Module 9 Solutions

Module 9

Reporting and AnalyzingOwner Financing

DISCUSSION QUESTIONS

Q9-1. Par value stock is stock that has a face value printed (identified) on the stock certificate. Historically, par value was the minimum selling price for one share.

From an accounting and analysis standpoint, there are no implications. The par value of the common stock is the amount added to the common stock account when the company sells stock. The remainder of the sale price is added to the additional paid-in-capital account. Stockholders’ equity increases by the total amount regardless of whether one or two accounts (line items) are used.

Q9-2. Typically, preferred stock has the following features: 1) Preferential claim to dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No voting rights.

Q9-3. Preferred stock is similar to debt when1. Dividends are cumulative.2. Dividends are nonparticipating.3. Preferred stockholders have preference to assets in liquidation.

Preferred stock is similar to common stock when1. Dividends are not cumulative.2. Dividends are fully participating.3. It is convertible into common stock.4. Preferred stockholders do not have a preference to assets in

liquidation.

©Cambridge Business Publishers, 2013Solutions Manual, Module 9 9-1

Q9-4. Dividends in arrears on preferred stock are the cumulative preferred dividends that have not been paid to date. The dividends in arrears and a current dividend must be paid to preferred stockholders before common stockholders can receive any dividends. In the example, the company must pay preferred stockholders $90,000 in dividends ($500,000 0.06 3 years = $90,000) before paying any dividends to common stockholders.

Q9-5. A corporation's authorized stock is the maximum number of shares of stock it may issue. When the corporation is formed, its charter specifies the authorized amounts and classes of stock. A corporation can later amend its charter to change the amount of authorized capital, but such actions must be approved by the company’s shareholders. Shares that have been sold and issued to stockholders are the company's issued stock.

Shares that have been sold and issued can be subsequently reacquired by the corporation—these shares are called treasury stock. When treasury stock is held, the issued shares exceed the outstanding shares.

Q9-6. Contributed capital represents the total investment “contributed” by shareholders when they purchase stock. It is considered contributed because the company is under no legal obligation to repay the shareholders. Earned capital represents the cumulative net income that the company has earned, less the portion of that income that has been paid out to shareholders in the form of dividends.

When profit is earned, the company can either pay out a portion of that profit as a dividend or reinvest the earnings in order to grow the company. In fact, many companies title the Retained Earnings account as Reinvested Earnings. Earned capital, thus, represents an implicit investment by the shareholders in the form of forgone dividends.

©Cambridge Business Publishers, 2013Financial & Managerial Accounting for MBAs, 3rd Edition9-2

Q9-7. Contributed capital is dividend into two accounts: the common or preferred stock account at par and additional paid-in capital. The common stock or preferred stock accounts at par increase by the par value of each share issued. But, if companies sell shares for more than par, it is the market price of the stock that determines the company’s proceeds. The difference between the share’s market price and its par value is added to the additional paid-in capital account. The breakdown of contributed capital between the common or preferred stock accounts and additional paid-in capital is not informative – it does not yield any implications regarding the financial condition of the company.

Q9-8. A stock split refers to the issuance of additional shares to the current stockholders in proportion to their ownership interests. This is normally accompanied by a proportionate reduction in the par or stated value of the stock. For example, a 2-for-1 stock split doubles the number of shares outstanding and halves the par or stated value of the shares. The market value of the stock typically falls to half in the event of a 2:1 stock split. Consequently, there is no change to the company’s balance sheet; the amount of contributed capital remains the same after the stock split. The major reason for a stock split is to reduce the share price of the stock. It is believed that when the stock price is very high, few investors can afford to purchase the stock. Another possible reason is to lead shareholders to believe that there has been some distribution of value.

Q9-9. Treasury stock is stock, previously issued, that the corporation has reacquired from shareholders.

A corporation might repurchase treasury stock to give to employees who exercise stock options or to offset dilution resulting from option grants. It is also used by management to prop up stock price when management believes its stock is inappropriately underpriced.

On the balance sheet, treasury stock is carried at its cost (the cash the corporation pays to acquire the stock) and is shown as a deduction (a negative amount) on the balance sheet. Thus, total stockholders' equity is net of treasury stock, which is known as a contra-equity account.


Q9-10. The $2,400 increase should not be shown on the income statement as income or gain. The $2,400 is properly treated as additional paid-in capital and is shown as such in the stockholders' equity section of the balance sheet. The latter treatment is justified because treasury stock transactions are considered capital rather than operating transactions. GAAP does not permit corporations to “own” themselves. Thus, the company’s treasury stock is not shown as an investment. GAAP prohibits companies from reporting gains or losses from stock transactions with their own shareholders, therefore no gain is reported.

Q9-11. The book value per share of common stock is the total stockholders' equity divided by the number of shares outstanding. Shares outstanding are 300,000 issued less 40,000 treasury shares. Thus book value is $4,628,000 / 260,000 = $17.80 per share.

Q9-12. A stock dividend is the distribution of additional shares of a corporation's stock to its existing stockholders. A stock dividend does not change a stockholder's relative ownership interest, because each stockholder owns the same fractional share of the corporation before and after the stock dividend. There is empirical evidence, however, suggesting that the stock price does not decline fully to compensate for the additional shares issued. That is, if a company does a 2-for-1 stock split, the market price of each share should be half as much after the split. This does not always happen. The price usually falls by only 45 to 48% of the pre-split price. One hypothesis to explain this phenomenon is that, by splitting the stock, the company is sending a signal to the market that the firm is going to have a price increase (which warrants the split).

Q9-13. All stock dividends transfer capital from retained earnings to contributed capital. For a small stock dividend, this transfer is recorded at the market price of the shares at the time of the dividend. For a large stock dividend, the transfer is made at the par value of the stock. Thus, large stock dividends are treated like stock splits.


Q9-14. Many companies repurchase shares (as treasury stock) in order to offset the dilutive effects of stock options, because stock options increase the number of outstanding shares in the diluted EPS calculation. Stock repurchases typically decrease cash, which has immediate and ongoing economic effects. Some companies increase debt to repurchase stock. Analysts need to be concerned about the consequences of increased leverage solely to prop up diluted EPS.

Q9-15. The statement of stockholders' equity analyzes and reconciles changes in all major components of stockholders' equity during an accounting period. The statement starts with the beginning balances of key stockholders' equity accounts, reports the items that explain the changes in these accounts, and ends with the period-end balances.

Q9-16. Other Comprehensive Income (OCI) represents changes in stockholders’ equity that are caused by factors other than net income and transactions with the company’s shareholders. Some examples include unrealized gains (losses) on available-for-sale securities, foreign currency translation adjustments, unrealized gains (losses) on certain types of derivatives, and pension liability adjustments.

Q9-17. A spin-off is the distribution of shares of a subsidiary company to shareholders in the form of a dividend. In a split-off, the parent company exchanges shares that it owns in a subsidiary for shares of the parent company owned by its shareholders. Only a split-off can result in the recognition of a gain if the distribution of shares to the shareholders is not pro rata, which means that shareholders can opt to exchange their shares or not.

Q9-18. When a convertible bond is converted, the company removes the net book value of the debt from the balance sheet. That is, the company removes both the face amount and any associated unamortized premium or discount. The stock is, then, issued for a “purchase price” equal to the bond’s net book value (face amount net of any unamortized premium or discount). This purchase price is, then, allocated to common stock and additional paid-in capital. No gain or loss is ever reported upon the conversion.


MINI EXERCISES

M9-19 (10 minutes)

Balance Sheet Income Statement

TransactionCash Asset

+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 544,000 PS 400,000 APIC 144,000

(a) Issue 8,000 shares of $50 par value preferred stock at $68 cash per share

+544,000Cash

=

+400,000Preferred

Stock

+144,000Additional

Paid-inCapital

– =

Cash 120,000 CS 12,000 APIC 108,000

(b) Issue 12,000 shares of $1 par value common stock at $10 cash per share

+120,000Cash

=

+12,000Common

Stock

+108,000Additional

Paid-inCapital

– =


M9-20 (10 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 864,000 PS 180,000 APIC 684,000

(a) Issue 18,000 shares of $10 par value preferred stock at $48 cash per share

+864,000Cash

=

+180,000Preferred

Stock

+684,000Additional

Paid-inCapital

– =

Cash 4,440,000 CS 240,000 APIC 4,200,000

(b) Issue 120,000 shares of $2 par value common stock at $37 cash per share

+4,440,000Cash =

+240,000Common

Stock

+4,200,000Additional

Paid-inCapital

– =

M9-21 (10 minutes)

a. Common stock.............................................................................. $ 6*

Additional paid-in capital.............................................................. 37,787Total................................................................................................ $37,793* Cisco’s common stock has a par value of $0.001. The common stock

account therefore includes, 5,655 million shares issued $0.001 par value, rounded up to $6 million.

b. Because the par value of Cisco’s common stock is so small, Cisco management likely decided to simply include common stock and additional paid-in capital in one account on the balance sheet.


M9-22 (10 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 1,250,000 PS 500,000 APIC 750,000

Issue 5,000 shares of $100 par value preferred stock at $250 cash per share

+1,250,000Cash =

+500,000Preferred

Stock

+750,000Additional

Paid-inCapital

– =

TS 415,000 Cash 415,000 Repurchase

5,000 shares of $1 par value common stock at $83 per share

-415,000Cash

=-415,000Treasury

Stock– =

M9-23 (10 minutes)

A stock split in which the par value is proportionately reduced does not create an accounting transaction and, as a result, does not require an entry into the accounting records. The number of outstanding shares is changed in the parenthetical note to the common stock account in the stockholders’ equity section of the balance sheet, and the par value of the stock is proportionately reduced.

In Medco’s two-for-one stock split effected in the form of a 100% stock dividend, each shareholder receives one additional share for each share owned, thus doubling the outstanding shares, but the par value of the shares remained unchanged. Since the par value is not reduced, an accounting entry is required to transfer the par value of the shares issued from retained earnings to the common stock account. Earnings per share is also recomputed for all years presented in the income statement to reflect the additional shares outstanding after the split.


M9-24 (15 minutes)

a. 103,300,000 shares issued $0.01 par = $1,033,000. This amount is reported in thousands as $1,033.

b. Outstanding shares are equal to issued shares less repurchased shares. For 2011, Abercrombie & Fitch has 103,300,000 – 16,054,000 = 87,246,000 shares outstanding.

c. Total proceeds from the sale are the sum of the common stock and additional paid-in capital accounts. For 2011, this total is $350,291,000 ($1,033,000 + $349,258,000). The average price at which Abercrombie issued common stock is $3.39 ($350,291,000 / 103,300,000 shares).

d. The average price at which Abercrombie & Fitch repurchased treasury stock is $45.18 ($725,308,000 / 16,054,000 shares).

M9-25 (10 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

RE 106,000 Cash 106,000

Declare and pay preferred and common dividends

–106,000Cash

=–106,000RetainedEarnings

– =

Preferred dividends = $18,000 ($3 6,000 shares); Common dividends = $88,000 ($2.20 40,000 shares).


M9-26 (10 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

RE 58,800 CS 14,000 APIC 44,800

Declare and pay stock dividend.

=

+14,000Common

Stock

+44,800Additional

Paid-inCapital

–58,800RetainedEarnings

– =

Stock dividend = $58,800: market price of the shares distributed (70,000 shares 4% $21).

M9-27 (10 minutes)

a. Immediately after the 3-for-2 stock split, the company has 375,000 shares of $10 par value common stock [250,000 shares × (3/2) = 375,000 shares] issued and outstanding.

b. The dollar balance in the Common Stock account is unchanged by the stock split; the balance remains at $3,750,000 (375,000 shares at the new $10 par value per share).

c. The usual reason for a corporation to split its stock is to reduce the share price of the stock thereby improving the stock's marketability. Weiss’ stock is trading at $165 which is pricey if investors want to buy the stock in a round lot, which is 100 shares. To increase transactions (and hence demand for the stock), Weiss has dropped its stock price to around $100 ($165 × 2/3 = $110).


M9-28 (15 minutes)

Distribution to Preferred Common

a. $1,000,000 6%................................................... $60,000Balance to common............................................. $100,000Per share

$60,000 / 20,000 shares............................. $3.00$100,000 / 80,000 shares........................... $1.25

b. $1,000,000 6% 2 years.................................. $120,000Balance to common............................................. $40,000Per share

$120,000 / 20,000 shares........................... $6.00$40,000 / 80,000 shares............................. $0.50

M9-29 (10 minutes)

BAMBER COMPANY

STATEMENT OF RETAINED EARNINGS

FOR YEAR ENDED DECEMBER 31, 2012

Retained Earnings, December 31, 2011.......................... $347,000

Add: Net Income............................................................... 94,000

441,000

Less: Cash Dividends Declared....................................... $35,000

Stock Dividends Declared...................................... 28,000 63,000

Retained Earnings, December 31, 2012.......................... $378,000


M9-30 (10 minutes)

a. A spin-off is a distribution of shares of a subsidiary to the company’s shareholders in the form of a dividend. A split-off is the exchange of shares between the company and its shareholders. In a split-off, NCR’s shareholders would exchange their shares in the company for Teradata shares owned by NCR. The end result of a spin-off and a split-off is the same economically (the shareholders end up owning the subsidiary directly rather than indirectly via the company), but the accounting differs.

A spin-off is accounted for as a dividend. Both the investment account and the retained earnings account are reduced by the book value of the shares distributed. A split-off is accounted for like a purchase of treasury stock. The treasury stock account is increased and the equity method investment account is reduced (reflecting the distribution of that asset). The dollar amount recorded for this transaction depends on whether the split-off is a pro rata distribution or a non pro rata distribution.

b. As is the case with all dividends, there is no effect on NCR’s income statement from the spin-off. The assets on NCR’s balance sheet are reduced by the book value of the Teradata investment and its stockholders’ equity is reduced by the same amount through a reduction in retained earnings for the “spin-off” dividend.

M9-31 (10 minutes)

a. A split-off is an exchange of shares between the parent company and its shareholders. For example, Viacom shareholders would exchange their shares in the company for Blockbuster shares owned by Viacom. This is like Viacom buying its own shares back and using Blockbuster shares instead of cash.

b. The repurchased shares are treated as treasury stock, hence Viacom’s outstanding shares will decline.

c. Viacom can report a gain, equal to the value of the Blockbuster subsidiary in excess of its carrying amount on the balance sheet, if the exchange with its shareholders is not pro rata.


M9-32 (10 minutes)

a. A spin-off is a distribution of shares of a subsidiary to the company’s shareholders in the form of a dividend. A spin-off is accounted for as a dividend. Both the investment account and the retained earnings account are reduced by the book value of the shares distributed.

b. The spin-off of Philip Morris reduced Altria’s assets (the investment in Philip Morris by Altria) and stockholders’ equity (retained earnings) by $14.4 billion. There is no effect on income or cash flow.

M9-33 (10 minutes)

a. The conversion of any security, whether debt or equity, results in the following effects on the balance sheet: the book value of the converted security (just before the conversion) is removed and common stock is issued for the same amount. In JetBlue’s case, the book value of the 3¾% convertible debentures would be removed from long-term debt and common stock issued for this book value amount. The conversion would increase the par value and additional paid-in capital accounts just like the issuance of shares for cash.

b. Conversion of debt is a balance sheet transaction and does not impact the income statement in the conversion period. In subsequent years, JetBlue would report lower interest expense because the debentures would be removed from the balance sheet.


EXERCISES

E9-34 (15 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 250,000 CS 10,000 APIC 240,000

Feb 20: Issued 10,000 shares of $1 par value common stock at $25 cash per share

+250,000Cash

=

+10,000Common

Stock

+240,000Additional

Paid-inCapital

– =

Cash 4,125,000 PS 1,500,000 APIC 2,625,000 Feb 21: Issued

15,000 shares of $100 par value 8% preferred stock at $275 cash per share

+4,125,000Cash =

+1,500,000Preferred

Stock

+2,625,000Additional

Paid-inCapital

– =

TS 30,000 Cash 30,000 Jun 30:

Purchased 2,000 shares of common stock at $15 per share

–30,000Cash

=–30,000Treasury

Stock– =

Cash 21,000 TS 15,000 APIC 6,000

Sep 25: Sold 1,000 shares of treasury stock at $21 cash per share

+21,000Cash

=

+15,000Treasury

Stock

+6,000Additional

Paid-inCapital

– =


E9-35 (20 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 425,000 CS 125,000 APIC 300,000

Jan 15: Issued 25,000 shares of $5 par value common stock at $17 cash per share

+425,000Cash

=

+125,000Common

Stock

+300,000Additional

Paid-inCapital

– =

Cash 468,000 PS 300,000 APIC 168,000

Jan 20: Issued 6,000 shares of $50 par value 8% preferred stock at $78 cash per share

+468,000Cash

=

+300,000Preferred

Stock

+168,000Additional

Paid-inCapital

– =

TS 60,000 Cash 60,000 Mar 31:

Purchased 3,000 shares of common stock at $20 per share

–60,000Cash

=–60,000Treasury

Stock– =

Cash 52,000 TS 40,000 APIC 12,000

Jun 25: Sold 2,000 shares of treasury stock at $26 cash per share

+52,000Cash

=

+40,000Treasury

Stock

+12,000Additional

Paid-inCapital

– =

Cash 19,000APIC 1,000 TS 20,000

Jul 15: Sold 1,000 shares of treasury stock at $19 cash per share

+19,000Cash

=

+20,000Treasury

Stock

–1,000Additional

Paid-inCapital

– =


E9-36 (20 minutes)

Campbell Soup has issued (and outstanding) 542 million shares. At its $0.0375 par value, its common stock is recorded at $20.325 million, which is rounded down to $20 million.

a. Campbell Soup issued shares at an average price of $0.67 per share, computed as ($20 million + $341 million)/ 542 million shares.

b. ($ millions)

Retained earnings, August 2, 2009................................................... $8,288Net earnings........................................................................................ 844Dividends............................................................................................ (372) Retained earnings, August 1, 2010................................................... $8,760

c. The foreign currency translation adjustment relates to Campbell Soup’s foreign subsidiaries. During the year, the $US equivalent of the foreign subsidiary balance sheets changed because the $US value fluctuated. The $39 million positive amount implies that the $US weakened during the year vis-à-vis the currencies in which Campbell Soup’s subsidiaries maintain their financial statements. Consequently, the net equity of the foreign subsidiaries increased in their $US value, resulting in a positive foreign currency translation adjustment. This adjustment has no effect on Campbell Soup’s reported net earnings until the subsidiary is sold, at which time the balance in the foreign currency translation account relating to that subsidiary is taken into current income.

d. The exercise of employee stock options resulted in the issuance of 7 million shares of stock for a total of $216 million ($207 million + $9 million). Because the Treasury Stock shares were sold, the Treasury Stock account is reduced (an addition reduces the negative amount for Treasury Stock) by the original purchase cost of the shares ($207 million) and Additional Paid-In Capital is increased for the balance of the price paid by the employees.

e. Campbell Soup repurchased 14 million shares of common stock for a total of $472 million, or at a cost of $33.71 per share. The effect of the repurchase of stock is to reduce Cash and Stockholders’ Equity, thereby shrinking the company.


E9-37 (20 minutes)

a.

Dividend Distribution

Preferred CommonPreferred per Share

Common per Share

2010 Preferred $0 $0 .00 Common $0 $0 .00

2011 Preferred dividendsin arrears[7% (20,000 $60)] $ 84,000

Current year preferreddividends[7% (20,000 $60)] 84,000

Remainder to common $15,000Total distribution $168,000 $15,000

Per sharePreferred ($168,000 / 20,000) $8 .40 Common ($15,000 / 100,000) $0 .15

2012 Current year preferreddividends[7% (20,000 $60)] $ 84,000

Remainder to common $116,000



E9-37 (concluded)

b.



Common per Share

2010 Preferred $ 0 $0 .00 Common $ 0 $0 .00

2011 Preferred dividendsin arrears

[7% (20,000 $60)] $ 84,000

Per sharePreferred ($84,000 / 20,000) $4 .20

Common $0 .00

2012 Preferred dividendsin arrears[7% (20,000 $60)]$ 84,000

Current year preferreddividends (partial) 66,000Total distribution $150,000

Per sharePreferred ($150,000 / 20,000) $7 .50 Common $0 .00


E9-38 (20 minutes)

Distribution toPreferred Common

a. Year 1 $ 0 $ 0

Year 2: Dividends inarrears from Year 1($750,000 8%) $ 60,000

Current year dividend($750,000 8%) 60,000

Balance to common _______ $160,000 Total for Year 2 $120,000 $160,000

Year 3: Current year dividend($750,000 8%) $ 60,000 $ 0

b. Year 1 $ 0 $ 0

Year 2: Current year dividend($750,000 8%) $ 60,000 Balance to common $220,000

Year 3: Current year dividend($750,000 8%) $ 60,000 $ 0


E9-39 (20 minutes)

a. Altria reports 2,805,961,317 shares issued at the year-end 2010. Its par value is $0.33 1/3 per share. The common stock amount is 2,805,961,317 shares $0.33333 par value, which yields $935,320,439. This value is rounded down to $935 million on the balance sheet.

b. Altria issued its common shares at the average price of $2.38 per share. This value is computed as: ($935 million common stock + $5,751 million additional paid-in capital) / 2,805,961,317 shares.

c. Altria has 2,088,739,666 shares outstanding at year-end 2010. This is computed as 2,805,961,317 shares issued less 717,221,651 shares in treasury.

d. Altria repurchased its treasury stock at an average cost of $32.72 per share. This is computed as $23,469 million / 717,221,651 shares.

e. Companies repurchase stock for a variety of reasons, these include:

1. To offset the dilutive effects of shares issued to employees under stock option plans.

2. To mitigate a takeover threat by buying back enough shares so that the remaining shares are concentrated in “friendly hands.”

3. To send a signal to the market that the company feels its shares are undervalued.

4. To return excess cash to shareholders; companies often repurchase shares instead of declaring a cash dividend to respect those shareholders who do not want a cash dividend, and yet provide an “implicit cash dividend” to those who wish to sell their shares back to the company.

f. The Noncontrolling Interests account represents the equity of the

noncontrolling shareholders. These shareholders have an ownership interest in one or more of Altria’s subsidiaries. Their equity fluctuates much like that of Altria’s shareholders (it is increased by the profit attributable to noncontrolling shareholders and is decreased by dividends paid to those shareholders).


E9-40 (30 minutes)

a.



Common per Share

2010Current year preferred

dividends [6% (18,000 $50)] $54,000



2011Preferred $ 0 $0 .00 Common $ 0 $0 .00

2012Preferred dividends in arrears

[6% (18,000 $50)] $ 54,000

Current year preferreddividends [6% (18,000 $50)] 54,000


Total distribution $108,000 $270,000



E9-40 (concluded)

b.



Common per Share

2010Preferred $ 0 $0 .00 Common $ 0 $0 .00

2011

Preferred dividends in arrears[6% (18,000 $50)] $ 54,000

Current year preferreddividend[6% (18,000 $50)] 54,000

Common $ 0

Total distribution $108,000 $ 0

Per sharePreferred ($108,000 / 18,000) $6.00 Common $0 .00

2012

Current year preferreddividend[6% (18,000 $50)] $ 54,000




E9-41 (15 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

RE 47,500 Cash 47,500

Pay cash dividend on common stock1

-47,500Cash

=-47,500RetainedEarnings

– =

RE 35,000 CS 10,000 APIC 25,000

Issue 4% stock dividend on common stock2

=

+10,000Common

Stock

+25,000Additional

Paid-inCapital

+-35,000RetainedEarnings

– =

1 $1.90 25,000 = $47,500.2 Retained Earnings is reduced by the market price of the shares distributed (25,000 shares 4%

$35 market value = $35,000). Common Stock is increased by the par value (25,000 shares 4% $10) with the balance of the market price added to Additional Paid-in Capital.


E9-42 (20 minutes)

a.



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

RE 100,800 CS 56,000 APIC 44,800

May 12: Declare and issue stock dividend 1

=

+56,000Common

Stock

+44,800Additional

Paid-inCapital


– =

RE 64,200 Cash 64,200

Dec 31: Declare and pay cash dividend 2

-64,200Cash


– =

1 The 7% dividend is a small stock dividend and, accordingly, Retained Earnings is reduced by the market value of the shares distributed (7% 80,000 shares $18 = $100,800). Common Stock is increased by the par value of the shares ($56,000) and Additional Paid-in Capital is increased by the remainder ($44,800). After the stock dividend there are 85,600 shares outstanding (80,000 1.07).

2 Retained earnings are reduced by $0.75 per share on 85,600 shares outstanding and Cash is decreased by the same amount.

b.

PAGACH COMPANY



Retained Earnings, December 31, 2011 $305,000Add: Net Income 283,000

588,000Less: Cash Dividends Declared $ 64,200

Stock Dividends Declared 100,800 165,000Retained Earnings, December 31, 2012 $423,000


E9-43 (30 minutes)

a.



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

RE 250,000 CS 250,000

Apr 1: Issue stock dividend on common stock1

=+250,000Common

Stock

-250,000RetainedEarnings

– =

RE 42,000 CS 15,000 APIC 27,000

Dec 7: Issue 3% stock dividend on common stock2

=

+15,000Common

Stock

+27,000Additional

Paid-inCapital


– =

RE 102,400 Cash 102,400

Dec 20: Pay cash dividends on preferred and common stock3

-102,400Cash


– =

1 Large stock dividends are recorded at par value. The company reduces Retained Earnings and increases Common Stock by $250,000 (50,000 shares 100% $5 par value). There is no effect on APIC.

2 Small stock dividends are recorded at market value. The company reduces Retained Earnings by the market value of the shares to be distributed (3% 100,000 shares $14 per share = $42,000). Common Stock increases by the par value of the shares distributed (3% 100,000 $5 = $15,000) and APIC increases by the balance ($27,000).

3 Total dividends are 4,000 $5 = $20,000 for the preferred shares and 103,000 $0.80 = $82,400 for the common shares. Retained Earnings and Cash decrease to reflect the payment.

b.KINNEY COMPANY



Retained Earnings, December 31, 2011 $656,000Add: Net Income 253,000

909,000Less: Cash Dividends Declared $102,400

Stock Dividends Declared 292,000 394,400Retained Earnings, December 31, 2012 $514,600


E9-44 (15 minutes)

a. Immediately after the stock split, 800,000 shares (2 × 400,000 shares) of $10 par value common stock are issued and outstanding.

b. The stock split does not change the Common Stock account balance. The account balance is $8,000,000 just before and immediately after the stock split.

c. The stock split does not change the Paid-in Capital in Excess of Par Value account. The account balance is $3,400,000 just before and immediately after the stock split.

E9-45 (20 minutes)

a. Caterpillar’s outstanding shares equal the issued shares less treasury shares: 814,894,624 - 176,071,910 = 638,822,714 shares outstanding.

b. The phrase “at paid-in amount” refers to the total paid-in-capital, including the common stock par value along with the additional paid-in capital. That is, Caterpillar’s balance sheet does not distinguish between par value and the additional paid-in amounts for common stock.

c. Caterpillar purchased treasury shares, on average, for $59.05 per share; this is computed as: $10,397 million / 176,071,910 shares.

d. Companies repurchase shares for many reasons, including:1. To offset the dilutive effects of shares issued to employees

under stock option plans.2. To mitigate a takeover threat if the remaining shares are concentrated

in “friendly hands.”3. To send a signal to the market that the company feels its shares are

undervalued.4. To return excess cash to shareholders; companies often repurchase

shares instead of declaring a cash dividend to respect those shareholders who do not want a cash dividend, and yet provide an “implicit cash dividend” to those who wish to sell their shares back to the company.


E9-45 (concluded)

e. This occurs because CAT is selling shares previously repurchased and held as treasury stock. The issued shares, therefore, remains constant as no new shares have been sold; however, the dollar amount of the common stock account increases by the difference of the treasury stock sale proceeds less the cost when CAT purchased the shares.

E9-46 (25 minutes)

a. Companies typically describe the required dividends on Preferred Stock either as a percentage, as in Xerox’s case, or as a dollar value. When expressed as a percentage, the required dividends are equal to the percentage rate multiplied by the par value of the Preferred Stock. Since preferred shares normally carry a par value of $100 per share, the required dividends on Xerox’s Preferred Stock are $6.25 per share (6.25% × $100 par value). Thus, the dividends that must be paid each year are $57.5 million computed as 9.2 million shares × $6.25 per share.“Mandatory” means that the Preferred Stock must be retired (repaid) at some point in the future, and the 6.25% dividend must be paid each year similar to required interest payments (dividends are not an expense in the computation of net income, however). The repayment provision and the dividends make the Preferred Stock look more like debt than equity. Other provisions, such as the conversion feature, make the instrument appear more like equity. We see that preferred stock is, therefore, a very versatile security.

b. When convertible preferred stock is converted, the balance of the convertible preferred stock is eliminated and total contributed capital (common stock plus additional paid-in capital) is increased by that same amount: Common Stock increases by par value multiplied by the number of shares issued and Additional Paid-In Capital increases by the remainder. In 2006, Xerox decreased the preferred stock account by $889 million (the book value of the Preferred Stock on the date of conversion) and increased Common Stock and APIC by $75 and $814 respectively. Xerox issued 74.8 million common shares and the $75 increase to Common Stock is equal to the 74.8 million shares issued upon conversion multiplied by the $1.00 par value per share (rounded to $75 million).


E9-46 (concluded)

c. Companies typically issue debt and preferred stock with conversion features to get a higher price for the securities. This higher price reduces the cost of the debt and equity, respectively. Companies must balance this higher price, however, with the future dilution of the interests of existing shareholders when the securities are converted.

Since conversion will increase the number of shares outstanding, the dilutive effect of these convertible securities is included in the computation of diluted EPS.

E9-47 (20 minutes)

a. Merck has issued 3,576,948,356 shares at a par value of $0.50.Shares issued Par value = Common Stock amount3,576,948,356 $0.50 = $1,788,474,178 rounded down to $1,788 million.

b. Merck issued its common stock at an average price of $11.88 per share.(Common Stock + Other Paid-In Capital) /Shares issued = Average Issue price($1,788 million + $40,701 million) / 3,576,948,356 = $11.88 per share

c. Merck repurchased its common stock at an average price of $45.34 per share.Treasury Stock / Treasury shares = Average cost per share$22,433 million / 494,841,533 = $45.33 per share

d. Shares issued – Treasury shares = Shares outstanding3,576,948,356 – 494,841,533 = 3,082,106,823 shares outstanding


PROBLEMS

P9-48 (30 minutes)a.



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 476,000 CS 280,000 APIC 196,000

Jan 10 1 +476,000Cash

=

+280,000Common

Stock

+196,000Additional

Paid-inCapital

– =

TS 152,000 Cash 152,000

Jan 23 2 –152,000Cash

=–152,000Treasury

Stock– =

Cash 84,000 TS 76,000 APIC 8,000

Mar 14 3 +84,000Cash

=

+76,000Treasury

Stock

+8,000Additional

Paid-inCapital

– =

Cash 128,000 PS 80,000 APIC 48,000

Jul 15 4 +128,000Cash

=

+80,000Preferred

Stock

+48,000Additional

Paid-inCapital

– =


P9-48 (continued)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 24,000 TS 19,000 APIC 5,000

Nov 15: 5 +24,000Cash

=

+19,000Treasury

Stock

+5,000Additional

Paid-inCapital

– =

1 Cash increases by the total proceeds of 28,000 $17 = $476,000. Common Stock increases by the par value of the shares issued (28,000 $10 = $280,000) and Additional Paid-In Capital increases by the remainder ($196,000).

2 Cash decreases and Treasury Stock increases by the purchase price of 8,000 shares $19 = $152,000. The increase in Treasury Stock reduces paid-in capital because Treasury Stock is a contra-equity account.

3 Cash received is 4,000 shares $21 = $84,000. Treasury Stock is reduced by the original cost of $19 per share and the remainder of $8,000 is reflected as an increase in Additional Paid-In Capital.

4 Gupta receives cash of $128,000. The Preferred Stock account increases by the par value of the preferred shares issued (3,200 $25 = $80,000) and Additional Paid-In Capital increases by the remainder ($48,000).

5 Gupta receives cash of 1,000 shares $24 = $24,000. Treasury Stock is reduced by its original cost of 1,000 shares $19 = $19,000, thus increasing paid-in-capital, and Additional Paid-In Capital increases by the remainder ($5,000).


P9-48 (concluded)

b. Gupta Company

Stockholders' EquityDecember 31, 2012

Paid-in capital8% Preferred stock, $25 par value,

50,000 shares authorized; 10,000 sharesissued and outstanding $250,000

Common stock, $10 par value, 200,000shares authorized; 78,000 shares issued,(3,000 shares in treasury) 780,000 $1,030,000

Additional paid-in capitalPaid-in capital in excess of par

value—preferred stock 116,000

Paid-in capital in excess of parvalue—common stock 396,000

Paid-in capital from treasury stock 13,000 525,000Total paid-in capital 1,555,000

Retained earnings 329,0001,884,000

Less: Treasury stock (3,000 commonshares) at cost (57,000 )

Total Stockholders’ equity $1,827,000


P9-49 (30 minutes)

a. Balance Sheet Income Statement


+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

No transaction recorded

Jan 12 1

TS 100,000 Cash 100,000

Sep 1 2 –100,000Cash

=–100,000Treasury

Stock– =

Cash 18,000 TS 15,000 APIC 3,000

Oct 12 3 +18,000Cash

=

+15,000Treasury

Stock

+3,000Additional

Paid-inCapital

– =

Cash 105,000 CS 25,000 APIC 80,000

Nov 21 4 +105,000Cash

=

+25,000Common

Stock

+80,000Additional

Paid-inCapital

– =

Cash 10,800APIC 1,200 TS 12,000

Dec 28: 5 +10,800Cash

=

+12,000Treasury

Stock

-1,200Additional

Paid-inCapital

– =

1 (Memorandum) Common stock split 3 for 1, authorized shares increased to 300,000 and par value reduced to $5 per share.

2 Cash paid: 10,000 shares $10 = $100,000. This increases the Treasury Stock account, which is a contra-equity account that reduces paid-in capital.

3 Cash received: 1,500 shares $12 per shares = $18,000. Treasury Stock is reduced by its cost of $10 per share and the balance ($3,000) is reflected as an increase in Additional Paid-In Capital.

4 Cash received: 5,000 shares $21 per share = $105,000. Common Stock increases by the par value (5,000 $5 = $25,000) and Additional Paid-In Capital increases by the difference ($80,000).

5 Cash received: 1,200 shares $9 = $10,800. Treasury Stock is reduced by the cost of the shares (1,200 shares $10 = $12,000) and APIC is reduced by the remainder ($10,800 - $12,000 = -$1,200).


P9-49 (concluded)

b.Sougiannis CompanyStockholders' EquityDecember 31, 2012


20,000 shares authorized; 5,000shares issued and outstanding $500,000

Common stock, $5 par value, 300,000shares authorized; 125,000 sharesissued 625,000 $1,125,000

Additional paid-in capitalPaid-in capital in excess of par value—preferred stock 24,000Paid-in capital in excess of par value—common stock 440,000

Paid-in capital from treasury stock 1,800 465,800Total paid-in capital 1,590,800


Less: Treasury stock (7,300 commonshares) at cost (73,000 )

Total stockholders' equity $1,925,800


P9-50 (45 minutes)

a.Balance Sheet Income Statement


+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 120,000 CS 50,000 APIC 70,000

Jan. 5 1 +120,000Cash

=

+50,000Common

Stock

+70,000Additional

Paid-inCapital

– =

TS 56,000 Cash 56,000

Jan. 18 2 –56,000Cash

=–56,000Treasury

Stock– =

Cash 17,000 TS 14,000 APIC 3,000

Mar. 12 3 +17,000Cash

=

+14,000Treasury

Stock

+3,000Additional

Paid-inCapital

– =

Cash 6,500APIC 500 TS 7,000

Jul. 17 4 +6,500Cash

=

+7,000Treasury

Stock

-500Additional

Paid-inCapital

– =

Cash 175,000 PS 125,000 APIC 50,000

Oct. 1 5 +175,000Cash

=

+125,000Preferred

Stock

+50,000Additional

Paid-inCapital

– =


P9-50 (concluded)

1 Cash increases by the proceeds from the stock sale (10,000 shares $12 = $120,000). Common Stock increases by the par value (10,000 shares $5) and Additional Paid-In Capital increases by the remainder ($70,000).

2 Cash decreases by the cost of the Treasury Stock (4,000 shares $14 = $56,000). The treasury Stock account increases by the same amount. Because Treasury Stock is a contra-equity account, the share repurchase reduces stockholders’ equity (paid-in capital).

3 Cash increases by the proceeds from the sale of the Treasury Stock (1,000 shares $17 = $17,000). The Treasury Stock account is reduced by the original cost of the shares (1,000 $14 = $14,000) and Additional Paid-In Capital increases by the remainder ($3,000).

4 Cash is increased by the proceeds from the sale of the Treasury Stock (500 shares $13 = $6,500). Treasury Stock is reduced by its original cost (500 shares $14 = $7,000) and Additional Paid-In Capital is reduced by the difference.

5 Cash increases by the proceeds from the sale of the Preferred Stock (5,000 shares $35 per share = $175,000). Preferred Stock increases by its par value (5,000 shares $25 = $125,000) and Additional Paid-in Capital increases by the remainder ($50,000).

b.

Verrecchia CompanyStockholders' EquityDecember 31, 2012


50,000 shares authorized, 5,000shares issued and outstanding $125,000

Common stock, $5 par value, 350,000shares authorized; 160,000 sharesissued 800,000 $ 925,000

Additional paid-in capitalPaid-in capital in excess of par

value—preferred stock 50,000Paid-in capital in excess of par

value—common stock 670,000Paid-in capital from treasury stock 2,500 722,500

Total paid-in capital 1,647,500


Less: Treasury stock (2,500 shares) at cost (35,000 )

Total Stockholders' Equity $2,031,000


P9-51 (30 minutes)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 62,000 PS 50,000 APIC 12,000

Jan. 15 1 +62,000Cash

=

+50,000Preferred

Stock

+12,000Additional

Paid-inCapital

– =

Cash 144,000 CS 80,000 APIC 64,000

Jan. 20 2 +144,000Cash

=

+80,000Common

Stock

+64,000Additional

Paid-inCapital

– =

No transaction recorded May 18 3 – =

Cash 60,000 CS 20,000 APIC 40,000

Jun. 1 4 +60,000Cash

=

+20,000Common

Stock

+40,000Additional

Paid-inCapital

– =

TS 45,000 Cash 45,000

Sep. 1 5 –45,000Cash

=–45,000Treasury

Stock– =


P9-51 (concluded)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 18,900 TS 16,200 APIC 2,700

Oct. 12 6 +18,900Cash

=

+16,200Treasury

Stock

+2,700Additional

Paid-inCapital

– =

Cash 29,500 PS 25,000 APIC 4,500

Dec. 22 7 +29,500Cash

=

+25,000Preferred

Stock

+4,500Additional

Paid-inCapital

– =

1 Cash increases by the proceeds from the sale of the Preferred Stock (1,000 shares $62 per share = $62,000). The Preferred Stock account is increased for its par value (1,000 shares $50 par = $50,000) and Additional Paid-In Capital is increased for the remainder ($12,000).

2 Cash increases by the proceeds from the sale of the Common Stock (4,000 shares $36 = $144,000). Common Stock increases by its par value (4,000 $20 = $80,000) and Additional Paid-In Capital increases by the remainder ($64,000).

3 (Memorandum) Common stock split 2 for 1, with authorized shares increased to 100,000 and par value reduced to $10 per share.

4 After the stock split, the par value is $10. Therefore, Common Stock increases by $20,000 (2,000 shares $10 par) and Additional Paid-In Capital increases by the remainder ($40,000).

5 Cash decreases by the cost of the Treasury Stock (2,500 shares $18 per share = $45,000). Because Treasury Stock is a contra-equity account, the stock repurchase decreases paid-in-capital.

6 Cash increases by the proceeds from the sale of the Treasury Stock (900 $21 = $18,900). The Treasury Stock account decreases by the original cost of the shares (900 $18 = $16,200), thereby increasing paid-in-capital, and Additional Paid-In Capital increases by the remainder ($2,700).

7 Cash increases by the proceeds from the sale of the Preferred Stock (500 $59 = $29,500). The Preferred Stock account increases for its par value (500 shares $50 = $25,000) and Additional Paid-In Capital increases for the remainder ($4,500).


P9-52 (50 minutes)

a. Convertible means the holder of the security has an option to convert (exchange) the security into another security. In the case of P&G Class A preferred, the holder can convert the preferred shares into P&G common shares.

b. During fiscal 2010, P&G issued 5.579 million shares of common stock when Class A preferred stock was converted. The statement of shareholders’ equity also reveals that these common shares came from treasury stock.

c. P&G issued 17.616 million shares of common stock relating to employee plans. This included both Treasury Stock and newly issued shares. P&G issued its common shares at an average price of $67.61 per share. This value is computed as: ($1 million common stock + $574 million additional paid-in capital + $616 million of Treasury Stock) / 17.616 million shares issued.

d. Comprehensive income reflects the change in net assets (assets less liabilities) during the year for transactions other than net income transactions, and transactions with shareholders (stock issuances, repurchases and dividends). Comprehensive income includes net income plus other items that affect stockholders’ equity but which do not flow through net income. In 2010, P&G reported total comprehensive income of $8,272 million; of this, $12,736 million was net earnings and the remainder of $(4,464) million is other comprehensive loss.

The cumulative effect of these other comprehensive income items (the balance at a point in time) is reported as accumulated other comprehensive income (AOCI) on the balance sheet. Examples of these other items include unrealized gains and losses on available-for-sale securities and derivative financial instruments (which will flow through net income when the securities are actually sold and the hedged transactions occur); and unrealized gains and losses from foreign currency translations (which will flow through net income if and when the related foreign subsidiary is sold); and unrealized gains and losses relating to pension plans. At June 30, 2010, P&G reported total AOCI of $(7,822) million.

e. In 2010, P&G paid common dividends of $5,239 million and preferred dividends of $219 million.


P9-53 (50 minutes)

a. The $2.67 is the amount of dividend per year on each share of Fortune Brands’ preferred stock. Preferred stock is typically sold in increments of $100. Thus, the $2.67 implies an initial dividend yield of 2.67%.

b. 234.9 million shares issued $3.125 par value = $734.06 million, rounded to 734.0 in the financial statement.

c. (Common stock + Additional paid-in capital) / Shares issued = Average issue price; computed as ($734.0 million + $820.2 million) / 234.9 million shares issued = $6.62 per share

d. Fortune Brands reports cumulative foreign exchange translation adjustments of $26.0 million, unrealized gains on financial derivative instruments of $2.8 million, and minimum pension liability adjustments of $11.0 million as part of its 2010 other comprehensive income adjustments.

The other comprehensive income or loss account also commonly includes changes in unrealized gains and losses from available-for-sale securities.

e. Tax benefits are calculated based on the intrinsic value of the options at exercise. But the expected tax benefit is calculated based on fair value of the options at exercise. If the stock price increases significantly, the company can receive more tax benefit than expected. This happened to Fortune Brands in 2011 – the company recorded $6.1 million of excess tax benefit. This excess is added to APIC directly and not on the income statement as a tax benefit.


P9-54 (30 minutes)

a. Assuming that the conversion option cannot be detached, which is customary, Alloy accounted for the issuance of its convertible bonds just like a bond without a conversion option. That is, the company recorded the bonds at the proceeds received on the sale, which is the present value of the interest and principal components of the bonds.

b. Each $1,000 bond is convertible to 29.851 common shares. Therefore, at any price above $33.50 per share ($1,000 / 29.851), debenture holders would have economic incentives to convert.

c.Balance Sheet Income Statement

Transaction(1,000s)

Cash Asset

+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

LTD 67,903 CS 20 APIC 67,883

August 30 – December 7, 2006

=

-67,903Convertible Debentures

+20Common

Stock

+67,883Additional

Paid-inCapital

– =

d. The higher sale price for the bonds as a result of the nondetachable conversion feature results in a lower discount or higher premium on the bonds which, when amortized, results in lower interest expense and higher net income (see Module 8). Alloy, therefore, receives an income benefit from the conversion feature. The cost of the conversion option, while not explicitly recognized in net income, will reduce diluted earnings per share (the denominator in EPS increases by the additional shares that will be issued upon conversion as discussed in part e).

e. The convertible bonds do not affect basic EPS but do affect diluted EPS. In the computation of diluted EPS, the company assumes that the bonds are converted at their earliest possible opportunity (January 1 of the current year if the bonds were issued in a prior year, or the issue date if the bonds were issued during the current year). As a result, the after-tax interest (e.g., interest expense [1-tax rate]) accrued on the bonds is added to net income in the numerator, and the shares issued upon conversion are added to the denominator. The net result is a reduction in diluted EPS as compared to basic EPS.


P9-55 (30 minutes)

a. “Mandatorily redeemable” means that the company must buy the stock back from shareholders at some pre-specified price and date. This reduces the downside risk to the preferred stock holders.“Convertible” means that the preferred stock can be exchanged for common stock. Usually this option rests with the holder of the preferred stock. Sometimes, companies can retain an option to force the conversion. This is spelled out in the preferred stock contract.

b. The balance sheet shows $350 million for the 3.5 million shares. Thus the par value of the preferred shares is $100.

c. The increase in the fair value of the preferred stock is due to the conversion feature. The common stock of Northrop Grumman has increased significantly in value and preferred shareholders can share in this price appreciation if they convert.

d. (in millions)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

PS 350 CS 6 APIC 344

April 4, 2008 =

-350Preferred

Stock

+6Common

Stock

+344Additional

Paid-inCapital

– =


P9-56 (50 minutes)

a. Balance Sheet Income Statement


+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

WE 1,000,000 APIC 1,000,000

Each year: 2009 through 2011*

=+1 mil.

AdditionalPaid-inCapital

-1 mil.Retained Earnings

– +1 mil.Wages

Expense

= -1 mil.

DTA 400,000 TE 400,000 Each year:

2009 through 2011

+400,000Deferred

Tax Asset

= +400,000Retained Earnings

– -400,000Tax

Expense

= +400,000

*(100,000 options × 2 × $15 fair value) / 3-year vesting period

b. No - if the stock price is $19 per share, the options are underwater (out of the money). You would exercise none of them because you would pay the strike price of $22 for a share that you could only sell for $19.

c.



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 2,200,000 APIC 2,200,000

2014* +2.2 mil.Cash

=+2.2 mil.Additional

Paid-inCapital

– =

*(100,000 options × $22 strike price)

d. Weaver industries will receive a tax benefit based on the options’ intrinsic value at exercise. The intrinsic value of the CEO’s options is $40 market price at exercise less $22 strike price, or $18 per share. For the 100,000 options exercised, this is $1,800,000 total intrinsic value. At the company’s tax rate of 40%, Weaver will receive a tax benefit of $720,000.The CEO will be taxed on the intrinsic value of $1,800,000 at her tax rate. This is taxed as ordinary income and not as a capital gain. Taxes are due even if the CEO does not sell the shares.


P9-57 (50 minutes)

a. During 2010, Intel expensed share-based compensation of $917 million. During the year the company granted 20.2 million shares at a fair value of $23.25 per share for a total fair value of options granted of $469.65 million. The expense represents the fair value of options granted in 2010 spread over the vesting period plus the fair value of options granted in prior years, also spread over the vesting period. Thus, the expense in 2010 is a cumulative cost of current and prior years’ option grants.

b. The Black-Scholes fair value estimate increases with volatility and with risk-free rate. In 2010, the volatility estimate declined significantly from 46% to 28% which decreased the fair value of the options granted and the share-based compensation expense for options granted in that year. In contrast, the risk-free rate estimate increased from 1.8% to 2.5% which increased both fair value and compensation expense for options granted in that year.

c. During 2010, 16.6 million shares were exercised at an average exercise price of $18.36. This means that Intel received total cash from employees of $304.8 million.

d. The intrinsic value can be estimated by comparing the average exercise price of 2010 exercises ($18.36) to the average stock price during 2010. If we assume that Intel grants options at the money, then the average exercise price of options granted during 2010 ($23.25) is a reasonable approximation of 2010 average stock price. Thus, employees earned a profit of $4.89 per option ($23.25 - $18.36) for a total profit of $81.2 million in 2010.

e. Tax benefit will be $30.03 million calculated as intrinsic value $4.89 million x 16.6 million options exercised × 0.37.

f. The average exercise price of options that expired was $60.68. Given that the average stock price was about $23.25 during 2010 (approximated by average exercise price of 2010 grants), the expired options were out of the money. Thus, it was not economically rational for employees to exercise these options.


P 9-58 (50 minutes)

a. Stock options grant the holder the right, but not the obligation, to purchase shares in the future at a preset price. Restricted stock is the actual shares of stock but the employee cannot sell the stock until a vesting period has expired. The two are different in that the options can expire worthless if the stock price falls below the exercise price. Restricted stock will always have some value, unless the stock price falls to $0. The two forms of share-based compensation are the same in that they provide incentive to employees to increase share price.

b. The vesting period is designed to retain the employee. Until the employee can “sell” the stock, the employee has incentive to increase the stock price. This aligns the employees’ incentives with those of other shareholders.

c. (in millions)



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

DC 731 CS .03 APIC 730.97

2010* =

+0.03Common

Stock

+730.97Additional

Paid-inCapital

-731Deferred Compen-

sation

– =

*32.4 million shares × $22.56 per share is total deferred compensation of $731 million. The par value of the stock is $0.001 so 32.4 million shares is par value of $32,400 or $.03 million. The remainder increases APIC.

d. (in thousands) : wage expense = $1.2 billion / 1.3 years = $923 million / year.



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

WE 923 DC 923

2011 =+923

Deferred Compen-

sation

-923Retained Earnings

– +923Wages

Expense

= -923


IFRS APPLICATIONS

I9-59 (15 minutes)

As the note on page 9-29 of the textbook indicates, asset revaluation is permitted under IFRS. Balance sheet values for fixed assets, in this case, are reported at fair values. In 2009, the fair value of land increased (by $1,000) but then decreased by even more ($3,000) in 2010. Buildings declined in value both years. These revaluations do not affect the income statement. Instead, they go to a separate equity account on the balance sheet. When the assets are sold, then any realized gains or losses do flow to the income statement.

I9-60 (25 minutes)

a. 1,700,000,000 shares authorized at fiscal year ended January 3, 2010.

b. 1,191,888,000 shares issued at fiscal year ended January 3, 2010. 2009 average issued share price = €358 million + €9,916 million = €10,274 million / 1,191,888,000 = €8.62 per share

c. 10,674,000 shares held as treasury stock at 2009 fiscal year-end. 2009 average treasury share price = €112 million / 10,674,000 = €10.49

per share.

d. Shares issued – Shares held in treasury = Shares outstanding1,191,888,000 – 10,674,000 = 1,181,214,000 shares outstanding.

e. €9.32 × 1,181,214,000 shares outstanding = €11,009 million. The net book value at January 3, 2010 is €5,440 million. The company has a market to book ratio in excess of 2 which means that the market perceives the company to have future profitability in excess of what the book value of the assets would imply.


I9-61 (25 minutes)

a. No, there was no activity in either the ordinary or preferred share accounts during fiscal 2010.

b. The company recorded “distributions” of €244 million during fiscal 2010. We can infer that these were payments of dividends. The bulk of these dividends (€225 million) were paid to the shareholders of Henkel. The rest (€19 million) were paid by Henkel’s subsidiaries to noncontrolling shareholders. This arises because Henkel does not own 100% of the stock of all its subsidiaries. Thus, when a subsidiary pays a dividend, part of it is received by Henkel (and eliminated as an intercompany transaction) and part is paid to the other shareholders.

c. Henkel did not repurchase any treasury stock – the only transaction is a sale. We can infer this because the total euro value of the treasury stock declined during the year. The company received €19 million in exchange for the sale of treasury stock during fiscal 2010.

d. Henkel made a €9 million (computed €19 million less €10 million) as economic profit on the sale of treasury stock during fiscal year 2010. This was recorded as in a direct increase to retained earnings. This amount was not recorded in net income. Any such gain or loss is never reflected in the income statement. Instead, the gain (or loss) is added to (or deducted from) retained earnings in shareholders’ equity.


I9-62 (35 minutes)

a. At September 31, 2009 there were 51,015,552 treasury shares. The balance sheet reports €1,421,000,000. This is an average price per treasury share of €27.85.

b. We can infer that the company sold 920,845 shares during fiscal 2010, calculated as: 51,015,552 - 50,094,707 = 920,845. The cash proceeds were €21 million which is an average price of €22.81 per share. However the treasury shares account decreases by €25 million which implies that the company sold the treasury shares for less than their original cost.

c. In € millions



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 21RE 4 TS 25

Record sale of treasury stock in fiscal 2010

+21Cash =

- 4RetainedEarnings

+25Treasury

Stock

– =

d. In € millions



+Noncash Assets

=Liabil-ities

+Contrib. Capital

+EarnedCapital

Rev-enues

–Expen-

ses=

NetIncome

Cash 1,631 TS 1,378 APIC 253

Record sale of treasury stock in fiscal 2011

+1,631Cash* =

+253Add’nlPaid InCapital

+1,378Treasury Stock**

– =

* 49,480,000 shares ×€32.96 = €1,630,860,800 = €1,631 million** 49,480,000 shares ×€27.85 (part a) = €1,378,018,000 = €1,378 million


I9-62 (concluded)

e. The total proceeds, as shown in the template above, are €1,630,860,800. This will reduce debt from €6,500,000,000 to €4,869,139,200. The balance sheet reports equity at September 30, 2010 of €10,388,000,000. When treasury shares are sold, equity will increase to €12,018,860,800. The debt to equity ratio before and after the treasury stock sale are:€6,500,000,000 / €10,388,000,000 = 0.626€4,869,139,200 / €12,018,860,800 = 0.405.


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