ACC1002X Financial Accounting

Semester 2 of Academic Year 2015-2016

SOLUTIONS to Optional Questions
CHAPTER 10: 10-43, 10-55, 10-58, 10-63

10-43 Dollar amounts (except per share amount) are in thousands.

Rate of return on common equity
=

(Net income Preferred dividends)

Average of (Total stockholders equity Liquidating value of preferred stock)

= ($2,400 $400) [($18,400 $4,400) + ($20,000 $4,400)]

= $2,000 ($14,000 + $15,600) = $2,000 $14,800 = 13.5%
Earnings per share of common stock
= (Net income Preferred dividends) Average number of shares outstanding
= $2,000 4,000 = $.50
Price-earnings ratio
= Market price per share of common stock Earnings per share of common stock
= $11.00 $.50 = 22
Dividend-payout ratio
= Common dividends per share Common earnings per share
= $.20 $.50 = 40%
Dividend-yield ratio
= Common dividends per share Market price per share of common stock
= $.20 $11.00 = 1.8%

Book value per share of common stock

= (Stockholders equity Liquidating value of preferred stock)
Number of common shares outstanding
= ($20,000 $4,400) 4,000 = $3.90

Note that the book value is lower than the market value. This is typical. The shareholders are
paying for earning power rather than for assets.

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10-55 Dollar amounts are in millions.

1.

Dr. Cash
2,800
Cr. Common stock
200
Cr. Additional paid-in capital
2,600
To record the issuance of 200 million shares of $1 par value common stock for an
average price of $14 per share.
An alternate journal entry follows:
Dr. Cash
Cr. Paid-in capital, common stock

2.

2,800
2,800

Before
2-for-1 Split
Common stock, 200 million
shares @ $1 par
Additional paid-in capital
Total paid-in capital
Retained earnings
Stockholders equity

$ 200
2,600
2,800
5,000
$7,800

Changes
200 @ $1 par
+ 400 @ $.50 par

After
2-for-1 Split

$ 200
2,600
2,800
5,000
$7,800

There is no effect on the reported amount of the total stockholders equity. Although no
formal journal entry is required, the underlying stockholder records will be changed to
indicate the number of shares held by each shareholder.

3.

Before 100%
Stock
Dividend
Common stock, 200 million
shares @ $1 par
Additional paid-in capital
Total paid-in capital
Retained earnings

$ 200

Stockholders equity

$7,800

2,600
2,800
5,000

Changes
+ (200 @ $1) =
200
200 par value of
dividend

After 100%
Stock
Dividend
$ 400
2,600
3,000
4,800
$7,800

The journal entry would be:

Dr. Retained earnings
200
Cr. Common stock
200
To record stock split in the form of a 100% stock dividend, necessitating a transfer
from Retained Earnings to Common stock of the par value of the additional shares issued,
200 million $1 = $200 million.
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4.

(Amounts not in millions)

Dr. Investment in common stock of AT&T
14,000
Cr. Cash
14,000
To record investment in 1,000 shares of an original issue of AT&T common stock at $14
per share.
The stock split at 2 for 1 (or if received as a 100% dividend) would call for no journal
entry. A memorandum would be made to show that 2,000 shares are now held at a cost
of $7.00 each instead of 1,000 shares at a cost of $14 each.

10-58 Dollar amounts (except per share amounts) and numbers of shares are in millions.
1.

Beginning balance, treasury shares

Purchases of treasury shares
Dispositions of treasury shares
Ending balance, treasury shares

$36,896
3,508
X = $3,707*
$36,697

*X = $36,896 + $3,508 $36,697 = $3,707

2.

Number of treasury shares purchased, $3,508 $20

Number of treasury shares disposed of, $3,707 $25
Total increase in number of treasure shares

175.4
148.3
27.1

3.

There are two main ways to return money to shareholders, paying dividends and buying
back shares of stock. General Electric has historically used both. In 1999, for example,
General Electric returned $7,488 to shareholders by purchasing its own shares and
returned $4,786 by paying cash dividends. In 2008 these numbers were $1,649 and
$3,508 respectively. Note that GE has shifted cash distributions to shareholders to be
more dividend based and less repurchase based. The financial crisis in 20082009 lead
to a break in the prior pattern of consistent dividend increases. Changes in dividends are
important signals to the financial markets and reductions are interpreted by the financial
markets as statements about the long term ability to generate steady or increasing cash
flow. Because GE had been making large share repurchases, when the recession began,
they did not have to slash dividend payments as much as they would have if all
distributions to shareholders had been via dividends. The use of share repurchases
increased flexibility in dividend distributions as conditions worsened.

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10-63
The stockholders equity section would be affected as follows:
Before
Repurchase
Changes
of 100,000
Because of
Outstanding
Treasury
Shares
Stock
Common stock, 2,000,000
shares @ R3 par
R 6,000,000
Paid-in capital in excess of par
34,000,000
Total paid-in capital
R40,000,000
Retained earnings
18,000,000
Total
R58,000,000
Deduct:
Cost of treasury stock

4,000,000
Stockholders equity
R58,000,000
1.

After
Repurchase
of 100,000
Outstanding
Shares
R 6,000,000
34,000,000
R40,000,000
18,000,000
R58,000,000
4,000,000
R54,000,000

The journal entry would be:

Dr. Treasury stock
4,000,000
Cr. Cash
4,000,000
To record acquisition of 100,000 shares of common stock @ R40 (to be held as treasury
stock).
Note that the treasury stock account does not represent an asset but a negative element of
stockholders equity.
2.

Dr. Cash
5,000,000
Cr. Treasury stock
4,000,000
Cr. Paid-in capital in excess of par
1,000,000
To record sale of treasury stock, 100,000 shares @ R50. Cost was R40 per share.

3.

Dr. Cash
3,000,000
Dr. Paid-in capital in excess of par
1,000,000
Cr. Treasury stock
4,000,000
To record sale of treasury stock, 100,000 shares @ R30. Cost was R40 per share.

If the treasury shares are resold below their cost, accountants tend to debit Additional Paid-in
Capital for the difference, $10 per share in this case.
Additional Paid-in Capital is sometimes divided into several separate accounts that identify
different sources of capital, for example:
Additional paid-in capitalpreferred stock
Additional paid-in capitalcommon stock
Additional paid-in capitaltreasury stock transactions
A consistent accounting treatment would call for debiting only Additional Paid-in Capital
Treasury Stock Transaction (and no other paid-in capital account) for the excess of the cost over
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the resale price of treasury shares. If there is no balance in such a Paid-in Capital account, the
debit should be made to Retained Earnings.
The accounting illustrated here assumes ongoing transactions in treasury stock. As illustrated in
the text, when shares are purchased in the open market and retired, paid-in capital accounts are
reduced proportionately and retained earnings is also typically reduced.
4.

Book value is calculated based on outstanding shares. The original book value per share
was R29. The new book values will be:
(1)
(2)
(3)

R54,000,000/1,900,000 shares = R28.42

R59,000,000/2,000,000 shares = R29.50
R57,000,000/2,000,000 shares = R28.50

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