state and local governments—just about everyone in the broadest sense of the term Req Student opinions on this will vary It might be interesting to divide the class into two teams and conduct a debate, each team taking a side Req The measures of ―deficiency‖ can vary, but usually are: excessively high debt ratios, continuing and increasing deficits in retained earnings, debt covenants that are being violated, labor troubles, litigation If the company is not too far gone, in some cases, downsizing helps by cutting costs to be more in line with revenues Students’ teams might brainstorm this question as well Req Student opinions on this will vary Chapter 10 Stockholders’ Equity 10-87 Find more at www.downloadslide.com (continued) Group Project in Ethics Req Student opinions on this will vary and should be related to the opinions they express in requirement This question has economic, political and social ramifications Some would say that government taking equity positions in private businesses violates principles of free market economics and tends toward socialism If the equity positions were carefully crafted and sufficiently restricted to appear to have more debt than equity features, perhaps this could be justified in some people’s minds 10-88 Financial Accounting 9/e Solutions Manual ... gains through an increase in the value of the company’s stock is unlimited 10-2 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 10-4 TO: Jessica Johnson... acquire building and equipment The balances in all accounts are the same 10-4 Financial Accounting 9/e Solutions Manual 425,000 425,000 Find more at www.downloadslide.com (5-10 min.) S 10-8 Thousands... decreased by $7 million ($22 million paid out minus $15 million received) 10-6 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (15-20 min.) S 10-11 Req MEMORANDUM