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August 1, 2014
Lesson 155
From: Joe
You can still pass all 4 parts before the end of the year!
August begins and a lot of you guys are getting ready to take one or more parts of the CPA Exam before the summer window closes. Now is the time to put on the push. Now is the time to work as many questions as possible to get yourself ready to earn those 75 points that you need in order to pass.
A great sports team gets stronger as the big game approaches.
A champion athlete gets stronger as the big match moves to its conclusion.
A great CPA Exam candidate gets stronger as the exam approaches.
You want to be at your very strongest on the day you walk into the test site.
Remember, www.CPAreviewforFREE.com has 2,500 free (yes, FREE) questions and answers. I wrote most of them myself based on my 34 years in the review business. Work them once and learn from your mistakes and then work them again. Do that and you should be ready and raring to go into that site and knock out that exam.
In hopes of adding points in the quickest possible way, I want to do something entirely different in today’s email lesson. I spent a lot of time on this lesson because I want to help you pass. At the same time, you can help us. We here at CPA Review for FREE would greatly appreciate your passing this message along to anyone that you know who is getting ready to take the CPA Exam. I think this is the quickest way that you will ever see to add points to your score.
Below, I have written four essential questions, one for each part of the exam – information that I really believe that you should know in order to demonstrate the knowledge to pass. I want you to work each question. However, instead of a written answer, I have made four short videos to guide you through each answer.
I want you to LEARN how to answer these questions. Don’t just read the answer. I want you to see how to get to the answer.
Remember, work the question first and then watch the video. I spent some real time making these videos and I did this just to help you (not the guy beside you but you) add points and pass the CPA Exam in August of 2014.
Our Partner, Fast Forward Academy, Provides Amazing CPA Review!
While many places offer you a practice exam tool, or a study bank, or books, our partner, Fast Forward Academy for CPA Review, offers an entire powerful and intelligent platform - everything you need to study, learn, and pass your exam on the very first try. We have tools and features that no one else has, creating an educational experience like no other.
Time for some practice.
FAR
I thought I would start with a question on determining earnings per share. The question is not easy but it is one that follows a very set pattern that you can come to understand very quickly with some practice.
The Smolich Co. is publicly held and has 20,000 shares of preferred stock outstanding and 100,000 shares of common. Preferred pays a $4.00 per share dividend while common pays $.60 per share. Net income is $600,000; the effective tax rate is 40 percent. Each preferred share can be converted into 2.5 shares of common. What is basic earnings per share and diluted EPS?
A. $4.60 and $3.60
B. $5.00 and $4.20
C. $5.20 and $4.00
D. $5.68 and $3.79
What’s the correct answer? The goal here is not to learn to work this one question. The goal here is to learn how to work problems dealing with the computation of earnings per share. That is what you want to know.
Once you work the problem and get your answer, go here and watch my explanation. I think this video will help you to be able to work this kind of question in the future.
Auditing
I thought that a question on analytical procedures might be a good one to study here today. My guess is that is a topic that the examiners want you to know very well.
The firm of Willard and Jones CPAs is performing an audit of the North Central Corporation. The company reports accounts receivable of $700,000. The auditors are interested in assessing the risk that this figure contains a material misstatement and begin to carry out analytical procedures. Which of the following would the auditors be most likely to perform initially?
A. Compare bad debt expense reported for this year to the amount written off last year.
B. Measure the average age of accounts receivable this year versus the average age in the previous year.
C. Create a flowchart of the internal controls for accounts receivable to compare with the controls used in the previous year.
D. Determine the expected amount of accounts receivable at the present time.
After you have read the question carefully and considered the four answers, make your selection. Then watch my video as I analyze each answer until I eliminate three of the possibilities and wind up with the correct answer.
Regulation
Now, let’s work a question now dealing with partnership income taxes. Most candidates have a decent knowledge of individual and corporate taxes. Partnership income taxes get less coverage at a lot of schools and that can make the questions tougher. Here, I wanted to show you a very fundamental question on partnership income taxes.
The partnership of Shelstad and Evans had the following balances for its latest tax year: revenues - $300,000, cost of goods sold - $200,000, rent expense - $20,000, charitable contributions - $10,000, and guaranteed payments to Evans for work done - $30,000. Shelstad and Evans are both 50 percent owners. What will be the increase in Shelstad’s adjusted gross income on his individual income tax return?
A. $20,000
B. $25,000
C. $40,000
D. $50,000
If you have worked in the taxation area for a while or had a great taxation course in college, this is probably a fairly easy question. Otherwise, this is a question that might be challenging. Once again, watch the video and learn how this type of question is taken apart so that the answer can be determined.
BEC
And, finally, here is a question from the BEC section. The BEC section covers so much territory that it is hard to pick one area but I thought a cost-volume-profit question on finding the breakeven point might be helpful. This is the kind of computation that I could see a CPA helping a company to make.
The Towson Corporation produces a product that it sells for $200 per unit. Last year, it sold 200 units per month with a variable cost of $120 each. Fixed cost were $5,000 per month. This year, the company sells the same item but for $240 to help pay for an increase in fixed costs to $6,000 per month. Variable cost is not affected. How is the annual break-even point for this product affected?
A. Increases by 100 units
B. Increases by 150 units
C. Decreases by 150 units
D. Decreases by 100 units
Notice here that two things change. The sales price goes from $200 to $240 per unit while the fixed cost rises from $5,000 per month to $6,000 per month. How does that impact the break-even point? After you work the question, watch my video to see how I go about attacking this question.
Have fun – these can be interesting, challenging questions. Don’t let the study process always seem so dreary. You want to stay in a good mood. Working questions can (and should be) fun.
We here at CPAreviewforFREE.com want to help you pass the CPA Exam and do it now. It really does not have to cost thousands of dollars. Our questions are waiting for you right now for FREE.
And, if you want to see how our site works and everything we have to offer, here is one final video just to give you the guided tour:
Have a great day. Keep answering questions and adding points. Now go toCPAreviewforFREE and work more questions.
Joe Hoyle
President CPAreviewforFREE
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Tuesday, August 12, 2014
Joe's Videos Explain How to Add Four Points to Your Score
Five C's to Success on the CPA Exam; Free New Questions
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July 8, 2014
Lesson 154
From: Joe
Scores Recently Released--Did You Pass?
Thanks to everyone who writes in to tell us about your passing scores on the CPA Exam. We clearly didn’t get into this business to make money (“FREE” is a tough pricing strategy if making money is your goal). We got into this business to help people become successful and pass. So, thanks for all the kind messages. You make our days better.
The Five "C's"
The July-August CPA Exam testing window is now open!!! That means that candidates from all over the world are getting ready to go to an exam site to seek those essential 75 points.
I was recently on vacation in Prague and one of my favorite college students from last semester sent me an email. She said that she had been studying diligently for her first part of the CPA Exam but was getting a bit nervous. She wanted to know if I had any last minute advice.
I told her that for decades I have suggested that candidates who are getting ready to take the CPA Exam should focus on the “five C’s.” I am a big believer that anyone who puts in a sufficient amount of study time probably has enough knowledge in their head to pass. Thus, the key to success during the exam is making sure that this knowledge gets out of the head and onto the test. The five C’s can help that to happen. They can assist you in maximizing your points. And, that is really what you want – to be able to earn all of the points that you deserve.
If you are taking the CPA Exam during the July-August testing window, here are five C’s that I would like for you to think about as the day gets closer. More...
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Facebook and Ten Favorite Quotes to Keep You On Track
If you follow us on our Facebook page, you know that we post a “success” quote most days that come from my book “Don’t Just Dream About Success: Stack the Odds in Your Favor” (available for $8.99 on Amazon – both paperback and Kindle). I went back recently and looked through all the quotes for the past few months and here are ten of my very favorites:
--“Success comes to the person who makes the best use of today.”
--“Mediocrity is a disease that is easy to catch.”
--“Successful people examine their failures – not to feel guilty or assign blame – but in search of improvement.”
--“No one experiences an extraordinary life through procrastination.”
--“Avoid settling for short cuts and easy answers. We all have unlimited possibilities, but they are only available to those who are willing to push through self-imposed boundaries.”
--“Most successful people have a few Level-3 goals that light up their days and nights and push them forward, often at blinding speed.”
--“Too often, we settle for dreams that merely scratch the surface of our abilities and then wonder why we are dissatisfied with the results.”
--“The desire for success burning within the heart has to be hot enough to push the person to do the difficult work that is necessary.”
--“Some people linger in the past while others long for the future. Success always dwells in the current moment.”
--“Success always starts with a dream. The bolder the dream, the bolder the success can be.”
Attack the Day!
We were in Vienna recently as part of our vacation. We had a wonderful tour guide who met us each morning and led us through the museums, cathedrals, art galleries, and restaurants. She set a tone for us every day that provided the energy necessary to get out and experience the life of that city.
Every morning, as we gathered in the hotel (often with sleep in our eyes), our tour guide would rouse our spirits with her daily battle cry: “Let’s go out there and attack the day.”
“Attack the day” – what a great mantra for starting each day. It is very easy to be passive, to sit on a chair and hope that we don’t miss too much of life. In other words, it is very easy to be lazy.
But lazy is no way to have a life that means something. Lazy is no way to make a difference in this world. Lazy is no way to become successful. We really need to be more aggressive in our actions. We need to move forward with a more ambitious attitude. “Attack the day.”
When we get up each morning, we have the possibility of creating something great, something wonderful, something worth remembering. Every day holds that possibility. But lazy is never going to make it happen. You have to be willing to attack the day. Whether it is the CPA Exam or your job or school or some other goal that you have in mind, success only comes if you get up and make it happen.
Yes, do go out there and attack the day.
While many places offer you a practice exam tool, or a study bank, or books, our partner, Fast Forward Academy for CPA Review, offers an entire powerful and intelligent platform - everything you need to study, learn, and pass your exam on the very first try. We have tools and features that no one else has, creating an educational experience like no other.
Time for some practice.
Let’s see if we can add a few points to your CPA Exam scores. You can do it.
Auditing
Which of the following is an auditor allowed to do using computer-assisted auditing techniques (CAAT)?
I. Select accounts receivable to confirm with customers based on variables such as the size and age of the balance.
II. Uncover inventory quantities for extra testing because the balances seem excessively high in comparison to the sales volume.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
FAR
At the start of Year One, Vivian Knox begins to work for the Fort Louis Corporation. By the end of Year One, Knox has earned 3 vacation days and 2 sick days. She is normally paid $200 per day. Knox did not have time to take the vacation in Year One but is expected to do so in Year Two. Knox had not been sick in Year One but realizes that she might well be sick and be forced to miss work in Year Two. When she eventually quits, she cannot demand payment for unused vacation pay or sick pay. At the end of Year One, what liability (if any) does the Fort Louis Corporation have to recognize for its obligation to Know?
A. Zero
B. $400
C. $600
D. $1,000
Regulation
The Williamton Corporation is a large and successful organization that files a corporate income tax return every year using a December 31 year-end. On March 8, Year Two, the company donated cash of $12,000 to the American Heart Fund. Because of the high level of taxable income in Year One, the corporation wants to include this charitable contribution in filing its income taxes for Year One. How is that possible?
A. It is not possible. It must be reported as a charitable contribution in Year Two.
B. All contributions made before March 15 of one year can be deducted in the prior year.
C. It can only be included in Year One if the company’s board of directors authorized the contribution during Year One
D. The contribution cannot be deducted in Year One because it is a gift of cash and not a long-term capital gain property.
BEC
A company needs to raise a lot of money in a hurry. Which of the following is not an advantage of debt-financing over equity-financing?
A. Interest payments are tax deductible but dividend payments are not.
B. Payouts are usually fixed for debt but not for equity financing
C. Creditors do not automatically gain any control in a company which does happen in equity financing.
D. Bankruptcy is less likely as a result of debt financing than it is as a result of equity financing.
Answers
Auditing
Answer is C
Both of these tasks are basically mechanical and a computer can do mechanical tasks much faster and more efficiently than a human. Software can be created that allows the auditor access to the client’s digital records. The software can be programmed to make selections based on predetermined criteria such as size and age. As computers and programming become more sophisticated, the number of tasks that can be carried out using computer-assisted auditing techniques will continue to grow.
FAR
Answer is C
A compensated absence for vacation pay must be recognized if earned and will probably be taken at a later point in time and the amount can be estimated. The $600 (3 days at $200 per day) meets the criteria. However, sick pay is not accrued here because it is dependent on a future event – Knox has to get sick. She cannot otherwise demand payment. Because a future event must occur for the sick pay to be necessary, there is no liability until she actually gets sick and misses work. There is no obligation at the present time.
Regulation
Answer is C
If a contribution is authorized by a company’s board of directors in one year and the gift is made prior to March 15 (for a corporation filing with a December 31, year-end) of the following year, the gift can be deducted in the initial year of authorization. Many companies do not know the amount of their income until late in the year and, therefore, are not in position to know the precise amount of their giving until the beginning of the following year. This time extension allows them to assess the amount that they can afford to contribute.
BEC
Answer is D.
There are many advantages of debt financing. Interest payments can be deducted as expense but dividend payments are not deductible. Payments of interest and principal are usually set which is good for financial planning purposes. With equity, dividend payments might have to rise if the company becomes especially profitable. And, unless treasury stock is reacquired, eliminating equity is unlikely. When stock is issued, new stockholders are likely to be drawn in who can possibly want to be involved in the management. Creditors rarely have that opportunity unless the company has trouble making repayments. Unless that happens, the creditors are properly not involved with running the company. However, bankruptcy is always more likely in connection with debt financing because the creditors can force the company into bankruptcy if scheduled payments cannot be made as they come due.
Joe Hoyle
President CPAreviewforFREE
|
Work New Practice Questions; How to Be a Champion
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June 18, 2014
Lesson 153
From: Joe
Thank You!
Thanks to everyone who has written us notes recently about your CPA Exam success stories. We are always delighted to get such good news. Our one and only goal is to help everyone pass the CPA Exam and be able to move on with their lives and careers. Don’t let the outrageous cost of some CPA Exam Review programs hold you back from the success that you need and deserve.
And, also, thanks to everyone who has passed along information about our program to others. We have over 2,500 of the best questions you ever studied and they are all available for free. However, we simply cannot afford to advertise. One of the challenges of “free” is that there is never enough money available for marketing purposes. We depend on you to spread the word.
All those other courses charge a fortune but, consequently, they have money available to advertise. So, if you spend money for a bad program, you are helping them prosper and entice other people to follow them.
Be a smart shopper. Try us first before you give away any of your hard-earned money. People just like you pass the CPA Exam every day using our materials. Don’t throw your money away. Try us first. Here’s a video that shows how our program works.
How to Become a Champion
It is an interesting time in sports. The Los Angeles Kings just won the National Hockey League championship and the San Antonio Spurs recently became the champions of the National Basketball Association. And, of course, soccer’s World Cup competition is being played in Brazil.
I have always been fascinated by teams who manage to take on the best competition and win. This year, the Kings in ice hockey and the Spurs in basketball were quite simply the best. They just played better. And, at the end, they won and got to celebrate like a bunch of kids. You couldn’t help but be excited for them.
Okay, if someone came up to you and asked the question: How do you become a champion? How would you answer? What would you say? How would you respond to the question, "How do you become a champion?"
It really isn’t a mystery. I think we all have a pretty good idea of what it takes.
After some thought, here is my answer (or at least some parts of my answer). More...
Good luck—you can do it!!!
Thanks for buying our book!
And, while I am at it, thanks to everyone who has bought my book: Don’t Just Dream About Success: Stack the Odds in Your Favor. It is less than $9.00. Just to help you get a notion of what it covers, here are two reviews from Amazon (and, truthfully, I have no clue who wrote either of these reviews):
Review One: Initially hesitant to read a "self help" book, I was pleasantly surprised to find that this is not what this is. Instead of pointing out a path to success, Hoyle instead forces you to think about what you deem success, your goals, and how to make these goals come to fruition. As he states in so many ways, there is no magic bullet, and the goal has to be worth the associated sacrifices otherwise you will never achieve it. This book is best in the questions it asks you (yes YOU!) the reader to think about, and has my mind working over what my own goals and successes are.
Review Two: I love this book. It is the best motivational book not only for those who are studying for the CPA exam, but also for every kid who wants to be a successful in his or her life. As Mr. Hoyle says, "You have to have the intestinal fortitude to sit down and do the work today (now)".
Championship teams seem to have a way of playing their very best game at the crucial time. When it comes time for the most important game, they are able to deliver their best effort. That is exactly what I want from you. When you walk in to take the CPA Exam, I want you to be at the very top of your game. Feel strong and confident. Make that the best test you ever took.
Practice, practice, practice
Let’s do some practice questions. The first problem below (both the question and the answer) comes from our friends over at Fast Forward Academy. If you are looking for a complete program, check them out and get a 10% discount by giving them the discount code: CPAREVIEWFORFREE
Auditing and Attestation
An auditor’s report would be designated a special report when it is issued in connection with:
A. Interim financial information of a publicly held company that is subject to a limited review.
B. Compliance with aspects of regulatory requirements related to audited financial statements.
C. Application of accounting principles to specified transactions.
D. Limited use prospective financial statements such as a financial projection.
FAR
The Grazino Corporation bought several other companies a few years ago and recognized a large amount of goodwill. In preparing financial statements for the current year, one of the reporting units in this business combination has a significant portion of that goodwill. At the end of the current year, officials have looked at a variety of qualitative factors and believe that there is a 59 percent chance that this particular reporting unit has a fair value that is larger than its current carrying value. What is the impact of this determination?
A. There is no impact based on this determination
B. The reporting unit must now perform tests to determine if the goodwill balance has been impaired.
C. No further testing is needed this year for this reporting unit as far as goodwill impairment is concerned.
D. Goodwill is impaired according to this information and must be written down and a loss recognized.
Regulation
What is a prospectus?
A. It is a different term for the MD & A (Management’s Discussion and Analysis) which appears with financial statements.
B. A document filed with the Securities and Exchange Commission to provide details about an investment that is offered for sale to the public.
C. A legal account registered by an approved investment advisor.
D. A contract maintained by an agent to show the authority that has been conveyed.
BEC
During the current year, the price of widgets went up 10 percent. During the same period, suppliers increased the quantity of widgets supplied by 15 percent. Which of the following is true based on that set of information?
A. The supply is said to be elastic.
B. The demand is said to be elastic.
C. The supply is said to be inelastic.
D. The demand is said to be inelastic.
ANSWERS
Auditing and Attestation
Answer is B
Special reports are issued in connection with various types of statements including: (1) financial statements which are prepared in conformity with another comprehensive basis of accounting other than US GAAP such as the cash basis; (2) specified elements, accounts, or items found in a financial statement (such as a report on just the amount of sales made during a period of time); (3) compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements; and (4) financial information presented in prescribed forms or schedules that require a prescribed form for the auditor’s reports.
Based on that list, the answer has to be B. The client apparently needs a report on its compliance with aspects of regulatory requirements related to information in its audited financial statements. According to the rules, a report resulting from that type engagement is identified as a special report and, therefore, must follow the requirements for special reports.
What about the other three possible answers? Why are they not considered special reports?
Answer A is incorrect because audits and reviews of historical financial statements fall under basic auditing and review rules and are not identified by a separate classification system. You might say that they are normal reports and not special reports.
Answer C is incorrect because this type of request is often referred to as “opinion shopping.” A company’s auditors have probably refused to provide an unqualified or unmodified opinion because of the handling of a certain transaction. The reporting company has gone to a different auditing firm to see if that group might be more willing to accept the proposed accounting. The idea being that the company will switch auditors if the new group will accept the desired method of reporting. As you can imagine, this tactic is frowned on in the auditing profession. Consequently, there are only a few rules that guide this type of response. The practice is not justified by inclusion as an official type of special report.
Answer D is incorrect. Normally engagements dealing with future events such as projections are classified as attestation engagements. Because reporting problems are different when looking at the impact of future events, a separate classification system has been set up.
FAR
Answer is C
According to a FASB Update in 2011: “The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in (US GAAP). The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.” And, then, “If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.” In other words, because the qualitative factors show that there is greater than a 50 percent that the reporting unit is worth more than its current fair value, no further testing is required because the goodwill is not impaired. Conversely, if the chances are not greater than 50 percent, then the company must carry out the full testing procedures to determine if goodwill has been impaired.
Regulation
Answer is B
A prospectus is a formal legal document required by and filed with the Securities and Exchange Commission. It provides a range of information and details about an investment offering for sale to the public. A prospectus is intended to contain the facts that a potential investor needs to know in order to make informed investment decisions.
BEC
Answer is A
The price of widgets rose causing the supply of widgets on the market to rise as manufacturers hope to make more profits. They supply more so the answer here has to be A or C. The answer here has to be either A or C because the question is asking about the impact of the price change on the supply of the items. The ratio of the increase in supply over the price change is 15%/10% or 1.5. Because that figure is greater than 1.0, supply is said to be elastic, it expands more quickly than the price change. Had this figure been less than 1.0, supply would have been said to be inelastic.
Thanks for being with us. Study hard and add points.
Joe Hoyle
CoFounder
President
CPAreviewforFREE.com
|
Wednesday, May 28, 2014
New Questions and Contest; Essential Content Chapter for Free-Answers
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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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