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GAMMON, INC.: REVIEW PROBLEM
Gammon, Inc.: Review Problem
1. Entries in T accounts:
2. Stockholders’ equity section of the balance sheet:
3. Dividends yield on common stock, price/earnings ratio of common stock, and
return on equity:
Common Stock Dividend ϭ _______
Dividends per Share ϭ _________________________
Common Shares Outstanding 426,000
Dividends per Share
$0.07 ϭ 4.4%
Dividends Yield ϭ ___________________ ϭ _____
Market Price per Share $1.60
Market Price per Share $1.60
ϭ 11.4 times
Price/Earnings Ratio ϭ ___________________ ϭ _____
Earnings per Share
The opening balance of stockholders’ equity on February 1, 2010, was $250,000.
Return on Equity ϭ _________________________
Average Stockholders’ Equity
($1,517,380 ϩ $250,000) Ϭ 2
Stop & Review
LO1 Identify and explain
issues related to contributed capital.
Contributed capital is a critical component in corporate financing. Managing
contributed capital requires an understanding of the advantages and disadvantages of the corporate form of business and of the issues involved in using equity
financing. Managers must also know how to determine dividend policies and
how to evaluate these policies using dividends yield, return on equity, and the
price/earnings ratio. The liability for payment of dividends arises on the date
the board of directors declares a dividend. The declaration is recorded with a
debit to Dividends and a credit to Dividends Payable. The record date—the date
on which ownership of the stock, and thus of the right to receive a dividend,
is determined—requires no entry. On the payment date, the Dividends Payable
account is eliminated, and the Cash account is reduced. Another issue involved in
managing contributed capital is using stock options as compensation.
LO2 Identify the components of stockholders’
The stockholders’ equity section of a corporate balance sheet usually has at least
three components: contributed capital, retained earnings, and treasury stock.
Contributed capital consists of money raised through stock issues. A corporation
can issue two types of stock: common stock and preferred stock. Common stockholders have voting rights; they also share in the earnings of the corporation.
Preferred stockholders usually have preference over common stockholders in one
or more areas. Retained earnings are reinvested in the corporation; they represent
stockholders’ claims to assets resulting from profitable operations. Treasury stock
is stock that the issuing corporation has reacquired. It is treated as a deduction
from stockholders’ equity.
LO3 Identify the characteristics of preferred stock.
Preferred stock generally gives its owners first right to dividend payments. Only
after these stockholders have been paid can common stockholders receive any portion of a dividend. If the preferred stock is cumulative and dividends are in arrears,
a corporation must pay the amount in arrears to preferred stockholders before it
pays any dividends to common stockholders. Preferred stockholders also usually
have preference over common stockholders in terms of their claims to corporate
assets if the corporation is liquidated. In addition, preferred stock may be convertible to common stock, and it is often callable at the option of the corporation.
LO4 Account for the issuance
of stock for cash and
Corporations normally issue their stock in exchange for cash or other assets. Most
states require corporations to issue stock at a minimum value called legal capital.
Legal capital is represented by the stock’s par or stated value.
When stock is issued for cash at par or stated value, Cash is debited and Common Stock or Preferred Stock is credited. When stock is sold at an amount greater
than par or stated value, the excess is recorded in Additional Paid-in Capital.
When stock is issued for noncash assets, the general rule is to record the stock
at its market value. If this value cannot be determined, the fair market value of the
asset received is used to record the transaction.
LO5 Account for
Treasury stock is stock that the issuing company has reacquired. A company may
buy back its own stock for several reasons, including a desire to create stock option
plans, maintain a favorable market for the stock, increase earnings per share, or
purchase other companies. Treasury stock is recorded at cost and is deducted
from stockholders’ equity. It can be reissued or retired. It is similar to unissued
stock in that it does not have rights until it is reissued.
REVIEW of Concepts and Terminology
The following concepts and terms
were introduced in this chapter:
Initial public offering (IPO) 519
Articles of incorporation 520 (LO1)
Issued shares 530 (LO2)
Start-up and organization
costs 523 (LO1)
Authorized shares 530 (LO2)
Legal capital 523 (LO1)
Stated value 535 (LO4)
Callable preferred stock 533 (LO3)
Liquidating dividend 524 (LO1)
Stock certificates 522 (LO1)
Common stock 529 (LO2)
Noncumulative preferred stock
Stock option plans 527 (LO1)
Convertible preferred stock
Cumulative preferred stock
Declaration date 524 (LO1)
Dividends 520 (LO1)
Dividends in arrears 531 (L03)
Double taxation 522 (LO1)
Ex-dividend 524 (LO1)
No-par stock 534 (LO4)
Share of stock 520 (LO1)
Treasury stock 526 (LO1)
Underwriter 523 (LO1)
Outstanding shares 530 (LO2)
Par value 522 (LO1)
Payment date 524 (LO1)
Dividends yield 525 (LO1)
Preferred stock 529 (LO2)
Price/earnings (P/E) ratio
Record date 524 (LO1)
Residual equity 529 (LO2)
Return on equity 526 (LO1)
BUILDING Your Basic Knowledge and Skills
SE 1. Indicate whether each of the following actions is related to (a) managing
under the corporate form of business, (b) using equity financing, (c) determining
dividend policies, (d) evaluating performance using return on equity, or (e) issuing
Considering whether to make a distribution to stockholders
Controlling day-to-day operations
Determining whether to issue preferred or common stock
Compensating management based on the company’s meeting or exceeding
the targeted return on equity
5. Compensating employees by giving them the right to purchase shares at a
6. Transferring shares without the approval of other owners
Advantages and Disadvantages of a Corporation
SE 2. Identify whether each of the following characteristics is an advantage or a
disadvantage of the corporate form of business:
1. Ease of transfer of ownership
3. Separate legal entity
4. Lack of mutual agency
5. Government regulation
6. Continuous existence
Effect of Start-up and Organization Costs
SE 3. At the beginning of 2011, Patel Company incurred the following
start-up and organization costs: (1) attorneys’ fees with a market value
of $20,000, paid with 12,000 shares of $1 par value common stock, and
(2) incorporation fees of $12,000. Calculate total start-up and organization
costs. What will be the effect of these costs on the income statement and
Exercise of Stock Options
SE 4. On June 6, Aretha Dafoe exercised her option to purchase 20,000 shares
of Shalom Company $1 par value common stock at an option price of $8. The
market price per share was $8 on the grant date and $36 on the exercise date.
(1) When must the fair value of the option be estimated? (2) Is the market price
of the stock on the exercise date most relevant to Dafoe or to Shalom Company?
SE 5. Prepare the stockholders’ equity section of Fina Corporation’s balance sheet
from the following accounts and balances on December 31, 2011:
Common Stock, $10 par value, 30,000 shares authorized,
20,000 shares issued, and 19,500 shares outstanding
Additional Paid-in Capital
Treasury Stock, Common (500 shares, at cost)
SE 6. Tone Corporation has authorized 200,000 shares of $1 par value common
stock, of which 160,000 are issued and 140,000 are outstanding. On May 15,
the board of directors declared a cash dividend of $0.20 per share, payable on
June 15 to stockholders of record on June 1. Prepare the entries in T accounts, as
necessary, for each of the three dates.
Preferred Stock Dividends with Dividends in Arrears
SE 7. The Ferris Corporation has 2,000 shares of $100, 8 percent cumulative preferred stock outstanding and 40,000 shares of $1 par value common stock outstanding. In the company’s first three years of operation, its board of directors
paid cash dividends as follows: 2010, none; 2011, $40,000; and 2012, $80,000.
Determine the total cash dividends and dividends per share paid to the preferred
and common stockholders during each of the three years.
Issuance of Stock
SE 8. Rattich Company is authorized to issue 50,000 shares of common stock.
The company sold 2,500 shares at $12 per share. Prepare entries in journal form
to record the sale of stock for cash under each of the following independent alternatives: (1) The stock has a par value of $5, and (2) the stock has no par value but
a stated value of $1 per share.
Issuance of Stock for Noncash Assets
SE 9. Embossing Corporation issued 32,000 shares of its $1 par value common
stock in exchange for land that had a fair market value of $200,000. Prepare in
journal form the entries necessary to record the issuance of the stock for the land
under each of these conditions: (1) The stock was selling for $7 per share on the
day of the transaction; (2) management attempted to place a value on the common stock but could not do so.
Treasury Stock Transactions
SE 10. Prepare in journal form the entries necessary to record the following stock
transactions of the Seoul Company during 2011:
Purchased 2,000 shares of its own $2 par value common stock
for $20 per share, the current market price.
Sold 500 shares of treasury stock purchased on October 1 for
$25 per share.
Retirement of Treasury Stock
SE 11. On October 28, 2011, the Seoul Company (SE 10) retired the remaining
1,500 shares of treasury stock. The shares were originally issued at $5 per share.
Prepare the necessary entry in journal form.
E 1. Develop brief answers to each of the following questions:
1. Why are most large companies established as corporations rather than as
2. Why do many companies like to give stock options as compensation?
3. If an investor sells shares after the declaration date but before the date of
record, does the seller still receive the dividend?
4. Why does a company usually not want to issue all its authorized shares?
E 2. Develop brief answers to each of the following questions:
1. Why would a company want to issue callable preferred stock?
2. What arguments can you give for treating preferred stock as debt rather than
equity when carrying out financial analysis?
3. What relevance does par value or stated value have to a financial ratio, such as
return on equity or debt to equity?
4. Why is treasury stock not considered an investment or an asset?
Dividends Yield and Price/Earnings Ratio
E 3. In 2011, Rainbow Corporation earned $8.80 per share and paid a dividend
of $4.00 per share. At year end, the price of its stock was $132 per share. Calculate the dividends yield and the price/earnings ratio.
E 4. The following accounts and balances are from the records of Stuard Corporation on December 31, 2011:
Preferred Stock, $100 par value, 9 percent cumulative,
10,000 shares authorized, 3,000 shares issued and
Common Stock, $12 par value, 45,000 shares
authorized, 15,000 shares issued, and 14,250 shares
Additional Paid-in Capital
Treasury Stock, Common (750 shares, at cost)
Prepare the stockholders’ equity section of Stuard Corporation’s balance sheet as
of December 31, 2011.
Characteristics of Common and Preferred Stock
E 5. Indicate whether each of the following characteristics is more closely associated with common stock (C) or preferred stock (P):
1. Often receives dividends at a set rate
2. Is considered the residual equity of a company
3. Can be callable
4. Can be convertible
5. More likely to have dividends that vary in amount from year to year
6. Can be entitled to receive dividends not paid in past years
7. Likely to have full voting rights
8. Receives assets first in liquidation
9. Generally receives dividends before other classes of stock
Stock Entries Using T Accounts; Stockholders’ Equity
E 6. Shark School Supply Corporation was organized in 2011. It was authorized
to issue 200,000 shares of no-par common stock with a stated value of $5 per
share, and 40,000 shares of $100 par value, 6 percent noncumulative preferred
stock. On March 1, the company issued 60,000 shares of its common stock for
$15 per share and 8,000 shares of its preferred stock for $100 per share.
1. Record the issuance of the stock in T accounts.
2. Prepare the stockholders’ equity section of Shark School Supply Corporation’s balance sheet as it would appear immediately after the company issued
the common and preferred stock.
E 7. Pine Corporation secured authorization from the state for 100,000 shares
of $10 par value common stock. It has 40,000 shares issued and 35,000 shares
outstanding. On June 5, the board of directors declared a $0.25 per share cash
dividend to be paid on June 25 to stockholders of record on June 15. Prepare
entries in T accounts to record these events.
E 8. Avena Corporation has 250,000 authorized shares of $1 par value common
stock, of which 100,000 are issued, including 10,000 shares of treasury stock. On
October 15, the corporation’s board of directors declared a cash dividend of $0.50
per share payable on November 15 to stockholders of record on November 1.
Prepare entries in T accounts for each of the three dates.
Cash Dividends with Dividends in Arrears
E 9. Ghana Corporation has 10,000 shares of its $100 par value, 7 percent
cumulative preferred stock outstanding and 50,000 shares of its $1 par value
common stock outstanding. In Ghana’s first four years of operation, its board
of directors paid cash dividends as follows: 2009, none; 2010, $120,000;
2011, $140,000; 2012, $140,000. Determine the dividends per share and
total cash dividends paid to the preferred and common stockholders during
each of the four years.
Cash Dividends on Preferred and Common Stock
E 10. Dylan Corporation pays dividends at the end of each year. The dividends that
it paid for 2010, 2011, and 2012 were $80,000, $60,000, and $180,000, respectively. Calculate the total amount of dividends Dylan Corporation paid in each of
these years to its common and preferred stockholders under both of the following
capital structures: (1) 20,000 shares of $100 par, 6 percent noncumulative preferred
stock and 60,000 shares of $10 par common stock; (2) 10,000 shares of $100 par,
7 percent cumulative preferred stock and 60,000 shares of $10 par common stock.
Dylan Corporation had no dividends in arrears at the beginning of 2010.
Issuance of Stock
E 11. Powet Net Company is authorized to issue 50,000 shares of common stock.
On August 1, the company issued 2,500 shares at $25 per share. Prepare entries
in journal form to record the issuance of stock for cash under each of the following alternatives:
1. The stock has a par value of $25.
2. The stock has a par value of $10.
3. The stock has no par value.
4. The stock has a stated value of $1 per share.
Issuance of Stock for Noncash Assets
E 12. On July 1, 2011, Kosa, a new corporation, issued 20,000 shares of its common stock to finance a corporate headquarters building. The building has a fair
market value of $600,000 and a book value of $400,000. Because Kosa is a new
corporation, it is not possible to establish a market value for its common stock.
Record the issuance of stock for the building, assuming the following conditions:
(1) the par value of the stock is $10 per share; (2) the stock is no-par stock; and
(3) the stock has a stated value of $4 per share.
Treasury Stock Transactions
E 13. Record in T accounts the following stock transactions of Pigua Corporation, which represent all the company’s treasury stock transactions during 2011:
Purchased 1,600 shares of its own $2 par value common stock
for $40 per share, the current market price.
Sold 600 shares of treasury stock purchased on May 5 for
$44 per share.
Sold 400 shares of treasury stock purchased on May 5 for
$40 per share.
Sold the remaining 600 shares of treasury stock purchased on
May 5 for $38 per share.
Treasury Stock Transactions Including Retirement
E 14. Record in T accounts the following stock transactions of Lopez Corporation, which represent all its treasury stock transactions for the year:
Purchased 2,000 shares of its own $15 par value common stock
for $35 per share, the current market price.
Sold 500 shares of treasury stock purchased on June 1 for $40
Sold 700 shares of treasury stock purchased on June 1 for $29
Retired the remaining shares purchased on June 1. The original
issue price was $21 per share.
Common Stock Transactions and Stockholders’ Equity
P 1. On March 1, 2011, Dora Corporation began operations with a charter from
the state that authorized 50,000 shares of $4 par value common stock. Over the
next quarter, the firm engaged in the transactions that follow.
User insight Ǡ
Issued 15,000 shares of common stock, $100,000.
Paid fees associated with obtaining the charter and starting up
and organizing the corporation, $12,000.
Issued 6,500 shares of common stock, $65,000.
Purchased 2,500 shares of common stock, $25,000
The board of directors declared a $0.20 per share cash dividend
to be paid on June 15 to shareholders of record on June 10.
1. Record the above transactions in T accounts.
2. Prepare the stockholders’ equity section of Dora Corporation’s balance sheet
on May 31, 2011. Net income earned during the first quarter was $15,000.
3. What effect, if any, will the cash dividend declaration on May 31 have on Dora
Corporation’s net income, retained earnings, and cash flows?
Preferred and Common Stock Dividends and Dividends Yield
P 2. The Rago Corporation had the following stock outstanding from 2009
Preferred stock: $100 par value, 8 percent cumulative, 5,000 shares authorized,
issued, and outstanding
Common stock: $10 par value, 100,000 shares authorized, issued, and outstanding
The company paid $30,000, $30,000, $94,000, and $130,000 in dividends during 2009, 2010, 2011, and 2012, respectively. The market price per
common share was $7.25 and $8.00 per share at the end of years 2011 and
User insight Ǡ
1. Determine the dividends per share and the total dividends paid to common
stockholders and preferred stockholders in 2009, 2010, 2011, and 2012.
2. Perform the same computations, with the assumption that the preferred stock
3. Calculate the 2011 and 2012 dividends yield for common stock, using the
dividends per share computed in requirement 2.
4. How are cumulative preferred stock and noncumulative preferred stock similar to long-term bonds? How do they differ from long-term bonds?
Comprehensive Stockholders’ Equity Transactions
P 3. In January 2010, Janas Corporation was organized and authorized to issue
1,000,000 shares of no-par common stock and 25,000 shares of 5 percent, $50
par value, noncumulative preferred stock. The stock-related transactions for the
first year’s operations were as follows:
Sold 7,500 shares of
common stock for
$15,750. State law
requires a minimum of
$1 stated value per share.
Issued 2,500 shares of
common stock to attorneys and accountants for
services valued at $5,500
and provided during the
organization of the corporation.
Issued 15,000 shares
of common stock for
a building that had
an appraised value of
Purchased 5,000 shares
of its common stock at
$3 per share.
Issued 2,500 shares
of common stock to
employees under a stock
option plan that allows
any employee to buy
shares at the current market price, which is now
$3 per share.
Sold 1,250 shares of
treasury stock for $4 per
Declared a cash dividend
of $0.15 per common
share to be paid on September 25 to stockholders of record on September 15.
Date of record for cash
Paid cash dividends to
stockholders of record on
Issued 2,000 shares of
common stock for a piece
of land. The stock was
selling for $3 per share,
land had a fair market
value of $6,000.
Issued 1,100 shares of
preferred stock for $50
1. For each of the above transactions, enter in the blanks provided the account
numbers and dollar amounts (as shown in the example) for the account(s)
debited and credited. The account numbers are listed below.
220 Dividends Payable
305 Preferred Stock
310 Common Stock
User insight Ǡ
312 Additional Paid-in Capital
313 Paid-in Capital, Treasury Stock
340 Retained Earnings
350 Treasury Stock, Common
510 Start-up and Organization Costs
2. Why is the stockholders’ equity section of the balance sheet an important
consideration in analyzing the performance of a company?
Comprehensive Stockholders’ Equity Transactions and Stockholders’ Equity
P 4. Kras, Inc., was organized and authorized to issue 50,000 shares of $100
par value, 9 percent preferred stock and 50,000 shares of no-par, $5 stated
value common stock on July 1, 2011. Stock-related transactions for Kras are
1 Issued 10,000 shares of common stock at $11 per share.
1 Issued 500 shares of common stock at $11 per share for services
rendered in connection with the organization of the company.
2 Issued 1,000 shares of preferred stock at par value for cash.
10 Issued 2,500 shares of common stock for land on which the
asking price was $35,000. Market value of the stock was $12.
Management wishes to record the land at the market value of