Chapter 11

Problems and exercises

Brief Ex. 11.1

• Alpha Co. sold 10,000 shares of common stock, which has a par value
of $10, for $13 per share.
• The company’s balance in retained earnings is $75,000. Prepare the
stockholders’ equity section of the company’s balance sheet.

Ordinary shares (10,000 shares @ $10)   $100,000

Share premium (10,000 shares @ $3)   30,000
Retained earnings   75,000
Total shareholders' equity   $205,000
Brief Ex. 11.3
• Zeta Co. has outstanding 100,000 shares of $100 par value cumulative
preferred stock which has a dividend rate of 6 percent. The company
has not declared any cash dividends on the preferred stock for the last
three years.
• Calculate the amount of dividends in arrears on Zeta’s preferred stock
and briefly explain how this amount will be known to investors and
creditors who may use the company’s financial statements.
Dividends on arrears on preference shares for three years are
calculated as follows:

100,000 shares x $100 par value x 6% dividend rate x 3 years

=
$1,800,000

The amount of dividends in arrears must be disclosed in the

financial statements, but they are not formally included as a
liability in the balance sheet until declared by the Board of
Directors of the company.
Brief Ex. 11.5

• Walla Company has common and preferred stock outstanding as

follows:
• Common stock: 100,000 shares, $30 par value
• 8 percent preferred stock: 10,000 shares, $100 par value
• Dividends on preferred stock have not been paid for the last three
years (in addition to the current year). If the company pays a total of
$120,000 in dividends,
• how much will the common stockholders receive per share if the
preferred stock is not cumulative?
• How will your answer differ if the preferred stock is cumulative?
Total dividend declared $120,000
Dividend requirements for noncumulative preference shares:
10,000 x $100 par x 8% x 1 year 80,000
Dividends available for ordinary shares $40,000
Dividends per share on ordinary shares:
$40,000/100,000 shares $0.40

If the preference shares is cumulative, the entire dividend goes to preference

shares and the ordinary shareholders will receive none of the $120,000
dividends declared. In fact, satisfaction of the full claim of the preference
sharesholders in this case will require $320,000, determined as follows:

10,000 x $100 par x 8% x 4 years = $320,000

B.E 11.6 Practice Assignment
B.E 11.7
B.E 11.8
B.E 11.9
B.E 11.10
EXERCISE 11.8

a. Compute the amount of net assets (stockholders’ equity).

b. Compute the book value per share of common stock.
c. Is book value per share (answer to part b ) the amount common
stockholders should expect to receive if Corporation were to cease operations
and liquidate? Explain.
Net assets (shareholders’ equity):
Preference shares ……………………………………………………….. $ 200,000
Ordinary shares, $5 par, 60,000 shares issued ……………………………………..
300,000
Share premium ………………………………………………………………… 452,800
Total issued and fully paid capital ……………………………………………………………..
$ 952,800
Less: Deficit ……………………………………………………………………………… 146,800
Total net assets (shareholders’ equity) …………………………………………..
$ 806,000

Book value per ordinary share:

Total shareholders’ equity (from part a) …………………………………………………..
$ 806,000
Less: Claims of preference sharesholders ($200,000 plus
dividends in arrears, $16,000) ………………………………………………… 216,000
Equity of ordinary shareholders ……………………………………………………………… $ 590,000
Number of ordinary shares outstanding ………………………………………….. 60,000
Book value per share ($590,000  60,000 shares) $ 9.83

No. The book value pe r share re pre se nts the share holde rs’ share of the ne t
book value of the corporation’s ass e ts , not the asse ts’ liquidation value s. The
share holde rs may re ce ive more or le ss than the book value pe r s hare if the
corporation is liquidate d, de pe nding primarily on the amounts at which the
corporation’s asse ts are sold.
EXERCISE 11.9

• Johnston, Inc., engaged in the following transactions involving treasury

stock:
• Feb. 10 Purchased for cash 17,000 shares of treasury stock at a price of
$25 per share.
• June 4 Reissued 6,000 shares of treasury stock at a price of $33 per share.
• Dec. 22 Reissued 4,000 shares of treasury stock at a price of $22 per
share.
• a. Prepare general journal entries to record these transactions.
• b. Compute the amount of retained earnings that should be restricted
because of the treasury stock still owned at December 31.
• c. Does a restriction on retained earnings affect the dollar amount of
retained earnings reported in the balance sheet? Explain briefly.
a. Feb. 10 Treasury Shares ………………………………………………. 425,000
Cash ………………………………………………… 425,000
Purchased 17,000 shares of treasury
shares at $25 per share.
June 4 Cash 198,000
Treasury Shares ………………………………… 150,000
Share premium: ……………………….
Treasury Shares…………………….. 48,000
Sold 6,000 shares of treasury shares,
cost $150,000, for $33 per share.
Dec. 22 Cash ……………………………………………………………. 88,000
Share premium: Treasury
Shares …………………………………………… 12,000
Treasury Shares ………………………………………. 100,000
Sold 4,000 shares of treasury shares,
cost $100,000, for $22 per share.
b. Restriction of retained earnings for treasury shares owned at year-end:
$175,000 (7,000 shares still owned x $25 per share cost)

c. No, a restriction on retained earnings does not affect the total amount of
retained earnings reported in the balance sheet. A restriction of retained
earnings is disclosed, but does not reduce the total amount of retained
earnings of a company. The restriction on retained earnings simply limits the
amount of dividends the corporation can pay as long as it holds treasury
shares.
EXERCISE 11.10

• The common stock of Fido Corporation was trading at $45 per share
on October 15, 2010. A year later, on October 15, 2011, it was trading
at $80 per share. On this date, Fido’s board of directors decided to
split the company’s common stock.
• a. If the company decides on a 2-for-1 split, at what price would you
expect the stock to trade immediately after the split goes into effect?
• b. If the company decides on a 4-for-1 split, at what price would you
expect the stock to trade immediately after the split goes into effect?
• c. Why do you think Fido’s board of directors decided to split the
company’s stock?
a. Had the shares been split 2-for-1, it would begin trading at approximately
$40 per share immediately after the split ($80 ¸ 2 = $40).

b. Had the shares been split 4-for-1, it would begin trading at approximately
$20 per share immediately after the split ($80 ¸ 4 = $20).

c. When the market price of a corporation’s ordinary shares appreciate in

value significantly, as it had in the case of Fido Corporation, it may become
too expensive for many investors. Thus, the decision to split the company’s
shares were probably made with the intent of making it more affordable to
investors.
EXERCISE 11.14

• Twin Towns, Inc., was authorized to issue 200,000 shares of common

stock and originally issued 100,000 shares of $10 par value stock at
$18 per share. Subsequently, 25,000 shares were repurchased
• at $20, of which 10,000 were subsequently resold at $23.
• Assume the company’s retained earnings balance is $120,000.
• a. Prepare the stockholders’ equity section of Twin Towns’s balance
sheet, including all appropriate disclosures.
• b. Briefly explain how the declaration and distribution of a 2-for-1
stock split subsequent to the above transactions would affect the
stockholders’ equity section you have prepared.
Calculations: b. After a 2:1 share split is distributed, the par value of the ordinary shares will
Share premium on ordinary shares:
be reduced to half ($10 x 1/2 = $5) and all of the share numbers will double.
100,000 shares x ($18 - $10) = $800,000
Share premium on treasury shares: The 2:1 split has no effect on the total figures for ordinary shares, share
10,000 shares x ($23 - $20) = $30,000 premium, retained earnings, treasury shares, or total shareholders' equity.
Treasury shares:
15,000 shares x $20 = $300,000
a. Ordinary Shares, $10 par value, 200,000 share s authorize d, $1,000,000
100,000 share s issue d

Share pre mium on ordinary shares 800,000

Share pre mium on treasury shares

Transactions 30,000

Total Issued and fully paid capital $1,830,000

Retaine d e arnings 120,000

Total issue d and fully paid capital and re tained earnings $1,950,000

Le ss: Treasury share s (300,000)

Total shareholde rs' e quity $1,650,000

PROBLEM 11.1A Practice/Assignment
PROBLEM 11.5A
PROBLEM 11.9A
Ex. 11.4
Ex.11.5
Ex.11.6
PROBLEM 11.2A

• Waller Publications was organized early in 2006 with authorization to

issue 20,000 shares of $100 par value preferred stock and 1 million
shares of $1 par value common stock. All of the preferred stock was
issued at par, and 300,000 shares of common stock were sold for $20
per share. The preferred stock pays a 10 percent cumulative dividend.
• During the first five years of operations (2006 through 2010) the
corporation earned a total of $4,460,000 and paid dividends of $1 per
share each year on the common stock. In 2011, however, the
corporation reported a net loss of $1,750,000 and paid no dividends.
WALLER PUBLICATIONS
Partial Balance Sheet
December 31, 2009
Shareholders' equity
10% cumulative preference shares, $100 par value,
authorized, issued, and outstanding 20,000 shares $ 2,000,000
Ordinary shares, $1 par value, authorized 1 million shares,
issued and outstanding 300,000 shares 300,000
Share premium: ordinary shares 5,700,000
Total issued and fully paid capital $ 8,000,000
Retained earnings* 210,000
Total shareholders' equity $ 8,210,000

*Computation of retained earnings at December 31, 2009:

Profit for the five-year period 2004-2008 $ 4,460,000
Less: Preference share dividends ($200,000 x 5 years) $ 1,000,000
Ordinary share dividends ($1 x 300,000 shares x 5 years) 1,500,000 2,500,000
Retained earnings, December 2008 $ 1,960,000
Less: Net loss of 2009 1,750,000
Retained earnings, December 31, 2009 $ 210,000

b. Note to financial statements:

Since the corporation sustained a loss of $1,750,000 the directors recommended that no
dividends shall be paid for the year 2009.
PROBLEM 11.4A
• Early in the year Bill Barnes and several friends organized a corporation called Barnes Communications,
Inc. The corporation was authorized to issue 50,000 shares of $100 par value, 10 percent cumulative
preferred stock and 400,000 shares of $2 par value common stock. The following transactions (among
others) occurred during the year:
• Jan. 6 Issued for cash 20,000 shares of common stock at $14 per share. The shares were issued to Barnes
and 10 other investors.
• Jan. 7 Issued an additional 500 shares of common stock to Barnes in exchange for his services in
organizing the corporation. The stockholders agreed that these services were worth $7,000.
• Jan. 12 Issued 2,500 shares of preferred stock for cash of $250,000.
• June 4 Acquired land as a building site in exchange for 15,000 shares of common stock. In view of the
appraised value of the land and the progress of the company, the directors agreed that the common
stock was to be valued for purposes of this transaction at $15 per share.
• Nov. 15 The first annual dividend of $10 per share was declared on the preferred stock to be paid
December 20. (Hint: Record the dividend by debiting Dividends and crediting Dividends Payable.)
• Dec. 20 Paid the cash dividend declared on November 15.
• Dec. 31 After the revenue and expenses were closed into the Income Summary account, that account
indicated a net income of $147,200.
Jan 6 Cash 280,000
Ordinary Shares 40,000
Share Premium: Ordinary Shares 240,000
Issued 20,000 shares of $2 par value ordinary
shares
at $14 per share.

7 Organization Costs Expense 7,000

Ordinary Shares 1,000
Share Premium: Ordinary Shares 6,000
Issued 500 shares of ordinary shares to Barnes in
exchange for services relating to formation of the
corporation. Implied issuance price ($7,000 ÷ 500
shares) = $14 per share.

12 Cash 250,000
Preference Shares 250,000
Issued 2,500 shares of $100 par value, 10%,
preference shares at par value.

June 4 Land 225,000

Ordinary Shares 30,000
Share Premium: Ordinary Shares 195,000
Issued 15,000 shares of ordinary shares in
for land valued at $225,000 (15,000 shares x $15).
Nov 15 Dividends (Preference Shares) 25,000
Dividends Payable 25,000
To record declaration of annual dividends of $10
per share on 2,500 preference shares outstanding.
Payable Dec. 20.

Dec 20 Dividends Payable 25,000

Cash 25,000
To record payment of dividend declared Nov. 15.

31 Income Summary
Retained Earnings 147,200
To close the Income Summary account for the 147,200
year.

31 Retained Earnings 25,000

Dividends 25,000
To close the Dividends account.
PROBLEM 11.6A
• a. How many shares of common stock have been issued?
• b. What is the total amount of the annual dividends paid to preferred
stockholders?
• c. What is the total amount of paid-in capital?
• d. What is the book value per share of common stock?
• e. Briefly explain the advantages and disadvantages to Parsons of being publicly
owned rather than operating as a closely held corporation.
• f. What is meant by the term convertible used in the caption of the preferred
stock? Is there any more information that investors need to know to evaluate
this conversion feature?
• g. Assume that the preferred stock currently is selling at $248 per share. Does
this provide a higher or lower dividend yield than an 8 percent, $50 par value
preferred with a market price of $57 per share? Show computations (round to
the nearest tenth of 1 percent). Explain why one preferred stock might yield less
than another.
In Thousands
(Except for Per
Share Amounts)
a. Par value of all ordinary shares outstanding $ 6,819
Par value per share 0.50
Number of shares outstanding ($6,819/$0.50) 13,638

b. Dividend requirement per preference share $ 17.20

Number of preference shares outstanding 345
Annual dividends paid to preference sharesholders ($17.20 x 345) $ 5,934

c. Par value of preference shares $ 86,250

Par value of ordinary shares 6,819
Share premium 87,260
Total issued and fully paid capital $ 180,329

d. Total shareholders’ equity $ 237,592

Less: Preference shares par value = ($250 x 345 shares) 86,250
Equity of ordinary shareholders $ 151,342
Number of ordinary shares outstanding 13,638
Book value per share ($151,342/13,638 shares) $ 11.10
PROBLEM 11.9A

• Early in 2007, Herndon Industries was formed with authorization to issue

200,000 shares of $10 par value common stock and 30,000 shares of $100 par
value cumulative preferred stock.
• During 2007, all the preferred stock was issued at par, and 120,000 shares of
common stock were sold for $16 per share. The preferred stock is entitled to a
dividend equal to 10 percent of its par value before any dividends are paid on
the common stock.
• During its first five years of business (2007 through 2011), the company earned
income totaling $3,700,000 and paid dividends of 50 cents per share each year
on the common stock outstanding.
• On January 2, 2009, the company purchased 20,000 shares of its own common
stock in the open market for $400,000. On January 2, 2011, it reissued 10,000
shares of this treasury stock for $250,000. The remaining 10,000 were still held
in treasury at December 31, 2011.
• a. Prepare the stockholders’ equity section of the balance sheet for
Herndon Industries at December 31, 2011. Include supporting schedules
showing (1) your computation of any paid-in capital on treasury stock
and (2) retained earnings at the balance sheet date. (Hint: Income
increases retained earnings, whereas dividends reduce retained
earnings. Dividends are not paid on shares of stock held in treasury.)
• b. As of December 31, compute Herndon’s book value per share of
common stock. (Hint: Book value per share is computed only on the
shares of stock outstanding.)
• c. At December 31, 2011, shares of the company’s common stock were
trading at $30. Explain what would have happened to the market price
per share had the company split its stock 3-for-1 at this date. Also
explain what would have happened to the par value of the common
stock and to the number of common shares outstanding.
*Computation of share premium on treasury shares:
Purchase price per share: $400,000 ÷ 20,000 shares = $20
per share
Reissue price per share: $250,000 ÷ 10,000 shares = $25
per share
Premium per share reissued: $5 per share ($25 - $20)
Total issued and fully paid capital on treasury shares: $50,000
($5 per share x 10,000 shares reissued)

**Computation of retained earnings at Dec. 31, 2009:

Profit (for years 2005–2009) $ 3,700,000
Less: Preference dividend (for years 2005–2009)
$100 x 10% x 30,000 shares x 5 years $ 1,500,000
Less: Ordinary dividends
2005–2006: 120,000 shares outstanding x $0.50 x 2 yrs 120,000
2007–2008: 100,000 shares outstanding x $0.50 x 2 yrs 100,000
2009: 110,000 shares outstanding x $0.50 55,000 1,775,000
Retained earnings, Dec. 31, 2009 $ 1,925,000
a.
Shareholders’ equity:
10% preference shares, $100 par, cumulative, authorized,
issued, and outstanding 30,000 shares $ 3,000,000
Ordinary shares, $10 par, 200,000 shares authorized,
120,000 shares issued, of which 10,000 shares are held in
treasury 1,200,000
Share premium: Ordinary shares 720,000
Share premium: Treasury shares* 50,000
Total issued and fully paid capital $ 4,970,000
Retained earnings** 1,925,000
Subtotal $ 6,895,000
Less: Treasury shares (10,000 shares x $20 cost per share) 200,000
Total shareholders’ equity at Dec. 31, 2009 $ 6,695,000

b. The company’s book value per share is approximately $33.59 ($6,695,000 total
shareholders’ equity - $3,000,000 of preference shares book value = $3,695,000;
$3,695,000 ¸ 110,000 shares outstanding = $33.59).

c. Had the company decided to split its ordinary shares 3-for-1 on December 31, 2009, the
market value would have fallen to approximately $10 per share ($30 ¸ 3). The par value
would have been reduced to $3.33 ($10 ÷ 3), and the number of shares outstanding would
have increased to 330,000 shares (110,000 x 3).