You are on page 1of 55

Chapter 13

Accounting for Corporations


QUESTIONS
1.

Organization expenses (costs) are incurred in creating a corporation. Examples include:


legal fees, promoter fees, accountant fees, costs of printing stock certificates, and fees paid
to obtain a state charter.

2.

Organization expenses (costs) are reported as expenses when incurredas part of operating
expenses. (Instructor note: Prior to SOP 98-5, organization costs were classified as part of
intangible assets and then allocated to amortization expense.)

3.

The board of directors of a corporation is responsible for directing the corporation's affairs.
The directors are elected by the corporations stockholders.

4.

The preemptive right of common stockholders is the right to maintain their relative
ownership interests in the corporation by having the first opportunity to purchase their
proportionate share of any additional common shares issued by the corporation.

5.

The general rights of common stockholders include: (1) the right to vote in stockholders
meetings, (2) the right to sell or otherwise dispose of stock, (3) the preemptive right, (4) the
right to share proportionately in dividends, and (5) the right to share proportionately in assets
remaining after the creditors are paid when, and if, the corporation is liquidated. In addition,
stockholders have the general right to receive timely and useful financial reports that
describe the corporations financial position and the results of its activities.

6.

Convertible preferred stock is potentially attractive because it offers the safety of a regular
return as well as the opportunity to share in the increased value of the issuers common
stock through conversion (or potential conversion).

7.

The par value is an arbitrary value placed on a share of stock when it is authorized. The call
price is an amount that a corporation must pay if it exercises the option to buy back and
retire a share of callable preferred stock.

8.

The three important dates governing dividends are:


a) date of declaration

the date the directors vote to pay a dividend.

b) date of record a future date specified by the directors to identify the particular
shareholders that are to receive the dividend.
c) date of payment
9.

the date when shareholders receive the dividend payment.

Cash dividends debited against contributed capital accounts are called liquidating dividends
because they represent a return of amounts originally invested in the corporation by the
stockholders. (They are a return of, not a return on, capital contributions.)

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


1

10. Declaring a stock dividend has no effect on assets, liabilities, or total equity. Also, the
subsequent distribution of the stock dividend has no effect on these items. Instead, the stock
dividend simply increases the number of shares outstanding and results in a transfer of
equity from retained earnings to contributed capital.
11. A stock dividend results in a distribution of additional shares to stockholders and the
capitalization of retained earnings. A stock split calls in the old shares and replaces them
with a different number of new shares with a new par value. Also, no entry is made to any of
the equity accounts with a stock split. In spite of these technical differences, there is no
practical difference in most cases between a stock split and a large stock dividend.
12. A stock dividend should not be considered income because it does not transfer any assets
from the corporation to the stockholders.
13. A treasury stock purchase reduces total assets and total equity by the same amount.
14. Treasury stock purchases affect the corporate assets and stockholders equity just like a
cash dividend. To keep a company from dissipating its assets by paying an inordinate
amount of dividends to its stockholders, state laws protect the companys creditors by
imposing limits on treasury stock purchases.
15. This gain is considered to be unusual but not infrequent. It would be included in the
calculation of income from continuing operations, with other unusual or infrequent gains and
lossesin a category often labeled Other Gains and Losses.
16. This decision (revision in asset life) is a change in an accounting estimate, not a change in
accounting principle. The change would be reflected in the financial statements with
decreased depreciation over the remaining six years of the assets revised useful life.
17. With a simple capital structure, earnings per share results are calculated by first subtracting
any declared preferred dividends from net income, and then dividing the difference by the
weighted-average number of shares of outstanding common stock. The resulting figure is
called the basic earnings per share.
18. Krispy Kreme has issued only one class of stock no par, common stock. Preferred stock
has been authorized but none is outstanding.
19. The par value for Tastykakes common stock is $0.50 per share (as reported on its balance
sheet). The company has likely set the par value this low to minimize the amount of legal
capital that the company must maintain (and that stockholders would be liable for).
20. As of December 28, 2002, Tastykakes balance sheet reports 1,012,798 treasury shares as
repurchased. The average cost to Tastykake for these treasury shares is computed as:
$12,538,632/ 1,012,798 = $12.38 per treasury share.
21. Harley-Davidson was a net purchaser of treasury stock for the fiscal year ended December 31,
2002. Its statement of cash flows (under financing) shows a net purchase of treasury stock
of $56,814,000.

McGraw-Hill Companies, Inc., 2005


2

Fundamental Accounting Principles, 17th Edition

QUICK STUDIES
Quick Study 13-1 (10 minutes)
True statements: 1, 3, 4, and 7
Quick Study 13-2 (15 minutes)
(a) Mar. 1 Cash

255,000
Common Stock, $4 Par Value.............................
Contributed Capital in Excess of Par
Value, Common Stock......................................

178,000
77,000

Issued par value stock for cash.

(b) Apr. 1 Cash...........................................................................50,000

Common Stock, No-Par Value............................

50,000

Issued no-par value stock for cash.

(c) Apr. 6

Inventory...................................................................35,000
Machinery..................................................................
135,000
Note Payable........................................................
Common Stock, $20 Par Value...........................
Contributed Capital in Excess of Par
Value, Common Stock......................................

84,000
40,000
46,000

Issued stock for inventory, machinery, and note.

Quick Study 13-3 (10 minutes)


Total cash dividend.............................................. $108,000
To preferred shareholders...................................
60,000*
Remainder to common shareholders................ $ 48,000
*75,000 shares x $5 par x .08 x 2 years = $60,000.

Quick Study 13-4 (10 minutes)


May 15 Retained Earnings..........................................................
48,000
Common Dividend Payable.....................................

48,000

Declared cash dividend on common.

July 31 Common Dividend Payable...........................................


48,000
Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


3

Cash...........................................................................

48,000

Paid cash dividend to common.

McGraw-Hill Companies, Inc., 2005


4

Fundamental Accounting Principles, 17th Edition

Quick Study 13-5 (10 minutes)


Catalina Company
Stockholders Equity
April 2 (after stock dividend)
Common stock $5 par value, 375,000 shares
authorized, 165,000 shares issued and outstanding ................ $ 825,000
Contributed capital in excess of par value, common stock.........
652,500
Total contributed capital ................................................................. 1,477,500
Retained earnings ...........................................................................
258,000
Total stockholders' equity .............................................................. $1,735,500
Supporting work
Apr.

Retained Earnings...........................................................375,000
Common Stock*.........................................................
Contributed Capital in Excess of
Par Value, Common Stock**..................................

75,000
300,000

To record declaration and distribution


of a 10% common stock dividend.
* 150,000 shares x 10% x $5 par value
** 150,000 shares x 10% x ($25 market value - $5 par value)

Quick Study 13-6 (10 minutes)


May 3

Treasury Stock (3,000 shares).......................................


27,000
Cash...........................................................................

27,000

Purchased treasury stock


($27,000 / 3,000 shares = $9 per share cost).

Nov. 4

Cash.................................................................................
7,080
Treasury Stock (750 x $9*).......................................
Contributed Capital, Treasury Stock......................

6,750
330

Reissued treasury stock at a price


greater than its cost.
*Cost of treasury share: $27,000/3,000 shares = $9 per share
Cost of 750 treasury shares: $9 per share x 750 shares = $6,750

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


5

Quick Study 13-7 (10 minutes)


1. This material error should be reported on the statement of retained
earnings (and/or the statement of stockholders equity) as a prior
period adjustment to the beginning retained earnings balance. Also, if
prior years financial numbers are reported, they should be revised to
show the correct numbers.
2. This change in the expected useful life is a change in an accounting
estimateaffecting current and future accounting periods. Therefore,
the current year depreciation should be modified to reflect the change
and the revised depreciation expense reported on the income
statement as a regular part of income from continuing operations. The
remaining two years depreciation also should reflect this new estimate
of useful life.

Quick Study 13-8 (10 minutes)


Net income - Preferred dividends
Weighted-average common shares outstanding

Basic earnings per share:

= ($450,000 - $10,000) / 200,000 shares


= $2.20 per share

Quick Study 13-9 (10 minutes)


Time Period

Outstanding
Shares

Weighted
Average

January..........................

100,000

1/12

February-May................

120,000

4/12

40,000

June-December............

160,000

7/12

93,333*

Weighted-average shares outstanding


*

Fraction of
Year

8,333*

141,666

Rounded to the nearest whole share.

McGraw-Hill Companies, Inc., 2005


6

Fundamental Accounting Principles, 17th Edition

Quick Study 13-10 (10 minutes)


Outstanding
Shares

Time Period

Effect of
Dividend

Fraction of
Year

Weighted
Average

January-March..............

150,000

1.1

3/12

= 41,250

April-May.......................

138,000

1.1

2/12

= 25,300

June-December............

151,800*

1.0

7/12

= 88,550

Weighted-average shares outstanding

155,100

* 138,000 shares x 1.1

Quick Study 13-11 (10 minutes)


Total stockholders' equity.................................................................. $920,000
Less equity attributable to preferred shares:
Call price (10,000 shares x $30)...................................................... 300,000
Equity applicable to common shares................................................ $620,000
Book value of common shares ($620,000/75,000 shares)............... $

8.27

Quick Study 13-12 (10 minutes)


Dividend yield =

Annual cash dividends per share


Market value per share

$2.10
$28.50

= 7.4%

Analysis: The companys dividend yield of 7.4% indicates that it should be


classified as an income stock. That is, the company annually pays out
cash dividends to its shareholders in an amount that equals 7.4% of the
companys market value.
Quick Study 13-13 (10 minutes)
Price-earnings ratio = Market value per share
Earnings per share

= $30.75
$4.10

= 7.5

Analysis: Many analysts consider stocks with a PE less than 5 to 8 as


potentially underpriced. This stock with a PE of 7.5 would meet this criterion.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


7

(Instructor note: This is a good point at which to emphasize that PE is based on


expectationsexpectations can prove to be higher or lower than actual results.)

McGraw-Hill Companies, Inc., 2005


8

Fundamental Accounting Principles, 17th Edition

EXERCISES
Exercise 13-1 (15 minutes)
Characteristic
Corporations
1. Owner authority and control......................One vote per share
2. Ease of formation........................................Requires government approval
3. Transferability of ownership.......................Readily transferred
4. Ability to raise large amounts of capital......High ability
5. Duration of life.............................................Unlimited
6. Owner liability..............................................Limited
7. Legal status..................................................Separate legal entity
8. Tax status of income...................................Corporate income is taxed and
its cash dividends are usually
taxed at the 15% rate (some
cases at a lower rate)

Exercise 13-2 (15 minutes)


1.
Feb. 20

Cash...........................................................................144,000
Common Stock, No-Par Value...........................
144,000
Issued common stock for cash.

2.
Feb. 20

Cash...........................................................................144,000
Common Stock, $20 Par Value..........................
120,000
Contributed Capital in Excess of Par
Value, Common Stock.....................................
24,000
Issued common stock for cash.

3.
Feb. 20

Cash...........................................................................144,000
Common Stock, $8 Stated Value......................
Contributed Capital in Excess of
Stated Value, Common Stock.........................

48,000
96,000

Issued common stock for cash.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


9

Exercise 13-3 (15 minutes)


1.

Organization Expenses.................................................... 30,000


Common Stock, No-Par Value...................................

30,000

Issued stock to promoters.

2.

Organization Expenses.................................................... 30,000


Common Stock, $1 Stated Value...............................
Contributed Capital in Excess of Stated
Value, Common Stock.............................................

2,000
28,000

Issued stock to promoters.

3.

Cash
70,000
Common Stock, $10 Par Value..................................
Contributed Capital in Excess of Par
Value, Common Stock.............................................

40,000
30,000

Issued common stock for cash.

4.

Cash
120,000
Preferred Stock, $100 Par Value.................................
100,000
Contributed Capital in Excess of Par
Value, Preferred Stock..............................................
20,000
Issued preferred stock for cash.

Exercise 13-4 (10 minutes)


1.

2.

3.

4.

5.

6.

McGraw-Hill Companies, Inc., 2005


10

Fundamental Accounting Principles, 17th Edition

Exercise 13-5 (30 minutes)


Preferred

Common

2003 ($10,000 paid)


Preferred*....................................................... $10,000
Common remainder.................................... ______
Total for the year........................................... $10,000

$
$

0
0

2004 ($24,000 paid)


Preferred*....................................................... $24,000
Common remainder.................................... ______
Total for the year........................................... $24,000

$
$

0
0

2005 ($100,000 paid)


Preferred*....................................................... $30,000
Common remainder.................................... ______
Total for the year........................................... $30,000

$ 70,000
$ 70,000

2006 ($196,000 paid)


Preferred*....................................................... $30,000
Common remainder.................................... ______
Total for the year........................................... $30,000

$166,000
$166,000

2003-2006 ($330,000 paid)


______
Total for four years....................................... $94,000

_______
$236,000

* The holders of the noncumulative preferred stock are entitled to no more than
$30,000 of dividends in any one year (7.5% x $10 x 40,000 shares).

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


11

Exercise 13-6 (25 minutes)


Preferred
2003 ($10,000 paid)
Preferred*....................................................... $ 10,000
Common remainder.................................... _______
Total for the year........................................... $ 10,000

Common
$
$

0
0

$
$

0
0

(Note: $20,000 in preferred stock dividends in arrears.)

2004 ($24,000 paid)


Preferred arrears from 2003...................... $ 20,000
Preferred*.......................................................
4,000
Common remainder.................................... _______
Total for the year........................................... $ 24,000
(Note: $26,000 in preferred stock dividends in arrears.)

2005 ($100,000 paid)


Preferred arrears from 2004...................... $ 26,000
Preferred*....................................................... 30,000
Common remainder.................................... _______
Total for the year........................................... $ 56,000

$ 44,000
$ 44,000

(Note: $0 in preferred stock dividends in arrears.)

2006 ($196,000 paid)


Preferred*....................................................... $ 30,000
Common remainder.................................... _______
Total for the year........................................... $ 30,000

$166,000
$166,000

(Note: $0 in preferred stock dividends in arrears.)

2003-2006 ($330,000 paid)


_______
Total for four years....................................... $120,000

_______
$210,000

* The holders of the cumulative preferred stock are entitled to no more than
$30,000 of dividends declared in any year (7.5% x $10 x 40,000 shares) plus
any dividends skipped in prior years.

McGraw-Hill Companies, Inc., 2005


12

Fundamental Accounting Principles, 17th Edition

Exercise 13-7 (20 minutes)


1.
a.

b.

c.

Retained earnings
Before dividend........................................................................
$10 par value of 25,000 dividend shares...............................
After dividend...........................................................................

$ 330,000
(250,000)
$ 80,000

Total stockholders equity


Common stock $10 par value, 60,000 shares
authorized, 50,000 shares issued and outstanding...........
Contributed capital in excess of par value............................
Total contributed capital..........................................................
Retained earnings....................................................................
Total stockholders equity.......................................................

$ 500,000
100,000
600,000
80,000
$ 680,000

Number of outstanding shares


Outstanding shares before the dividend..............................
Dividend shares......................................................................
Outstanding shares after the dividend.................................

25,000
25,000
50,000

2.
a.
b.

c.

3.

Retained earnings (no change)


Before and after dividend........................................................

$ 330,000

Total stockholders equity


Common stock $5 par value, 120,000 shares
authorized, 50,000 shares issued and outstanding...........
Contributed capital in excess of par value............................
Total contributed capital..........................................................
Retained earnings....................................................................
Total stockholders equity.......................................................

$ 250,000
100,000
350,000
330,000
$ 680,000

Number of outstanding shares


Outstanding shares before the split.......................................
Additional split shares (2-for-1)..............................................
Outstanding shares after the split..........................................

25,000
25,000
50,000

From a stockholders point of view, there is no practical


difference between the stock dividend and the stock split.
The number of shares will be increased equivalently
under either approach, and the market value change, if
any, should be approximately the same.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


13

Exercise 13-8 (25 minutes)


1.
Feb. 5 Retained Earnings..........................................................
480,000
Common Stock Dividend Distributable..................
300,000
Contributed Capital in Excess of Par,
Common Stock......................................................
180,000
Declared 20% common stock dividend
(60,000 x 20% x $40).

Feb.28

Common Stock Dividend Distributable........................


300,000
Common Stock, $25 Par Value................................
300,000
Distributed common stock dividend.

2.
Before
Total stockholders equity......................... $2,700,000
Issued and distributable shares............... 60,000
Book value per share................................. $
45.00

After
$2,700,000
72,000
$
37.50

Shares owned............................................. x
750
Total book value of shares........................ $ 33,750

X
900*
$ 33,750

* 750 shares x 120% = 900 shares.

3.
February 5
Market value per share..............................
$
40
Shares owned.............................................
x 750
Total market value of shares owned........
$30,000

February 28
$ 34.00
x 900
$30,600

Note: The total market value of the investors holdings is approximately the
same for February 5 and February 28. Assuming that the stock dividend is the
only value-relevant information/event between February 5 th and February 28th,
these per share values highlight the lack of value distributed in a stock
dividend.

Exercise 13-9 (25 minutes)


1.
Oct. 11 Treasury Stock (4,500 x $30).........................................
135,000
Cash...........................................................................
135,000
Purchased treasury stock.

Nov. 1

Cash (1,200 x $36)..........................................................


43,200
Treasury Stock (1,200 x $30)...................................
Contributed Capital, Treasury Stock......................

36,000
7,200

Reissued treasury stock at a price exceeding cost.


McGraw-Hill Companies, Inc., 2005
14

Fundamental Accounting Principles, 17th Edition

Exercise 13-9 (Concluded)


Nov. 25 Cash (3,300 x $25)..........................................................
82,500
Contributed Capital, Treasury Stock............................
7,200
Retained Earnings..........................................................
9,300
Treasury Stock (3,300 x $30)...................................

99,000

Reissued treasury stock at a price less than cost.

2. Changes to the equity section include the following


(i) The common stock account description line will change. After the
treasury stock purchase, it should read:
Common stock $10 par value; 36,000 shares
$360,000
authorized and issued; 4,500 shares in treasury.................
The dollar balance of this account does not change with a treasury
stock purchase.
(ii) The descriptions and dollar amounts for Contributed Capital in
Excess of Par Value, Common Stock, and for Total Contributed
Capital will not change.
(iii) The retained earnings dollar balance will not change but its
description should change to:
Retained earnings ($135,000 restricted for treasury stock).............
$432,000
(iv) After the purchase, a deduction for the cost of treasury stock is
reported immediately before the total line for stockholders equity as :
Less cost of treasury stock.........................................................
$(135,000)
(v) Total stockholders equity will change from $900,000 to $765,000.
Revised equity section appears as follows
Common stock $10 par value; 36,000 shares authorized
$ 360,000
and issued; 4,500 shares in treasury...................................................
Contributed capital in excess of par value, Common stock................
108,000
Total contributed capital...........................................................................
468,000
Retained earnings, $135,000 restricted by treasury stock...................
432,000
Total............................................................................................................
900,000
Less cost of treasury stock.....................................................................
(135,000)
Total stockholders equity........................................................................
$ 765,000

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


15

Exercise 13-10 (10 minutes)


1.
2.
3.
4.
5.
6.
7.
8.
9.

A
C
A
D
A
A
B
B
A

Income (loss) from continuing operations


Extraordinary gain (loss)
Income (loss) from continuing operations
Cumulative effect of change in accounting principle
Income (loss) from continuing operations
Income (loss) from continuing operations
Gain (loss) from disposing of a discontinued segment
Income (loss) from operating a discontinued segment
Income (loss) from continuing operations

Exercise 13-11 (15 minutes)


RANDA MERCHANDISING, INC.
Income Statement
For Year Ended December 31, 2005
Net sales
Expenses
Cost of goods sold......................................................$1,380,000
Salaries expense......................................................... 540,000
Depreciation expense................................................. 262,500
Total expenses.............................................................
Income from continuing operations before taxes.......
Income taxes expense...................................................
Income from continuing operations.............................
Discontinued segment
Loss from operating wholesale business
segment (net of tax)................................................. (555,000)
Gain on sale of wholesale business
segment (net of tax)................................................. 675,000
Income before extraordinary gain and cumulative
effect of a change in accounting principle...............

$2,700,000

2,182,500
517,500
207,000
310,500

120,000
430,500

Extraordinary gain on condemnation of


company property (net of tax)....................................

330,000

Cumulative effect of change in accounting


principle (net of tax)....................................................

135,000

Net income......................................................................

$ 895,500

McGraw-Hill Companies, Inc., 2005


16

Fundamental Accounting Principles, 17th Edition

Exercise 13-12 (30 minutes)


1. The income statement for 2006 and thereafter (years 2007-2009) will
report depreciation expense of $33,750 (the straight-line amount).
2. Since Fast Tek is subject to 35% income tax, the after-tax effect of this
change is $37,375 ($57,500 x [1-0.35]). Therefore, the 2006 income
statement will report an after-tax cumulative effect of a change in
accounting principle equal to $37,375 as an increase to net income.
Exercise 13-13 (25 minutes)
1.

Net income.....................................................................................
$1,350,000
Less preferred dividends............................................................. (195,000)
Net income available to common stockholders........................
$1,155,000

2.
Outstanding
Time Period
Shares
January-April....................
270,000
May-October.....................
450,000
November-December.......
342,000
Weighted-average shares outstanding
3.

Fraction
of Year
x
4/12
x
6/12
x
2/12

=
=
=

Weighted
Average
90,000
225,000
57,000
372,000

Net income available to common stockholders........................$1,155,000


Divided by weighted-average outstanding shares................... 372,000
Basic earnings per share.............................................................
$3.10

Exercise 13-14 (30 minutes)


1.

Net income......................................................................................$480,000
Less preferred dividends............................................................. (65,000)
Net income available to common stockholders........................ $415,000

2.
Original
Effect
Time Period
Shares
of Split
January-May..................... 50,000
3
June-August..................... 80,000
3
September......................... 67,000
3
October-December........... 201,000
1
Weighted-average shares outstanding
3.

Fraction
of Year
5/12
3/12
1/12
3/12

Weighted
Average
62,500
60,000
16,750
50,250
189,500

Net income available to common stockholders..................... $415,000


Divided by weighted-average outstanding shares................... 189,500

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


17

Basic earnings per share.............................................................

McGraw-Hill Companies, Inc., 2005


18

$2.19

Fundamental Accounting Principles, 17th Edition

Exercise 13-15 (20 minutes)


1.
Total stockholders equity..............................................
Less equity applicable to preferred shares
Call price ($30 x 5,000)................................................. $150,000
Cumulative dividends in arrears (none).....................
0
Equity applicable to common shares...........................

$ 792,500

Book value of preferred stock ($150,000/5,000)...........

30.00

Book value of common stock ($642,500/40,000).........

16.06

Total stockholders equity..............................................


Less equity applicable to preferred shares
Call price ($30 x 5,000)................................................. $150,000
Cumulative dividends in arrears (3 x 6% x $125,000)...
22,500
Equity applicable to common shares...........................

$ 792,500

Book value of preferred stock ($172,500/5,000)...........

34.50

Book value of common stock ($620,000/40,000).........

15.50

(150,000)
$ 642,500

2.

(172,500)
$ 620,000

Exercise 13-16 (15 minutes)


1.
2.
3.
4.

Dividend yield
$15.00 / $216.00
$12.00 / $128.00
$ 6.00 / $ 61.00
$ 1.20 / $ 86.00

=
=
=
=

6.9%
9.4%
9.8%
1.4%

Analysis: The yield of 1.4% on stock #4 is sufficiently low that it probably


would be classified as a growth stock, and not an income stock. Note that
classification involves expectations (not necessarily realizations).

Exercise 13-17 (15 minutes)


Market Value
Stock
per Share
1.............
$166.00
2.............
86.00
3.............
90.00

Solutions Manual, Chapter 13

Divided
by

Earnings
per Share
$10.00
9.00
6.50

=
=
=

Price-Earnings
Ratio
16.6
9.6
13.8

McGraw-Hill Companies, Inc., 2005


19

4.............

240.00

36.00

6.7

Analysis: Stocks with PE ratios less than about 5 to 8 are likely viewed as
potentially undervalued by the market. Of the stocks above, an analyst
might investigate stock #4 as possibly undervalued with a PE ratio of 6.7.

McGraw-Hill Companies, Inc., 2005


20

Fundamental Accounting Principles, 17th Edition

PROBLEM SET A
Problem 13-1A (30 minutes)
Part 1
a.

To record sale of 5,000 shares of $25 par value common stock for $30
per share.

b.

To record issuance of 2,500 shares of $25 par value common stock to


the companys promoters for their efforts in organizing the company
when the market value is $30 per share.

c.

To record acquisition of assets and liabilities by issuing 1,000 shares


of $25 par value common stock at $40 per share.

d.

To record sale of 1,500 shares of $25 par value common stock for $40
per share.

Part 2
Number of outstanding shares
Issued in (a)........................................
Issued in (b)........................................
Issued in (c)........................................
Issued in (d)........................................
Total.....................................................

5,000
2,500
1,000
1,500
10,000

Part 3
Minimum legal capital = Outstanding shares x Par value per share
= 10,000 x $25 = $250,000
Part 4
Total contributed capital from common stockholders
From transaction (a)......................... $150,000
From transaction (b)........................
75,000
From transaction (c).........................
40,000
From transaction (d)........................
60,000
Total contributed capital.................. $325,000
Part 5
Book value per common share
Total stockholders equity (given)....

$347,500

Outstanding shares (from Part 2).....

10,000

Book value per common share........

Solutions Manual, Chapter 13

34.75 ($347,500 / 10,000 shares)

McGraw-Hill Companies, Inc., 2005


21

Problem 13-2A (60 minutes)


Part 1
Jan. 1

Treasury Stock, Common..............................................


40,000
Cash...........................................................................

40,000

Purchased treasury stock (2,000 x $20).

Jan. 5

Retained Earnings..........................................................
36,000
Common Dividend Payable.....................................

36,000

Declared $2 dividend on 18,000 outstanding shares.

Feb. 28

Common Dividend Payable...........................................


36,000
Cash...........................................................................

36,000

Paid cash dividend.

July 6

Cash*...............................................................................
18,000
Treasury Stock, Common**.....................................
Contributed Capital, Treasury Stock***..................

15,000
3,000

Reissued treasury stock.


*(750 x $24) **(750 x $20) ***(750 x $4)

Aug. 22

Cash*...............................................................................
21,250
Contributed Capital, Treasury Stock............................
3,000
Retained Earnings.......................................................... 750
Treasury Stock, Common**.....................................

25,000

Reissued treasury stock.


*(1,250 x $17) **(1,250 x $20)

Sept. 5

Retained Earnings..........................................................
40,000
Common Dividend Payable.....................................

40,000

Declared $2 dividend on 20,000 outstanding shares.

Oct. 28

Common Dividend Payable...........................................


40,000
Cash...........................................................................

40,000

Paid cash dividend.

Dec. 31

Income Summary...........................................................
194,000
Retained Earnings....................................................
194,000
Closed Income Summary account.

McGraw-Hill Companies, Inc., 2005


22

Fundamental Accounting Principles, 17th Edition

Problem 13-2A (Concluded)


Part 2
CONTEXT CORPORATION
Statement of Retained Earnings
For Year Ended December 31, 2006
Retained earnings, Dec. 31, 2005..................................... $135,000
Plus net income.................................................................. 194,000
329,000
Less:Cash dividends declared......................................... (76,000)
Treasury stock reissuances....................................
(750)
Retained earnings, Dec. 31, 2006..................................... $252,250

Part 3
CONTEXT CORPORATION
Stockholders Equity Section of the Balance Sheet
December 31, 2006
Common stock $10 par value, 50,000 shares
authorized, 20,000 shares issued and outstanding...... $200,000
Contributed capital in excess of par value,
30,000
common stock..................................................................
Total contributed capital.................................................... 230,000
Retained earnings (from part 2)............................................. 252,250
Total stockholders equity................................................. $482,250

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


23

Problem 13-3A (45 minutes)


Part 1
Explanations for each of the journal entries
Oct.

2 Declared a cash dividend of $2 per share of common stock.


($120,000 / 60,000 shares)

Oct. 25 Paid the cash dividend on common stock.


Oct. 31 Declared a 10% stock dividend when the market value is $25 per
share. ($72,000/$12 par = 6,000 shares = 10% of 60,000 shares;
$150,000/6,000 shares = $25 per share)
Nov.

5 Distributed the common stock dividend.

Dec.

1 Executed a 3-for-1 stock split. ($12 par / $4 par = 3-for-1 ratio)

Dec. 31 Closed the Income Summary account to Retained Earnings.


Part 2
Oct. 2

Oct. 25

Oct. 31

Nov. 5

Dec. 1

Common stock......... $ 720,000 $ 720,000 $ 720,000 $ 792,000

Dec. 31

$ 792,000 $ 792,000

Common stock
dividend distributable. .

72,000

Contributed capital in
excess of par..........

180,000

180,000

258,000

258,000

258,000

258,000

Retained earnings......

520,000

520,000

370,000

370,000

370,000

790,000

Total equity............... $1,420,000 $1,420,000 $1,420,000 $1,420,000

McGraw-Hill Companies, Inc., 2005


24

$1,420,000 $1,840,000

Fundamental Accounting Principles, 17th Edition

Problem 13-4A (45 minutes)


Part 1
Outstanding common shares
Jan. 5
Beginning balance..........................20,000
Less treasury stock (Mar. 20).........
Plus dividend shares (July 31)*....... ______
Outstanding shares........................20,000

Apr. 5
20,000
(1,500)

July 5
20,000
(1,500)

______

______

18,500

18,500

Oct. 5
20,000
(1,500)
3,700
22,200

Apr. 5
18,500
$ 0.50
$ 9,250

July 5
18,500
$ 0.50
$ 9,250

Oct. 5
22,200
$ 0.50
$11,100

*(20% x 18,500)

Part 2
Cash dividend amounts
Jan. 5
Outstanding shares...................... 20,000
Dividend per share....................... $ 0.50
Total dividend................................ $10,000

Part 3
Capitalization of retained earnings for small stock dividend
Number of shares.........................................................................
3,700
Market value per share................................................................$
12
Total capitalized............................................................................$ 44,400
Part 4
Cost per share of treasury stock
Total amount paid.........................................................................$ 15,000
Shares purchased........................................................................
1,500
Cost per share..............................................................................$
10
Part 5
Net income
Retained earnings, beginning balance......................................$160,000
Less dividends: Jan. 5............................................................... (10,000)
Apr. 5............................................................... (9,250)
July 5............................................................... (9,250)
July 31.............................................................. (44,400)
Oct. 5............................................................... (11,100)
Total before net income...............................................................$ 76,000
Plus net income............................................................................
?
Retained earnings, ending balance............................................$200,000
Therefore, net income = $124,000

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


25

Problem 13-5A (60 minutes)


Part 1
Effect of income taxes (debits or losses in parentheses)
Pretax

30% Tax
Effect

After-Tax

h. Cumulative effect of change in accounting principle.....$(63,000) $(18,900) $(44,100)


j. Loss from operating a discontinued segment.............(19,500)

(5,850)

(13,650)

k. Gain on insurance recovery of tornado damage...... 28,500

8,550

19,950

n. Correction of overstatement of prior years sales.......(15,000)

(4,500)

(10,500)

o. Gain on sale of discontinued segments assets.......... 33,000

9,900

23,100

Part 2 Income from continuing operations (and its components)


l.
a.
g.
r.
b.
m.
e.
c.
p.

q.

Net sales..................................................................
Interest revenue......................................................
Gain from settling lawsuit......................................
Total revenues and gains.......................................
Cost of goods sold.................................................$487,500
Depreciation expenseEquipment...................... 36,000
Depreciation expenseBuildings........................ 54,000
Other operating expenses..................................... 97,500
Loss on sale of equipment.................................... 24,750
Loss from settling lawsuit..................................... 24,000
Total expenses........................................................

$ 970,500
12,000
42,000
1,024,500

Income from continuing operations before taxes.....


Income taxes expense (30%).................................
Income from continuing operations after taxes........

300,750
(90,225)
$ 210,525

McGraw-Hill Companies, Inc., 2005


26

(723,750)

Fundamental Accounting Principles, 17th Edition

Problem 13-5A (Concluded)


Part 3 Income from discontinued segment
j.
o.

Loss from operating a discontinued


segment (after-tax)....................................................................................
$ (13,650)
Gain on sale of discontinued segments
assets (after-tax)........................................................................................
23,100
Income from discontinued segment...........................................................
$ 9,450

Part 4 Income before extraordinary items and the cumulative effect of


changes in accounting principle
Income from continuing oper. after taxes (from Part 2)................................
$210,525
Income from discontinued segment (from Part 3).........................................
9,450
Income before extraordinary items and the
cumulative effect of changes in principle...............................................
$219,975

Part 5 Net income

k.

h.

Income before extraordinary items and the


cumulative effect of changes in principle..............................................
$219,975
Extraordinary item
Gain on insurance recovery of tornado damage (after19,950
tax)............................................................................................................
Cumulative effect of change in accounting
(44,100)
principle (after-tax)...................................................................................
Net income....................................................................................................
$195,825

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


27

Problem 13-6A (45 minutes)


Part 1
Yes generally accepted accounting principles allow the depreciation change
to be made as long as the change can be justified as producing more useful
financial statements. Consistency with other companies in the industry is
often a satisfactory justification.

Part 2 Double-declining-balance depreciation (Rate = 40%)


Beginning-Year
Book Value
2003................................... $600,000
2004...................................
360,000
2005...................................
216,000
Total................................

Depreciation
Expense
$240,000
144,000
86,400
$470,400

Year-End
Book Value
$360,000
216,000
129,600

Depreciation
Expense*
$114,000
114,000
114,000
$342,000

Year-End
Book Value
$486,000
372,000
258,000

Part 3 Straight-line depreciation


Beginning-Year
Book Value
2003................................... $600,000
2004...................................
486,000
2005...................................
372,000
Total................................

* Annual amount = ($600,000 - $30,000) / 5 years = $114,000

Part 4
Pretax cumulative effect of the accounting change
(see book, part 4)..........................................................................$128,400
After-tax cumulative effect of the accounting change
($128,400 x [1-0.30])......................................................................$ 89,880

McGraw-Hill Companies, Inc., 2005


28

Fundamental Accounting Principles, 17th Edition

Problem 13-6A (Concluded)


Part 5
The cumulative effect should be reported in the lower section of the income
statement after any extraordinary items but before net income. It will increase
income because it results from a retroactive restatement of the asset to a
higher book value.

Part 6
The 2006 income statement will report depreciation expense of $114,000. This
amount is the depreciation expense using the straight-line method.

Part 7
Effect of error on financial statements
On the 2006 income statement, the pre-tax cumulative effect of the change
from double-declining balance to straight-line depreciation of $128,400 (from
part (4)) less the 2006 straight-line depreciation of $114,000 yields an increase
to income before taxes of $14,400. Therefore, treating it as a change in an
accounting estimate (accounted for in current and future periods) would result
in an understatement of income before taxes by $64,200 ($49,800 * + $14,400).
This means net income (after-tax) would be understated by $44,940 [computed
as $64,200 x (1 - .30)].
On the 2006 balance sheet, retained earnings would be understated by
$44,940, income taxes payable would be understated by $19,260 ($64,200 x .
30), and assets would be understated by $64,200.
* Supporting computation Depreciation expense for 2006:
If switching depreciation methods is treated as a change in an
accounting estimate, then the straight-line depreciation amount
is computed and reported in 2006 as follows:
Book value, January 1, 2006.....................................................................
$ 129,600
Less salvage value....................................................................................
30,000
Depreciation expense...............................................................................
$ 99,600 / 2 years = $49,800

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


29

Problem 13-7A (60 minutes)


Part 1

Year 2003 weighted-average shares

Time Period

Outstanding
Shares

Effect
of Dividend

January-March..................40,000 x
April-June..........................36,000 x
July-September................48,000 x
October-December...........52,800 x
Weighted-average shares outstanding

1.1
1.1
1.1
1.0

Fraction
of Year
x
x
x
x

3/12
3/12
3/12
3/12

Weighted
Average
=
=
=
=

11,000
9,900
13,200
13,200
47,300

Part 2 Year 2003 earnings per share components


Reported
Divided
Total
by Shares
Income from continuing operations......... $137,500
47,300
Loss on discontinued segment................
(52,500)
47,300
Net income.................................................. $ 85,000
47,300

Part 3

Earnings
per Share
$2.91
(1.11)
$1.80

Year 2004 weighted-average shares

Outstanding Fraction of
Weighted
Time Period
Shares
Year
Average
January-June.......................... 52,800
x
6/12
=
26,400
July-October........................... 68,800
x
4/12
=
22,933*
November-December............. 64,000
x
2/12
=
10,667*
Weighted-average shares outstanding
60,000
*Rounded to nearest whole share.

Part 4

Year 2004 earnings per share components

Reported
Divided
Total
by Shares
Income from continuing operations......... $165,000
60,000
Extraordinary gain......................................
33,000
60,000
Net income.................................................. $198,000
60,000

McGraw-Hill Companies, Inc., 2005


30

Earnings
per Share
$2.75
0.55
$3.30

Fundamental Accounting Principles, 17th Edition

Problem 13-7A (Continued)


Part 5

Year 2005 weighted-average shares

Outstanding Effect of Fraction


Weighted
Time Period
Shares
Split
of Year
Average
January-July..................... 64,000 x
3
x
7/12
=
112,000
August............................... 84,000 x
3
x
1/12
=
21,000
September......................... 80,000 x
3
x
1/12
=
20,000
October-December...........240,000 x
1
x
3/12
=
60,000
Weighted-average shares outstanding
213,000

Part 6

Year 2005 earnings per share components

Reported Divided by
Total
Shares
Income from continuing operations......... $167,000
213,000
Extraordinary loss...................................... (70,000)
213,000
Net income.................................................. $ 97,000
213,000

Earnings
per Share
$ 0.78
(0.33)
$ 0.45**

** Adjusted for rounding.

Part 7
Of the three earnings per share figures in part 6, income from continuing
operations is most likely the best predictor of 2006 results. We might also
want to factor in any trend in earnings per share (adjusted for the stock split).
By definition, the 2005 extraordinary loss is both unusual and infrequent and
therefore extremely unlikely to occur again in 2006. However, the nature of the
extraordinary loss needs to be considered, and its impact on future operations
needs to be evaluated. For example, if the extraordinary loss was due to a
flood that occurred in December that damaged the plant, then production
would most likely be impaired in 2006, resulting in a decrease in income from
continuing operations.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


31

Problem 13-8A (40 minutes)


1. Market price = $170 per share (current stock exchange price given)
2. Computation of stock par values
Preferred: Paid-in amount / Number of shares = $100,000 / 1,000 = $100
Common: Paid-in amount / Number of shares = $160,000 / 4,000 = $40
3. Book values with no dividends in arrears
Book value per preferred share = par value (when not callable) = $100
Common stock
Total equity................................................ $ 560,000
Less equity for preferred..........................
(100,000)
Common stock equity............................... $ 460,000
Number of outstanding shares................

4,000

Book value per common share................

115 ($460,000 / 4,000 shares)

4. Book values with two years dividends in arrears


Preferred stock
Preferred stock par value........................... $ 100,000
Plus two years dividends in arrears*........
10,000
Preferred equity........................................... $ 110,000
*2 years dividends = 2 x ($100,000 x 5%) = $10,000

Number of outstanding shares..................


Book value per preferred share................. $

1,000
110 ($110,000 / 1,000 shares)

Common stock
Total equity................................................... $ 560,000
Less equity for preferred............................ (110,000)
Common stock equity................................. $ 450,000
Number of outstanding shares..................

4,000

Book value per common share.................. $ 112.50 ($450,000/4,000 shares)

McGraw-Hill Companies, Inc., 2005


32

Fundamental Accounting Principles, 17th Edition

Problem 13-8A (Concluded)


5. Book values with call price and two years dividends in arrears
Preferred stock
Preferred stock call price (1,000 x $110)...... $ 110,000
Plus two years dividends in arrears*..........
10,000
Preferred equity............................................. $ 120,000
*2 years dividends = 2 x ($100,000 x 5%) = $10,000

1,000

Number of outstanding shares.....................


Book value per preferred share....................

120 ($120,000 / 1,000 sh.)

Common stock
Total equity..................................................... $ 560,000
Less equity for preferred.............................. (120,000)
Common stock equity................................... $ 440,000
Number of outstanding shares.....................

4,000

Book value per common share.................... $

110 ($440,000 / 4,000 sh.)

6. Dividend allocation in total


Preferred
2 years dividends in arrears.... $10,000
Current year dividends..............
5,000
Remainder to common..............
Totals........................................... $15,000

Common
$
0
5,000
$5,000

Total
$10,000
5,000
5,000
$20,000

Dividends per share for the common stock


$5,000 / 4,000 shares = $1.25
7. Equity represents the residual interest of owners in the assets of the
business after subtracting claims of creditors. With few exceptions, these
assets and liabilities are reported at historical cost, not market value.
Therefore, the book value of common stock does not normally match its
market value. Also, the book value of common stock is based on past
transactions and events, whereas the market value takes into account
expected future earnings, growth, dividends, and other industry and
economic factors.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


33

PROBLEM SET B
Problem 13-1B (30 minutes)
Part 1
a. To record sale of 1,500 shares of $1 par value common stock for $40
per share.
b. To record issuance of 500 shares of $1 par value common stock to the
companys promoters for their efforts in organizing the company when
the market value is $40 per share.
c. To record acquisition of assets and liabilities by issuing 400 shares of
$1 par value common stock at $50 per share and issuing a note for
$3,150.
d. To record sale of 600 shares of $1 par value common stock for $50 per
share.
Part 2
Number of outstanding shares
Issued in (a)..........................................
Issued in (b)..........................................
Issued in (c)..........................................
Issued in (d)..........................................
Total.......................................................

1,500
500
400
600
3,000

Part 3
Minimum legal capital = Outstanding shares x Par value per share
= 3,000 x $1 = $3,000
Part 4
Total contributed capital from common stockholders
From transaction (a)............................ $60,000
From transaction (b)............................ 20,000
From transaction (c)............................ 20,000
From transaction (d)............................ 30,000
Total contributed capital.....................$130,000
Part 5
Book value per common share
Total stockholders equity (given)......$141,500
Outstanding shares (from 2)...............

3,000

Book value per common share..........$

47.17 ($141,500 / 3,000 shares)

McGraw-Hill Companies, Inc., 2005


34

Fundamental Accounting Principles, 17th Edition

Problem 13-2B (60 minutes)


Part 1
Jan. 10

Treasury Stock, Common..............................................


240,000
Cash...........................................................................

240,000

Purchased treasury stock (20,000 x $12).

Mar. 2

Retained Earnings..........................................................
120,000
Common Dividend Payable.....................................

120,000

Declared $1.50 dividend on 80,000 outstanding shares.

Mar. 31

Common Dividend Payable...........................................


120,000
Cash...........................................................................

120,000

Paid cash dividend.

Nov. 11

Cash*
156,000
Treasury Stock, Common**.....................................
Contributed Capital, Treasury Stock***..................

144,000
12,000

Reissued treasury stock.


*(12,000 x $13) **(12,000 x $12) ***(12,000 x $1)

Nov. 25

Cash*...............................................................................
76,000
Contributed Capital, Treasury Stock............................
12,000
Retained Earnings..........................................................
8,000
Treasury Stock, Common**.....................................

96,000

Reissued treasury stock.


*(8,000 x $9.50) **(8,000 x $12)

Dec. 1

Retained Earnings..........................................................
250,000
Common Dividend Payable.....................................

250,000

Declared $2.50 dividend on 100,000 outstanding shares.

Dec. 31

Income Summary...........................................................
536,000
Retained Earnings....................................................

536,000

Closed Income Summary account.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


35

Problem 13-2B (Concluded)


Part 2
BAYCORE CORP.
Statement of Retained Earnings
For Year Ended December 31, 2006
Retained earnings, Dec. 31, 2005..................................... $1,080,000
Plus net income..................................................................
536,000
1,616,000
Less Cash dividends declared........................................
(370,000)
Treasury stock reissuances...................................
(8,000)
Retained earnings, Dec. 31, 2006..................................... $1,238,000
Part 3
BAYCORE CORP.
Stockholders Equity Section of the Balance Sheet
December 31, 2006
Common stock $1 par value, 160,000 shares
authorized, 100,000 shares issued and outstanding.... $ 100,000
Contributed capital in excess of par value,
common stock..................................................................
700,000
Total contributed capital....................................................
800,000
Retained earnings (from part 2)............................................. 1,238,000
Total stockholders equity................................................. $2,038,000

McGraw-Hill Companies, Inc., 2005


36

Fundamental Accounting Principles, 17th Edition

Problem 13-3B (45 minutes)


Part 1
Explanations for each of the journal entries
Jan. 17 Declared a cash dividend of $1 per share of common stock.
($48,000 / 48,000 shares)
Feb.

5 Paid the cash dividend on common stock.

Feb. 28

Declared a 12.5% stock dividend when the market value is $21 per
share. ($60,000 / $10 par = 6,000 shares = 12.5% of 48,000 shares;
$126,000 / 6,000 shares = $21 per share)

Mar. 14 Distributed the common stock dividend.


Mar. 25 Executed a 2-for-1 stock split. ($10 par / $5 par = 2-for-1 ratio)
Mar. 31 Closed the Income Summary account to Retained Earnings.

Part 2
Jan. 17

Feb. 5

Feb. 28

Mar. 14

Common stock......... $ 480,000 $ 480,000 $ 480,000 $ 540,000


Common stock

Mar. 25

Mar. 31

$ 540,000 $ 540,000

dividend distributable. .

60,000

Contributed capital in
excess of par...........

192,000

192,000

258,000

258,000

258,000

258,000

Retained earnings......

752,000

752,000

626,000

626,000

626,000

986,000

Total equity...............$1,424,000 $1,424,000 $1,424,000 $1,424,000

Solutions Manual, Chapter 13

$1,424,000 $1,784,000

McGraw-Hill Companies, Inc., 2005


37

Problem 13-4B (45 minutes)


Part 1
Outstanding common shares
Feb. 15
Beginning balance........................... 8,500
Less treasury stock (Mar. 2)............
Plus dividend shares (Oct. 4)*......... _____
Outstanding shares.......................... 8,500

May 15
8,500
(500)

Aug. 15
8,500
(500)

_____

_____

8,000

8,000

Nov. 15
8,500
(500)
1,000
9,000

*(12.5% x 8,000)

Part 2
Cash dividend amounts
Feb. 15
Outstanding shares.......................... 8,500
Dividend per share...........................$ 0.40
Total dividend...................................$3,400

May 15
8,000
$ 0.40
$3,200

Aug. 15
8,000
$ 0.40
$3,200

Nov. 15
9,000
$ 0.40
$3,600

Part 3
Capitalization of retained earnings for small stock dividend
Number of shares...............................................................................
1,000
Market value per share......................................................................
$
42
Total capitalized..................................................................................
$42,000
Part 4
Cost per share of treasury stock
Total amount paid...............................................................................
$20,000
Shares purchased..............................................................................
500
Cost per share....................................................................................
$
40
Part 5
Net income
Retained earnings, beginning balance............................................
$135,000
Less dividends: Feb. 15...................................................................
(3,400)
May 15....................................................................
(3,200)
Aug. 15...................................................................
(3,200)
Oct. 4
(42,000)
Nov. 15...................................................................
(3,600)
Total before net income.....................................................................
$ 79,600
Plus net income..................................................................................
?
Retained earnings, ending balance..................................................
$147,600
Therefore, net income = $68,000

McGraw-Hill Companies, Inc., 2005


38

Fundamental Accounting Principles, 17th Edition

Problem 13-5B (60 minutes)


Part 1

Effect of income taxes (debits or losses in parentheses)


Pretax

c. Cumulative effect of change in accounting principle............


$ 46,000

25% Tax
Effect

After-Tax

$ 11,500

$ 34,500

f. Loss on hurricane damage..............................................


(32,000)

(24,000)
(8,000)

m.Loss from operating a discontinued segment......................


(60,000)

(45,000)
(15,000)

o. Correction of overstatement of prior years expense...........


24,000

6,000

q. Loss on sale of discontinued segments assets...................


(90,000)

18,000
(67,500)

(22,500)

Part 2
d.
b.
k.
p.
i.
n.
h.
l.
j.

e.

Income from continuing operations (and its components)

Net sales
$1,320,000
Interest revenue..............................................................
10,000
Gain from settling lawsuit.............................................
34,000
Total revenues and gains..............................................
1,364,000
Cost of goods sold.........................................................
$520,000
Depreciation expenseEquipment..............................
50,000
Depreciation expenseBuildings................................
78,000
Other operating expenses.............................................
164,000
Loss on sale of equipment............................................
12,000
Loss from settling lawsuit.............................................
18,000
Total expenses and losses............................................
842,000
Income from continuing operations before taxes.............
522,000
Income taxes expense (25%).........................................
(130,500)
Income from continuing operations after taxes................
$ 391,500

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


39

Problem 13-5B (Concluded)


Part 3
m.
q.

Income from discontinued segment

Loss from operating a discontinued segment (after-tax)..................$ (45,000)


Loss on sale of discontinued segments assets (after-tax)............... (67,500)

Loss from discontinued segment................................................$(112,500)

Part 4

Income before extraordinary items and the cumulative effect of


changes in accounting principle
Income from cont. oper. after taxes (from Part 2)...........................$ 391,500
Loss from discontinued segment (from Part 3).............................. (112,500)
Income before extraordinary items and the
cumulative effect of changes in principle................................$ 279,000

Part 5 Net income


Income before extraordinary items and the
cumulative effect of changes in principle................................$ 279,000
f.

Extraordinary item:
Loss on hurricane damage (after-tax)......................................... (24,000)

c.

Cumulative effect of change in accounting


principle (after-tax)..................................................................... 34,500
Net income.....................................................................................$ 289,500

McGraw-Hill Companies, Inc., 2005


40

Fundamental Accounting Principles, 17th Edition

Problem 13-6B (45 minutes)


Part 1
Yesgenerally accepted accounting principles allow the accounting
change to be made as long as the change can be justified as producing
more useful financial statements. Consistency with other companies in the
industry is often a satisfactory justification.
Part 2

Double-declining-balance depreciation (Rate = 40%)

Beginning-Year
Book Value
2003................................... $200,000
2004................................... 120,000
2005...................................
72,000
Total.................................
Part 3

Depreciation
Expense
$ 80,000
48,000
28,800
$156,800

Year-End
Book Value
$120,000
72,000
43,200

Depreciation
Expense*
$ 40,000
40,000
40,000
$120,000

Year-End
Book Value
$160,000
120,000
80,000

Straight-line depreciation

Beginning-Year
Book Value
2003................................... $200,000
2004................................... 160,000
2005................................... 120,000
Total...................................

*Annual amount = ($400,000 - $0) / 5 years = $80,000

Part 4
Pretax cumulative effect of the accounting change
(see book, part 4)...........................................................................$36,800
After-tax cumulative effect of the accounting change
($36,800 x [1-0.25]).........................................................................$27,600

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


41

Problem 13-6B (Concluded)


Part 5
The cumulative effect should be reported in the lower section of the income
statement after any extraordinary items but before net income. It will increase
income because it results from a retroactive restatement of the asset to a
higher book value.

Part 6
The 2006 income statement will report depreciation expense of $40,000.
This amount is the depreciation expense using the straight-line method.
Part 7
Effect of error on financial statements
On the 2006 income statement, the pre-tax cumulative effect of the change
from double-declining-balance to straight-line depreciation of $36,800 (from
part (4)) less the 2006 straight-line depreciation of $40,000 yields a decrease to
income before taxes of $3,200. Therefore, treating it as a change in an
accounting estimate (accounted for in current and future periods) would result
in an understatement of income before taxes by $18,400 ($21,600 * - $3,200).
This means net income (after-tax) would be understated by $13,800 [computed
as $18,400 x (1 - .25)].
On the 2006 balance sheet, retained earnings would be understated by
$13,800, income taxes payable would be understated by $4,600 ($18,400 x .25),
and assets would be understated by $18,400.
* Supporting computation Depreciation expense for 2006:
If switching depreciation methods is treated as a change in an
accounting estimate, then the straight-line depreciation amount is
computed and reported in 2006 as follows:
Book value, January 1, 2006.........................................................................
$43,200
Less salvage value........................................................................................
0
Depreciation expense....................................................................................
$43,200 / 2 years = $21,600

McGraw-Hill Companies, Inc., 2005


42

Fundamental Accounting Principles, 17th Edition

Problem 13-7B (60 minutes)


Part 1

Year 2003 weighted-average shares

Outstanding Effect of
Time Period
Shares
Dividend
January-June....................10,000
x
1.2
July-September................ 9,000
x
1.2
October-November...........12,500
x
1.2
December..........................15,000
x
1.0
Weighted-average shares outstanding

Part 2

x
x
x
x

Fraction
of Year
6/12
3/12
2/12
1/12

=
=
=
=

Year 2003 earnings per share components

Reported
Divided
Total
by Shares
Income from continuing operations......... $ 90,000
12,450
Loss on discontinued segment................ (26,145)
12,450
Net income.................................................. $ 63,855
12,450

Part 3

Earnings
per Share
$7.23
(2.10)
$5.13

Year 2004 weighted-average shares

Outstanding
Time Period
Shares
January-March..................
15,000
April-September...............
19,000
October-December...........
17,500
Weighted-average shares outstanding

Part 4

Weighted
Average
6,000
2,700
2,500
1,250
12,450

Fraction of
Weighted
Year
Average
x
3/12
=
3,750
x
6/12
=
9,500
x
3/12
=
4,375
17,625

Year 2004 earnings per share components

Reported
Divided
Total
by Shares
Income from continuing operations......... $85,000
17,625
Extraordinary gain...................................... 14,100
17,625
Net income.................................................. $99,100
17,625

Solutions Manual, Chapter 13

Earnings
per Share
$4.82
0.80
$5.62

McGraw-Hill Companies, Inc., 2005


43

Problem 13-7B (Concluded)


Part 5

Year 2005 weighted-average shares

Outstanding
Effect
Time Period
Shares
of Split
January-June.................... 17,500
x
2
July-September................ 20,500
x
2
October.............................. 18,750
x
2
November-December....... 37,500
x
1
Weighted-average shares outstanding

Part 6

x
x
x
x

Fraction
of Year
6/12
3/12
1/12
2/12

Weighted
Average
= 17,500
= 10,250
= 3,125
= 6,250
37,125

Year 2005 earnings per share components

Reported
Divided
Total
by Shares
Income from continuing operations......... $130,000
37,125
Extraordinary loss...................................... (37,125)37,125
Net income.................................................. $ 92,875
37,125

Earnings
per Share
$3.50
(1.00)
$2.50

Part 7
Of the three earnings per share figures in part 6, income from continuing
operations is most likely the best predictor of 2006 results. We might also
want to factor in any trend in earnings per share (adjusted for the stock split).
By definition, the 2005 extraordinary loss is both unusual and infrequent and
therefore extremely unlikely to occur again in 2006. However, the nature of the
extraordinary loss needs to be considered, and its impact on future operations
needs to be evaluated. For example, if the extraordinary loss was due to a fire
that occurred in December that damaged the plant, then production would
most likely be impaired in 2006, resulting in a decrease in income from
continuing operations.

McGraw-Hill Companies, Inc., 2005


44

Fundamental Accounting Principles, 17th Edition

Problem 13-8B (40 minutes)


1. Market price = $45 per share (current stock exchange price given)
2. Computation of stock par values
Preferred: Paid-in amount / Number of shares = $187,500 / 1,500 = $125
Common: Paid-in amount / Number of shares = $450,000 /18,000 = $ 25
3. Book values with no dividends in arrears
Book value per preferred share = par value (when not callable)
= $125
Common stock
Total equity................................................ $1,200,000
Less equity for preferred......................... (187,500)
Common stock equity.............................. $1,012,500

4.

Number of outstanding shares...............

18,000

Book value per common share...............

$56.25 ($1,012,500 / 18,000)

Book values with two years dividends in arrears


Preferred stock
Preferred stock par value........................ $ 187,500
Plus two years dividends in arrears*.....
30,000
Preferred equity........................................ $ 217,500
*2 years dividends = 2 x ($187,500 x 8%) = $30,000

Number of outstanding shares...............


Book value per preferred share.............. $

1,500
145.00 ($217,500 / 1,500)

Common stock
Total equity................................................ $1,200,000
Less equity for preferred......................... (217,500)
Common stock equity.............................. $ 982,500
Number of outstanding shares...............
Book value per common share............... $

Solutions Manual, Chapter 13

18,000
54.58 ($982,500 / 18,000)

McGraw-Hill Companies, Inc., 2005


45

Problem 13-8B (Concluded)


5. Book values with call price and two years dividends in arrears
Preferred stock
Preferred stock call price (1,500 x $140)
Plus two years dividends in arrears*...........
Preferred equity..............................................

$ 210,000
30,000
$ 240,000

*2 years dividends = 2 x ($187,500 x 8%) = $30,000

Number of outstanding shares.....................


Book value per preferred share....................
Common stock
Total equity......................................................
Less equity for preferred...............................
Common stock equity....................................

1,500
$

$1,200,000
(240,000)
$ 960,000

Number of outstanding shares.....................


Book value per common share.....................

160.00 ($240,000 / 1,500)

18,000
$

53.33 ($960,000 / 18,000)

6. Dividend allocation in total


2 years dividends in arrears....
Current year dividends..............
Remainder to common..............
Totals...........................................

Preferred
$30,000
15,000

$45,000

Common
$
0

5,000
$5,000

Total
$30,000
15,000
5,000
$50,000

Dividends per share for the common stock


$5,000 / 18,000 shares = $0.28
7.

Equity represents the residual interest of owners in the assets of the


business after subtracting claims of creditors. With few exceptions, these
assets and liabilities are valued at historical cost, not market value.
Therefore, the book value of common stock does not normally match its
market value. Also, the book value of common stock is based on past
transactions and events, whereas the market value takes into account
expected future earnings, growth, dividends, and other industry and
economic factors.

McGraw-Hill Companies, Inc., 2005


46

Fundamental Accounting Principles, 17th Edition

SERIAL PROBLEM
Serial Problem, Success Systems (30 minutes)
Part 1
Apr. 1

Kay Breeze, Capital........................................................


10,000
Common Stock, $1 Par Value..................................

10,000

Exchanged capital for 10,000 shares of $1 par


value common stock (10,000 x $1).

Apr. 1

Kay Breeze, Capital........................................................


119,034
Contributed Capital in Excess of Par
Value, Common Stock....................................

119,034

Transfer remaining capital to contributed capital


in excess of par.
Note: An April 1 compound entry is acceptable.

Part 2

Corporate Balance SheetEquity Section Only


SUCCESS SYSTEMS, INC.
Balance Sheet
April 1, 2005

Equity
Common stock$1 par value, 25,000 shares authorized,
10,000 shares issued and outstanding........................................ $ 10,000
Contributed capital in excess of par value, common stock......... 119,034
Total equity........................................................................................ $129,034

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


47

Reporting in Action

BTN 13-1

1. No. The balance sheet shows that 10,000 shares of no par value,
preferred stock has been authorized, however, none have been issued.
2. As of February 2, 2003, the number of shares of common stock issued
and outstanding are 56,295 (in thousands, see balance sheet). As of
February 3, 2002, the number of shares of common stock issued is
54,271.
The weighted average common shares used in calculating earnings per
share can be found under Krispy Kremes Selected Financial Data.
For 2003, the weighted average common shares used were 55,093 and
for 2002 were 53,703. Therefore, for both years, the shares outstanding
at year-end were slightly higher than the average shares outstanding
during the year.
3. Total stockholders equity as of February 2, 2003...........

$273,352,000

Book value of equity applicable to common stock*........

$273,352,000

* Given that there is only one class of stock, all the equity items listed can be considered to
represent the book value of the common stock.

4. Krispy Kreme has not paid cash dividends on its common shares since
2001; see its statement of cash flows.
5. Krispy Kremes income statement reports the following:
2003
2002
Basic earnings per common share.............. $0.61
$0.49

2001
$0.30

Its basic earnings per common share figure is has consistently grown
over this 3-year period. Moreover, the 2003 amount is considerably
larger than the prior two years.
6. Krispy Kremes consolidated balance sheet does not list any shares of
treasury stock in 2003 or 2002.
7. No extraordinary gains or losses, nor changes in accounting principle,
are reported for either 2003 or 2002 (see its income statement). Also, no
gains or losses on the disposal of a business segment are reported for
either year.
8. Answer depends on the financial statement information obtained.

McGraw-Hill Companies, Inc., 2005


48

Fundamental Accounting Principles, 17th Edition

Comparative Analysis

BTN 13-2

1. Book value per common share =


Krispy Kremes book value per common share:
= $273,352/ 55,093 = $4.96
Tastykakes book value per common share:
= $47,525/ 8,075

= $ 5.89

2. Earnings per share =


Krispy Kreme earnings per share: $33,478 / 55,093 = $0.61
Tastykake earnings per share:

$2,000*/ 8,075

= $0.25

* Excluding restructuring charge. If the net loss shown on the income statement is used
then earnings per share is $(0.54).

3. Dividend Yield =
Krispy Kreme dividend yield
Tastykake dividend yield

= $0 / 30.41
= 0.00%
= $0.48 / $9.20 = 5.22%

Analysis: The low dividend yield for Krispy Kreme suggests that it is a
growth stock.
4. Price-earnings ratio =
Krispy Kreme price-earnings ratio: $30.41 / $0.61 = 50
Tastykake price-earnings ratio:

$9.20 / $ 0.25 = 37

Interpretation: The price-earnings ratios of the companies are


considerably different. In Krispy Kremes case, the market appears
willing to pay a multiple of 50 times its earnings. For Tastykake, that
multiple is considerably less at 37 times its earnings.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


49

Ethics Challenge

BTN 13-3

The auditors primary responsibility is to determine whether the financial


statements are fairly stated in all material respects. The auditor in this
situation must decide if the income statement would be materially
misstated (or less useful) by showing a $56,000 increase in net income due
to the change from the double-declining-balance method of depreciation to
the straight-line method.
Notice that with the cumulative effect of the change, the net income is
$1,224,300. Without the change, the net income is $1,168,300. The ratio of
$56,000/$1,168,300 represents a change of close to 5%. This magnitude of
difference results in the need for the auditor to make a judgment call.
Perhaps the difference is not so material that it would affect the decisions
of some users relying on the information presented in the income
statement. Other users, however, may view $56,000 as a material amount.
The auditor must also consider whether generally accepted accounting
principles are being followed. Generally accepted accounting principles
allow a change in accounting method if the new method will present results
in a more useful fashion. In this particular case it does not appear that the
change would improve the financial reporting. The equipment in question
is of a high-tech nature, which often implies that it should be depreciated
using an accelerated method allowing most of the depreciation to be taken
early in the assets useful life.
Managements decision to change also seems to be related to securing a
higher bonus. The $56,000 obviously represents a material amount to the
managers of the company, or they would not have suggested the change.
Given these considerations it seems as though the auditor should ask
management to not change the method of applying depreciation. At a
minimum, management must be required to fully explain the rationale for
this change.

Communicating in Practice

BTN 13-4

There is no set solution to this activity. Solutions will vary based on the
industry and the companies selected.

McGraw-Hill Companies, Inc., 2005


50

Fundamental Accounting Principles, 17th Edition

Taking It to the Net

BTN 13-5

1. The balance sheet of HCA, Inc., shows that the company has only
issued common stock. However, the common stock is divided into
voting and nonvoting shares. In 2002 there were 493,176,000 voting
shares and 21,000,000 nonvoting shares outstanding.
2. Both the voting and nonvoting common shares have a par value of
$0.01.
3. The statement of cash flows (financing) shows that in 2002 HCA issued
common stock for proceeds of $267 million.
4. In 2002, the statement of cash flows (financing) shows that HCA
repurchased common stock shares for $282 million.
5. In 2002, the statement of cash flows (financing) shows that HCA paid
cash dividends of $40 million.

Teamwork in Action

BTN 13-6

1. The team statement should include the following:


a. When a corporation buys back its stock (engages in a treasury
stock acquisition), the effect on financial position is a decrease in
both assets (cash) and equity (treasury stock). Also, treasury stock
is a contra equity account that decreases equity.
b. Reasons for buybacks:
to use shares to acquire another corporation.
to avoid a hostile takeover by an investor seeking to take control
of the company.
to reissue shares to employees as compensation.
to maintain a strong or stable market for the stock.
2. The team should establish the acquisition entry as follows:
Treasury Stock, Common.........................................
Cash.....................................................................

13,400
13,400

Reacquired 100 shares of $100 par value


common stock at a cost of $134 per share.

Each member should prepare one of the following reissue entries:

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


51

Teamwork in Action (Continued)


a.

Cash...........................................................................................
13,400
Treasury Stock, Common..................................................

13,400

Received $134 per share for 100 treasury


shares costing $134 per share.

b.

Cash...........................................................................................
15,000
Contributed Capital, Treasury Stock................................
Treasury Stock, Common..................................................

1,600
13,400

Received $150 per share for 100 treasury


shares costing $134 per share.

c.

Cash...........................................................................................
12,000
Contributed Capital, Treasury Stock......................................
1,400
Treasury Stock, Common..................................................

13,400

Received $120 per share for 100 treasury


shares costing $134 per share.

d.

Cash...........................................................................................
12,000
Contributed Capital, Treasury Stock......................................
1,000
Retained Earnings....................................................................
400
Treasury Stock, Common..................................................

13,400

Received $120 per share for 100 treasury


shares costing $134 per share.

e.

Cash...........................................................................................
12,000
Retained Earnings....................................................................
1,400
Treasury Stock, Common..................................................

13,400

Received $120 per share for 100 treasury


shares costing $134 per share.

3. When presenting and explaining the above entries to the team, the
following points should be made by the team members:
The similarities in all reissue entries a through e are:
The net affect of the transaction is to increase assets and equity by
the amount received on reissue.
Cash (assets) is always increased by the amount received.
Treasury Stock is always decreased by the full cost regardless of
whether the reissue is at cost, above cost, or below cost.

McGraw-Hill Companies, Inc., 2005


52

Fundamental Accounting Principles, 17th Edition

Teamwork in Action (Concluded)


The differences in reissue entries a through e are:
(b) Reissuing above cost creates additional Contributed Capital.*
(c) Reissuing below cost reduces existing Contributed Capital.*
(d) Reissuing below cost reduces existing Contributed Capital,*
but after this accounts balance has been eliminated, then
Retained Earnings must be reduced by the additional amount below
cost.
(e) Reissuing below cost reduces Retained Earnings when Contributed
Capital* does not exist.
*Refers to the Contributed Capital, Treasury Stock account.

Business Week Activity

BTN 13-7

1. Start-up tech companies usually have limited cash. Most small tech
companies argue that they are better off pouring their cash into
research and development or other investments while also retaining a
cushion for any sharp downturns the industry might encounter.
2. The most prominent large tech companies do not pay cash dividends.
3. A recent poll of 500 institutional investors showed that investors were
clearly in favor of receiving dividends if the tax law changes so that
distributed dividends will not be taxed as part of the shareholder
personal income.
4. In the past, tech companies have often purchased treasury shares
(stock buybacks) with their excess cash. The share buybacks have
been popular with tech companies in the past because treasury stock
reduces shares outstanding. Stock options, which are highly utilized by
tech companies, will ultimately result in shares being issued. The tech
companies can manage the total number of shares outstanding by
balancing stock issued due to stock options with share repurchases.
5. CEOs of tech companies tend to hold considerable amounts of their
companys stocks. Therefore, the personal (cash) wealth of CEOs may
grow substantially if tech companies start to issue more dividends.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


53

Entrepreneurial Decision

BTN 13-8

1.
Net income..............................................................
Less preferred dividends.......................................
Net income for common stockholders.................

Plan A
$ 45,000
0
$ 45,000

Plan B
$ 45,000
(5,000)
$ 40,000

Chavezs share of common equity.......................


Chavezs share of income after any preferred
stock dividends.......................................................

80%

100%

$ 36,000

$ 40,000

Chavezs initial equity............................................

$250,000

$250,000

Chavezs return on equity.....................................

14.4%

16.0%

Net income..............................................................
Less preferred dividends.......................................
Net income for common stockholders.................

Plan A
$ 10,500
0
$ 10,500

2.
Plan B
$ 10,500
(5,000)
$ 5,500

Chavezs share of common equity.......................


Chavezs share of income after any preferred
stock dividends.......................................................

80%
$

Chavezs initial equity............................................

$250,000

$250,000

Chavezs return on equity.....................................

3.4%

2.2%

8,400

100%
$

5,500

3. The difference between the answers for parts 1 and 2 arises from the
percent return generated with the assets invested in the corporation.
In part 1, Get Real Girl Inc.s return on equity is 14.4% ($36,000/$250,000)
for Plan A, which is less than the 16.0% for Plan B. However, the return on
equity is only 3.4% ($8,400/$250,000) in part 2 for Plan A, BUT this is more
than the 2.2% for Plan B.
These results indicate that the 8% dividend rate on the preferred stock is
advantageous to Chavez as long as the rate of return on the assets is
greater than 8% (this is the same as saying net income is over $25,000).
This means Plan B is preferred. Net income over $25,000 yields a return on
assets greater than 8% (i.e., 8% equals $25,000/$312,500). If net income
falls below $25,000 (or less than 8% return on assets), then Plan A is
preferred.
McGraw-Hill Companies, Inc., 2005
54

Fundamental Accounting Principles, 17th Edition

Hitting the Road

BTN 13-9

There is no formal solution for this field activity. Students often find this
assignment interesting as it highlights the relevance of their accounting
studies.

Global Decision
1.

BTN 13-10

Earnings per share


2002

2001

2000

$0.83

$1.25

$1.39

The trend in earnings per share is a negative one, showing decreases


for the past two years.
2. Weighted Average Shares Outstanding (disclosed at the bottom of the
Income Statement)
2002

2001

1,175,821,000

1,321,642,000

Weighted average number of shares outstanding has decreased.


3. Cash dividends declared for shareholders (see Statement of Financial
Position- (financing)
2002

2001

$303,804

$286,184

Cash dividends paid to shareholders has increased.

Solutions Manual, Chapter 13

McGraw-Hill Companies, Inc., 2005


55

You might also like