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May 27, 2014
Lesson 152
From: Joe
Keeping Things Fresh
I wanted to do something entirely different in today’s email lesson. Obviously, we have over 2,500 free questions and answers to help you pass the CPA Exam as quickly as possible. In addition, we sell a product that we call “The Essentials” to help you gain the information you need to get those 75 points. We charge a small amount for The Essentials, money that goes to help support our CPAreviewforFREE website.
We get a lot of questions about The Essentials so I wanted to use today’s email lesson to provide an example of how The Essentials can help you gain the knowledge you need. Remember, the exam is a mile wide and an inch deep.
I have been doing work over the last few days making updates in the coverage included in The Essentials for FAR. We pride ourselves in keeping our website up to date. In that one part of the CPA Exam, we have 20 different topics including earnings per share, leases, bonds payable, and the like. If you have already passed FAR, forward this newsletter to one of your friends or colleagues who are still working on passing FAR.
Below is one of those 20 topics: stockholders’ equity. I just copied it out of The Essentials and pasted the content below. We try to provide all the information you need to pass. We want to provide information in a clear and understandable fashion.
Special Offer
Here is my special offer. Read our Essential Content below and then you will find four questions like you might see on the CPA Exam about stockholders’ equity. I’ll try not to make them too easy or too hard. Just normal questions.
For the first two people who send me correct answers to all four of these questions atjhoyle@cpareviewforfree.com, I will mail you an autographed copy of my book Don’t Just Dream About Success: Stack the Odds in Your Favor. It is available on Amazon for $8.99. Everyone else will get a consolation prize. But the first two people with all four answers correct will receive an autographed copy of the book.
Okay, read the Essential Content below and send me your answers to the four questions at the end of this lesson to jhoyle@cpareviewforfree.com.
FROM “THE ESSENTIALS” SOLD BY CPAreviewforFREE (Only $15/month or $30/3 months; Printable $39*) FOR THE FAR PORTION OF THE CPA EXAM:
STOCKHOLDERS’ EQUITY
The stockholders’ equity section of a balance sheet is equal to the reported assets minus liabilities (i.e., net assets). Basically, it shows the source of an entity’s net assets. Stockholders’ equity consists of two major categories: contributed capital (the amount of the net assets that were put into the business by owners) and retained earnings (the amount of the net assets generated by operations – all net income since operations began minus all dividends).
Businesses also report accumulated other comprehensive income to record gains and losses that are not reported on the entity’s income statement (such as gains and losses in the value of investments in available-for-sale securities). A fourth section within stockholders’ equity (treasury stock) is a negative to indicate that net assets have been used to repurchase shares of the business but those shares have not, as of yet, been retired.
Most companies report a statement of changes in stockholders’ equity within their financial statements which reports the change in each element of stockholders’ equity.
Common Stock
In the incorporation process, a business indicates the number of authorized ownership shares (the total number of shares that it wants to have the right to issue—this is often a huge number so that limitations are unlikely to be encountered in the future). The "shares issued" are the shares that have been provided to outside parties. The "shares outstanding" are the shares that are currently held by outside parties. The difference in issued shares and outstanding shares occurs because of treasury stock—issued shares that have been bought back by the business but not retired.
Ownership shares can be common stock or preferred stock. All companies have common stock while a few also issue preferred stock. The holders of common stock gain the rights specified by the state of incorporation. Those rights normally allow the owners to vote for the members of the board of directors that oversees the running of the company. Those rights also provide that each owner gets to share proportionally in any dividends that are distributed.
In most states, a corporation is required to indicate the par value of its common stock and preferred stock. With common stock, the legal purpose of par value has faded over the years. It basically means that anyone who buys the stock directly from the corporation for less than par value might eventually be held liable for this discount if the company ever goes bankrupt. Today, most corporations set the par value of their common stock at such a low amount (often a penny or a nickel) that no one ever buys the stock from the company for less than that amount.
Assume, for example, that a company issues one share of $1 par value common stock for $35 in cash. The journal entry is as follows. Note that the common stock is recorded at the par value (a traditional approach in accounting) with the excess shown in an account such as “additional paid-in capital” or “contributed capital in excess of par.” Together, these equity accounts indicate the total amount of contributed capital—the amount paid in by owners directly to the company.
Cash
Common stock 1
Additional paid-in capital
—common stock 34
If stock is issued to pay for an asset or expense, the recording is based on the fair value of the stock. Only if the value of the stock is not known is the value of the asset or expense used. However, assets should never be recorded at a figure that is above its own fair value.
Assume that $1 par value common stock is selling for $35 per share and 1,000 shares are issued for land that has a fair value of $36,000. The recording entry is as follows based on the $35,000 value of the shares issued.
Land
Common stock
($1 par value X 1,000 shares) 1,000
Additional paid-in capital
—common stock 34,000
In a few states, no-par stock is allowed. All of the proceeds from the issuance of no-par stock is credited to “common stock.”
Costs of registering and issuing common stock are generally netted against the proceeds so that a smaller amount is reported in the Additional Paid-in Capital account.
Preferred Stock
The holders of preferred stock have only the rights specified in the stock certificate. In effect, the common shareholders are giving up a preference to these specified rights in exchange for the cash or other assets being put into the business. Most commonly, the holders of preferred stock are given the right to receive a set amount of dividends. The amount of the dividend payout is specified as a dollar amount or as a set percentage of the par value of the preferred stock.
Additional possible features stated in a preferred stock certificate:
1. Participating—preferred stockholders share with common stockholders in any dividend distributions that occur after both preferred and common stockholders receive a specified level of the dividend payment. Thus, preferred stockholders benefit by any exceptional large dividend payments.
2. Cumulative—preferred dividends not paid in a prior year (known as “dividends in arrears”) that must be paid before any distributions can be made to common stockholders. Dividends in arrears are not reported as a liability until declared by the board of directors. However, they should be disclosed.
3. Convertible—preferred stockholders have an option of exchanging their stock for common stock at a specified ratio
4. Callable—the corporation has the option to repurchase the preferred stock at a specified price. In stock transactions, no gain or loss is ever recognized on the income statement. Instead, gains are recorded as increases in additional paid-in capital (or an account with a similar title). Losses are a bit more of a reporting problem. If a comparable additional paid-in capital balance exists, it can be reduced to record any loss from a stock transaction. As an alternative, or if no additional paid-in capital balance exists, retained earnings is reduced. Thus, under certain circumstances, retained earnings can be reduced by a stock transaction but can never be increased.
Mandatorily redeemable preferred stock is classified as a liability on the balance sheet (rather than as stockholders’ equity) because payment must be made in the future.
PRACTICE QUESTIONS
Okay, the first two people who send the correct answers (just include the question number and the letter of the correct answer in your email) to all four of the following questions will receive an autographed copy of my book Don’t Just Dream About Success: Stack the Odds in Your Favorwhich can be bought on Amazon for $8.99 (kindle or paperback).
Send your answers with the subject line "Answers" directly to me at Jhoyle@cpareviewforfree.com. Remember if you are not one of the first two people to answer all four questions correctly, there is a consolation prize. Everybody wins with correct answers.
ONE – On January 1, Year One, the VanHuss Corporation issues 1,000 shares of its preferred stock for its par value of $100 per share. The stock pays a 6 percent ($6) cumulative cash dividend every December 31. Both the company and the investor stipulate in the stock contract that these shares will be reacquired by VanHuss in exactly 8 years for par value plus any dividends that are unpaid at that time. On December 31, Year One, the first dividend payment is properly made. When the company then produces a balance sheet, how is this stock reported?
A – As a part of stockholders’ equity
B – As a liability
C – As a footnote disclosure
D – Between the liability section and the stockholders’ equity section.
TWO – The Hough Company issues 100,000 shares of $10 par value common stock for $12 per share. Two years later, the company reacquires 10,000 of these shares for $13 per share. The company is going to report this treasury stock by the cost method. However, at the last minute, company officials decide to report these shares by use of the par value method. How does that decision affect the total stockholders’ equity reported by Hough?
A. Total stockholders’ equity will be $10,000 lower because of the decision to use the par value method.
B. Total stockholders’ equity will be $20,000 lower because of the decision to use the par value method.
C. Total stockholders’ equity will be $30,000 lower because of the decision to use the par value method.
D. Total stockholders’ equity will not be impacted because of the decision to use the par value method.
THREE – The Lawson Company has 100,000 shares of common stock outstanding with a par value of $10 per share. The stock was originally issued for $14 per share. Currently, the stock has a fair value of $17 per share. The company issues 22,000 new shares of this common stock to its stockholders as a stock dividend. Retained earnings should be reduced because of this dividend by which of the following amounts?
A. $220,000 (22,000 shares at $10 per share)
B. $308,000 (22,000 shares at $14 per share)
C. $374,000 (22,000 shares at $17 per share)
D. The company can reduce retained earnings by either $220,000 or $374,000
FOUR – On January 1, Year One, the Smith Company issues 1,000 stock options to its president. The president must work for four years and then has three additional years in which to buy the stock at a price of $30 per share. The price of the stock on that day is $28 per share but it goes up in price by $3 per year thereafter. The conveyance qualifies as a compensatory stock option plan. According to a computer pricing model (Black-Scholes), one of these options is worth $5 on January 1, Year One but $8 on December 31, Year One, and $10 on December 31, Year Two. How much expense should this company recognize in Year Two?
A. No expense is recognized in Year Two.
B. $1,250
C. $2,000
D. $3,000
Okay, all of these questions can be answered from the material in The Essentials provided above. Send your four answers with the subject line "Answers" to jhoyle@cpareviewforfree.com
Go for it.
Joe Hoyle
*As of May 27, 2014. Prices subject to change.
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