Exercises and Problems – Week Six XACC/291

Resources: Ch. 11 & 12 of Financial Accounting

Complete Exercises E11-15, E12-1, & E12-2.

Complete Problem 11-6A.

Submit as a Microsoft® Excel® or Word document.

506

Chapter

Corporations:
Organization,
Stock Transactions,
Dividends, and

Retained Earnings

After studying this chapter, you should be
able to:
1 Identify the major characteristics of a

corporation.
2 Record the issuance of common stock.
3 Explain the accounting for treasury stock.
4 Differentiate preferred stock from

common stock.
5 Prepare the entries for cash

dividends

and stock dividends.
6 Identify the items that are reported in a

retained earnings statement.
7 Prepare and analyze a comprehensive

stockholders’ equity section.

S T U D Y O B J E C T I V E S

Feature Story

The Navigator✓

“HAVE YOU DRIVEN A FORD LATELY?”

A company that has produced such renowned successes as the Model T
and the Mustang, and such a dismal failure as the Edsel, would have some
interesting tales to tell. Henry Ford was a defiant visionary from the day

Understand Concepts for Review ■

Read Feature Story ■

Scan Study Objectives ■

Read Preview ■

Read text and answer
p. 515 ■ p. 517 ■ p. 520 ■ p. 523 ■
p. 529 ■ p. 533 ■ p. 536 ■ p. 539 ■

Work Comprehensive p. 541 ■

Review Summary of Study Objectives ■

Answer Self-Study Questions ■

Complete Assignments ■

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Do it!

JWCL165_c11_506-567.qxd 8/12/09 7:54 AM Page 506

507

Ford Motor Company
(www.ford.com) was
formed in 1903. His
goal from day one was
to design a car he
could mass-produce
and sell at a price that
was affordable to the
masses. In short order
he accomplished this
goal. By 1920, 60% of all vehicles on U.S. roads were Fords.

Henry Ford was intolerant of anything that stood between him and success.
In the early years Ford had issued shares to the public in order to finance
the company’s exponential growth. In 1916 he decided not to pay a dividend
in order to increase the funds available to expand the company.

The shareholders sued. Henry Ford’s reaction was swift and direct: If the
shareholders didn’t see things his way, he would get rid of them. In 1919
the Ford family purchased 100 percent of the outstanding shares of Ford,
eliminating any outside “interference.” It was over 35 years before shares
were again issued to the public.

Ford Motor Company has continued to evolve and grow over the years into
one of the largest international corporations. Today there are nearly a billion
shares of publicly traded Ford stock outstanding. But some aspects of the
company have changed very little. The Ford family still retains a significant
stake in Ford Motor Company. In a move Henry Ford might have supported,
top management recently decided to centralize decision making—that is, to
have more key decisions made by top management, rather than by division
managers. And, reminiscent of Henry Ford’s most famous car, the company
is attempting to make a “global car”—a mass-produced car that can be sold
around the world with only minor changes.

The Navigator✓

Inside Chapter 11…

• Directors Take on More Accountability (p. 511)

• How to Read Stock Quotes (p. 515)

• Why Did Reebok Buy Its Own Stock? (p. 522)

• What’s Happening to Dividends? (p. 529)

• All About You: Home-Equity Loans (p. 540)

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THE CORPORATE FORM OF ORGANIZATION

Preview of Chapter 11

Corporations like Nike have substantial resources. In fact, the corporation is the dominant form of business
organization in the United States in terms of dollar volume of sales and earnings, and number of employees.
All of the 500 largest companies in the United States are corporations. In this chapter we will explain the
essential features of a corporation and the accounting for a corporation’s capital stock transactions,
dividends, and retained earnings.

The content and organization of Chapter 11 are as follows.

The Navigator✓

508

Corporations: Organization,
Stock Transactions, Dividends,

and Retained Earnings

Statement Presentation
and Analysis

• Presentation
• Analysis

Corporate Organization
and Stock Transactions

• Corporate form of
organization

• Common stock issues
• Treasury stock
• Preferred stock

Dividends

• Cash dividends
• Stock dividends
• Stock splits

Retained Earnings

• Retained earnings
restrictions

• Prior period adjustments
• Retained earnings

statement

In 1819, Chief Justice John Marshall defined a corporation as “an artificial being,
invisible, intangible, and existing only in contemplation of law.” This definition is
the foundation for the prevailing legal interpretation that a corporation is an entity
separate and distinct from its owners.

A corporation is created by law, and its continued existence depends upon the
statutes of the state in which it is incorporated. As a legal entity, a corporation has
most of the rights and privileges of a person. The major exceptions relate to privi-
leges that only a living person can exercise, such as the right to vote or to hold public
office. A corporation is subject to the same duties and responsibilities as a person.
For example, it must abide by the laws, and it must pay taxes.

Two common ways to classify corporations are by purpose and by ownership.
A corporation may be organized for the purpose of making a profit, or it may be
not-for-profit. For-profit corporations include such well-known companies as
McDonald’s, Ford Motor Company, PepsiCo, and Google. Not-for-profit corpora-
tions are organized for charitable, medical, or educational purposes. Examples are
the Salvation Army, the American Cancer Society, and the Bill & Melinda Gates
Foundation.

Classification by ownership distinguishes between publicly held and privately
held corporations. A publicly held corporation may have thousands of stockhold-
ers. Its stock is regularly traded on a national securities exchange such as the

SECTION 1 The

Corporate Organization

and Stock Transactions

A L T E R N A T I V E
T E R M I N O L O G Y

Privately held corporations
are also referred to as
closely held corporations.

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New York Stock Exchange. Most of the largest U.S. corporations are publicly held.
Examples of publicly held corporations are Intel, IBM, Caterpillar Inc., and
General Electric.

In contrast, a privately held corporation usually has only a few stockholders,
and does not offer its stock for sale to the general public. Privately held companies
are generally much smaller than publicly held companies, although some notable
exceptions exist. Cargill Inc., a private corporation that trades in grain and other
commodities, is one of the largest companies in the United States.

Characteristics of a Corporation
A number of characteristics distinguish corporations from proprietorships
and partnerships. We explain the most important of these characteristics
below.

SEPARATE LEGAL EXISTENCE
As an entity separate and distinct from its owners, the corporation acts under its
own name rather than in the name of its stockholders. Ford Motor Company may
buy, own, and sell property. It may borrow money, and may enter into legally bind-
ing contracts in its own name. It may also sue or be sued, and it pays its own taxes.

Remember that in a partnership the acts of the owners (partners) bind the
partnership. In contrast, the acts of its owners (stockholders) do not bind the
corporation unless such owners are agents of the corporation. For example, if you
owned shares of Ford Motor Company stock, you would not have the right to pur-
chase automobile parts for the company unless you were appointed as an agent of
the company, such as a purchasing manager.

LIMITED LIABILITY OF STOCKHOLDERS
Since a corporation is a separate legal entity, creditors have recourse only to corpo-
rate assets to satisfy their claims. The liability of stockholders is normally limited to
their investment in the corporation. Creditors have no legal claim on the personal
assets of the owners unless fraud has occurred. Even in the event of bankruptcy,
stockholders’ losses are generally limited to their capital investment in the
corporation.

TRANSFERABLE OWNERSHIP RIGHTS
Shares of capital stock give ownership in a corporation. These shares are transfer-
able units. Stockholders may dispose of part or all of their interest in a corporation
simply by selling their stock. Remember that the transfer of an ownership interest
in a partnership requires the consent of each owner. In contrast, the transfer of
stock is entirely at the discretion of the stockholder. It does not require the ap-
proval of either the corporation or other stockholders.

The transfer of ownership rights between stockholders normally has no effect
on the daily operating activities of the corporation. Nor does it affect the corpora-
tion’s assets, liabilities, and total ownership equity. The transfer of these ownership
rights is a transaction between individual owners. After it first issues the capital
stock, the company does not participate in such transfers.

ABILITY TO ACQUIRE CAPITAL
It is relatively easy for a corporation to obtain capital through the issuance of
stock. Investors buy stock in a corporation to earn money over time as the share
price grows, and because a stockholder has limited liability and shares of stock are
readily transferable. Also, individuals can become stockholders by investing rela-
tively small amounts of money. In sum, the ability of a successful corporation to
obtain capital is virtually unlimited.

The Corporate Form of Organization 509

Identify the major characteristics
of a corporation.

S T U D Y O B J E C T I V E 1

WKK
Corp.

Stockholders

Legal existence separate

from owners

WKK
Corp.

Stockholders
Limited liability
of stockholders

Transferable
ownership rights

Ability to acquire capital

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CONTINUOUS LIFE
The life of a corporation is stated in its charter. The life may be perpetual, or it may
be limited to a specific number of years. If it is limited, the company can extend the
life through renewal of the charter. Since a corporation is a separate legal entity, its
continuance as a going concern is not affected by the withdrawal, death, or inca-
pacity of a stockholder, employee, or officer. As a result, a successful enterprise can
have a continuous and perpetual life.

CORPORATION MANAGEMENT
As in Ford Motor Company, stockholders legally own the corporation. But they
manage the corporation indirectly through a board of directors they elect. The
board, in turn, formulates the operating policies for the company. The board also
selects officers, such as a president and one or more vice presidents, to execute pol-
icy and to perform daily management functions.

Illustration 11-1 presents a typical organization chart showing the delegation
of responsibility. The chief executive officer (CEO) has overall responsibility
for managing the business. As the organization chart shows, the CEO delegates
responsibility to other officers.

510 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Continuous life

Vice President
Human

Resources

Vice President
Operations

Vice President
Finance/Chief

Financial

Officer

Vice President
Marketing

General
Counsel and

Secretary

Treasurer Controller

Chairman and
Board of
Directors

Stockholders

President and
Chief Executive

Officer

The chief accounting officer is the controller. The controller’s responsibilities
include (1) maintaining the accounting records, (2) maintaining an adequate

system of internal control, and (3) preparing financial statements, tax
returns, and internal reports. The treasurer has custody of the corporation’s
funds and is responsible for maintaining the company’s cash position.

The organizational structure of a corporation enables a company to
hire professional managers to run the business. On the other hand, the
separation of ownership and management prevents owners from having
an active role in managing the company, which some owners like to
have.

Illustration 11-1
Corporation organization
chart

E T H I C S N O T E

Managers who are not own-
ers are often compensated based
on the performance of the firm.
They thus may be tempted to
exaggerate firm performance by
inflating income figures.

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GOVERNMENT REGULATIONS
A corporation is subject to numerous state and federal regulations. State laws
usually prescribe the requirements for issuing stock, the distributions of earnings
permitted to stockholders, and the effects of retiring stock. Federal securities laws
govern the sale of capital stock to the general public. Also, most publicly held cor-
porations are required to make extensive disclosure of their financial affairs to the
Securities and Exchange Commission (SEC) through quarterly and annual reports.
In addition, when a corporation lists its stock on organized securities exchanges, it
must comply with the reporting requirements of these exchanges. Government
regulations are designed to protect the owners of the corporation.

ADDITIONAL TAXES
Neither proprietorships nor partnerships pay income taxes separate from the
owner’s share of earnings. Sole proprietors and partners report earnings on their
personal income tax returns and pay taxes on this amount. Corporations, on the
other hand, must pay federal and state income taxes as a separate legal entity.
These taxes are substantial.

In addition, stockholders must pay taxes on cash dividends (pro rata distributions
of net income). Thus, many argue that the government taxes corporate income twice
(double taxation)—once at the corporate level, and again at the individual level.

In summary, we can identify the following advantages and disadvantages of a
corporation compared to a proprietorship and a partnership.

The Corporate Form of Organization 511

Was Enron’s board of directors fulfilling its role in a corporate organization when it
waived Enron’s ethical code on two occasions?

E T H I C S I N S I G H T
Directors Take on More Accountability

In the wake of Enron’s collapse, the members of Enron’s board of directors were
questioned and scrutinized to determine what they knew, and when they knew it. A Wall
Street Journal story reported that Enron’s board contends it was “kept in the dark” by man-
agement and by Arthur Andersen—Enron’s longtime auditors—and didn’t learn about the
company’s troublesome accounting until October 2001. But, the Wall Street Journal reported
that according to outside attorneys, “directors on at least two occasions waived Enron’s
ethical code of conduct to approve partnerships between Enron and its chief financial officer.
Those partnerships kept significant debt off of Enron’s books and masked actual company
finances.”

Since Enron’s demise, passage of the Sarbanes-Oxley Act and proposals by the SEC and
the stock exchanges have created a new corporate-governance climate: Stronger boards, with
more independent directors, are now in favor.

Source: Carol Hymowitz, “Serving on a Board Now Means Less Talk, More Accountability,”Wall Street Journal,

January

29, 200

Government regulations

Federal
regulations

Stock
exchange
requirements

State laws SEC laws

WKK
Corp.

Additional taxes

Advantages Disadvantages

Separate legal existence Corporation management—separation of
Limited liability of stockholders ownership and management
Transferable ownership rights Government regulations
Ability to acquire capital Additional taxes
Continuous life
Corporation management—professional

managers

Illustration 11-2
Advantages and disadvan-
tages of a corporation

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Forming a Corporation
The initial step in forming a corporation is to file an application with the Secretary
of State in the state in which incorporation is desired. The application contains
such information as: (1) the name and purpose of the proposed corporation;
(2) amounts, kinds, and number of shares of capital stock to be authorized; (3) the
names of the incorporators; and (4) the shares of stock to which each has
subscribed.

After the state approves the application, it grants a charter. The charter may be
an approved copy of the application form, or it may be a separate document con-
taining the same basic data. The issuance of the charter creates the corporation.
Upon receipt of the charter, the corporation develops its by-laws. The by-laws
establish the internal rules and procedures for conducting the affairs of the corpo-
ration. They also indicate the powers of the stockholders, directors, and officers of
the enterprise.1

Regardless of the number of states in which a corporation has operating
divisions, it is incorporated in only one state. It is to the company’s advantage to
incorporate in a state whose laws are favorable to the corporate form of business
organization. General Motors, for example, is incorporated in Delaware, whereas
Qualcomm is a New Jersey corporation. Many corporations choose to incorporate
in states with rules favorable to existing management. For example, Gulf Oil at one
time changed its state of incorporation to Delaware to thwart possible unfriendly
takeovers. There, state law allows boards of directors to approve certain defensive
tactics against takeovers without a vote by shareholders.

Corporations engaged in interstate commerce must also obtain a license from
each state in which they do business. The license subjects the corporation’s operat-
ing activities to the corporation laws of the state.

Costs incurred in the formation of a corporation are called organization costs.
These costs include legal and state fees, and promotional expenditures involved in
the organization of the business. Corporations expense organization costs as in-
curred. To determine the amount and timing of future benefits is so difficult that it
is standard procedure to take a conservative approach of expensing these costs
immediately.

Ownership Rights of Stockholders
When chartered, the corporation may begin selling ownership rights in the form of
shares of stock. When a corporation has only one class of stock, it is common stock.
Each share of common stock gives the stockholder the ownership rights pictured in
Illustration 11-3 (next page). A corporation’s articles of incorporation or its by-
laws state the ownership rights of a share of stock.

Proof of stock ownership is evidenced by a form known as a stock certificate.
As Illustration 11-4 (next page) shows, the face of the certificate shows the name of
the corporation, the stockholder’s name, the class and special features of the stock,
the number of shares owned, and the signatures of authorized corporate officials.
Prenumbered certificates facilitate accountability. They may be issued for any
quantity of shares.

512 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

1
Following approval by two-thirds of the stockholders, the by-laws become binding upon all stock-

holders, directors, and officers. Legally, a corporation is regulated first by the laws of the state, second
by its charter, and third by its by-laws. Corporations must take care to ensure that the provisions of
the by-laws are not in conflict with either state laws or the charter.

A L T E R N A T I V E
T E R M I N O L O G Y

The charter is often
referred to as the articles
of incorporation.

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The Corporate Form of Organization 513

2
A number of companies have eliminated the preemptive right, because they believe it makes an

unnecessary and cumbersome demand on management. For example, by stockholder approval,
IBM has dropped its preemptive right for stockholders.

Vote in election of board
of directors at annual
meeting and vote on actions
that require stockholder
approval.

Share the corporate
earnings through receipt
of dividends.

Share in assets upon
liquidation in proportion
to their holdings. This is
called a residual claim:
owners are paid
with assets that remain
after all creditors’ claims
have been paid.

Keep the same
percentage ownership
when new shares of
stock are issued
(preemptive right2).

GON Corp.

dividends

Lenders Stockholders

Creditors

New shares issued

Before

Stockholders have the right to:

After

14% 14%

Illustration 11-4
A stock certificate

Illustration 11-3
Ownership rights of
stockholders

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Stock Issue Considerations
In considering the issuance of stock, a corporation must resolve a number of basic
questions: How many shares should it authorize for sale? How should it issue the
stock? At what price should it issue the shares? What value should the corporation
assign to the stock? These questions are addressed in the following sections.

AUTHORIZED STOCK
The charter indicates the amount of stock that a corporation is authorized to sell.
The total amount of authorized stock at the time of incorporation normally antici-
pates both initial and subsequent capital needs. As a result, the number of shares
authorized generally exceeds the number initially sold. If it sells all authorized
stock, a corporation must obtain consent of the state to amend its charter before it
can issue additional shares.

The authorization of capital stock does not result in a formal accounting entry.
This event has no immediate effect on either corporate assets or stockholders’
equity. However, the number of authorized shares is often reported in the stock-
holders’ equity section. It is then simple to determine the number of unissued
shares that the corporation can issue without amending the charter: subtract the
total shares issued from the total authorized. For example, if Advanced Micro was
authorized to sell 100,000 shares of common stock and issued 80,000 shares, 20,000
shares would remain unissued.

ISSUANCE OF STOCK
A corporation can issue common stock directly to investors. Or it can issue the
stock indirectly through an investment banking firm that specializes in bringing
securities to market. Direct issue is typical in closely held companies. Indirect issue
is customary for a publicly held corporation.

In an indirect issue, the investment banking firm may agree to underwrite the
entire stock issue. In this arrangement, the investment banker buys the stock from the
corporation at a stipulated price and resells the shares to investors. The corporation
thus avoids any risk of being unable to sell the shares.Also, it obtains immediate use of
the cash received from the underwriter. The investment banking firm, in turn, assumes
the risk of reselling the shares, in return for an underwriting fee.3 For example, Google
(the world’s number-one Internet search engine) used underwriters when it issued a
highly successful initial public offering, raising $1.67 billion. The underwriters charged
a 3% underwriting fee (approximately $50 million) on Google’s stock offering.

How does a corporation set the price for a new issue of stock? Among the
factors to be considered are: (1) the company’s anticipated future earnings, (2) its
expected dividend rate per share, (3) its current financial position, (4) the current
state of the economy, and (5) the current state of the securities market. The calcu-
lation can be complex and is properly the subject of a finance course.

MARKET VALUE OF STOCK
The stock of publicly held companies is traded on organized exchanges. The inter-
action between buyers and sellers determines the prices per share. In general, the
prices set by the marketplace tend to follow the trend of a company’s earnings and
dividends. But, factors beyond a company’s control, such as an oil embargo,
changes in interest rates, and the outcome of a presidential election, may cause
day-to-day fluctuations in market prices.

514 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

3
Alternatively, the investment banking firm may agree only to enter into a best-efforts contract

with the corporation. In such cases, the banker agrees to sell as many shares as possible at a
specified price. The corporation bears the risk of unsold stock. Under a best-efforts arrangement,
the banking firm is paid a fee or commission for its services.

Indirect issuance

Really Big
Investment Bank, Inc.

XYZ
Corp.

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before you go on…

The Corporate Form of Organization 515

Do it!
Indicate whether each of the following statements is true or false.

_____ 1. Similar to partners in a partnership, stockholders of a corporation have unlimited
liability.

_____ 2. It is relatively easy for a corporation to obtain capital through the issuance of stock.

_____ 3. The separation of ownership and management is an advantage of the corporate form of
business.

Corporate Organization

PAR AND NO-PAR-VALUE STOCKS
Par-value stock is capital stock to which the charter has assigned a value per

share.

Years ago, par value determined the legal capital per share that a company must
retain in the business for the protection of corporate creditors; that amount was not
available for withdrawal by stockholders. Thus, in the past, most states required the
corporation to sell its shares at par or above.

However, par value was often immaterial relative to the value of the company’s
stock—even at the time of issue. Thus, its usefulness as a protective device to credi-
tors was questionable. For example, Kellogg’s par value is $0.25 per share, yet a new
issue in early 2009 would have sold at a market value in the $38 per share range.
Thus, par has no relationship with market value; in the vast majority of cases, it is an
immaterial amount. As a consequence, today many states do not require a par value.
Instead, they use other means to determine legal capital to protect creditors.

No-par-value stock is capital stock to which the charter has not assigned a
value. No-par-value stock is quite common today. For example, Nike, Procter &
Gamble, and North American Van Lines all have no-par stock. In many states the
board of directors assigns a stated value to no-par shares.

For stocks traded on organized stock exchanges, how are the dollar prices per share
established? What factors might influence the price of shares in the marketplace?

I N V E S T O R I N S I G H T
How to Read Stock Quotes

The volume of trading on national and international exchanges is heavy. Shares in
excess of a billion are often traded daily on the New York Stock Exchange (NYSE) alone. For each
listed stock, the Wall Street Journal and other financial media report the total volume of stock
traded for a given day, the high and low price for the day, the closing market price, and the
net change for the day. A recent stock quote for PepsiCo, listed on the NYSE under the ticker
symbol PEP, is shown below.

These numbers indicate that PepsiCo’s trading volume was 4,305,600 shares. The high,
low, and closing prices for that date were $60.30, $59.32, and $60.02, respectively. The net
change for the day was an increase of $0.41 per share.

Stock Volume High Low Close Net Change

PepsiCo 4,305,600 60.30 59.32 60.02 �0.41

The trading of capital stock on securities exchanges involves the transfer of
already issued shares from an existing stockholder to another investor. These trans-
actions have no impact on a corporation’s stockholders’ equity.

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Corporate Capital

Owners’ equity is identified by various names: stockholders’ equity, shareholders’
equity, or corporate capital. The stockholders’ equity section of a corporation’s
balance sheet consists of two parts: (1) paid-in (contributed) capital and (2) retained
earnings (earned capital).

The distinction between paid-in capital and retained earnings is important
from both a legal and a financial point of view. Legally, corporations can make dis-
tributions of earnings (declare dividends) out of retained earnings in all states.
However, in many states they cannot declare dividends out of paid-in capital.
Management, stockholders, and others often look to retained earnings for the con-
tinued existence and growth of the corporation.

PAID-IN CAPITAL
Paid-in capital is the total amount of cash and other assets paid in to the corpora-
tion by stockholders in exchange for capital stock. As noted earlier, when a corpo-
ration has only one class of stock, it is common stock.

RETAINED EARNINGS
Retained earnings is net income that a corporation retains for future use. Net
income is recorded in Retained Earnings by a closing entry that debits Income
Summary and credits Retained Earnings. For example, assuming that net income
for Delta Robotics in its first year of operations is $130,000, the closing entry is:

516 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

_____ 4. The journal entry to record the authorization of capital stock includes a credit to the
appropriate capital stock account.

_____ 5. Most states require a par value per share for capital stock.

Solution

1. False. The liability of stockholders is normally limited to their investment in the corporation.

2. True.

3. False. The separation of ownership and management is a disadvantage of the corporate form
of business.

4. False. The authorization of capital stock does not result in a formal accounting entry.

5. False. Many states do not require a par value.

Related exercise material: BE11-1, E11-1, E11-2, and 11-1.Do it!

The Navigator✓

Action Plan

• Review the characteristics of
a corporation and understand
which are advantages and
which are disadvantages.

• Understand that corporations
raise capital through the
issuance of stock, which can
be par or no-par.

Income Summary 130,000
Retained Earnings 130,000

(To close Income Summary and transfer net
income to retained earnings)

If Delta Robotics has a balance of $800,000 in common stock at the end of its
first year, its stockholders’ equity section is as follows.

DELTA ROBOTICS

Balance Sheet (partial)

Stockholders’ equity
Paid-in capital

Common stock $800,000
Retained earnings 130,000

Total stockholders’ equity $930,000

Illustration 11-5
Stockholders’ equity section

Cash Flows
no effect

A SEL� �

�130,000 Inc
�130,000 RE

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before you go on…

Illustration 11-6 compares the owners’ equity (stockholders’ equity) accounts
reported on a balance sheet for a proprietorship and a corporation.

Accounting for Common Stock Issues 517

Proprietorship Corporation

Able, Capital

Normal bal.

Common Stock

Normal bal.
Retained Earnings
Normal bal.

Illustration 11-6
Comparison of owners’
equity accounts

Related exercise material: 11-2.Do it!

Action Plan

• Record net income in Retained
Earnings by a closing entry in
which Income Summary is
debited and Retained Earnings
is credited.

• In the stockholders’
equity section, show
(1) paid-in capital and
(2) retained earnings.

(a) Income Summary 122,000
Retained Earnings 122,000

(To close Income Summary and transfer
net income to retained earnings)

(b) Stockholders’ equity
Paid-in capital

Common stock $750,000
Retained earnings 122,000

Total stockholders’ equity $872,000

Do it!
At the end of its first year of operation, Doral Corporation has $750,000 of

common stock and net income of $122,000. Prepare (a) the closing entry for net income and
(b) the stockholders’ equity section at year-end.

Solution
Corporate Capital
The Navigator✓

ACCOUNTING FOR COMMON STOCK ISSUES

Let’s now look at how to account for issues of common stock. The primary
objectives in accounting for the issuance of common stock are: (1) to identify
the specific sources of paid-in capital, and (2) to maintain the distinction
between paid-in capital and retained earnings. The issuance of common
stock affects only paid-in capital accounts.

Issuing Par-Value Common Stock for Cash
As discussed earlier, par value does not indicate a stock’s market value. Therefore,
the cash proceeds from issuing par-value stock may be equal to, greater than, or
less than par value. When the company records issuance of common stock for cash,

Record the issuance of common
stock.

S T U D Y O B J E C T I V E 2

JWCL165_c11_506-567.qxd 8/10/09 11:59 AM Page 517

it credits to Common Stock the par value of the shares. It records in a separate
paid-in capital account the portion of the proceeds that is above or below par
value.

To illustrate, assume that Hydro-Slide, Inc. issues 1,000 shares of $1 par-value
common stock at par for cash. The entry to record this transaction is:

518 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Cash 1,000
Common Stock 1,000

(To record issuance of 1,000 shares of $1 par
common stock at par)

If Hydro-Slide issues an additional 1,000 shares of the $1 par-value common
stock for cash at $5 per share, the entry is:

Cash 5,000
Common Stock 1,000
Paid-in Capital in Excess of Par Value 4,000

(To record issuance of 1,000 shares of $1 par
common stock)

The total paid-in capital from these two transactions is $6,000, and the legal
capital is $2,000. Assuming Hydro-Slide, Inc. has retained earnings of $27,000,
Illustration 11-7 shows the company’s stockholders’ equity section.

When a corporation issues stock for less than par value, it debits the account
Paid-in Capital in Excess of Par Value, if a credit balance exists in this account. If
a credit balance does not exist, then the corporation debits to Retained Earnings
the amount less than par. This situation occurs only rarely: Most states do not
permit the sale of common stock below par value, because stockholders may be
held personally liable for the difference between the price paid upon original sale
and par value.

Issuing No-Par Common Stock for Cash
When no-par common stock has a stated value, the entries are similar to those
illustrated for par-value stock. The corporation credits the stated value to Common
Stock. Also, when the selling price of no-par stock exceeds stated value, the corpo-
ration credits the excess to Paid-in Capital in Excess of Stated Value.

A L T E R N A T I V E
T E R M I N O L O G Y

Paid-in Capital in Excess
of Par is also called
Premium on Stock.

Illustration 11-7
Stockholders’ equity—
paid-in capital in excess of
par value

HYDRO-SLIDE, INC.
Balance Sheet (partial)

Stockholders’ equity
Paid-in capital

Common stock $ 2,000
Paid-in capital in excess of par value 4,000

Total paid-in capital 6,000
Retained earnings 27,000

Total stockholders’ equity $33,000

Cash Flows
�1,000

A SEL� �

�1,000
�1,000 CS

Cash Flows
�5,000

A SEL� �

�5,000
�1,000 CS
�4,000 CS

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 518

For example, assume that instead of $1 par-value stock, Hydro-Slide, Inc. has
$5 stated value no-par stock and the company issues 5,000 shares at $8 per share
for cash. The entry is:

Accounting for Common Stock Issues 519

Cash 40,000
Common Stock 25,000
Paid-in Capital in Excess of Stated Value 15,000

(To record issue of 5,000 shares of $5 stated
value no-par stock)

Hydro-Slide, Inc. reports Paid-in Capital in Excess of Stated Value as part of paid-
in capital in the stockholders’ equity section.

What happens when no-par stock does not have a stated value? In that case,
the corporation credits the entire proceeds to Common Stock. Thus, if Hydro-Slide
does not assign a stated value to its no-par stock, it would record the issuance of the
5,000 shares at $8 per share for cash as follows.

Cash 40,000
Common Stock 40,000

(To record issue of 5,000 shares of no-par stock)

Issuing Common Stock for Services
or Noncash Assets
Corporations also may issue stock for services (compensation to attorneys or con-
sultants) or for noncash assets (land, buildings, and equipment). In such cases, what
cost should be recognized in the exchange transaction? To comply with the cost
principle, in a noncash transaction cost is the cash equivalent price. Thus, cost is
either the fair market value of the consideration given up, or the fair market value
of the consideration received, whichever is more clearly determinable.

To illustrate, assume that attorneys have helped Jordan Company incorporate.
They have billed the company $5,000 for their services. They agree to accept 4,000
shares of $1 par value common stock in payment of their bill. At the time of the ex-
change, there is no established market price for the stock. In this case, the market
value of the consideration received, $5,000, is more clearly evident. Accordingly,
Jordan Company makes the following entry:

Organization Expense 5,000
Common Stock 4,000
Paid-in Capital in Excess of Par Value 1,000

(To record issuance of 4,000 shares of $1 par
value stock to attorneys)

As explained on page 512, organization costs are expensed as incurred.
In contrast, assume that Athletic Research Inc. is an existing publicly held

corporation. Its $5 par value stock is actively traded at $8 per share. The company
issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000.
The most clearly evident value in this noncash transaction is the market price of the
consideration given, $80,000. The company records the transaction as follows.

Land 80,000
Common Stock 50,000
Paid-in Capital in Excess of Par Value 30,000

(To record issuance of 10,000 shares of $5 par
value stock for land)

Cash Flows
�40,000

A SEL� �

�40,000
�25,000 CS
�15,000 CS

Cash Flows
�40,000
A SEL� �

�40,000
�40,000 CS

Cash Flows
no effect
A SEL� �

�5,000 Exp
�4,000 CS
�1,000 CS

Cash Flows
no effect
A SEL� �

�80,000
�50,000 CS
�30,000 CS

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 519

before you go on…

As illustrated in these examples, the par value of the stock is never a factor in
determining the cost of the assets received. This is also true of the stated value of
no-par stock.

520 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

ACCOUNTING FOR TREASURY STOCK

Treasury stock is a corporation’s own stock that it has issued and subse-
quently reacquired from shareholders, but not retired. A corporation may
acquire treasury stock for various reasons:

1. To reissue the shares to officers and employees under bonus and stock com-
pensation plans.

2. To signal to the stock market that management believes the stock is under-
priced, in the hope of enhancing its market value.

3. To have additional shares available for use in the acquisition of other
companies.

4. To reduce the number of shares outstanding and thereby increase earnings per
share.

5. To rid the company of disgruntled investors, perhaps to avoid a takeover, as
illustrated in the Ford Motor Company Feature Story.

Many corporations have treasury stock. One survey of 600 U.S. companies
found that approximately two-thirds have treasury stock.4 For example,
ExxonMobil Corp., Microsoft Corp., and Time Warner Inc. purchased a combined
$14.37 billion of their shares in the first quarter of a recent year.

Explain the accounting for
treasury stock.

S T U D Y O B J E C T I V E 3

Do it!
Cayman Corporation begins operations on March 1 by issuing 100,000 shares

of $10 par value common stock for cash at $12 per share. On March 15 it issues 5,000 shares of
common stock to attorneys in settlement of their bill of $50,000 for organization costs. Journalize
the issuance of the shares, assuming the stock is not publicly traded.

Solution

Issuance of Stock

Mar. 1 Cash 1,200,000
Common Stock 1,000,000
Paid-in Capital in Excess of Par Value 200,000

(To record issuance of 100,000 shares
at $12 per share)

Mar. 15 Organization Expense 50,000
Common Stock 50,000

(To record issuance of 5,000 shares
for attorneys’ fees)

Related exercise material: BE11-2, BE11-3, BE11-4, E11-3, E11-4, and 11-3.Do it!

The Navigator✓
Action Plan

• In issuing shares for cash,
credit Common Stock for par
value per share.

• Credit any additional proceeds
in excess of par value to a
separate paid-in capital account.

• When stock is issued for
services, use the cash
equivalent price.

• For the cash equivalent price
use either the fair market value
of what is given up or the
fair market value of what is
received, whichever is more
clearly determinable.

4
Accounting Trends & Techniques 2007 (New York: American Institute of Certified Public

Accountants).

H E L P F U L H I N T
Treasury shares do not
have dividend rights or
voting rights.

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 520

Purchase of

Treasury Stock

Companies generally account for treasury stock by the cost method. This method
uses the cost of the shares purchased to value the treasury stock. Under the cost
method, the company debits Treasury Stock for the price paid to reacquire the
shares.

When the company disposes of the shares, it credits to Treasury Stock the same
amount it paid to reacquire the shares. To illustrate, assume that on January 1, 2011,
the stockholders’ equity section of Mead, Inc. has 100,000 shares of $5 par value
common stock outstanding (all issued at par value) and Retained Earnings of
$200,000. The stockholders’ equity section before purchase of treasury stock is as
follows.

Accounting for Treasury Stock 521

On February 1, 2011, Mead acquires 4,000 shares of its stock at $8 per share. The
entry is:

Feb. 1 Treasury Stock 32,000
Cash 32,000

(To record purchase of 4,000 shares
of treasury stock at $8 per share)

Note that Mead debits Treasury Stock for the cost of the shares purchased. Is the
original paid-in capital account, Common Stock, affected? No, because the number
of issued shares does not change. In the stockholders’ equity section of the balance
sheet, Mead deducts treasury stock from total paid-in capital and retained earnings.
Treasury Stock is a contra stockholders’ equity account. Thus, the acquisition of
treasury stock reduces stockholders’ equity.

The stockholders’ equity section of Mead, Inc. after purchase of treasury stock
is as follows.

MEAD, INC.
Balance Sheet (partial)

Stockholders’ equity
Paid-in capital

Common stock, $5 par value, 100,000 shares issued
and 96,000 shares outstanding $500,000

Retained earnings 200,000

Total paid-in capital and retained earnings 700,000
Less: Treasury stock (4,000 shares) 32,000

Total stockholders’ equity $668,000

MEAD, INC.
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital

Common stock, $5 par value, 100,000 shares
issued and outstanding $500,000

Retained earnings 200,000

Total stockholders’ equity $700,000

Illustration 11-8
Stockholders’ equity with
no treasury stock

Illustration 11-9
Stockholders’ equity with
treasury stock

Cash Flows
�32,000

A SEL� �

�32,000 TS
�32,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 521

In the balance sheet, Mead discloses both the number of shares issued
(100,000) and the number in the treasury (4,000). The difference between
these two amounts is the number of shares of stock outstanding (96,000).
The term outstanding stock means the number of shares of issued stock
that are being held by stockholders.

Some maintain that companies should report treasury stock as an
asset because it can be sold for cash. Under this reasoning, companies
should also show unissued stock as an asset, clearly an erroneous conclu-
sion. Rather than being an asset, treasury stock reduces stockholder

claims on corporate assets. This effect is correctly shown by reporting treasury
stock as a deduction from total paid-in capital and retained earnings.

522 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Why Did Reebok Buy Its Own Stock?

In a bold (and some would say risky) move, Reebok at one time bought back
nearly a third of its shares. This repurchase of shares dramatically reduced

Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the re-
purchase. In a press release, management stated that it was repurchasing the shares because
it believed its stock was severely underpriced. The repurchase of so many shares was meant
to signal management’s belief in good future earnings.

Skeptics, however, suggested that Reebok’s management was repurchasing shares to
make it less likely that another company would acquire Reebok (in which case Reebok’s top
managers would likely lose their jobs). By depleting its cash, Reebok became a less likely ac-
quisition target. Acquiring companies like to purchase companies with large cash balances so
they can pay off debt used in the acquisition.

What signal might a large stock repurchase send to investors regarding management’s
belief about the company’s growth opportunities?

ACCOUNTING ACROSS THE ORGANIZATION

Disposal of Treasury Stock
Treasury stock is usually sold or retired. The accounting for its sale differs when
treasury stock is sold above cost than when it is sold below cost.

SALE OF TREASURY STOCK ABOVE COST
If the selling price of the treasury shares is equal to their cost, the company records
the sale of the shares by a debit to Cash and a credit to Treasury Stock. When the
selling price of the shares is greater than their cost, the company credits the differ-
ence to Paid-in Capital from Treasury Stock.

To illustrate, assume that on July 1, Mead sells for $10 per share the 1,000 shares
of its treasury stock, previously acquired at $8 per share. The entry is as follows.

E T H I C S N O T E

The purchase of treasury
stock reduces the cushion for
creditors and preferred stock-
holders. A restriction for the cost
of treasury stock purchased is
often required. The restriction
is usually applied to retained
earnings.

H E L P F U L H I N T
Treasury stock transac-
tions are classified as
capital stock transactions.
As in the case when
stock is issued, the
income statement is
not involved.

July 1 Cash 10,000
Treasury Stock 8,000
Paid-in Capital from Treasury Stock 2,000

(To record sale of 1,000 shares of treasury
stock above cost)

Mead does not record a $2,000 gain on sale of treasury stock for two reasons:
(1) Gains on sales occur when assets are sold, and treasury stock is not an asset.
(2) A corporation does not realize a gain or suffer a loss from stock transactions

Cash Flows
�10,000

A SEL� �

�10,000
�8,000 TS
�2,000 TS

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 522

before you go on…

with its own stockholders. Thus, companies should not include in net income any paid-
in capital arising from the sale of treasury stock. Instead, they report

Paid-in Capital

from Treasury Stock separately on the balance sheet, as a part of paid-in capital.

SALE OF TREASURY STOCK BELOW COST
When a company sells treasury stock below its cost, it usually debits to Paid-in
Capital from Treasury Stock the excess of cost over selling price. Thus, if Mead, Inc.
sells an additional 800 shares of treasury stock on October 1 at $7 per share, it
makes the following entry.

Accounting for Treasury Stock 523

Oct. 1 Cash 5,600
Paid-in Capital from Treasury Stock 800

Treasury Stock 6,400
(To record sale of 800 shares of treasury
stock below cost)

Observe the following from the two sales entries: (1) Mead credits Treasury
Stock at cost in each entry. (2) Mead uses Paid-in Capital from Treasury Stock
for the difference between cost and the resale price of the shares. (3) The original
paid-in capital account, Common Stock, is not affected. The sale of treasury stock
increases both total assets and total stockholders’ equity.

After posting the foregoing entries, the treasury stock accounts will show the
following balances on October 1.

When a company fully depletes the credit balance in Paid-in Capital from
Treasury Stock, it debits to Retained Earnings any additional excess of cost over
selling price. To illustrate, assume that Mead, Inc. sells its remaining 2,200 shares
at $7 per share on December 1. The excess of cost over selling price is $2,200
[2,200 � ($8 � $7)]. In this case, Mead debits $1,200 of the excess to Paid-in
Capital from Treasury Stock. It debits the remainder to Retained Earnings. The
entry is:

Dec. 1 Cash 15,400
Paid-in Capital from Treasury Stock 1,200
Retained Earnings 1,000

Treasury Stock 17,600
(To record sale of 2,200 shares of
treasury stock at $7 per share)

Treasury Stock Paid-in Capital from Treasury Stock

Feb. 1 32,000 July 1 8,000 Oct. 1 800 July 1 2,000
Oct. 1 6,400

Oct. 1 Bal. 1,200
Oct. 1 Bal. 17,600

Illustration 11-10
Treasury stock accounts

Cash Flows
�5,600

A SEL� �

�5,600
�800 TS

�6,400 TS

Cash Flows
�15,400

A SEL� �

�15,400
�1,200 TS
�1,000 RE

�17,600 TS

Do it!
Santa Anita Inc. purchases 3,000 shares of its $50 par value common stock for

$180,000 cash on July 1. It will hold the shares in the treasury until resold. On November 1, the
corporation sells 1,000 shares of treasury stock for cash at $70 per share. Journalize the treasury
stock transactions.

Treasury Stock

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 523

Cash 120,000
Preferred Stock 100,000
Paid-in Capital in Excess of Par Value–Preferred Stock 20,000

(To record the issuance of 10,000 shares of
$10 par value preferred stock)

524 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Solution

July 1 Treasury Stock 180,000
Cash 180,000

(To record the purchase of 3,000 shares
at $60 per share)

Nov. 1 Cash 70,000
Treasury Stock 60,000
Paid-in Capital from Treasury Stock 10,000

(To record the sale of 1,000 shares
at $70 per share)

Related exercise material: BE11-5, E11-5, and 11-4.Do it!

The Navigator✓
Action Plan

• Record the purchase of treasury
stock at cost.

• When treasury stock is sold
above its cost, credit the excess
of the selling price over cost to
Paid-in Capital from Treasury
Stock.

• When treasury stock is sold
below its cost, debit the excess
of cost over selling price to Paid-
in Capital from Treasury Stock.

PREFERRED STOCK

To appeal to more investors, a corporation may issue an additional class
of stock, called preferred stock. Preferred stock has provisions that give it
some preference or priority over common stock. Typically, preferred
stockholders have a priority as to (1) distributions of earnings (dividends)

and (2) assets in the event of liquidation. However, they generally do not have
voting rights.

Like common stock, corporations may issue preferred stock for cash or for non-
cash assets. The entries for these transactions are similar to the entries for common
stock. When a corporation has more than one class of stock, each paid-in capital
account title should identify the stock to which it relates. A company might have the
following accounts: Preferred Stock, Common Stock, Paid-in Capital in Excess of
Par Value—Preferred Stock, and Paid-in Capital in Excess of Par Value—Common
Stock. For example, if Stine Corporation issues 10,000 shares of $10 par value pre-
ferred stock for $12 cash per share, the entry to record the issuance is:

Differentiate preferred stock
from common stock.

S T U D Y O B J E C T I V E 4

Preferred stock may have either a par value or no-par value. In the stockholders’
equity section of the balance sheet, companies list preferred stock first because of
its dividend and liquidation preferences over common stock.

We discuss various features associated with the issuance of preferred stock on
the following pages.

Dividend Preferences
As noted earlier, preferred stockholders have the right to receive dividends before
common stockholders. For example, if the dividend rate on preferred stock is
$5 per share, common shareholders will not receive any dividends in the current year
until preferred stockholders have received $5 per share. The first claim to dividends
does not, however, guarantee the payment of dividends. Dividends depend on many
factors, such as adequate retained earnings and availability of cash. If a company
does not pay dividends to preferred stockholders, it cannot of course pay dividends
to common stockholders.

Dividend Preference

Preferred
stockholders

Common
stockholders

I hope there
is some money
left when it’s

my turn.

Cash Flows
�120,000

A SEL� �

�120,000
�100,000 PS

�20,000 PS

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 524

The per share dividend amount is stated as a percentage of the preferred
stock’s par value or as a specified amount. For example, at one time Crane
Company specified a 33⁄4% dividend on its $100 par value preferred ($100 � 33⁄4% =
$3.75 per share). PepsiCo has a $5.46 series of no-par preferred stock.

CUMULATIVE DIVIDEND
Preferred stock often contains a cumulative dividend feature. This means that pre-
ferred stockholders must be paid both current-year dividends and any unpaid
prior-year dividends before common stockholders receive dividends. When pre-
ferred stock is cumulative, preferred dividends not declared in a given period are
called dividends in arrears.

To illustrate, assume that Scientific Leasing has 5,000 shares of 7%, $100 par
value, cumulative preferred stock outstanding. The annual dividend is $35,000
(5,000 � $7 per share), but dividends are two years in arrears. In this case, preferred
stockholders are entitled to receive the following dividends in the current year.

Preferred Stock 525

Dividends in arrears ($35,000 � 2) $ 70,000
Current-year dividends 35,000

Total preferred dividends $105,000

The company cannot pay dividends to common stockholders until it pays the entire
preferred dividend. In other words, companies cannot pay dividends to common
stockholders while any preferred stock is in arrears.

Are dividends in arrears considered a liability? No—no payment obligation
exists until the board of directors declares a dividend. However, companies should
disclose in the notes to the financial statements the amount of dividends in arrears.
Doing so enables investors to assess the potential impact of this commitment on
the corporation’s financial position.

Companies that are unable to meet their dividend obligations are not looked
upon favorably by the investment community. As a financial officer noted in dis-
cussing one company’s failure to pay its cumulative preferred dividend for a period
of time, “Not meeting your obligations on something like that is a major black
mark on your record.” The accounting entries for preferred stock dividends are
explained later in the chapter.

Liquidation Preference
Most preferred stocks also have a preference on corporate assets if the corporation
fails. This feature provides security for the preferred stockholder. The preference to
assets may be for the par value of the shares or for a specified liquidating value. For
example, Commonwealth Edison issued preferred stock that entitles its holders to
receive $31.80 per share, plus accrued and unpaid dividends, in the event of involun-
tary liquidation. The liquidation preference establishes the respective claims of
creditors and preferred stockholders in litigation pertaining to bankruptcy lawsuits.

Preferred
stockholders

Dividend
in

arrears

Current
dividend

Payment of a
Cumulative Dividend

SECTION 2 Dividends

A dividend is a corporation’s distribution of cash or stock to its stock-
holders on a pro rata (proportional) basis. Investors are very interested in
a company’s dividend policies and practices. Dividends can take four
forms: cash, property, scrip (a promissory note to pay cash), or stock. Cash

Prepare the entries for cash
dividends and stock dividends.

S T U D Y O B J E C T I V E 5

Illustration 11-11
Computation of total
dividends to preferred stock

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 525

dividends predominate in practice. Also, companies declare stock dividends with
some frequency. These two forms of dividends will be the focus of discussion in
this chapter.

Dividends may be expressed in two ways: (1) as a percentage of the par or
stated value of the stock, or (2) as a dollar amount per share. The financial press
generally reports dividends as a dollar amount per share. For example, Boeing
Company’s dividend rate is $1.45 a share, Hershey Foods Corp.’s is $1.19, and
Nike’s is $0.94.

526 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

CASH DIVIDENDS

A cash dividend is a pro rata distribution of cash to stockholders. For a corporation
to pay a cash dividend, it must have:

1. Retained earnings. The legality of a cash dividend depends on the laws of the
state in which the company is incorporated. Payment of cash dividends from
retained earnings is legal in all states. In general, cash dividend distributions
from only the balance in common stock (legal capital) are illegal.

A dividend declared out of paid-in capital is termed a liquidating dividend.
Such a dividend reduces or “liquidates” the amount originally paid in by
stockholders. Statutes vary considerably with respect to cash dividends based
on paid-in capital in excess of par or stated value. Many states permit such
dividends.

2. Adequate cash. The legality of a dividend and the ability to pay a dividend are
two different things. For example, Nike recently had a retained earnings balance
of approximately $5 billion, could legally declare a dividend of this amount. But
Nike’s cash balance is only a little over $2 billion.

Before declaring a cash dividend, a company’s board of directors must
carefully consider both current and future demands on the company’s cash
resources. In some cases, current liabilities may make a cash dividend inappro-
priate. In other cases, a major plant expansion program may warrant only a
relatively small dividend.

3. A declaration of dividends. A company does not pay dividends unless its board
of directors decides to do so, at which point the board “declares”the dividend.
The board of directors has full authority to determine the amount of income to
distribute in the form of a dividend and the amount to retain in the business.
Dividends do not accrue like interest on a note payable, and they are not a lia-
bility until declared.

The amount and timing of a dividend are important issues.The payment of a large
cash dividend could lead to liquidity problems for the company. On the other hand,
a small dividend or a missed dividend may cause unhappiness among stockholders.
Many stockholders expect to receive a reasonable cash payment from the company
on a periodic basis. Many companies declare and pay cash dividends quarterly.

Entries for Cash Dividends
Three dates are important in connection with dividends: (1) the declaration date,
(2) the record date, and (3) the payment date. Normally, there are two to four
weeks between each date. Companies make accounting entries on two of the
dates—the declaration date and the payment date.

On the declaration date, the board of directors formally declares (authorizes)
the cash dividend and announces it to stockholders. Declaration of a cash dividend
commits the corporation to a legal obligation. The obligation is binding and cannot

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 526

be rescinded. The company makes an entry to recognize the cash dividend (decrease
in retained earnings) and the increase in the liability Dividends Payable.

To illustrate, assume that on December 1, 2011, the directors of Media General
declare a 50¢ per share cash dividend on 100,000 shares of $10 par value common
stock. The dividend is $50,000 (100,000 � 50¢). The entry to record the declaration is:

Cash Dividends 527

Declaration Date

Dec. 1 Cash Dividends 50,000
Dividends Payable 50,000

(To record declaration of cash dividend)

In Chapter 1, we used an account called Dividends to record a cash dividend.
Here, we use the more specific title Cash Dividends to differentiate from other
types of dividends, such as stock dividends. A company may have separate dividend
accounts for each class of stock.

Dividends Payable is a current liability: It will normally be paid within the next
several months. At the end of the year, the company transfers the balance of the
dividends account to Retained Earnings by a closing entry.

At the record date, the company determines ownership of the outstanding
shares for dividend purposes. The records maintained by the corporation supply
this information. In the interval between the declaration date and the record date,
the corporation updates its stock ownership records. For Media General, the
record date is December 22. No entry is required on this date because the corpora-
tion’s liability recognized on the declaration date is unchanged.

Record Date

Dec. 22
No entry necessary

On the payment date, the company mails dividend checks to the stockholders
and records the payment of the dividend. Assuming that the payment date is
January 20 for Media General, the entry on that date is:

Payment Date

Jan. 20 Dividends Payable 50,000
Cash 50,000

(To record payment of cash dividend)

H E L P F U L H I N T
The purpose of the
record date is to identify
the persons or entities
that will receive the
dividend, not to
determine the amount
of the dividend liability.

Note that payment of the dividend reduces both current assets and current liabili-
ties. It has no effect on stockholders’ equity. The cumulative effect of the declaration
and payment of a cash dividend is to decrease both stockholders’ equity and total
assets. Illustration 11-12 (page 528) summarizes the three important dates associ-
ated with dividends for Media General.

Allocating Cash Dividends between Preferred

and Common Stock

As explained earlier in the chapter, preferred stock has priority over common
stock in regard to dividends. Holders of cumulative preferred stock must be paid
any unpaid prior-year dividends before common stockholders receive dividends.

To illustrate, assume that at December 31, 2011, IBR Inc. has 1,000 shares of 8%,
$100 par value cumulative preferred stock. It also has 50,000 shares of $10 par value
common stock outstanding. The dividend per share for preferred stock is $8 ($100
par value � 8%). The required annual dividend for preferred stock is therefore

Cash Flows
no effect
A SEL� �

�50,000 Div
�50,000

Cash Flows
�50,000

A SEL� �

�50,000
�50,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 527

$8,000 (1,000 � $8). At December 31, 2011, the directors declare a $6,000 cash
dividend. In this case, the entire dividend amount goes to preferred stockholders
because of their dividend preference. The entry to record the declaration of the
dividend is:

528 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

December

Declaration
date
Board

authorizes
dividends

Record date
Registered shareholders
are eligible for dividend

Payment date
The company

issues dividend checks

S M Tu W Th F S
2 3 4 5 6

7 8 9 10 11 12 13
14 16 17 18 19 20
21 23 24 25 27
28 29 31

26
15

January

S M Tu W Th F S
1 2 3

4 5 6 7 8 10
11 13 14 15 16 17
18 19 22 24
25 26 27 28

23
29 30 31

12
9

30
22 21

Illustration 11-12
Key dividend dates

Dec. 31 Cash Dividends 6,000
Dividends Payable 6,000

(To record $6 per share cash dividend
to preferred stockholders)

Because of the cumulative feature, dividends of $2 per share are in arrears on
preferred stock for 2011. The company must pay these dividends to preferred
stockholders before it can pay any future dividends to common stockholders. IBR
should disclose dividends in arrears in the financial statements.

At December 31, 2012, IBR declares a $50,000 cash dividend. The allocation of
the dividend to the two classes of stock is as follows.

The entry to record the declaration of the dividend is:

Dec. 31 Cash Dividends 50,000
Dividends Payable 50,000

(To record declaration of cash dividends
of $10,000 to preferred stock and $40,000
to common stock)

What if IBR’s preferred stock were not cumulative? In that case preferred
stockholders would have received only $8,000 in dividends in 2012. Common stock-
holders would have received $42,000.

Total dividend $50,000
Allocated to preferred stock

Dividends in arrears, 2011 (1,000 � $2) $2,000
2012 dividend (1,000 � $8) 8,000 10,000

Remainder allocated to common stock $40,000

Illustration 11-13
Allocating dividends to
preferred and common
stock

Cash Flows
no effect
A SEL� �

�6,000 Div
�6,000

Cash Flows
no effect
A SEL� �
�50,000 Div
�50,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 528

before you go on…

Cash Dividends 529

Related exercise material: E11-6, E11-7, and 11-5.Do it!

Action Plan

• Determine dividends on
preferred shares by multiplying
the dividend rate times the par
value of the stock times the
number of preferred shares.

• Understand the cumulative
feature: If preferred stock is
cumulative, then any missed
dividends (dividends in arrears)
and the current year’s dividend
must be paid to preferred
stockholders before dividends are
paid to common stockholders.

1. The company has not missed past dividends and the preferred stock is noncumulative; thus,
the preferred stockholders are paid only this year’s dividend. The dividend paid to preferred
stockholders would be $12,000 (2,000 � .06 � $100). The dividend paid to common stockhold-
ers would be $48,000 ($60,000 � $12,000).

2. The preferred stock is noncumulative; thus, past unpaid dividends do not have to be paid. The
dividend paid to preferred stockholders would be $12,000 (2,000 � .06 � $100). The dividend
paid to common stockholders would be $48,000 ($60,000 � $12,000).

3. The preferred stock is cumulative; thus, dividends that have been missed (dividends in arrears)
must be paid. The dividend paid to preferred stockholders would be $36,000 (3 � 2,000 �
.06 � $100). The dividend paid to common stockholders would be $24,000 ($60,000 � $36,000).

The Navigator✓

Do it!
MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred

stock outstanding at December 31, 2011. At December 31, 2011, the company declared a $60,000
cash dividend. Determine the dividend paid to preferred stockholders and common stockholders
under each of the following scenarios.

1. The preferred stock is noncumulative, and the company has not missed any dividends in
previous years.

2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the
two previous years.

3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two
previous years.

Solution

Dividends on Preferred

and Common Stock

What’s Happening to Dividends?

The decision whether to pay a dividend, and how much to pay, is a very impor-
tant management decision. In recent years, many companies have substantially

increased their dividends, and total dividends paid by U.S. companies hit record levels.
One explanation for the increase is that Congress lowered, from 39% to 15%, the tax rate

paid by investors on dividends received, making dividends more attractive to investors.
Another driving force for the dividend increases was that companies were sitting on record
amounts of cash. Because they did not see a lot of profitable investment opportunities, com-
panies decided to return the cash to shareholders.

However, due to the prolonged recession, numerous companies cut their dividends in
late 2008 and early 2009. Banks in particular reduced their dividends significantly. For example,
Wells Fargo cut its dividend by 85%, and U.S. Bancorp cut its by 88%.

Source: Alan Levinsohn, “Divine Dividends,”Strategic Finance, May 2005, pp. 59–60.

ACCOUNTING ACROSS THE ORGANIZATION

What factors must management consider in deciding how large a dividend to pay?

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 529

The company has disbursed no cash, and has assumed no liabilities. What are
the purposes and benefits of a stock dividend? Corporations issue stock dividends
generally for one or more of the following reasons.

1. To satisfy stockholders’ dividend expectations without spending cash.
2. To increase the marketability of the corporation’s stock. When the number of

shares outstanding increases, the market price per share decreases. Decreasing
the market price of the stock makes it easier for smaller investors to purchase
the shares.

3. To emphasize that a portion of stockholders’ equity has been permanently
reinvested in the business (and is unavailable for cash dividends).

When the dividend is declared, the board of directors determines the size of the
stock dividend and the value assigned to each dividend. Generally, if the company
issues a small stock dividend (less than 20–25% of the corporation’s issued stock),
the value assigned to the dividend is the fair market value per share. This treatment
is based on the assumption that a small stock dividend will have little effect on the
market price of the outstanding shares. Many stockholders consider small stock
dividends to be distributions of earnings equal to the fair market value of the shares
distributed. If a company issues a large stock dividend (greater than 20–25%), the
value assigned to the dividend is the par or stated value. Small stock dividends pre-
dominate in practice. Thus, we will illustrate only entries for small stock dividends.

Entries for Stock Dividends
To illustrate the accounting for small stock dividends, assume that Medland
Corporation has a balance of $300,000 in retained earnings. It declares a 10% stock

530 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

STOCK DIVIDENDS

A stock dividend is a pro rata distribution to stockholders of the corporation’s own
stock. Whereas a company pays cash in a cash dividend, a company issues shares of
stock in a stock dividend. A stock dividend results in a decrease in retained earnings
and an increase in paid-in capital. Unlike a cash dividend, a stock dividend does not
decrease total stockholders’ equity or total assets.

To illustrate, assume that you have a 2% ownership interest in Cetus Inc.; you
own 20 of its 1,000 shares of common stock. If Cetus declares a 10% stock dividend,
it would issue 100 shares (1,000 � 10%) of stock. You would receive two shares
(2% � 100). Would your ownership interest change? No, it would remain at 2% (22 �
1,100). You now own more shares of stock, but your ownership interest has not
changed. Illustration 11-14 shows the effect of a stock dividend for stockholders.

Number of shares owned increases, but
percentage of company owned remains the same.

Before stock dividend After stock dividend

10
shares

10
shares
10
shares
10
shares

10 10 10 10
10 10 10 10
10 10 10 10

“I owned 40
shares before and I own
120 shares now, but I still

own only 1⁄4 of the
company!”

Illustration 11-14
Effect of stock dividend for
stockholders

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 530

dividend on its 50,000 shares of $10 par value common stock. The current fair market
value of its stock is $15 per share. The number of shares to be issued is 5,000 (10% �
50,000). Therefore the total amount to be debited to Stock Dividends (decreases re-
tained earnings) is $75,000 (5,000 � $15). The entry to record the declaration of the
stock dividend is as follows.

Stock Dividends 531

Stock Dividends 75,000
Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par Value 25,000

(To record declaration of 10% stock dividend)

At the declaration date, Medland increases (debits) Stock Dividends for the fair
market value of the stock issued ($15 � 5,000). It increases (credits) Common
Stock Dividends Distributable for the par value of the dividend shares ($10 �
5,000), and increases (credits) the excess over par ($5 � 5,000) to an additional
paid-in capital account.

Common Stock Dividends Distributable is a stockholders’ equity account. It is
not a liability because assets will not be used to pay the dividend. If the company
prepares a balance sheet before it issues the dividend shares, it reports the distrib-
utable account under paid-in capital, as shown in Illustration 11-15.

When Medland issues the dividend shares, it debits Common Stock Dividends
Distributable, and credits Common Stock, as follows.

Common Stock Dividends Distributable 50,000
Common Stock 50,000

(To record issuance of 5,000 shares in a stock dividend)

Effects of Stock Dividends
How do stock dividends affect stockholders’ equity? They change the composition
of stockholders’ equity, because they transfer to paid-in capital a portion of retained
earnings. However, total stockholders’ equity remains the same. Stock dividends
also have no effect on the par or stated value per share, but the number of shares
outstanding increases. Illustration 11-16 shows these effects for Medland
Corporation.

Paid-in capital
Common stock $500,000
Common stock dividends distributable 50,000 $550,000

Before After
Dividend Dividend

Stockholders’ equity
Paid-in capital

Common stock, $10 par $500,000 $550,000
Paid-in capital in excess of par value — 25,000

Total paid-in capital 500,000 575,000
Retained earnings 300,000 225,000

Total stockholders’ equity $800,000 $800,000

Outstanding shares 50,000 55,000

Illustration 11-15
Statement presentation of
common stock dividends
distributable

Illustration 11-16
Stock dividend effects

Cash Flows
no effect
A SEL� �

�75,000 Div
�50,000 CS
�25,000 CS

Cash Flows
no effect
A SEL� �

�50,000 CS
�50,000 CS

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 531

In this example, total paid-in capital increases by $75,000, and retained earnings
decreases by the same amount. Note also that total stockholders’ equity remains
unchanged at $800,000.

532 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

STOCK SPLITS

A stock split, like a stock dividend, involves issuance of additional shares to stock-
holders according to their percentage ownership. A stock split results in a reduc-
tion in the par or stated value per share. The purpose of a stock split is to increase
the marketability of the stock by lowering its market value per share.

The effect of a split on market value is generally inversely proportional to
the size of the split. For example, after a recent 2-for-1 stock split, the market
value of Nike’s stock fell from $111 to approximately $55. The lower market
value stimulated market activity, and within one year the stock was trading above
$100 again.

In a stock split, the number of shares increases in the same proportion that
par or stated value per share decreases. For example, in a 2-for-1 split, one share of
$10 par value stock is exchanged for two shares of $5 par value stock. A stock
split does not have any effect on total paid-in capital, retained earnings, or total
stockholders’ equity. However, the number of shares outstanding increases.
Illustration 11-17 shows these effects for Medland Corporation, assuming that it
splits its 50,000 shares of common stock on a 2-for-1 basis.

H E L P F U L H I N T
A stock split changes
the par value per share
but does not affect any
balances in stockholders’
equity.

A stock split does not affect the balances in any stockholders’ equity accounts.
Therefore it is not necessary to journalize a stock split.

Illustration 11-18 summarizes the significant differences between stock splits
and stock dividends.

Before After
Stock Split Stock Split

Stockholders’ equity
Paid-in capital

Common stock $500,000 $500,000
Paid-in capital in excess of par value –0– –0–

Total paid-in capital 500,000 500,000
Retained earnings 300,000 300,000

Total stockholders’ equity $800,000 $800,000

Outstanding shares 50,000 100,000

Item Stock Split Stock Dividend

Total paid-in capital No change Increase
Total retained earnings No change Decrease
Total par value (common stock) No change Increase
Par value per share Decrease No change

Illustration 11-17
Stock split effects

Illustration 11-18
Differences between the
effects of stock splits and
stock dividends

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 532

before you go on…

Retained Earnings 533

SECTION 3 Retained Earnings

Retained earnings is net income that a company retains for use in the busi-
ness. The balance in retained earnings is part of the stockholders’ claim on
the total assets of the corporation. It does not, however, represent a claim
on any specific asset. Nor can the amount of retained earnings be associ-
ated with the balance of any asset account. For example, a $100,000 balance in re-
tained earnings does not mean that there should be $100,000 in cash. The reason is
that the company may have used the cash resulting from the excess of revenues
over expenses to purchase buildings, equipment, and other assets. Illustration 11-19
shows recent amounts of retained earnings and cash in selected companies.

Identify the items reported in a
retained earnings statement.

S T U D Y O B J E C T I V E 6

Related exercise material: BE11-8, BE11-9, E11-14, E11-15, and 11-6.Do it!

Action Plan

• Calculate the stock dividend’s
effect on retained earnings by
multiplying the number of new
shares times the market price
of the stock (or par value for a
large stock dividend).

• Recall that a stock dividend
increases the number of
shares without affecting total
stockholders’ equity.

• Recall that a stock split only
increases the number of shares
outstanding and decreases the
par value per share.

(a) (1) The stock dividend amount is $2,250,000 [(500,000 � 10%) � $45]. The new balance in
retained earnings is $7,750,000 ($10,000,000 � $2,250,000).

(2) The retained earnings balance after the stock split would be the same as it was before
the split: $10,000,000.

(b) (1) Stock dividends change the composition of stockholders’ equity because they transfer
to paid-in capital a portion of retained earnings. However, total stockholders’ equity
remains the same.

(2) In a stock split, the number of shares increases in the same proportion that par or stated
value per share decreases. A stock split therefore does not have any effect on total paid-
in capital, retained earnings, or total stockholders’ equity.

The Navigator✓

Do it!
Sing CD Company has had five years of record earnings. Due to this success,

the market price of its 500,000 shares of $2 par value common stock has tripled from $15 per
share to $45. During this period, paid-in capital remained the same at $2,000,000. Retained earn-
ings increased from $1,500,000 to $10,000,000. CEO Joan Elbert is considering either (1) a 10%
stock dividend or (2) a 2-for-1 stock split. She asks you to show the before-and-after effects of
each option on (a) retained earnings, and (b) total stockholders’ equity.

Solution

Stock Dividends

and Stock Splits

(in millions)
Retained

Company Earnings Cash

Disney Co. $28,413 $3,001
Intel Corp. 26,537 3,305
Kellogg Co. 4,836 255
Amazon.com (730) 2,769

Illustration 11-19
Retained earnings and cash
balances

Remember that when a company has net income, it closes net income to re-
tained earnings. The closing entry is a debit to Income Summary and a credit to
Retained Earnings.

H E L P F U L H I N T
Remember that Retained
Earnings is a stockholders’
equity account, whose
normal balance is a credit.

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 533

When a company has a net loss (expenses exceed revenues), it also closes this
amount to retained earnings. The closing entry in this case is a debit to Retained
Earnings and a credit to Income Summary. This is done even if it results in a debit
balance in Retained Earnings. Companies do not debit net losses to paid-in capital
accounts. To do so would destroy the distinction between paid-in and earned capital.
A debit balance in Retained Earnings is identified as a deficit. It is reported as a
deduction in the stockholders’ equity section, as shown below.

534 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Balance Sheet (partial)
Stockholders’ equity
Paid-in capital

Common stock $800,000
Retained earnings (deficit) (50,000)

Total stockholders’ equity $750,000

Illustration 11-20
Stockholders’ equity with
deficit

RETAINED EARNINGS RESTRICTIONS

The balance in retained earnings is generally available for dividend declarations.
Some companies state this fact. For example, Lockheed Martin Corporation states
the following in the notes to its financial statements.

In some cases, there may be retained earnings restrictions. These make a
portion of the retained earnings balance currently unavailable for dividends.
Restrictions result from one or more of the following causes.

1. Legal restrictions. Many states require a corporation to restrict retained earn-
ings for the cost of treasury stock purchased. The restriction keeps intact the
corporation’s legal capital that is being temporarily held as treasury stock.
When the company sells the treasury stock, the restriction is lifted.

2. Contractual restrictions. Long-term debt contracts may restrict retained earn-
ings as a condition for the loan. The restriction limits the use of corporate assets
for payment of dividends. Thus, it increases the likelihood that the corporation
will be able to meet required loan payments.

3. Voluntary restrictions. The board of directors may voluntarily create retained
earnings restrictions for specific purposes. For example, the board may author-
ize a restriction for future plant expansion. By reducing the amount of retained
earnings available for dividends, the company makes more cash available for
the planned expansion.

Companies generally disclose retained earnings restrictions in the notes to the
financial statements. For example, Tektronix Inc., a manufacturer of electronic

LOCKHEED MARTIN CORPORATION
Notes to the Financial Statements

At December 31, retained earnings were unrestricted and available for dividend payments.

Illustration 11-21
Disclosure of unrestricted
retained earnings

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 534

measurement devices, had total retained earnings of $774 million, but the unre-
stricted portion was only $223.8 million.

Prior Period Adjustments 535

TEKTRONIX INC.
Notes to the Financial Statements

Certain of the Company’s debt agreements require compliance with debt covenants.
Management believes that the Company is in compliance with such requirements. The
Company had unrestricted retained earnings of $223.8 million after meeting those
requirements.

Illustration 11-22
Disclosure of restriction

PRIOR PERIOD ADJUSTMENTS

Suppose that a corporation has closed its books and issued financial statements.
The corporation then discovers that it made a material error in reporting net in-
come of a prior year. How should the company record this situation in the accounts
and report it in the financial statements?

The correction of an error in previously issued financial statements is known as
a prior period adjustment. The company makes the correction directly to Retained
Earnings, because the effect of the error is now in this account. The net income for
the prior period has been recorded in retained earnings through the journalizing
and posting of closing entries.

To illustrate, assume that General Microwave discovers in 2011 that it under-
stated depreciation expense in 2010 by $300,000 due to computational errors.
These errors overstated both net income for 2010 and the current balance in re-
tained earnings. The entry for the prior period adjustment, ignoring all tax effects,
is as follows.

Retained Earnings 300,000
Accumulated Depreciation 300,000

(To adjust for understatement of depreciation in
a prior period)

A debit to an income statement account in 2011 is incorrect because the error per-
tains to a prior year.

Companies report prior period adjustments in the retained earnings statement.
They add (or deduct, as the case may be) these adjustments from the beginning
retained earnings balance. This results in an adjusted beginning balance. For example,
assuming a beginning balance of $800,000 in retained earnings, General Microwave
reports the prior period adjustment as follows.

GENERAL MICROWAVE
Retained Earnings Statement (partial)

Balance, January 1, as reported $ 800,000

Correction for overstatement of net income
in prior period (depreciation error) (300,000)

Balance, January 1, as adjusted $ 500,000

Illustration 11-23
Statement presentation of
prior period adjustments

Cash Flows
no effect
A SEL� �

�300,000 RE
�300,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 535

before you go on…

Again, reporting the correction in the current year’s income statement would be
incorrect because it applies to a prior year’s income statement.

536 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

RETAINED EARNINGS STATEMENT

The retained earnings statement shows the changes in retained earnings during
the year. The company prepares the statement from the Retained Earnings
account. Illustration 11-24 shows (in account form) transactions that affect retained
earnings.

Retained Earnings

1. Net loss 1. Net income

2. Prior period adjustments for 2. Prior period adjustments for
overstatement of net income understatement of net income

3. Cash dividends and stock dividends

4. Some disposals of treasury stock

Illustration 11-24
Debits and credits to
retained earnings

As indicated, net income increases retained earnings, and a net loss decreases re-
tained earnings. Prior period adjustments may either increase or decrease retained
earnings. Both cash dividends and stock dividends decrease retained earnings. The
circumstances under which treasury stock transactions decrease retained earnings
are explained on page 523.

A complete retained earnings statement for Graber Inc., based on assumed
data, is as follows.

GRABER INC.
Retained Earnings

Statement

For the Year Ended December 31, 2011

Balance, January 1, as reported $1,050,000
Correction for understatement of net income

in prior period (inventory error) 50,000

Balance, January 1, as adjusted 1,100,000
Add: Net income 360,000

1,460,000
Less: Cash dividends $100,000

Stock dividends 200,000 300,000

Balance, December 31 $1,160,000

Illustration 11-25
Retained earnings
statement

Do it!
Vega Corporation has retained earnings of $5,130,000 on January 1, 2011.

During the year, Vega earned $2,000,000 of net income. It declared and paid a $250,000 cash divi-
dend. In 2011, Vega recorded an adjustment of $180,000 due to the understatement (from a mathe-
matical error) of 2010 depreciation expense. Prepare a retained earnings statement for 2011.

Retained Earnings
Statement

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 536

Statement Presentation and Analysis 537

STATEMENT PRESENTATION AND ANALYSIS

In the stockholders’ equity section of the balance sheet, paid-in capital
and retained earnings are reported. The specific sources of paid-in capital
are identified. Within paid-in capital, two classifications are recognized:

1. Capital stock. This category consists of preferred and common stock.
Preferred stock is shown before common stock because of its prefer-
ential rights. Par value, shares authorized, shares issued, and shares outstanding
are reported for each class of stock.

2. Additional paid-in capital. This includes the excess of amounts paid over par or
stated value and paid-in capital from treasury stock.

Presentation
The stockholders’ equity section of Graber Inc.’s balance sheet is presented in
Illustration 11-26 (page 538). Note the following: (1) “Common stock dividends
distributable” is shown under “Capital stock,” in “Paid-in capital.” (2) A retained
earnings restriction is disclosed in the notes.

The stockholders’ equity section of Graber Inc. in Illustration 11-26 includes
most of the accounts discussed in this chapter. The disclosures pertaining to
Graber’s common stock indicate that: 400,000 shares are issued; 100,000 shares
are unissued (500,000 authorized less 400,000 issued); and 390,000 shares are
outstanding (400,000 issued less 10,000 shares in treasury).

In published annual reports, the individual sources of additional paid-in capital
are often combined and reported as a single amount, as shown in Illustration 11-27
(page 538). In addition, authorized shares are sometimes not reported.

In practice, the term “capital surplus” is sometimes used in place of additional
paid-in capital and “earned surplus” in place of retained earnings. The use of the term
“surplus” suggests that an excess amount of funds is available. Such is not necessarily
the case. Therefore, the term “surplus” should not be employed in accounting.
Unfortunately, a number of financial statements still do use it.

Instead of presenting a detailed stockholders’ equity section in the balance
sheet and a retained earnings statement, many companies prepare a stockholders’
equity statement. This statement shows the changes in each stockholders’ equity

Prepare and analyze a
comprehensive stockholders’
equity section.

S T U D Y O B J E C T I V E 7

Solution
The Navigator✓

VEGA CORPORATION
Retained Earnings Statement

For the Year Ended December 31, 2011

Balance, January 1, as reported $5,130,000
Correction for overstatement of net income

in prior period (depreciation error) (180,000)

Balance, January 1, as adjusted 4,950,000
Add: Net income 2,000,000

6,950,000
Less: Cash dividends 250,000

Balance, December 31 $6,700,000

Action Plan

• Recall that a retained earnings
statement begins with retained
earnings, as reported at the end
of the previous year.

• Add or subtract any prior period
adjustments to arrive at the
adjusted beginning figure.

• Add net income and subtract
dividends declared to arrive at
the ending balance in retained
earnings.

Related exercise material: BE11-10, BE11-11, E11-17, E11-18, and 11-7.Do it!

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 537

account and in total that have occurred during the year. An example of a stock-
holders’ equity statement is illustrated in PepsiCo’s financial statements in
Appendix A and in an appendix to this chapter (Illustration 11-A1).

Analysis
Profitability from the viewpoint of the common stockholder can be measured by
the return on common stockholders’ equity. This ratio shows how many dollars of
net income were earned for each dollar invested by the stockholders. It is com-
puted by dividing net income available to common stockholders (which is net in-
come minus preferred stock dividends) by average common stockholders’ equity.

538 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

KELLOGG COMPANY
Balance Sheet (partial)

($ in millions)

Stockholders’ equity
Common stock, $0.25 par value, 1,000,000,000 shares authorized

Issued: 418,842,707 shares $ 105
Capital in excess of par value 438
Retained earnings 4,836
Treasury stock, at cost

36,981,580 shares (1,790)
Accumulated other comprehensive income (2,141)

Total stockholders’ equity $1,448

GRABER INC.
Balance Sheet (partial)

Stockholders’ equity
Paid-in capital

Capital stock
9% Preferred stock, $100 par value, cumulative,

callable at $120, 10,000 shares authorized,
6,000 shares issued and outstanding $ 600,000

Common stock, no par, $5 stated value,
500,000 shares authorized, 400,000 shares issued
and 390,000 outstanding $2,000,000

Common stock dividends distributable 50,000 2,050,000

Total capital stock 2,650,000
Additional paid-in capital

In excess of par value—preferred stock 30,000
In excess of stated value—common stock 1,050,000

Total additional paid-in capital 1,080,000

Total paid-in capital 3,730,000
Retained earnings (see Note R) 1,160,000

Total paid-in capital and retained earnings 4,890,000
Less: Treasury stock—common (10,000 shares) 80,000

Total stockholders’ equity $4,810,000

Note R: Retained earnings is restricted for the cost of treasury stock, $80,000.

Illustration 11-26
Comprehensive stock-
holders’ equity section

Illustration 11-27
Published stockholders’
equity section

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 538

before you go on…

To illustrate, Kellogg Company’s beginning-of-the-year and end-of-the-year
common stockholders’ equity were $2,526 and $1,448 million, respectively. Its net
income was $1,148 million, and no preferred stock was outstanding. The return on
common stockholders’ equity ratio is computed as follows.

Statement Presentation and Analysis 539

Illustration 11-28
Return on common
stockholders’ equity ratio
and computation

Net Income
minus �

Average Common
�

Return on Common

Preferred Dividends
Stockholders’ Equity

Stockholders’ Equity

($1,148 � $0) �
($2,526 � $1,448)

� 57.8%
2

As shown in Illustration 11-28, if a company has preferred stock, the amount of
preferred dividends is deducted from net income to compute income available to
common stockholders. Also, the par value of preferred stock is deducted from total
average stockholders’ equity to arrive at the amount of common stockholders’ equity.

Related exercise material: E11-22 and 11-8.Do it!

Action Plan

• Determine return on common
stockholders’ equity by dividing
net income available to common
stockholders by the average
common stockholders’ equity.

(a)

2010 2011

Return on common ($110,000 � $10,000)
� 20%

($110,000 – $10,000)
� 25%stockholders’ equity ($500,000 � $500,000)/2 ($400,000 + $400,000)/2

(b) Between 2010 and 2011, return on common stockholders’ equity improved from 20% to
25%. While this would appear to be good news for the company’s common stockholders, this
increase should be carefully evaluated. It is important to note that net income did not change
during this period. The increase in the ratio was due to the purchase of treasury shares, which
reduced the denominator. As the company repurchases its own shares, it becomes more
reliant on debt and thus increases its risk.

The Navigator✓

Do it!
On January 1, 2011, Sienna Corporation purchased 2,000 shares of treasury

stock. Other information regarding Siena Corporation is provided below.

2010 2011

Net income $110,000 $110,000
Dividends on preferred stock $10,000 $10,000
Dividends on common stock $2,000 $1,600
Weighted-average number of shares outstanding 10,000 8,000*
Common stockholders’ equity, beginning of year $500,000 $400,000*
Common stockholders’ equity, end of year $500,000 $400,000

*Adjusted for purchase of treasury stock.

Compute (a) return on common stockholders’ equity for each year and (b) discuss the changes.

Solution
Stockholders’ Equity

Home-Equity Loans
on page 540 for infor-

mation on how topics in
this chapter apply to you.

all about Y U*
Be sure to read

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 539

Some Facts*

*all about Y U*

IIn this chapter you learned that companiessometimes reduce their stockholders’ equity by
buying treasury stock or paying dividends. They do
this for a variety of reasons—some good, and some
not so good. Individuals who own homes sometimes
engage in equity-reducing transactions by using
home-equity loans. Home-equity loans use the equity
existing in the home as collateral for borrowing
additional monies.

Many people have chosen to use home-equity
loans to finance vacations, new cars, improvements
to the home, educational pursuits, and so on, or to
consolidate debt. However, by taking out a home-
equity loan, a homeowner is reducing the equity in
that home.

Now with the housing market in chaos, loans of
this nature were $14.7 billion delinquent through
September 2008, and matters are getting worse, not
better. Lenders even went so far as to provide credit
for the down payment on homes.

What Do You Think?*
Your home has increased in value by $50,000 during the last five years. You
have very little savings outside of the equity in your home. You desperately
need a vacation, and you are considering taking out a $5,000 home-equity
loan to finance a two-week dream vacation in Europe. Is this is a bad idea?

YES: This represents a significant portion of your savings. Home-equity
loans should be used to finance investments of a lasting nature, not items of a
fleeting nature like vacations.

NO: You need a vacation. If you use a little of the equity in your home now,
you can make it up when your house increases in value in the future.

*
The authors’ comments on this situation appear on page 567.

Source: Ruth Simon, “Lenders Push Home-Equity Deals,” Wall Street Journal, April 27, 2006, p. D1; Marc
Eisenson and Nancy Castleman, “When Mining Your Home for Money, Beware of Fool’s Gold,” Good Advice
Press, www.goodadvicepress.com/omhomeequity.htm (accessed June 20, 2006).

Home-Equity Loans

540

About the Numbers*

* Home-equity loans are now difficult to get. The
reasons are that banks are not making the loans,
and sinking home prices give homeowners less
equity to borrow against.

* Four major reasons why many individuals employ
home-equity loans are: (1) to invest, (2) to get a tax
deduction, (3) to defer other debt, or (4) to buy from
a wish list.

* While home-equity loans tend to have fixed rates,
home-equity lines of credit, which allow the
homeowner to borrow up to a certain amount
whenever they want to, have variable rates. Rates
on home-equity lines of credit averaged 8.33% in
April 2006, versus about 14% for credit card debt.

* Home-equity loan interest is tax-deductible (like
home mortgage interest). Interest on car loans, most
student loans, and credit cards is not.

Home-equity loans can be very tempting. Suppose that you wanted to borrow $5,000
to take a vacation. You could spread your payments over 15 years and you would have
to pay only about $50 per month. But look what your total payments would be over the
life of the 15-year loan. Some vacation!

Source: Data from Marc Eisenson and Nancy Castleman, “When Mining Your Home for Money, Beware of
Fool’s Gold,” Good Advice Press, www.goodadvicepress.com/omhomeequity.htm (accessed June 20, 2006).

Amount of Monthly
Payment on a $5,000, 9% Loan

$0 $50 $100 $150 $200

5 Years

L
o

a
n

T
e
rm 10 Years

5 Years

3 Years

Total Cost Over Life of $5,000, 9% Loan

$0 $2,000 $4,000 $6,000 $8,000 $10,000

15 Years

L
o
a
n
T
e
rm 10 Years
5 Years
3 Years

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 540

Comprehensive Do it! 541

Comprehensive

The Rolman Corporation is authorized to issue 1,000,000 shares of $5 par value common stock.
In its first year, the company has the following stock transactions.

Jan. 10 Issued 400,000 shares of stock at $8 per share.
July 1 Issued 100,000 shares of stock for land. The land had an asking price of $900,000.

The stock is currently selling on a national exchange at $8.25 per share.
Sept. 1 Purchased 10,000 shares of common stock for the treasury at $9 per share.
Dec. 1 Sold 4,000 shares of the treasury stock at $10 per share.

Instructions
(a) Journalize the transactions.
(b) Prepare the stockholders’ equity section assuming the company had retained earnings of

$200,000 at December 31.

Solution to Comprehensive Do it!

Do it!

(a) Jan. 10 Cash 3,200,000
Common Stock 2,000,000
Paid-in Capital in Excess of Par Value 1,200,000

(To record issuance of 400,000 shares of $5
par value stock)

July 1 Land 825,000
Common Stock 500,000
Paid-in Capital in Excess of Par Value 325,000

(To record issuance of 100,000 shares of $5
par value stock for land)

Sept. 1 Treasury Stock 90,000
Cash 90,000

(To record purchase of 10,000 shares of
treasury stock at cost)

Dec. 1 Cash 40,000
Treasury Stock 36,000
Paid-in Capital from Treasury Stock 4,000

(To record sale of 4,000 shares of treasury
stock above cost)

(b) ROLMAN CORPORATION
Balance Sheet (partial)

Stockholders’ equity
Paid-in capital

Capital stock
Common stock, $5 par value, 1,000,000 shares

authorized, 500,000 shares issued, 494,000
shares outstanding $2,500,000

Additional paid-in capital
In excess of par value $1,525,000
From treasury stock 4,000

Total additional paid-in capital 1,529,000

Total paid-in capital 4,029,000
Retained earnings 200,000

Total paid-in capital and retained earnings 4,229,000
Less: Treasury stock (6,000 shares) 54,000

Total stockholders’ equity $4,175,000

Action Plan

• When common stock has a par
value, credit Common Stock for
par value.

• Use fair market value in
a noncash transaction.

• Debit and credit the Treasury
Stock account at cost.

• Record differences between the
cost and selling price of treasury
stock in stockholders’ equity
accounts, not as gains or losses.

The Navigator✓

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 541

542 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

1 Identify the major characteristics of a corporation.
The major characteristics of a corporation are separate
legal existence, limited liability of stockholders, transferable
ownership rights, ability to acquire capital, continuous life,
corporation management, government regulations, and
additional taxes.

2 Record the issuance of common stock. When the is-
suance of common stock for cash is recorded, the par value
of the shares is credited to Common Stock. The portion of
the proceeds that is above or below par value is recorded in
a separate paid-in capital account. When no-par common
stock has a stated value, the entries are similar to those for
par value stock. When no-par stock does not have a stated
value, the entire proceeds are credited to Common Stock.

3 Explain the accounting for treasury stock. The cost
method is generally used in accounting for treasury stock.
Under this approach, Treasury Stock is debited at the price
paid to reacquire the shares. The same amount is credited
to Treasury Stock when the shares are sold. The difference
between the sales price and cost is recorded in stockholders’
equity accounts, not in income statement accounts.

4 Differentiate preferred stock from common stock.
Preferred stock has contractual provisions that give it
priority over common stock in certain areas. Typically,
preferred stockholders have a preference to (1) dividends
and (2) assets in liquidation. They usually do not have
voting rights.

5 Prepare the entries for cash dividends and stock divi-
dends. Entries for both cash and stock dividends are
required on the declaration date and the payment date. At

the declaration date the entries are: cash dividend—debit
Cash Dividends, and credit Dividends Payable; small stock
dividend—debit Stock Dividends, credit Paid-in Capital in
Excess of Par (or Stated) Value, and credit Common Stock
Dividends Distributable. On the payment date, the entries
for cash and stock dividends are: cash dividend—debit
Dividends Payable and credit Cash; small stock dividend—
debit Common Stock Dividends Distributable and credit
Common Stock.

6 Identify the items that are reported in a retained earn-
ings statement. Each of the individual debits and credits
to retained earnings should be reported in the retained
earnings statement. Additions consist of net income and
prior period adjustments to correct understatements of
prior years’ net income. Deductions consist of net loss, ad-
justments to correct overstatements of prior years’ net in-
come, cash and stock dividends, and some disposals of
treasury stock.

7 Prepare and analyze a comprehensive stockholders’
equity section. In the stockholders’ equity section, paid-
in capital and retained earnings are reported and specific
sources of paid-in capital are identified. Within paid-in cap-
ital, two classifications are shown: capital stock and addi-
tional paid-in capital. If a corporation has treasury stock,
the cost of treasury stock is deducted from total paid-in
capital and retained earnings to obtain total stockholders’
equity. One measure of profitability is the return on com-
mon stockholders’ equity. It is calculated by dividing net in-
come minus preferred stock dividends by average common
stockholders’ equity.

SUMMARY OF STUDY OBJECTIVES

The Navigator✓

GLOSSARY

Authorized stock The amount of stock that a corporation is
authorized to sell as indicated in its charter. (p. 514).

By-laws The internal rules and procedures for conducting
the affairs of a corporation. (p. 512).

Cash dividend A pro rata distribution of cash to stock-
holders. (p. 526).

Charter A document that creates a corporation. (p. 512).

Corporation A business organized as a legal entity sepa-
rate and distinct from its owners under state corporation
law. (p. 508).

Cumulative dividend A feature of preferred stock entitling
the stockholder to receive current and unpaid prior-year
dividends before common stockholders receive any divi-
dends. (p. 525).

Declaration date The date the board of directors formally de-
clares the dividend and announces it to stockholders. (p. 526).

Deficit A debit balance in retained earnings. (p. 534).

Dividend A distribution by a corporation to its stockholders
on a pro rata (proportional) basis. (p. 525).

Liquidating dividend A dividend declared out of paid-in
capital. (p. 526).

No-par-value stock Capital stock that has not been as-
signed a value in the corporate charter. (p. 515).

Organization costs Costs incurred in the formation of a
corporation. (p. 512).

Outstanding stock Capital stock that has been issued and
is being held by stockholders. (p. 522).

Paid-in capital Total amount of cash and other assets paid in
to the corporation by stockholders in exchange for capital
stock. (p. 516).

Par-value stock Capital stock that has been assigned a
value per share in the corporate charter. (p. 515).

Payment date The date dividend checks are mailed to
stockholders. (p. 527).

Preferred stock Capital stock that has some contractual
preferences over common stock. (p. 524).

Prior period adjustment The correction of an error in pre-
viously issued financial statements. (p. 535).

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 542

Privately held corporation A corporation that has only a
few stockholders and whose stock is not available for sale
to the general public. (p. 509).

Publicly held corporation A corporation that may have
thousands of stockholders and whose stock is regularly
traded on a national securities exchange. (p. 508).

Record date The date when ownership of outstanding
shares is determined for dividend purposes. (p. 527).

Retained earnings Net income that a corporation retains
for future use. (pp. 516, 533).

Retained earnings restrictions Circumstances that make
a portion of retained earnings currently unavailable for
dividends. (p. 534).

Retained earnings statement A financial statement that
shows the changes in retained earnings during the year.
(p. 536).

Return on common stockholders’ equity ratio A ratio
that measures profitability from the stockholders’ point of

Appendix 11A Stockholders’ Equity Statement 543

view. It is computed by dividing net income available to
common stockholders by average common stockholders’
equity. (p. 538).

Stated value The amount per share assigned by the board
of directors to no-par stock that becomes legal capital per
share. (p. 515).

Stock dividend A pro rata distribution of the corporation’s
own stock to stockholders. (p. 530).

Stock split The issuance of additional shares of stock to
stockholders accompanied by a reduction in the par or
stated value per share. (p. 532).

Stockholders’ equity statement A statement that shows
the changes in each stockholders’ equity account and in
total stockholders’ equity during the year. (p. 537).

Treasury stock A corporation’s own stock that the corpora-
tion has issued, fully paid for, and reacquired but not
retired. (p. 520).

APPENDIX 11A Stockholders’ Equity Statement
When balance sheets and income statements are presented by a corpora-
tion, changes in the separate accounts comprising stockholders’ equity
should also be disclosed. Disclosure of such changes is necessary to make
the financial statements sufficiently informative for users. The disclosures
may be made in an additional statement or in the notes to the financial
statements.

Many corporations make the disclosures in a stockholders’ equity statement.
The statement shows the changes in each stockholders’ equity account and in total
stockholders’ equity during the year. As shown in Illustration 11A-1 the stockhold-
ers’ equity statement is prepared in columnar form. It contains columns for each
account and for total stockholders’ equity. The transactions are then identified and
their effects are shown in the appropriate columns.

Describe the use and content
of the stockholders’ equity
statement.

S T U D Y O B J E C T I V E 8

HAMPTON CORPORATION
Stockholders’ Equity Statement

For the Year Ended December 31, 2011

Paid-in Capital
Common Stock in Excess of Retained Treasury

($5 Par) Par Earnings Stock Total
Balance January 1 $300,000 $200,000 $650,000 $(34,000) $1,116,000
Issued 5,000 shares of common

stock at $15 25,000 50,000 75,000
Declared a $40,000 cash dividend (40,000) (40,000)
Purchased 2,000 shares for

treasury at $16 (32,000) (32,000)
Net income for year 240,000 240,000

Balance December 31 $325,000 $250,000 $850,000 $(66,000) $1,359,000

Illustration 11A-1
Stockholders’ equity
statement

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 543

In practice, additional columns are usually provided to show the number of
shares of issued stock and treasury stock. The stockholders’ equity statement for
PepsiCo, for a three-year period, is shown in Appendix A. When a stockholders’
equity statement is presented, a retained earnings statement is not necessary
because the retained earnings column explains the changes in this account.

544 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

8 Describe the use and content of the stockholders’
equity statement. Corporations must disclose changes in
stockholders’ equity accounts and may choose to do so by
issuing a separate stockholders’ equity statement. This

statement, prepared in columnar form, shows changes in
each stockholders’ equity account and in total stockholders’
equity during the accounting period. When this statement is
presented, a retained earnings statement is not necessary.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 11A

APPENDIX 11B Book Value—Another
Per-Share Amount

Book Value per Share
You have learned about a number of per share amounts in this chapter.
Another per-share amount of some importance is book value per share. It
represents the equity a common stockholder has in the net assets of the
corporation from owning one share of stock. Remember that the net assets

(total assets minus total liabilities) of a corporation must be equal to total stock-
holders’ equity. Therefore, the formula for computing book value per share when a
company has only one class of stock outstanding is:

Compute book value per share.

S T U D Y O B J E C T I V E 9

Thus, if Marlo Corporation has total stockholders’ equity of $1,500,000 (common
stock $1,000,000 and retained earnings $500,000) and 50,000 shares of common
stock outstanding, book value per share is $30 ($1,500,000 � 50,000).

When a company has both preferred and common stock, the computation of
book value is more complex. Since preferred stockholders have a prior claim on
net assets over common stockholders, their equity must be deducted from total
stockholders’ equity. Then we can determine the stockholders’ equity that applies
to the common stock. The computation of book value per share involves the fol-
lowing steps.

1. Compute the preferred stock equity. This equity is equal to the sum of the call
price of preferred stock plus any cumulative dividends in arrears. If the pre-
ferred stock does not have a call price, the par value of the stock is used.

2. Determine the common stock equity. Subtract the preferred stock equity from
total stockholders’ equity.

3. Determine book value per share. Divide common stock equity by shares of
common stock outstanding.

Total Number of
Stockholders’ � Common Shares �

Book Value

Equity Outstanding
per Share

Illustration 11B-1
Book value per share
formula

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EXAMPLE
We will use the stockholders’ equity section of Graber Inc. shown in Illustration 11-26.
Graber’s preferred stock is callable at $120 per share and is cumulative. Assume
that dividends on Graber’s preferred stock were in arrears for one year, $54,000
(6,000 � $9). The computation of preferred stock equity (Step 1 in the preceding
list) is:

Appendix 11B Book Value—Another Per-Share Amount 545

Call price (6,000 shares � $120) $720,000
Dividends in arrears (6,000 shares � $9) 54,000

Preferred stock equity $774,000

Total stockholders’ equity $4,810,000
Less: Preferred stock equity 774,000

Common stock equity $4,036,000

Shares of common stock outstanding 390,000

Book value per share ($4,036,000 � 390,000) $10.35

Book Value Market Range
Company (year-end) (for the year)

The Limited, Inc. $13.38 $31.03–$22.89
H. J. Heinz Company $ 7.48 $40.61–$34.53
Cisco Systems $ 3.66 $21.24–$17.01
Wal-Mart Stores $12.79 $50.87–$42.31

The computation of book value (Steps 2 and 3) is as follows.

Note that we used the call price of $120 instead of the par value of $100. Note
also that the paid-in capital in excess of par value of preferred stock, $30,000, is not
assigned to the preferred stock equity. Preferred stockholders ordinarily do not
have a right to amounts paid-in in excess of par value. Therefore, such amounts are
assigned to the common stock equity in computing book value.

Book Value versus Market Value
Be sure you understand that book value per share may not equal market value per
share. Book value generally is based on recorded costs. Market value reflects the
subjective judgments of thousands of stockholders and prospective investors about
a company’s potential for future earnings and dividends. Market value per share
may exceed book value per share, but that fact does not necessarily mean that the
stock is overpriced. The correlation between book value and the annual range of a
company’s market value per share is often remote, as indicated by the following
recent data.

Book value per share is useful in determining the trend of a stockholder’s per
share equity in a corporation. It is also significant in many contracts and in court
cases where the rights of individual parties are based on cost information.

Illustration 11B-2
Computation of preferred
stock equity—Step 1

Illustration 11B-4
Book and market values
compared

Illustration 11B-3
Computation of book value
per share with preferred
stock—Steps 2 and 3

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546 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

9 Compute book value per share. Book value per share rep-
resents the equity a common stockholder has in the net assets
of a corporation from owning one share of stock. When there

is only common stock outstanding, the formula for computing
book value is: Total stockholders’ equity � Number of com-
mon shares outstanding � Book value per share.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 11B

Answers are at the end of the chapter.

1. Which of the following is not a major advantage of a
corporation?
a. Separate legal existence.
b. Continuous life.
c. Government regulations.
d. Transferable ownership rights.

2. A major disadvantage of a corporation is:
a. limited liability of stockholders.
b. additional taxes.
c. transferable ownership rights.
d. none of the above.

3. Which of the following statements is false?
a. Ownership of common stock gives the owner a voting

right.
b. The stockholders’ equity section begins with paid-in

capital.
c. The authorization of capital stock does not result in a

formal accounting entry.
d. The par value of a share of stock is equal to its market

value.
4. ABC Corporation issues 1,000 shares of $10 par value

common stock at $12 per share. In recording the transac-
tion, credits are made to:
a. Common Stock $10,000 and Paid-in Capital in Excess

of Stated Value $2,000.
b. Common Stock $12,000.
c. Common Stock $10,000 and Paid-in Capital in Excess

of Par Value $2,000.
d. Common Stock $10,000 and Retained Earnings $2,000.

5. XYZ, Inc. sells 100 shares of $5 par value treasury stock at
$13 per share. If the cost of acquiring the shares was $10
per share, the entry for the sale should include credits to:
a. Treasury Stock $1,000 and Paid-in Capital from

Treasury Stock $300.
b. Treasury Stock $500 and Paid-in Capital from Treasury

Stock $800.
c. Treasury Stock $1,000 and Retained Earnings $300.

d. Treasury Stock $500 and Paid-in Capital in Excess of
Par Value $800.

6. In the stockholders’ equity section, the cost of treasury
stock is deducted from:
a. total paid-in capital and retained earnings.
b. retained earnings.
c. total stockholders’ equity.
d. common stock in paid-in capital.

7. Preferred stock may have priority over common stock
except in:
a. dividends.
b. assets in the event of liquidation.
c. cumulative dividend features.
d. voting.

8. M-Bot Corporation has 10,000 shares of 8%, $100 par value,
cumulative preferred stock outstanding at December 31,
2011. No dividends were declared in 2009 or 2010. If
M-Bot wants to pay $375,000 of dividends in 2011, common
stockholders will receive:
a. $0.
b. $295,000.
c. $215,000.
d. $135,000.

9. Entries for cash dividends are required on the:
a. declaration date and the payment date.
b. record date and the payment date.
c. declaration date, record date, and payment date.
d. declaration date and the record date.

10. Which of the following statements about small stock divi-
dends is true?
a. A debit to Stock Dividends for the par value of the

shares issued should be made.
b. A small stock dividend decreases total stockholders’

equity.
c. Market value per share should be assigned to the divi-

dend shares.
d. A small stock dividend decreases Stock Dividends

Distributable.

SELF-STUDY

QUESTIONS

Book value per share The equity a common stockholder
has in the net assets of the corporation from owning one
share of stock. (p. 544).

*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

GLOSSARY FOR APPENDIX 11B

(SO 1)

(SO 2)

(SO 3)

(SO 4)

(SO 4, 5)

(SO 5)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 546

11. All but one of the following is reported in a retained earn-
ings statement. The exception is:
a. cash and stock dividends.
b. net income and net loss.
c. some disposals of treasury stock below cost.
d. sales of treasury stock above cost.

12. A prior period adjustment is:
a. reported in the income statement as a nontypical

item.
b. a correction of an error that is made directly to re-

tained earnings.
c. reported directly in the stockholders’ equity section.
d. reported in the retained earnings statement as an ad-

justment of the ending balance of retained earnings.
13. In the stockholders’ equity section of the balance sheet,

common stock:
a. is listed before preferred stock.
b. is added to total capital stock.
c. is part of paid-in capital.
d. is part of additional paid-in capital.

14. Which of the following is not reported under additional
paid-in capital?
a. Paid-in capital in excess of par value.
b. Common stock.
c. Paid-in capital in excess of stated value.
d. Paid-in capital from treasury stock.

15. Katie Inc. reported net income of $186,000 during 2011
and paid dividends of $26,000 on common stock. It also
has 10,000 shares of 6%, $100 par value, noncumulative

Questions 547

preferred stock outstanding. Common stockholders’
equity was $1,200,000 on January 1, 2011, and $1,600,000
on December 31, 2011. The company’s return on com-
mon stockholders’ equity for 2011 is:
a. 10.0%.
b. 9.0%.
c. 7.1%.
d. 13.3%.

*16. When a stockholders’ equity statement is presented, it is
not necessary to prepare a(an):
a. retained earnings statement.
b. balance sheet.
c. income statement.
d. None of the above.

*17. The ledger of JFK, Inc. shows common stock, common
treasury stock, and no preferred stock. For this company,
the formula for computing book value per share is:
a. Total paid-in capital and retained earnings divided by

the number of

shares of common stock issued.

b. Common stock divided by the number of shares of

common stock issued.
c. Total stockholders’ equity divided by the number of

shares of common stock outstanding.
d. Total stockholders’ equity divided by the number of

shares of common stock issued.

Go to the book’s companion website,
www.wiley.com/college/weygandt,
for Additional Self-Study Questions.

(SO 6)

(SO 7)

(SO 7)
(SO 7)

(SO 8)

(SO 9)

The Navigator✓
QUESTIONS

1. Mike Horn, a student, asks your help in understanding the
following characteristics of a corporation: (a) separate
legal existence, (b) limited liability of stockholders, and
(c) transferable ownership rights. Explain these character-
istics to Mike.

2. (a) Your friend Veena Gall cannot understand how the
characteristic of corporation management is both an
advantage and a disadvantage. Clarify this problem
for Veena.

(b) Identify and explain two other disadvantages of a
corporation.

3. Kari Jonas believes a corporation must be incorporated in
the state in which its headquarters office is located. Is Kari
correct? Explain.

4. What are the basic ownership rights of common stock-
holders in the absence of restrictive provisions?

5. A corporation has been defined as an entity separate and
distinct from its owners. In what ways is a corporation a
separate legal entity?

6. (a) What are the two principal components of stock-
holders’ equity?

(b) What is paid-in capital? Give three examples.
7. The corporate charter of Sokol Corporation allows the is-

suance of a maximum of 100,000 shares of common stock.

During its first two years of operations, Sokol sold 80,000
shares to stockholders and reacquired 7,000 of these
shares. After these transactions, how many shares are au-
thorized, issued, and outstanding?

8. Which is the better investment—common stock with a par
value of $5 per share, or common stock with a par value of
$20 per share? Why?

9. What factors help determine the market value of stock?
10. Why is common stock usually not issued at a price that is

less than par value?
11. Land appraised at $80,000 is purchased by issuing 1,000

shares of $20 par value common stock. The market price
of the shares at the time of the exchange, based on active
trading in the securities market, is $90 per share. Should
the land be recorded at $20,000, $80,000, or $90,000?
Explain.

12. For what reasons might a company like IBM repurchase
some of its stock (treasury stock)?

13. Chen, Inc. purchases 1,000 shares of its own previously
issued $5 par common stock for $12,000. Assuming
the shares are held in the treasury, what effect does
this transaction have on (a) net income, (b) total assets,
(c) total paid-in capital, and (d) total stockholders’
equity?

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 547

14. The treasury stock purchased in question 13 is resold by
Chen, Inc. for $15,000. What effect does this transaction
have on (a) net income, (b) total assets, (c) total paid-in
capital, and (d) total stockholders’ equity?

15. (a) What are the principal differences between common
stock and preferred stock?

(b) Preferred stock may be cumulative. Discuss this feature.
(c) How are dividends in arrears presented in the financial

statements?
16. Identify the events that result in credits and debits to

retained earnings.
17. Indicate how each of the following accounts should be

classified in the stockholders’ equity section.
(a) Common Stock.
(b) Paid-in Capital in Excess of Par Value.
(c) Retained Earnings.
(d) Treasury Stock.
(e) Paid-in Capital from Treasury Stock.
(f) Paid-in Capital in Excess of Stated Value.
(g) Preferred Stock.

18. What three conditions must exist before a cash dividend
is paid?

19. Three dates associated with Naperville Company’s cash
dividend are May 1, May 15, and May 31. Discuss the sig-
nificance of each date and give the entry at each date.

548 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

20. Contrast the effects of a cash dividend and a stock divi-
dend on a corporation’s balance sheet.

21. Mark Federia asks,“Since stock dividends don’t change any-
thing, why declare them?” What is your answer to Mark?

22. Fields Corporation has 20,000 shares of $10 par value
common stock outstanding when it announces a 2-for-1
stock split. Before the split, the stock had a market price of
$120 per share. After the split, how many shares of stock
will be outstanding? What will be the approximate market
price per share?

23. The board of directors is considering either a stock split or
a stock dividend. They understand that total stockholders’
equity will remain the same under either action. However,
they are not sure of the different effects of the two types of
actions on other aspects of stockholders’ equity. Explain
the differences to the directors.

24. What is a prior period adjustment, and how is it reported
in the financial statements?

25. What is the purpose of a retained earnings restriction?
Identify the possible causes of retained earnings restrictions.

*26. What is the formula for computing book value per share
when a corporation has only common stock?

*27. Alou Inc.’s common stock has a par value of $1, a book
value of $29, and a current market value of $15. Explain
why these amounts are all different.

BE11-1 Ron Child is studying for his accounting midterm examination. Identify for Ron the
advantages and disadvantages of the corporate form of business organization.

BE11-2 On May 10, Romano Corporation issues 1,000 shares of $10 par value common stock
for cash at $18 per share. Journalize the issuance of the stock.

BE11-3 On June 1, Herrera Inc. issues 3,000 shares of no-par common stock at a cash price of
$7 per share. Journalize the issuance of the shares assuming the stock has a stated value of $1 per
share.

BE11-4 Tara Inc.’s $10 par value common stock is actively traded at a market value of $16 per
share. Tara issues 5,000 shares to purchase land advertised for sale at $85,000. Journalize the
issuance of the stock in acquiring the land.

BE11-5 On July 1, Fritz Corporation purchases 500 shares of its $5 par value common stock for
the treasury at a cash price of $9 per share. On September 1, it sells 300 shares of the treasury
stock for cash at $11 per share. Journalize the two treasury stock transactions.

BE11-6 Ervay Inc. issues 5,000 shares of $100 par value preferred stock for cash at $120 per
share. Journalize the issuance of the preferred stock.

BE11-7 Chavez Corporation has 50,000 shares of common stock outstanding. It declares a $1
per share cash dividend on November 1 to stockholders of record on December 1. The dividend
is paid on December 31. Prepare the entries on the appropriate dates to record the declaration
and payment of the cash dividend.

BRIEF

EXERCISES

List the advantages and disad-
vantages of a corporation.

(SO 1)

Prepare entry for issuance of
par value common stock.

(SO 2)
Prepare entry for issuance of
no-par value common stock.

(SO 2)

Prepare entry for issuance of
stock in a noncash transaction.

(SO 2)

Prepare entries for treasury
stock transactions.

(SO 3)

Prepare entry for issuance of
preferred stock.

(SO 4)

Prepare entries for a cash
dividend.

(SO 5)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 548

BE11-8 Walters Corporation has 60,000 shares of $10 par value common stock outstanding. It
declares a 10% stock dividend on December 1 when the market value per share is $16. The divi-
dend shares are issued on December 31. Prepare the entries for the declaration and distribution
of the stock dividend.

BE11-9 The stockholders’ equity section of Martin Corporation consists of common stock
($10 par) $2,000,000 and retained earnings $300,000. A 10% stock dividend (20,000 shares) is
declared when the market value per share is $14. Show the before-and-after effects of the dividend
on the following.

(a) The components of stockholders’ equity.
(b) Shares outstanding.

BE11-10 For the year ending December 31, 2011, Mount Inc. reports net income $120,000 and
dividends $85,000. Prepare the retained earnings statement for the year assuming the balance in
retained earnings on January 1, 2011, was $220,000.

BE11-11 The balance in retained earnings on January 1, 2011, for Ola Smith Inc, was $800,000.
During the year, the corporation paid cash dividends of $90,000 and distributed a stock dividend
of $8,000. In addition, the company determined that it had understated its depreciation expense
in prior years by $50,000. Net income for 2011 was $150,000. Prepare the retained earnings state-
ment for 2011.

BE11-12 Ingram Corporation has the following accounts at December 31: Common Stock,
$10 par, 5,000 shares issued, $50,000; Paid-in Capital in Excess of Par Value $10,000; Retained
Earnings $45,000; and Treasury Stock—Common, 500 shares, $11,000. Prepare the stockholders’
equity section of the balance sheet.

*BE11-13 The balance sheet for Jimenez Inc. shows the following: total paid-in capital and re-
tained earnings $870,000, total stockholders’ equity $810,000, common stock issued 44,000
shares, and common stock outstanding 40,000 shares. Compute the book value per share.

Do it! Review 549

Prepare entries for a stock
dividend.

(SO 5)

Show before-and-after effects of
a stock dividend.

(SO 5)

Prepare a retained earnings
statement.

(SO 6)
Prepare a retained earnings
statement.
(SO 6)

Prepare stockholders’ equity
section.

(SO 7)
Compute book value per share.
(SO 9)

11-1 Indicate whether each of the following statements is true or false.

_____ 1. The corporation is an entity separate and distinct from its owners.
_____ 2. The liability of stockholders is normally limited to their investment in the corporation.
_____ 3. The relative lack of government regulation is an advantage of the corporate form of

business.
_____ 4. There is no journal entry to record the authorization of capital stock.
_____ 5. No-par value stock is quite rare today.

11-2 At the end of its first year of operation, Dade Corporation has $1,000,000 of
common stock and net income of $216,000. Prepare (a) the closing entry for net income and
(b) the stockholders’ equity section at year-end.

11-3 Caribbean Corporation began operations on April 1 by issuing 60,000 shares
of $5 par value common stock for cash at $13 per share. On April 19, it issued 2,000 shares of
common stock to attorneys in settlement of their bill of $27,500 for organization costs. Journalize
both issuances, assuming the stock is not publicly traded.

11-4 Chiapas Corporation purchased 2,000 shares of its $10 par value common stock
for $120,000 on August 1. It will hold these shares in the treasury until resold. On December 1,
the corporation sold 1,200 shares of treasury stock for cash at $72 per share. Journalize the trea-
sury stock transactions.

11-5 Mensa Corporation has 3,000 shares of 7%, $100 par value preferred stock out-
standing at December 31, 2011. At December 31, 2011, the company declared a $105,000 cash
dividend. Determine the dividend paid to preferred stockholders and common stockholders
under each of the scenarios on page 550.

Do it!
Do it!
Do it!
Do it!
Do it!

ReviewDo it!
Analyze statements about
corporate organization.

(SO 1)

Close net income and prepare
stockholders’ equity section.

(SO 1)

Journalize issuance of stock.

(SO 2)

Journalize treasury stock
transactions.

(SO 3)

Determine dividends paid
to preferred and common
stockholders.

(SO 5)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 549

1. The preferred stock is noncumulative, and the company has not missed any dividends in pre-
vious years.

2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the
two previous years.
3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two
previous years.

11-6 Riff CD Company has had 4 years of retained earnings. Due to this success,
the market price of its 400,000 shares of $3 par value common stock has increased from $12 per
share to $51. During this period, paid-in capital remained the same at $2,400,000. Retained earn-
ings increased from $1,800,000 to $12,000,000. CEO Josh Borke is considering either (1) a 15%
stock dividend or (2) a 2-for-1 stock split. He asks you to show the before-and-after effects of
each option on (a) retained earnings and (b) total stockholders’ equity.

11-7 Alpha Centuri Corporation has retained earnings of $3,100,000 on January 1,
2011. During the year, Alpha Centuri earned $1,200,000 of net income. It declared and paid a
$150,000 cash dividend. In 2011, Alpha Centuri recorded an adjustment of $110,000 due to the
overstatement (from mathematical error) of 2010 depreciation expense. Prepare a retained earn-
ings statement for 2011.

11-8 On January 1, 2011, Tuscany Corporation purchased 1,000 shares of treasury
stock. Other information regarding Tuscany Corporation is provided below.

2010 2011

Net income $200,000 $210,000
Dividends on preferred stock $ 30,000 $ 30,000
Dividends on common stock $ 20,000 $ 25,000
Weighted-average number of common shares outstanding 10,000 9,000
Common stockholders’ equity beginning of year $600,000 $750,000
Common stockholders’ equity end of year $750,000 $830,000

Compute (a) return on common stockholders’ equity for each year and (b) discuss the changes.
Do it!
Do it!
Do it!

550 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Compute return on stock-
holders’ equity and discuss
changes.

(SO 7)

Determine effects of stock
dividend and stock split.

(SO 5)
Prepare a retained earnings
statement.
(SO 6)

E11-1 Jeff Lynne has prepared the following list of statements about corporations.

1. A corporation is an entity separate and distinct from its owners.
2. As a legal entity, a corporation has most of the rights and privileges of a person.
3. Most of the largest U.S. corporations are privately held corporations.
4. Corporations may buy, own, and sell property; borrow money; enter into legally binding con-

tracts; and sue and be sued.
5. The net income of a corporation is not taxed as a separate entity.
6. Creditors have a legal claim on the personal assets of the owners of a corporation if the cor-

poration does not pay its debts.
7. The transfer of stock from one owner to another requires the approval of either the corpo-

ration or other stockholders.
8. The board of directors of a corporation legally owns the corporation.
9. The chief accounting officer of a corporation is the controller.

10. Corporations are subject to less state and federal regulations than partnerships or propri-
etorships.

Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.

E11-2 Jeff Lynne (see E11-1) has studied the information you gave him in that exercise and
has come to you with more statements about corporation.

1. Corporation management is both an advantage and a disadvantage of a corporation com-
pared to a proprietorship or a partnership.

EXERCISES

Identify characteristics of a
corporation.

(SO 1)
Identify characteristics of a
corporation.

(SO 1, 2)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 550

2. Limited liability of stockholders, government regulations, and additional taxes are the major
disadvantages of a corporation.

3. When a corporation is formed, organization costs are recorded as an asset.
4. Each share of common stock gives the stockholder the ownership rights to vote at stock-

holder meetings, share in corporate earnings, keep the same percentage ownership when
new shares of stock are issued, and share in assets upon liquidation.

5. The number of issued shares is always greater than or equal to the number of authorized
shares.

6. A journal entry is required for the authorization of capital stock.
7. Publicly held corporations usually issue stock directly to investors.
8. The trading of capital stock on a securities exchange involves the transfer of already issued

shares from an existing stockholder to another investor.
9. The market value of common stock is usually the same as its par value.

10. Retained earnings is the total amount of cash and other assets paid in to the corporation by
stockholders in exchange for capital stock.

Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.

E11-3 During its first year of operations, Klumpe Corporation had the following transactions
pertaining to its common stock.

Jan. 10 Issued 70,000 shares for cash at $5 per share.
July 1 Issued 40,000 shares for cash at $8 per share.

Instructions
(a) Journalize the transactions, assuming that the common stock has a par value of $5 per share.
(b) Journalize the transactions, assuming that the common stock is no-par with a stated value of

$1 per share.

E11-4 Grossman Corporation issued 1,000 shares of stock.

Instructions
Prepare the entry for the issuance under the following assumptions.

(a) The stock had a par value of $5 per share and was issued for a total of $52,000.
(b) The stock had a stated value of $5 per share and was issued for a total of $52,000.
(c) The stock had no par or stated value and was issued for a total of $52,000.
(d) The stock had a par value of $5 per share and was issued to attorneys for services during

incorporation valued at $52,000.
(e) The stock had a par value of $5 per share and was issued for land worth $52,000.

E11-5 Mad City Corporation purchased from its stockholders 5,000 shares of its own previ-
ously issued stock for $250,000. It later resold 2,000 shares for $54 per share, then 2,000 more
shares for $49 per share, and finally 1,000 shares for $40 per share.

Instructions
Prepare journal entries for the purchase of the treasury stock and the three sales of treasury
stock.

E11-6 AI Corporation issued 100,000 shares of $20 par value, cumulative, 8% preferred stock
on January 1, 2009, for $2,100,000. In December 2011, AI declared its first dividend of $500,000.

Instructions
(a) Prepare AI’s journal entry to record the issuance of the preferred stock.
(b) If the preferred stock is not cumulative, how much of the $500,000 would be paid to common

stockholders?

E11-7 Garza Co. had the following transactions during the current period.

Mar. 2 Issued 5,000 shares of $1 par value common stock to attorneys in payment of a bill for
$30,000 for services provided in helping the company to incorporate.

June 12 Issued 60,000 shares of $1 par value common stock for cash of $375,000.
July 11 Issued 1,000 shares of $100 par value preferred stock for cash at $110 per share.
Nov. 28 Purchased 2,000 shares of treasury stock for $80,000.

Exercises 551

Journalize issuance of common
stock.

(SO 2)
Journalize issuance of common
stock.
(SO 2)
Journalize treasury stock
transactions.
(SO 3)

Differentiate between preferred
and common stock.

(SO 4)

Journalize issuance of common
and preferred stock and
purchase of treasury stock.

(SO 2, 3, 4)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 551

Instructions
Journalize the transactions shown on the preceding page.

E11-8 As an auditor for the CPA firm of Agler and Carl, you encounter the following situa-
tions in auditing different clients.

1. Desi Corporation is a closely held corporation whose stock is not publicly traded. On
December 5, the corporation acquired land by issuing 5,000 shares of its $20 par value com-
mon stock. The owners’ asking price for the land was $120,000, and the fair market value of
the land was $110,000.

2. Lucille Corporation is a publicly held corporation whose common stock is traded on the
securities markets. On June 1, it acquired land by issuing 20,000 shares of its $10 par value
stock. At the time of the exchange, the land was advertised for sale at $250,000. The stock was
selling at $11 per share.

Instructions
Prepare the journal entries for each of the situations above.

E11-9 On January 1, 2011, the stockholders’ equity section of Rowen Corporation shows:
common stock ($5 par value) $1,500,000; paid-in capital in excess of par value $1,000,000; and re-
tained earnings $1,200,000. During the year, the following treasury stock transactions occurred.

Mar. 1 Purchased 50,000 shares for cash at $16 per share.
July 1 Sold 10,000 treasury shares for cash at $17 per share.
Sept. 1 Sold 8,000 treasury shares for cash at $15 per share.

Instructions
(a) Journalize the treasury stock transactions.
(b) Restate the entry for September 1, assuming the treasury shares were sold at $13 per share.

E11-10 Tinker Corporation is authorized to issue both preferred and common stock. The par
value of the preferred is $50. During the first year of operations, the company had the following
events and transactions pertaining to its preferred stock.

Feb. 1 Issued 20,000 shares for cash at $51 per share.
July 1 Issued 10,000 shares for cash at $57 per share.

Instructions
(a) Journalize the transactions.
(b) Post to the stockholders’ equity accounts.
(c) Indicate the financial statement presentation of the related accounts.

E11-11 The stockholders’ equity section of Lumley Corporation at December 31 is as follows.

LUMLEY CORPORATION
Balance Sheet (partial)

Paid-in capital
Preferred stock, cumulative, 10,000 shares authorized, 6,000 shares issued

and outstanding $ 600,000
Common stock, no par, 750,000 shares authorized, 600,000 shares issued 1,200,000

Total paid-in capital 1,800,000
Retained earnings 1,858,000

Total paid-in capital and retained earnings 3,658,000
Less: Treasury stock (12,000 common shares) 64,000

Total stockholders’ equity $3,594,000

Instructions
From a review of the stockholders’ equity section, as chief accountant, write a memo

to the president of the company answering the following questions.
(a) How many shares of common stock are outstanding?
(b) Assuming there is a stated value, what is the stated value of the common stock?
(c) What is the par value of the preferred stock?
(d) If the annual dividend on preferred stock is $30,000, what is the dividend rate on preferred stock?
(e) If dividends of $60,000 were in arrears on preferred stock, what would be the balance in

Retained Earnings?

552 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Journalize noncash common
stock transactions.

(SO 2)
Journalize treasury stock
transactions.
(SO 3)

Journalize preferred stock
transactions and indicate
statement presentation.

(SO 4, 7)

Answer questions about
stockholders’ equity section.

(SO 2, 3, 4, 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 552

E11-12 Flores Corporation recently hired a new accountant with extensive experience in ac-
counting for partnerships. Because of the pressure of the new job, the accountant was unable to
review his textbooks on the topic of corporation accounting. During the first month, the account-
ant made the following entries for the corporation’s capital stock.

May 2 Cash 120,000
Capital Stock 120,000

(Issued 10,000 shares of $10 par value
common stock at $12 per share)

10 Cash 600,000
Capital Stock 600,000

(Issued 10,000 shares of $50 par value
preferred stock at $60 per share)

15 Capital Stock 14,000
Cash 14,000

(Purchased 1,000 shares of common stock
for the treasury at $14 per share)

31 Cash 8,000
Capital Stock 5,000
Gain on Sale of Stock 3,000

(Sold 500 shares of treasury stock at $16
per share)

Instructions
On the basis of the explanation for each entry, prepare the entry that should have been made for
the capital stock transactions.

E11-13 On January 1, Armada Corporation had 95,000 shares of no-par common stock issued
and outstanding. The stock has a stated value of $5 per share. During the year, the following
occurred.

Apr. 1 Issued 15,000 additional shares of common stock for $17 per share.
June 15 Declared a cash dividend of $1 per share to stockholders of record on June 30.
July 10 Paid the $1 cash dividend.
Dec. 1 Issued 2,000 additional shares of common stock for $19 per share.
Dec. 15 Declared a cash dividend on outstanding shares of $1.20 per share to stockholders of

record on December 31.

Instructions
(a) Prepare the entries, if any, on each of the three dividend dates.
(b) How are dividends and dividends payable reported in the financial statements prepared at

December 31?

E11-14 On January 1, 2011, Abdella Corporation had $1,000,000 of common stock outstand-
ing that was issued at par. It also had retained earnings of $750,000. The company issued 60,000
shares of common stock at par on July 1 and earned net income of $400,000 for the year.

Instructions
Journalize the declaration of a 15% stock dividend on December 10, 2011, for the following in-
dependent assumptions.

1. Par value is $10, and market value is $18.
2. Par value is $5, and market value is $20.

E11-15 On October 31, the stockholders’ equity section of Omar Company consists of com-
mon stock $600,000 and retained earnings $900,000. Omar is considering the following two
courses of action: (1) declaring a 5% stock dividend on the 60,000, $10 par value shares outstand-
ing, or (2) effecting a 2-for-1 stock split that will reduce par value to $5 per share. The current
market price is $14 per share.

Instructions
Prepare a tabular summary of the effects of the alternative actions on the components of stock-
holders’ equity and outstanding shares. Use the following column headings: Before Action, After
Stock Dividend, and After Stock Split.

Exercises 553

Prepare correct entries for
capital stock transactions.

(SO 2, 3, 4)

Journalize cash dividends;
indicate statement presentation.

(SO 5)

Journalize stock dividends.

(SO 5)

Compare effects of a stock
dividend and a stock split.

(SO 5)

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E11-16 Before preparing financial statements for the current year, the chief accountant for
Springer Company discovered the following errors in the accounts.

1. The declaration and payment of $50,000 cash dividend was recorded as a debit to Interest
Expense $50,000 and a credit to Cash $50,000.

2. A 10% stock dividend (1,000 shares) was declared on the $10 par value stock when the
market value per share was $16. The only entry made was: Retained Earnings (Dr.) $10,000
and Dividends Payable (Cr.) $10,000. The shares have not been issued.

3. A 4-for-1 stock split involving the issue of 400,000 shares of $5 par value common stock for
100,000 shares of $20 par value common stock was recorded as a debit to Retained Earnings
$2,000,000 and a credit to Common Stock $2,000,000.

Instructions
Prepare the correcting entries at December 31.

E11-17 On January 1, 2011, Castle Corporation had retained earnings of $550,000. During the
year, Castle had the following selected transactions.

1. Declared cash dividends of $120,000.
2. Corrected overstatement of 2010 net income because of depreciation error $30,000.
3. Earned net income of $350,000.
4. Declared stock dividends of $80,000.

Instructions
Prepare a retained earnings statement for the year.

E11-18 Sasha Company reported retained earnings at December 31, 2010, of $310,000. Sasha
had 200,000 shares of common stock outstanding throughout 2011.

The following transactions occurred during 2011.

1. An error was discovered: in 2009, depreciation expense was recorded at $70,000, but the cor-
rect amount was $50,000.

2. A cash dividend of $0.50 per share was declared and paid.
3. A 5% stock dividend was declared and distributed when the market price per share was $15

per share.
4. Net income was $285,000.

Instructions
Prepare a retained earnings statement for 2011.

E11-19 The ledger of O’Dell Corporation contains the following accounts: Common Stock,
Preferred Stock, Treasury Stock—Common, Paid-in Capital in Excess of Par Value—Preferred
Stock, Paid-in Capital in Excess of Stated Value—Common Stock, Paid-in Capital from Treasury
Stock, and Retained Earnings.

Instructions
Classify each account using the following table headings.

Paid-in Capital

Capital Retained
Account Stock Additional Earnings Other

E11-20 The following accounts appear in the ledger of Tiger Inc. after the books are closed at
December 31.

Common Stock, no par, $1 stated value, 400,000 shares authorized;
300,000 shares issued $ 300,000

Common Stock Dividends Distributable 60,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,200,000
Preferred Stock, $5 par value, 8%, 40,000 shares authorized;

30,000 shares issued 150,000
Retained Earnings 700,000
Treasury Stock (10,000 common shares) 74,000
Paid-in Capital in Excess of Par Value—Preferred Stock 344,000

554 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Prepare correcting entries for
dividends and a stock split.

(SO 5)
Prepare a retained earnings
statement.
(SO 6)
Prepare a retained earnings
statement.
(SO 6)

Classify stockholders’ equity
accounts.

(SO 7)

Prepare a stockholders’ equity
section.

(SO 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 554

Instructions
Prepare the stockholders’ equity section at December 31, assuming retained earnings is re-
stricted for plant expansion in the amount of $100,000.

E11-21 Kelly Groucutt Company reported the following balances at December 31, 2010: com-
mon stock $400,000; paid-in capital in excess of par value $100,000; retained earnings $250,000.
During 2011, the following transactions affected stockholder’s equity.

1. Issued preferred stock with a par value of $125,000 for $200,000.
2. Purchased treasury stock (common) for $40,000.
3. Earned net income of $140,000.
4. Declared and paid cash dividends of $56,000.

Instructions
Prepare the stockholders’ equity section of Kelly Groucutt Company’s December 31, 2011, balance
sheet.

E11-22 In 2011, Mike Singletary Corporation had net sales of $600,000 and cost of goods sold
of $360,000. Operating expenses were $153,000, and interest expense was $7,500. The corpora-
tion’s tax rate is 30%. The corporation declared preferred dividends of $15,000 in 2011, and its
average common stockholders’ equity during the year was $200,000.

Instructions
(a) Prepare an income statement for Mike Singletary Corporation.
(b) Compute Mike Singletary Corporation’s return on common stockholders’ equity for 2011.

*E11-23 In a recent year, the stockholders’ equity section of Aluminum Company of America
(Alcoa) showed the following (in alphabetical order): additional paid-in capital $6,101, common
stock $925, preferred stock $56, retained earnings $7,428, and treasury stock $2,828. All dollar
data are in millions.

The preferred stock has 557,740 shares authorized, with a par value of $100 and an annual $3.75
per share cumulative dividend preference. At December 31, 557,649 shares of preferred are issued
and 546,024 shares are outstanding. There are 1.8 billion shares of $1 par value common stock
authorized, of which 924.6 million are issued and 844.8 million are outstanding at December 31.

Instructions
(a) Prepare the stockholders’ equity section, including disclosure of all relevant data.
(b) Compute the book value per share of common stock, assuming there are no preferred divi-

dends in arrears. (Round to two decimals.)

*E11-24 At December 31, Missouri Corporation has total stockholders’ equity of $3,000,000.
Included in this total are preferred stock $500,000 and paid-in capital in excess of par value—
preferred stock $50,000. There are 10,000 shares of $50 par value 10% cumulative preferred
stock outstanding. At year-end, 200,000 shares of common stock are outstanding.

Instructions
Compute the book value per share of common stock, under each of the following assumptions.

(a) There are no preferred dividends in arrears, and the preferred stock does not have a call price.
(b) Preferred dividends are one year in arrears, and the preferred stock has a call price of $60 per

share.

*E11-25 On October 1, Chile Corporation’s stockholders’ equity is as follows.

Common stock, $5 par value $200,000
Paid-in capital in excess of par value 25,000
Retained earnings 75,000

Total stockholders’ equity $300,000

On October 1, Chile declares and distributes a 10% stock dividend when the market value of the
stock is $15 per share.

Instructions
(a) Compute the book value per share (1) before the stock dividend and (2) after the stock

dividend. (Round to two decimals.)
(b) Indicate the balances in the three stockholders’ equity accounts after the stock dividend

shares have been distributed.

Exercises 555

Prepare stockholders’ equity
section.
(SO 7)

Prepare an income statement
and compute return on
stockholders’ equity.

(SO 7)
Prepare a stockholders’ equity
section.

(SO 7, 9)

Compute book value per share
with preferred stock.

(SO 4, 9)

Compute book value per share;
indicate account balances after
a stock dividend.

(SO 5, 7, 9)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 555

556 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Exercise Set B and a set of Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

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PROBLEMS: SET A

P11-1A Hayslett Corporation was organized on January 1, 2011. It is authorized to issue
20,000 shares of 6%, $50 par value preferred stock, and 500,000 shares of no-par common stock
with a stated value of $2 per share. The following stock transactions were completed during the
first year.

Jan. 10 Issued 100,000 shares of common stock for cash at $3 per share.
Mar. 1 Issued 10,000 shares of preferred stock for cash at $55 per share.
Apr. 1 Issued 25,000 shares of common stock for land. The asking price of the land was

$90,000. The company’s estimate of the fair market value of the land was $85,000.
May 1 Issued 75,000 shares of common stock for cash at $4 per share.
Aug. 1 Issued 10,000 shares of common stock to attorneys in payment of their bill for $50,000

for services provided in helping the company organize.
Sept. 1 Issued 5,000 shares of common stock for cash at $6 per share.
Nov. 1 Issued 2,000 shares of preferred stock for cash at $58 per share.

Instructions
(a) Journalize the transactions.
(b) Post to the stockholders’ equity accounts. (Use J1 as the posting reference.)
(c) Prepare the paid-in capital section of stockholders’ equity at December 31, 2011.

P11-2A Greeve Corporation had the following stockholders’ equity accounts on January 1,
2011: Common Stock ($1 par) $400,000, Paid-in Capital in Excess of Par Value $500,000, and
Retained Earnings $100,000. In 2011, the company had the following treasury stock transactions.

Mar. 1 Purchased 5,000 shares at $7 per share.
June 1 Sold 1,000 shares at $10 per share.
Sept. 1 Sold 2,000 shares at $9 per share.
Dec. 1 Sold 1,000 shares at $5 per share.

Greeve Corporation uses the cost method of accounting for treasury stock. In 2011, the company
reported net income of $60,000.

Instructions
(a) Journalize the treasury stock transactions, and prepare the closing entry at December 31,

2011, for net income.
(b) Open accounts for (1) Paid-in Capital from Treasury Stock, (2) Treasury Stock, and

(3) Retained Earnings. Post to these accounts using J12 as the posting reference.
(c) Prepare the stockholders’ equity section for Greeve Corporation at December 31, 2011.

P11-3A The stockholders’ equity accounts of Jajoo Corporation on January 1, 2011, were as
follows.

Preferred Stock (10%, $100 par noncumulative, 5,000 shares authorized) $ 300,000
Common Stock ($5 stated value, 300,000 shares authorized) 1,000,000
Paid-in Capital in Excess of Par Value—Preferred Stock 20,000
Paid-in Capital in Excess of Stated Value—Common Stock 425,000
Retained Earnings 488,000
Treasury Stock—Common (5,000 shares) 40,000

During 2011, the corporation had the following transactions and events pertaining to its stock-
holders’ equity.

Journalize stock transactions,
post, and prepare paid-in
capital section.

(SO 2, 4, 7)

Journalize and post treasury
stock transactions, and prepare
stockholders’ equity section.

(SO 3, 7)

Journalize and post
transactions, prepare
stockholders’ equity section.

(SO 2, 3, 4, 7, 9)

(b) Treasury Stock $7,000
(c) Total stockholders’ equity

$1,058,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 556

Feb. 1 Issued 3,000 shares of common stock for $25,000.
Mar. 20 Purchased 1,500 additional shares of common treasury stock at $8 per share.
June 14 Sold 4,000 shares of treasury stock—common for $36,000.
Sept. 3 Issued 2,000 shares of common stock for a patent valued at $17,000.
Dec. 31 Determined that net income for the year was $340,000.

Instructions
(a) Journalize the transactions and the closing entry for net income.
(b) Enter the beginning balances in the accounts and post the journal entries to the stockholders’

equity accounts. (Use J1 as the posting reference.)
(c) Prepare a stockholders’ equity section at December 31, 2011.

P11-4A On January 1, 2011, Galactica Corporation had the following stockholders’ equity
accounts.

Common Stock ($20 par value, 60,000 shares issued and
outstanding) $1,200,000

Paid-in Capital in Excess of Par Value 200,000
Retained Earnings 500,000

During the year, the following transactions occurred.

Feb. 1 Declared a $1 cash dividend per share to stockholders of record on February 15,
payable March 1.

Mar. 1 Paid the dividend declared in February.
Apr. 1 Announced a 5-for-1 stock split. Prior to the split, the market price per share was $35.
July 1 Declared a 5% stock dividend to stockholders of record on July 15, distributable July

31. On July 1, the market price of the stock was $7 per share.
July 31 Issued the shares for the stock dividend.
Dec. 1 Declared a $0.50 per share dividend to stockholders of record on December 15,

payable January 5, 2012.
31 Determined that net income for the year was $380,000.

Instructions
(a) Journalize the transactions and closing entries.
(b) Enter the beginning balances and post the entries to the stockholders’ equity accounts.

(Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.

P11-5A The ledger of Nakona Corporation at December 31, 2011, after the books have been
closed, contains the following stockholders’ equity accounts.

Preferred Stock (10,000 shares issued) $1,000,000
Common Stock (400,000 shares issued) 2,000,000
Paid-in Capital in Excess of Par Value—Preferred 200,000
Paid-in Capital in Excess of Stated Value—Common 1,100,000
Common Stock Dividends Distributable 200,000
Retained Earnings 2,365,000

A review of the accounting records reveals the following.

1. No errors have been made in recording 2011 transactions or in preparing the closing entry for
net income.

2. Preferred stock is 8%, $100 par value, noncumulative, and callable at $125. Since January 1,
2010, 10,000 shares have been outstanding; 20,000 shares are authorized.

3. Common stock is no-par with a stated value of $5 per share; 600,000 shares are authorized.
4. The January 1 balance in Retained Earnings was $2,450,000.
5. On October 1, 100,000 shares of common stock were sold for cash at $8 per share.
6. A cash dividend of $600,000 was declared and properly allocated to preferred and common

stock on November 1. No dividends were paid to preferred stockholders in 2010.
7. On December 31, a 10% common stock dividend was declared out of retained earnings on

common stock when the market price per share was $7.

Problems: Set A 557

Prepare dividend entries and
stockholders’ equity section.

(SO 5, 7)

Prepare retained earnings state-
ment and stockholders’ equity
section, and compute earnings
per share.

(SO 5, 6, 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 557

8. Net income for the year was $795,000.
9. On December 31, 2011, the directors authorized disclosure of a $100,000 restriction of retained

earnings for plant expansion. (Use Note A.)

Instructions
(a) Reproduce the Retained Earnings account (T account) for the year.
(b) Prepare a retained earnings statement for the year.
(c) Prepare a stockholders’ equity section at December 31.
(d) Compute the earnings per share of common stock using 325,000 as the weighted-average

shares outstanding for the year.
(e) Compute the allocation of the cash dividend to preferred and common stock.

P11-6A Arnold Corporation has been authorized to issue 40,000 shares of $100 par value, 8%,
noncumulative preferred stock and 2,000,000 shares of no-par common stock. The corporation
assigned a $5 stated value to the common stock. At December 31, 2011, the ledger contained the
following balances pertaining to stockholders’ equity.

Preferred Stock $ 240,000
Paid-in Capital in Excess of Par Value—Preferred 56,000
Common Stock 2,000,000
Paid-in Capital in Excess of Stated Value—Common 5,700,000
Treasury Stock—Common (1,000 shares) 22,000
Paid-in Capital from Treasury Stock 3,000
Retained Earnings 560,000

The preferred stock was issued for land having a fair market value of $296,000. All common stock
issued was for cash. In November, 1,500 shares of common stock were purchased for the treasury
at a per share cost of $22. In December, 500 shares of treasury stock were sold for $28 per share.
No dividends were declared in 2011.

Instructions
(a) Prepare the journal entries for the:

(1) Issuance of preferred stock for land.
(2) Issuance of common stock for cash.
(3) Purchase of common treasury stock for cash.
(4) Sale of treasury stock for cash.

(b) Prepare the stockholders’ equity section at December 31, 2011.

P11-7A On January 1, 2011, Snider Corporation had the following stockholders’ equity
accounts.

Common Stock ($10 par value, 90,000 shares issued and
outstanding) $900,000

Paid-in Capital in Excess of Par Value 200,000
Retained Earnings 540,000

During the year, the following transactions occurred.

Jan. 15 Declared a $1 cash dividend per share to stockholders of record on January 31, payable
February 15.

Feb. 15 Paid the dividend declared in January.
Apr. 15 Declared a 10% stock dividend to stockholders of record on April 30, distributable

May 15. On April 15, the market price of the stock was $15 per share.
May 15 Issued the shares for the stock dividend.
July 1 Announced a 2-for-1 stock split. The market price per share prior to the announcement

was $17. (The new par value is $5.)
Dec. 1 Declared a $0.50 per share cash dividend to stockholders of record on December 15,

payable January 10, 2012.
31 Determined that net income for the year was $250,000.

Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts.

(Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.

558 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Prepare entries for stock
transactions and stockholders’
equity section.

(SO 2, 3, 4, 7)
Prepare dividend entries and
stockholders’ equity section.
(SO 5, 7)

(b) Retained earnings
$2,365,000

(b) Total stockholders’ equity
$8,537,000

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 558

*P11-8A The following stockholders’ equity accounts arranged alphabetically are in the ledger
of McGrath Corporation at December 31, 2011.

Common Stock ($10 stated value) $1,500,000
Paid-in Capital from Treasury Stock 6,000
Paid-in Capital in Excess of Stated Value—Common Stock 690,000
Paid-in Capital in Excess of Par Value—Preferred Stock 288,400
Preferred Stock (8%, $100 par, noncumulative) 400,000
Retained Earnings 776,000
Treasury Stock—Common (8,000 shares) 88,000

Instructions
(a) Prepare a stockholders’ equity section at December 31, 2011.
(b) Compute the book value per share of the common stock, assuming the preferred stock has a

call price of $110 per share.

*P11-9A On January 1, 2011, Hamblin Inc. had the following stockholders’ equity balances.

Common Stock (500,000 shares issued) $1,000,000
Paid-in Capital in Excess of Par Value 500,000
Common Stock Dividends Distributable 100,000
Retained Earnings 600,000

During 2011, the following transactions and events occurred.

1. Issued 50,000 shares of $2 par value common stock as a result of 10% stock dividend declared
on December 15, 2010.

2. Issued 30,000 shares of common stock for cash at $5 per share.
3. Purchased 25,000 shares of common stock for the treasury at $6 per share.
4. Declared and paid a cash dividend of $111,000.
5. Sold 8,000 shares of treasury stock for cash at $6 per share.
6. Earned net income of $360,000.

Instructions
Prepare a stockholders’ equity statement for the year.

Problems: Set B 559

Prepare stockholders’ equity
section; compute book value
per share.

(SO 7, 9)

Prepare stockholders’ equity
statement.

(SO 8)

Total stockholders’ equity
$3,572,400

Total stockholders’ equity
$2,497,000

P11-1B Keeler Corporation was organized on January 1, 2011. It is authorized to issue 10,000
shares of 8%, $100 par value preferred stock, and 500,000 shares of no-par common stock with a
stated value of $3 per share. The following stock transactions were completed during the first year.

Jan. 10 Issued 80,000 shares of common stock for cash at $4 per share.
Mar. 1 Issued 5,000 shares of preferred stock for cash at $105 per share.
Apr. 1 Issued 24,000 shares of common stock for land. The asking price of the land was

$90,000. The fair market value of the land was $85,000.
May 1 Issued 80,000 shares of common stock for cash at $4.50 per share.
Aug. 1 Issued 10,000 shares of common stock to attorneys in payment of their bill of $40,000

for services provided in helping the company organize.
Sept. 1 Issued 10,000 shares of common stock for cash at $5 per share.
Nov. 1 Issued 1,000 shares of preferred stock for cash at $109 per share.

Instructions
(a) Journalize the transactions.
(b) Post to the stockholders’ equity accounts. (Use J5 as the posting reference.)
(c) Prepare the paid-in capital section of stockholders’ equity at December 31, 2011.

P11-2B Goldberg Corporation had the following stockholders’ equity accounts on January 1,
2011: Common Stock ($5 par) $500,000, Paid-in Capital in Excess of Par Value $200,000, and
Retained Earnings $100,000. In 2011, the company had the following treasury stock transactions.

Mar. 1 Purchased 5,000 shares at $8 per share.
June 1 Sold 1,000 shares at $12 per share.
Sept. 1 Sold 2,000 shares at $10 per share.
Dec. 1 Sold 1,000 shares at $6 per share.

PROBLEMS: SET B

Journalize stock transactions,
post, and prepare paid-in
capital section.
(SO 2, 4, 7)

Journalize and post treasury
stock transactions, and prepare
stockholders’ equity section.
(SO 3, 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 559

Goldberg Corporation uses the cost method of accounting for treasury stock. In 2011, the com-
pany reported net income of $40,000.

Instructions
(a) Journalize the treasury stock transactions, and prepare the closing entry at December 31,
2011, for net income.
(b) Open accounts for (1) Paid-in Capital from Treasury Stock, (2) Treasury Stock, and

(3) Retained Earnings. Post to these accounts using J10 as the posting reference.
(c) Prepare the stockholders’ equity section for Goldberg Corporation at December 31, 2011.

P11-3B The stockholders’ equity accounts of Port Corporation on January 1, 2011, were as
follows.

Preferred Stock (8%, $50 par cumulative, 10,000 shares authorized) $ 400,000
Common Stock ($1 stated value, 2,000,000 shares authorized) 1,000,000
Paid-in Capital in Excess of Par Value—Preferred Stock 100,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,450,000
Retained Earnings 1,816,000
Treasury Stock—Common (10,000 shares) 40,000

During 2011, the corporation had the following transactions and events pertaining to its stock-
holders’ equity.

Feb. 1 Issued 25,000 shares of common stock for $100,000.
Apr. 14 Sold 6,000 shares of treasury stock—common for $33,000.
Sept. 3 Issued 5,000 shares of common stock for a patent valued at $30,000.
Nov. 10 Purchased 1,000 shares of common stock for the treasury at a cost of $6,000.
Dec. 31 Determined that net income for the year was $452,000.

No dividends were declared during the year.

Instructions
(a) Journalize the transactions and the closing entry for net income.
(b) Enter the beginning balances in the accounts, and post the journal entries to the stock hold-

ers’ equity accounts. (Use J5 for the posting reference.)
(c) Prepare a stockholders’ equity section at December 31, 2011, including the disclosure of the

preferred dividends in arrears.

P11-4B On January 1, 2011, Argentina Corporation had the following stockholders’ equity
accounts.

Common Stock ($20 par value, 75,000 shares issued and
outstanding) $1,500,000

Paid-in Capital in Excess of Par Value 200,000
Retained Earnings 600,000

During the year, the following transactions occurred.
Feb. 1 Declared a $1 cash dividend per share to stockholders of record on February 15,
payable March 1.

Mar. 1 Paid the dividend declared in February.
Apr. 1 Announced a 2-for-1 stock split. Prior to the split, the market price per share was $36.
July 1 Declared a 10% stock dividend to stockholders of record on July 15, distributable

July 31. On July 1, the market price of the stock was $13 per share.
31 Issued the shares for the stock dividend.

Dec. 1 Declared a $0.50 per share dividend to stockholders of record on December 15,
payable January 5, 2012.

31 Determined that net income for the year was $350,000.

Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts.
(Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.

560 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

(b) Treasury Stock $8,000

Journalize and post
transactions, prepare
stockholders’ equity section.
(SO 2, 3, 4, 7, 9)
Prepare dividend entries and
stockholders’ equity section.
(SO 5, 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 560

P11-5B On December 31, 2010, Bradstrom Company had 1,500,000 shares of $10 par common
stock issued and outstanding. The stockholders’ equity accounts at December 31, 2010, had the
following balances.

Common Stock $15,000,000
Additional Paid-in Capital 1,500,000
Retained Earnings 900,000

Transactions during 2011 and other information related to stockholders’ equity accounts were as
follows.

1. On January 10, 2011, Bradstrom issued at $105 per share 100,000 shares of $100 par value, 7%
cumulative preferred stock.

2. On February 8, 2011, Bradstrom reacquired 15,000 shares of its common stock for $16 per
share.

3. On June 8, 2011, Bradstrom declared a cash dividend of $1 per share on the common stock
outstanding, payable on July 10, 2011, to stockholders of record on July 1, 2011.

4. On December 15, 2011, Bradstrom declared the yearly cash dividend on preferred stock,
payable January 10, 2012, to stockholders of record on December 15, 2011.

5. Net income for the year is $3,600,000.
6. It was discovered that depreciation expense had been overstated in 2010 by $80,000.

Instructions
(a) Prepare a retained earnings statement for the year ended December 31, 2011.
(b) Prepare the stockholders’ equity section of Bradstrom’s balance sheet at December 31, 2011.

P11-6B The post-closing trial balance of Chen Corporation at December 31, 2011, contains
the following stockholders’ equity accounts.

Preferred Stock (15,000 shares issued) $ 750,000
Common Stock (250,000 shares issued) 2,500,000
Paid-in Capital in Excess of Par Value—Preferred 250,000
Paid-in Capital in Excess of Par Value—Common 400,000
Common Stock Dividends Distributable 250,000
Retained Earnings 902,000

A review of the accounting records reveals the following.

1. No errors have been made in recording 2011 transactions or in preparing the closing entry
for net income.

2. Preferred stock is $50 par, 8%, and cumulative; 15,000 shares have been outstanding since
January 1, 2010.

3. Authorized stock is 20,000 shares of preferred, 500,000 shares of common with a $10 par
value.

4. The January 1 balance in Retained Earnings was $1,170,000.
5. On July 1, 20,000 shares of common stock were sold for cash at $16 per share.
6. On September 1, the company discovered an understatement error of $90,000 in computing

depreciation in 2010. The net of tax effect of $63,000 was properly debited directly to
Retained Earnings.

7. A cash dividend of $250,000 was declared and properly allocated to preferred and common
stock on October 1. No dividends were paid to preferred stockholders in 2010.

8. On December 31, a 10% common stock dividend was declared out of retained earnings on
common stock when the market price per share was $18.

9. Net income for the year was $495,000.
10. On December 31, 2011, the directors authorized disclosure of a $200,000 restriction of re-

tained earnings for plant expansion. (Use Note X.)

Instructions
(a) Reproduce the Retained Earnings account for the year.
(b) Prepare a retained earnings statement for the year.
(c) Prepare a stockholders’ equity section at December 31.
(d) Compute the earnings per share of common stock using 240,000 as the weighted-average

shares outstanding for the year.
(e) Compute the allocation of the cash dividend to preferred and common stock.

Problems: Set B 561

(b) Retained earnings
$902,000

(b) Total stockholders’ equity
$29,155,000

Prepare retained earnings state-
ment and stockholders’ equity
section.

(SO 6, 7)

Prepare retained earnings state-
ment and stockholders’ equity
section, and compute earnings
per share.
(SO 5, 6, 7)

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 561

*P11-7B The following stockholders’ equity accounts arranged alphabetically are in the ledger
of Rizzo Corporation at December 31, 2011.

Common Stock ($5 stated value) $2,500,000
Paid-in Capital from Treasury Stock 10,000
Paid-in Capital in Excess of Stated Value—Common Stock 1,600,000
Paid-in Capital in Excess of Par Value—Preferred Stock 679,000
Preferred Stock (8%, $50 par, noncumulative) 800,000
Retained Earnings 1,448,000
Treasury Stock—Common (10,000 shares) 130,000

Instructions
(a) Prepare a stockholders’ equity section at December 31, 2011.
(b) Compute the book value per share of the common stock, assuming the preferred stock has a

call price of $60 per share.

562 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Prepare stockholders’ equity
section; compute book value
per share.
(SO 7, 9)

Total stockholders’ equity
$6,907,000

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set C.

PROBLEMS: SET C ww
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CP11-1 Hiatt Corporation’s balance sheet at December 31, 2010, is presented below.

HIATT CORPORATION
Balance Sheet

December 31, 2010

Cash $ 24,600 Accounts payable $ 25,600
Accounts receivable 45,500 Common stock ($10 par) 80,000
Allowance for doubtful Retained earnings 127,400

accounts (1,500)

$233,000

Supplies 4,400
Land 40,000
Building 142,000
Accumulated depreciation-

building (22,000)

$233,000

During 2011, the following transactions occurred.

1. On January 1, 2011, Hiatt issued 1,500 shares of $20 par, 7% preferred stock for $33,000.
2. On January 1, 2011, Hiatt also issued 900 shares of the $10 par value common stock for

$21,000.
3. Hiatt performed services for $280,000 on account.
4. On April 1, 2011, Hiatt collected fees of $36,000 in advance for services to be performed

from April 1, 2011, to March 31, 2012.
5. Hiatt collected $267,000 from customers on account.
6. Hiatt bought $35,100 of supplies on account.
7. Hiatt paid $32,200 on accounts payable.
8. Hiatt reacquired 400 shares of its common stock on June 1, 2011, for $38 per share.
9. Paid other operating expenses of $188,200.

10. On December 31, 2011, Hiatt declared the annual preferred stock dividend and a $1.20 per
share dividend on the outstanding common stock, all payable on January 15, 2012.

11. An account receivable of $1,300 which originated in 2010 is written off as uncollectible.

COMPREHENSIVE PROBLEM

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Financial Reporting Problem: PepsiCo, Inc.
BYP11-1 The stockholders’ equity section for PepsiCo, Inc. is shown in Appendix A. You will
also find data relative to this problem on other pages of the appendix.

Instructions
(a) What is the par or stated value per share of PepsiCo’s common stock?
(b) What percentage of PepsiCo’s authorized common stock was issued at December 27, 2008?
(c) How many shares of common stock were outstanding at December 27, 2008, and at

December 29, 2007?
*(d) What was the book value per share at December 27, 2008, and at December 29, 2007?
(e) What were the high and low market price per share in the fourth quarter of fiscal 2008, as

reported under Selected Financial Data?

FINANCIAL REPORTING AND ANALYSIS

B R O A D E N I N G Y O U R P E R S P E C T I V E

Adjustment data:

1. A count of supplies indicates that $5,900 of supplies remain unused at year-end.
2. Recorded revenue earned from item 4 above.
3. The allowance for doubtful accounts should have a balance of $3,500 at year end.
4. Depreciation is recorded on the building on a straight-line basis based on a 30-year life and a

salvage value of $10,000.
5. The income tax rate is 30%. (Hint: Prepare the income statement up to income before taxes

and multiply by 30% to compute the amount.)

Instructions
(You may want to set up T accounts to determine ending balances.)

(a) Prepare journal entries for the transactions listed above and adjusting entries.
(b) Prepare an adjusted trial balance at December 31, 2011.
(c) Prepare an income statement and a retained earnings statement for the year ending

December 31, 2011, and a classified balance sheet as of December 31, 2011.

Broadening Your Perspective 563

(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 10.)

CCC11 Natalie and her friend Curtis Lesperance decide that they can benefit from joining
Cookie Creations and Curtis’s coffee shop. In the first part of this problem, they come to you
with questions about setting up a corporation for their new business. In the second part of the
problem, they want your help in preparing financial information following the first year of oper-
ations of their new business, Cookie & Coffee Creations.

CONTINUING COOKIE CHRONICLE

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to see the completion of this problem.

(b) Totals $671,350
(c) Net income $54,250

Tot. assets $361,200

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Comparative Analysis Problem: PepsiCo, Inc.
vs. The Coca-Cola Company

*BYP11-2 PepsiCo’s financial statements are presented in Appendix A. Coca-Cola’s financial
statements are presented in Appendix B.

Instructions
(a) Based on the information contained in these financial statements, compute the 2008 book

value per share for each company. (Hint: Use the value reported for “common shareholders’
equity” as the numerator for PepsiCo.)

(b) Compare the market value per share for each company to the book value per share at year-
end 2008. Assume that the market value of Coca-Cola’s stock was $45.27 at year-end 2008.

(c) Why are book value and market value per share different?
(d) Compute earnings per share and return on common stockholders’ equity for both compa-

nies for the year ending in January 2008. Assume PepsiCo’s weighted-average shares were
1,575 million and Coca-Cola’s weighted-average shares were 2,462 million. Can these measures
be used to compare the profitability of the two companies? Why or why not?

(e) What was the total amount of dividends paid by each company in 2008?

Exploring the Web
BYP11-3 Use the stockholders’ equity section of an annual report and identify the major
components.

Address: www.reportgallery.com, or go to www.wiley.com/college/weygandt

Steps
1. From Report Gallery Homepage, choose Search by Alphabet, and choose a letter.
2. Select a particular company.
3. Choose Annual Report.
4. Follow instructions below.

Instructions
Answer the following questions.

(a) What is the company’s name?
(b) What classes of capital stock has the company issued?
(c) For each class of stock:

(1) How many shares are authorized, issued, and/or outstanding?
(2) What is the par value?

(d) What are the company’s retained earnings?
(e) Has the company acquired treasury stock? How many shares?

564 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

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Decision Making Across the Organization
BYP11-4 The stockholders’ meeting for Harris Corporation has been in progress for some
time. The chief financial officer for Harris is presently reviewing the company’s financial state-
ments and is explaining the items that comprise the stockholders’ equity section of the balance
sheet for the current year. The stockholders’ equity section of Harris Corporation at December 31,
2011, is shown on page 565.

CRITICAL THINKING

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HARRIS CORPORATION
Balance Sheet (partial)
December 31, 2011

Paid in capital
Capital stock

Preferred stock, authorized 1,000,000 shares
cumulative, $100 par value, $8 per share, 6,000
shares issued and outstanding $ 600,000

Common stock, authorized 5,000,000 shares, $1 par
value, 3,000,000 shares issued, and 2,700,000
outstanding 3,000,000

Total capital stock 3,600,000
Additional paid-in capital

In excess of par value—preferred stock $ 50,000
In excess of par value—common stock 25,000,000

Total additional paid-in capital 25,050,000

Total paid-in capital 28,650,000
Retained earnings 900,000

Total paid-in capital and retained earnings 29,550,000
Less: Common treasury stock (300,000 shares) 9,300,000

Total stockholders’ equity $20,250,000

At the meeting, stockholders have raised a number of questions regarding the stockholders’
equity section.

Instructions
With the class divided into groups, answer the following questions as if you were the chief
financial officer for Harris Corporation.

(a) “What does the cumulative provision related to the preferred stock mean?”
(b) “I thought the common stock was presently selling at $29.75, but the company has the stock

stated at $1 per share. How can that be?”
(c) “Why is the company buying back its common stock? Furthermore, the treasury stock has a

debit balance because it is subtracted from stockholders’ equity. Why is treasury stock not
reported as an asset if it has a debit balance?”

(d) “Why is it necessary to show additional paid-in capital? Why not just show common stock at
the total amount paid in?”

Communication Activity
BYP11-5 Sal Greco, your uncle, is an inventor who has decided to incorporate. Uncle Sal
knows that you are an accounting major at U.N.O. In a recent letter to you, he ends with the
question, “I’m filling out a state incorporation application. Can you tell me the difference in the
following terms: (1) authorized stock, (2) issued stock, (3) outstanding stock, (4) preferred
stock?”

Instructions
In a brief note, differentiate for Uncle Sal among the four different stock terms. Write the letter
to be friendly, yet professional.

Ethics Case
BYP11-6 The R&D division of Healy Chemical Corp. has just developed a chemical for ster-
ilizing the vicious Brazilian “killer bees” which are invading Mexico and the southern states of
the United States. The president of Healy is anxious to get the chemical on the market to boost
Healy’s profits. He believes his job is in jeopardy because of decreasing sales and profits. Healy
has an opportunity to sell this chemical in Central American countries, where the laws are much
more relaxed than in the United States.

Broadening Your Perspective 565

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 565

The director of Healy’s R&D division strongly recommends further testing in the laboratory
for side-effects of this chemical on other insects, birds, animals, plants, and even humans. He
cautions the president, “We could be sued from all sides if the chemical has tragic side-effects
that we didn’t even test for in the labs.” The president answers, “We can’t wait an additional year
for your lab tests. We can avoid losses from such lawsuits by establishing a separate wholly owned
corporation to shield Healy Corp. from such lawsuits. We can’t lose any more than our investment
in the new corporation, and we’ll invest just the patent covering this chemical. We’ll reap the
benefits if the chemical works and is safe, and avoid the losses from lawsuits if it’s a disaster.”
The following week Healy creates a new wholly owned corporation called Dryden Inc., sells the
chemical patent to it for $10, and watches the spraying begin.

Instructions
(a) Who are the stakeholders in this situation?
(b) Are the president’s motives and actions ethical?
(c) Can Healy shield itself against losses of Dryden Inc.?

“All About You” Activity
BYP11-7 A high percentage of Americans own stock in corporations. As a shareholder in a
corporation, you will receive an annual report. One of the goals of this course is for you to learn
how to navigate your way around an annual report.

Instructions
Use the annual report provided in Appendix A to answer the following questions.

(a) What CPA firm performed the audit of PepsiCo’s financial statements?
(b) What was the amount of PepsiCo’s basic earnings per share in 2008?
(c) What were net sales in 2008?
(d) How many shares of treasury stock did the company have at the end of 2008?
(e) How much cash did PepsiCo spend on capital expenditures in 2008?
(f) Over what life does the company depreciate its buildings?
(g) What was the total amount of dividends paid in 2008?

FASB Codification Activity
BYP11-8 Access the FASB Codification at http://asc.fasb.org to prepare responses to the
following.

(a) What is a stock dividend?
(b) What is a stock split?
(c) At what percentage point does the issuance of additional shares qualify as a stock dividend,

as opposed to a stock split?

Answers to Insight and Accounting Across
the Organization Questions
p. 511 Directors Take on More Accountability
Q: Was Enron’s board of directors fulfilling its role in a corporate organization when it waived

Enron’s ethical code on two occasions?
A: The board of directors is elected by the owners (stockholders) of the corporation to manage the

corporation. One of its roles is to formulate the ethical and operating policies for the company and
to assume an oversight responsibility on behalf of the stockholders and other third parties. It was
the responsibility of the board of directors to enforce the corporation’s ethical code, not to waive it.

p. 515 How to Read Stock Quotes
Q: For stocks traded on organized stock exchanges, how are the dollar prices per share

established?
A: The dollar prices per share are established by the interaction between buyers and sellers of the

shares.
Q: What factors might influence the price of shares in the marketplace?
A: The price of shares is influenced by a company’s earnings and dividends as well as by factors

beyond a company’s control, such as changes in interest rates, labor strikes, scarcity of supplies

566 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 566

or resources, and politics. The number of willing buyers and sellers (demand and supply) also
plays a part in the price of shares.

p. 522 Why Did Reebok Buy Its Own Stock?
Q: What signal might a large stock repurchase send to investors regarding management’s belief

about the company’s growth opportunities?
A: When a company has many growth opportunities it will normally conserve its cash in order to be

better able to fund expansion. A large use of cash to buy back stock (and essentially shrink the
company) would suggest that management was not optimistic about its growth opportunities.

p. 529 What’s Happening to Dividends?
Q: What factors must management consider in deciding how large a dividend to pay?
A: Management must consider the size of its retained earnings balance, the amount of available

cash, its expected near-term cash needs, its growth opportunities, and what level of dividend it
will be able to sustain based upon its expected future earnings.

Authors’ Comments on All About You:
Home-Equity Loans, p. 540
The reasons why people reduce the equity in their homes with home-equity loans are as varied
as the reasons why companies reduce their stockholders’ equity by buying treasury stock or pay-
ing dividends. There are good and bad reasons to buy treasury stock and pay dividends, and there
are good and bad reasons to use a home-equity loan.

Suppose you are considering putting an addition on your house, which would increase its
value. That may be a good use of a home-equity loan, since it increases the value of your invest-
ment. Or suppose that you need to buy a new car. Financing the purchase with a home-equity
loan can make good financial sense, since the interest on a home-equity loan is tax-deductible,
while the interest on a car loan is not. But you should be sure you repay the home-equity loan
over the same time period that you would have repaid the car loan. As the graphs in the box
show, if you spread the loan over a long period, you could end up owing more money than the car
is worth when it comes time to sell it.

Borrowing against the equity in your home to go on a vacation is not a financially prudent
thing to do. If you want to go on a vacation, you should set up a separate travel fund as part of
your personal budget, and go on the vacation only when you can actually afford it.

The bottom line is this: Reducing equity, either corporate or personal, increases reliance on
debt and therefore increases risk. It is a decision that should be carefully considered.

Answers to Self-Study Questions
1. c 2. b 3. d 4. c 5. a 6. a 7. d 8. d 9. a 10. c 11. d 12. b 13. c 14. b 15. b
*16. a *17. c

Broadening Your Perspective 567

Remember to go back to the Navigator box on the chapter-opening page and check off your completed work.✓

JWCL165_c11_506-567.qxd 8/8/09 7:57 PM Page 567

568

Chapter

Investments

After studying this chapter, you should be
able to:
1 Discuss why corporations invest in debt

and stock securities.
2 Explain the accounting for debt

investments.
3 Explain the accounting for stock

investments.
4 Describe the use of consolidated

financial statements.
5 Indicate how debt and stock

investments are reported in financial
statements.

6 Distinguish between short-term and
long-

term investments.

S T U D Y O B J E C T I V E S

Feature Story

The Navigator✓

“IS THERE ANYTHING ELSE WE CAN BUY?”

In a rapidly changing world you must change rapidly or suffer the conse-
quences. In business, change requires investment.

A case in point is found in the entertainment industry. Technology is bring-
ing about innovations so quickly that it is nearly impossible to guess which
technologies will last and which will soon fade away. For example, will both
satellite TV and cable TV survive, or will just one succeed, or will both be
replaced by something else? Or consider the publishing industry. Will paper
newspapers and magazines be replaced by online news via the World Wide
Web? If you are a publisher, you have to make your best guess about what
the future holds and invest accordingly.

Time Warner, Inc. (www.timewarner.com) lives at the center of this arena. It is
not an environment for the timid, and Time Warner’s philosophy is anything

Scan Study Objectives ■

Read Feature Story ■

Read Preview ■

Read text and answer
p. 573 ■ p. 578 ■ p. 581 ■ p. 584 ■

Work Comprehensive p. 587 ■

Review Summary of Study Objectives ■

Answer Self-Study Questions ■

Complete Assignments ■

The Navigator✓

Do it!

JWCL165_c12_568-611.qxd 8/12/09 8:29 AM Page 568

569

but that. It might be character-
ized as, “If we can’t beat you,
we will buy you.” Its mantra is
“invest, invest, invest.” A list of
Time Warner’s holdings giv

an idea of its reach. Magazines:
People, Time, Life, Sports Illus-
trated, and Fortune. Book pub-
lishers: Time-Life Books, Book-
of-the-Month Club, Little, Brown & Co, and Sunset Books. Television and
movies: Warner Bros. (“ER,” “Without a Trace,” the WB Network), HBO, and
movies like Harry Potter and the Goblet of Fire, and Batman Begins. Broad-
casting: TNT, CNN news, and Turner’s library of thousands of classic movies.
Internet: America Online and AOL Anywhere. Time Warner owns more infor-
mation and entertainment copyrights and brands than any other company in
the world.

The merger of America Online (AOL) with Time Warner, one of the biggest
mergers ever, was originally perceived by many as the gateway to the
future. In actuality, it was a financial disaster. It is largely responsible for
much of the decline in Time Warner’s stock price, from a high of $95.80 to
a recent level of $14.07. Ted Turner, who was at one time Time Warner’s
largest shareholder, lost billions of dollars on the deal and eventually sold
most of his shares.

The Navigator✓

Inside Chapter 12…

• How Procter & Gamble Accounts for Gillette (p. 577)

• And the Correct Way to Report Investments Is…? (p. 580)

• All About You: A Good Day to Start Saving (p. 586)

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 569

WHY CORPORATIONS INVEST

Preview of Chapter 12
Time Warner’s management believes in aggressive growth through investing in the stock of existing compa-
nies. Besides purchasing stock, companies also purchase other securities such as bonds issued by corpora-
tions or by governments. Companies can make investments for a short or long period of time, as a passive
investment, or with the intent to control another company. As you will see in this chapter, the way in which
a company accounts for its investments is determined by a number of factors.

The content and organization of Chapter 12 are as follows.

Corporations purchase investments in debt or stock securities generally
for one of three reasons. First, a corporation may have excess cash that it
does not need for the immediate purchase of operating assets. For exam-
ple, many companies experience seasonal fluctuations in sales. A Cape

Cod marina has more sales in the spring and summer than in the fall and winter. At
the end of an operating cycle, the marina may have cash on hand that is temporar-
ily idle until the start of another operating cycle. It may invest the excess funds to
earn a greater return than it would get by just holding the funds in the bank.
Illustration 12-1 depicts the role that such temporary investments play in the oper-
ating cycle.

Accounting for Debt
Investments

• Recording acquisition of
bonds

• Recording bond interest
• Recording sale of bonds

Why Corporations Invest

• Cash management
• Investment income
• Strategic reasons

Accounting for Stock
Investments

• Holdings of less than 20%
• Holdings between 20%

and

50%

• Holdings of more than

50%

Valuing and Reporting
Investments

• Categories of securities
• Balance sheet

presentation
• Realized and unrealized

gain or loss
• Classified balance sheet

The Navigator✓
Investments

Discuss why corporations invest
in debt and stock securities.

S T U D Y O B J E C T I V E 1

Accounts
Receivable

Inventory

Invest
Temporary
InvestmentsSellCash

Illustration 12-1
Temporary investments and
the operating cycle

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 570

Excess cash may also result from economic cycles. For example, when the
economy is booming, General Electric generates considerable excess cash. It uses
some of this cash to purchase new plant and equipment and pays out some of the
cash in dividends. But it may also invest excess cash in liquid assets in anticipation
of a future downturn in the economy. It can then liquidate these investments
during a recession, when sales slow and cash is scarce.

When investing excess cash for short periods of time, corporations invest in
low-risk, highly liquid securities—most often short-term government securities. It is
generally not wise to invest short-term excess cash in shares of common stock because
stock investments can experience rapid price changes. If you did invest your short-
term excess cash in stock and the price of the stock declined significantly just before
you needed cash again, you would be forced to sell your stock investment at a loss.

A second reason some companies purchase investments is to generate earnings
from investment income. For example, banks make most of their earnings by lend-
ing money, but they also generate earnings by investing in debt. Conversely, mutual
stock funds invest primarily in equity securities in order to benefit from stock-price
appreciation and dividend revenue.

Third, companies also invest for strategic reasons. A company can exercise
some influence over a customer or supplier by purchasing a significant, but not
controlling, interest in that company. Or, a company may purchase a noncontrol-
ling interest in another company in a related industry in which it wishes to establish
a presence. For example, Time Warner initially purchased an interest of less than
20% in Turner Broadcasting to have a stake in Turner’s expanding business oppor-
tunities. At a later date Time Warner acquired the remaining 80%. Subsequently,
Time Warner merged with AOL and became AOL Time Warner, Inc. Now, it is
again just Time Warner, Inc., having dropped the “AOL” from its name in late 2003.

A corporation may also choose to purchase a controlling interest in another com-
pany. For example, as the Accounting Across the Organization box on page 577 shows,
Procter & Gamble purchased Gillette. Such purchases might be done to enter a new
industry without incurring the tremendous costs and risks associated with starting
from scratch. Or a company might purchase another company in its same industry.

In summary, businesses invest in other companies for the reasons shown in
Illustration 12-2.

Why Corporations Invest 571

Low-risk, high-liquidity, short-term securities
such as government-issued securities

Debt securities (banks and other financial institutions)
and stock securities (mutual funds and pension funds)

To generate earnings

To house excess cash until needed

Stocks of companies in a related industry or in an
unrelated industry that the company wishes to enter

Reason Typical Investment

I need
1,000 Treasury
bills by tonight

To meet strategic goals

Illustration 12-2
Why corporations invest

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572 Chapter 12 Investments

ACCOUNTING FOR DEBT INVESTMENTS

Debt investments are investments in government and corporation bonds.
In accounting for debt investments, companies make entries to record
(1) the acquisition, (2) the interest revenue, and (3) the sale.

Recording Acquisition of Bonds
At acquisition, the cost principle applies. Cost includes all expenditures necessary
to acquire these investments, such as the price paid plus brokerage fees (commis-
sions), if any.

Assume, for example, that Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year,
$1,000 bonds on January 1, 2011, for $54,000, including brokerage fees of $1,000.
The entry to record the investment is:

Explain the accounting for debt
investments.

S T U D Y O B J E C T I V E 2

Jan. 1 Debt Investments 54,000
Cash 54,000

(To record purchase of 50 Doan Inc.
bonds)

Recording Bond Interest
The Doan, Inc. bonds pay interest of $2,000 semiannually on July 1 and January 1
($50,000 � 8% � 1⁄2). The entry for the receipt of interest on July 1 is:

July 1 Cash 2,000
Interest Revenue 2,000

(To record receipt of interest on Doan
Inc. bonds)

If Kuhl Corporation’s fiscal year ends on December 31, it accrues the interest
of $2,000 earned since July 1. The adjusting entry is:

Dec. 31 Interest Receivable 2,000
Interest Revenue 2,000

(To accrue interest on Doan Inc. bonds)

Kuhl reports Interest Receivable as a current asset in the balance sheet. It reports
Interest Revenue under “Other revenues and gains” in the income

statement.

Kuhl reports receipt of the interest on January 1 as follows.

Jan. 1 Cash 2,000
Interest Receivable 2,000

(To record receipt of accrued interest)

A credit to Interest Revenue at this time is incorrect because the company earned
and accrued interest revenue in the preceding accounting period.

Recording Sale of Bonds
When Kuhl sells the bonds, it credits the investment account for the cost of the
bonds. Kuhl records as a gain or loss any difference between the net proceeds from
the sale (sales price less brokerage fees) and the cost of the bonds.

Assume, for example, that Kuhl Corporation receives net proceeds of $58,000
on the sale of the Doan Inc. bonds on January 1, 2012, after receiving the interest due.

Cash Flows

�54,000

A SEL� �

�54,000
�54,000

Cash Flows

�2,000

A SEL� �

�2,000
�2,000

Cash Flows
�2,000
A SEL� �

�2,000
�2,000 Rev

Cash Flows
no effect

A SEL� �
�2,000
�2,000 Rev

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 572

before you go on…

Since the securities cost $54,000, the company realizes a gain of $4,000. It records
the sale as:

Accounting for Stock Investments 573

Jan. 1 Cash 58,000
Debt Investments 54,000
Gain on Sale of Debt Investments 4,000

(To record sale of Doan Inc. bonds)

Kuhl reports the gain on sale of debt investments under “Other revenues and
gains” in the income statement and reports losses under “Other expenses and losses.”

Cash Flows

�58,000

A SEL� �

�58,000
�54,000

�4,000 Rev

Stock investments are investments in the capital stock of other corpora-
tions. When a company holds stock (and/or debt) of several different cor-
porations, the group of securities is identified as an investment portfolio.

The accounting for investments in common stock depends on the
extent of the investor’s influence over the operating and financial affairs of the issuing
corporation (the investee). Illustration 12-3 (next page) shows the general guidelines.

ACCOUNTING FOR STOCK INVESTMENTS

Explain the accounting for stock
investments.

S T U D Y O B J E C T I V E 3

Related exercise material: BE12-1, E12-2, E12-3, and 12-1.Do it!

Action Plan

• Record bond investments
at cost.

• Record interest when received
and/or accrued.

• When bonds are sold, credit the
investment account for the cost
of the bonds.

• Record any difference between
the cost and the net proceeds
as a gain or loss.

(a) Jan. 1 Debt Investments 30,900
Cash 30,900

(To record purchase of 30 Hillary
Co. bonds)

July 1 Cash 1,500
Interest Revenue ($30,000 � .10 � 6/12) 1,500

(To record receipt of interest on Hillary
Co. bonds)

July 1 Cash 14,600
Loss on Sale of Debt Investments 850

Debt Investments ($30,900 � 15/30) 15,450
(To record sale of 15 Hillary Co. bonds)

(b) Dec. 31 Interest Receivable 750
Interest Revenue ($15,000 � .10 � 6/12) 750

(To accrue interest on Hillary Co. bonds)

The Navigator✓

Waldo Corporation had the following transactions pertaining to debt investments.

Jan. 1 Purchased 30, $1,000 Hillary Co. 10% bonds for $30,000, plus brokerage fees of $900.
Interest is payable semiannually on July 1 and January 1.

July 1 Received semiannual interest on Hillary Co. bonds.
July 1 Sold 15 Hillary Co. bonds for $15,000, less $400 brokerage fees.

(a) Journalize the transactions, and (b) prepare the adjusting entry for the accrual of interest on
December 31.

Solution

Debt Investments
Do it!

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Companies are required to use judgment instead of blindly following the guide-
lines.1 On the following pages we will explain the application of each guideline.

Holdings of Less than 20%
In accounting for stock investments of less than 20%, companies use the cost
method. Under the cost method, companies record the investment at cost, and rec-
ognize revenue only when cash dividends are received.

RECORDING ACQUISITION OF STOCK INVESTMENTS
At acquisition, the cost principle applies. Cost includes all expenditures necessary
to acquire these investments, such as the price paid plus any brokerage fees (com-
missions).

Assume, for example, that on July 1, 2011, Sanchez Corporation acquires 1,000
shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the purchase is:

574 Chapter 12 Investments

Investor’s Ownership
Interest in Investee’s

Common Stock
Presumed Influence

on Investee Accounting Guidelines

Less than 20% Cost methodInsignificant

Between 20%
and 50%

Equity methodSignificant

More than 50% Consolidated financial
statements

Controlling

Illustration 12-3
Accounting guidelines for
stock investments

1
Among the questions that are considered in determining an investor’s influence are these:

(1) Does the investor have representation on the investee’s board? (2) Does the investor participate
in the investee’s policy-making process? (3) Are there material transactions between the investor
and investee? (4) Is the common stock held by other stockholders concentrated or dispersed?

H E L P F U L H I N T
The entries for invest-
ments in common stock
also apply to investments
in preferred stock.

July 1 Stock Investments 40,500
Cash 40,500

(To record purchase of 1,000 shares of
Beal Corporation common stock)

RECORDING DIVIDENDS
During the time Sanchez owns the stock, it makes entries for any cash dividends re-
ceived. If Sanchez receives a $2 per share dividend on December 31, the entry is:

Dec. 31 Cash (1,000 � $2) 2,000
Dividend Revenue 2,000

(To record receipt of a cash dividend)

Sanchez reports Dividend Revenue under “Other revenues and gains” in the
income statement. Unlike interest on notes and bonds, dividends do not accrue.
Therefore, companies do not make adjusting entries to accrue dividends.

Cash Flows

�40,500

A SEL� �

�40,500
�40,500

Cash Flows
�2,000
A SEL� �
�2,000
�2,000 Rev

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 574

RECORDING SALE OF STOCK
When a company sells a stock investment, it recognizes as a gain or a loss the dif-
ference between the net proceeds from the sale (sales price less brokerage fees)
and the cost of the stock.

Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale
of its Beal stock on February 10, 2012. Because the stock cost $40,500, Sanchez
incurred a loss of $1,000. The entry to record the sale is:

Accounting for Stock Investments 575

Feb. 10 Cash 39,500
Loss on Sale of Stock Investments 1,000

Stock Investments 40,500
(To record sale of Beal common stock)

Sanchez reports the loss under “Other expenses and losses” in the income state-
ment. It would show a gain on sale under “Other revenues and gains.”

Holdings Between 20% and 50%
When an investor company owns only a small portion of the shares of stock of
another company, the investor cannot exercise control over the investee. But, when
an investor owns between 20% and 50% of the common stock of a corporation, it
is presumed that the investor has significant influence over the financial and oper-
ating activities of the investee. The investor probably has a representative on the
investee’s board of directors, and through that representative, may exercise some
control over the investee. The investee company in some sense becomes part of the
investor company.

For example, even prior to purchasing all of Turner Broadcasting, Time
Warner owned 20% of Turner. Because it exercised significant control over major
decisions made by Turner, Time Warner used an approach called the equity
method. Under the equity method, the investor records its share of the net income
of the investee in the year when it is earned. An alternative might be to delay rec-
ognizing the investor’s share of net income until the investee declares a cash divi-
dend. But that approach would ignore the fact that the investor and investee are,
in some sense, one company, making the investor better off by the investee’s
earned income.

Under the equity method, the investor company initially records the invest-
ment in common stock at cost. After that, it annually adjusts the investment account
to show the investor’s equity in the investee. Each year, the investor does the
following: (1) It increases (debits) the investment account and increases (credits)
revenue for its share of the investee’s net income.2 (2) The investor also decreases
(credits) the investment account for the amount of dividends received. The invest-
ment account is reduced for dividends received, because payment of a dividend
decreases the net assets of the investee.

RECORDING ACQUISITION OF STOCK INVESTMENTS
Assume that Milar Corporation acquires 30% of the common stock of Beck
Company for $120,000 on January 1, 2011. Milar records this transaction as:

2
Or, the investor increases (debits) a loss account and decreases (credits) the investment account

for its share of the investee’s net loss.

H E L P F U L H I N T
Under the equity method,
the investor recognizes
revenue on the accrual
basis—i.e., when it is
earned by the investee.

Jan. 1 Stock Investments 120,000
Cash 120,000

(To record purchase of Beck common
stock)

Cash Flows

�39,500

A SEL� �

�39,500
�1,000 Exp

�40,500
Cash Flows

�120,000

A SEL� �

�120,000
�120,000

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 575

RECORDING REVENUE AND DIVIDENDS
For 2011, Beck reports net income of $100,000. It declares and pays a $40,000 cash
dividend. Milar records (1) its share of Beck’s income, $30,000 (30% � $100,000)
and (2) the reduction in the investment account for the dividends received, $12,000
($40,000 � 30%). The entries are:

576 Chapter 12 Investments

(1)
Dec. 31 Stock Investments 30,000

Revenue from Investment in Beck Company 30,000
(To record 30% equity in Beck’s 2010
net income)

(2)
Dec. 31 Cash 12,000

Stock Investments 12,000
(To record dividends received)

Cash Flows
no effect
A SEL� �

�30,000
�30,000 Rev

Cash Flows

�12,000

A SEL� �

�12,000
�12,000

After Milar posts the transactions for the year, its investment and revenue accounts
will show the following.

Revenue from Investment
Stock Investments in Beck Company

Jan. 1 120,000 Dec. 31 12,000 Dec. 31 30,000
Dec. 31 30,000

Dec. 31 Bal. 138,000

Illustration 12-4
Investment and revenue
accounts after posting

During the year, the net increase in the investment account was $18,000. As indi-
cated above, the investment account increased by $30,000 due to Milar’s share of
Beck’s income, and it decreased by $12,000 due to dividends received from Beck.
In addition, Milar reports $30,000 of revenue from its investment, which is 30% of
Beck’s net income of $100,000.

Note that the difference between reported revenue under the cost method and
reported revenue under the equity method can be significant. For example, Milar
would report only $12,000 of dividend revenue (30% � $40,000) if it used the cost
method.

Holdings of More than 50%
A company that owns more than 50% of the common stock of another en-
tity is known as the parent company. The entity whose stock the parent
company owns is called the subsidiary (affiliated) company. Because of its
stock ownership, the parent company has a controlling interest in the

subsidiary.
When a company owns more than 50% of the common stock of another com-

pany, it usually prepares consolidated financial statements. These statements pre-
sent the total assets and liabilities controlled by the parent company. They also
present the total revenues and expenses of the subsidiary companies. Companies
prepare consolidated statements in addition to the financial statements for the
parent and individual subsidiary companies.

As noted earlier, when Time Warner had a 20% investment in Turner, it re-
ported this investment in a single line item—Other Investments. After the merger,
Time Warner instead consolidated Turner’s results with its own. Under this

Describe the use of consolidated
financial statements.

S T U D Y O B J E C T I V E 4

H E L P F U L H I N T
If parent (A) has three
wholly owned subsidiaries
(B, C, & D), there are four
separate legal entities.
From the viewpoint of the
shareholders of the
parent company, there
is only one economic
entity.

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 576

approach, Time Warner included Turner’s individual assets and liabilities with its
own: Its plant and equipment were added to Time Warner’s plant and equipment,
its receivables were added to Time Warner’s receivables, and so on.

Accounting for Stock Investments 577

ACCOUNTING ACROSS THE ORGANIZATION

How Procter & Gamble Accounts for Gillette

Recently, Procter & Gamble Company acquired Gillette Company for $53.4 billion.
The common stockholders of Procter & Gamble elect the board of directors

of the company, who, in turn, select the officers and managers of the company. Procter &
Gamble’s board of directors controls the property owned by the corporation, which includes
the common stock of Gillette. Thus, they are in a position to elect the board of directors of
Gillette and, in effect, control its operations. These relationships are graphically illustrated
here.

Where on Procter & Gamble’s balance sheet will you find its investment in Gillette
Company?

Gillette Company

Board of Directors

Procter & Gamble
Company

Board of Directors
Gillette Company
Procter & Gamble
Company
Procter & Gamble
Company

Controlling
Group

Separate Legal
Entities

Single Economic
Entity

Control

Elects

Consolidated statements are useful to the stockholders, board of directors, and
managers of the parent company. These statements indicate the magnitude and
scope of operations of the companies under common control. For example, regulators
and the courts undoubtedly used the consolidated statements of AT&T to deter-
mine whether a breakup of AT&T was in the public interest. Listed below are three
companies that prepare consolidated statements and some of the companies they
have owned. One, Disney, is Time Warner’s arch rival.

Toys “R” Us, Inc. Cendant The Disney Company

Kids “R” Us Howard Johnson Capital Cities/ABC, Inc.
Babies “R” Us Ramada Inn Disneyland, Disney World
Imaginarium Century 21 Mighty Ducks
Toysrus.com Coldwell Banker Anaheim Angels

Avis ESPN

Illustration 12-5
Examples of consolidated
companies and their
subsidiaries

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 577

before you go on…

578 Chapter 12 Investments

Presented below are two independent situations.

1. Rho Jean Inc. acquired 5% of the 400,000 shares of common stock of Stillwater Corp. at a
total cost of $6 per share on May 18, 2011. On August 30, Stillwater declared and paid a
$75,000 dividend. On December 31, Stillwater reported net income of $244,000 for the year.

2. Debbie, Inc. obtained significant influence over North Sails by buying 40% of North Sails’
60,000 outstanding shares of common stock at a cost of $12 per share on January 1, 2011. On
April 15, North Sails declared and paid a cash dividend of $45,000. On December 31, North
Sails reported net income of $120,000 for the year.

Prepare all necessary journal entries for 2011 for (1) Rho Jean Inc. and (2) Debbie, Inc.

Solution

Stock Investments

(1) May 18 Stock Investments (20,000 � $6) 120,000
Cash 120,000

(To record purchase of 20,000 shares of
Stillwater Co. stock)

Aug. 30 Cash 3,750
Dividend Revenue ($75,000 � 5%) 3,750

(To record receipt of cash dividend)

(2) Jan. 1 Stock Investments (60,000 � 40% � $12) 288,000
Cash 288,000

(To record purchase of 24,000 shares of
North Sails’ stock)

Apr. 15 Cash 18,000
Stock Investments ($45,000 � 40%) 18,000

(To record receipt of cash dividend)

Dec. 31 Stock Investments ($120,000 � 40%) 48,000
Revenue from Investment in North Sails 48,000

(To record 40% equity in North Sails’
net income)

Related exercise material: BE12-2, BE12-3, E12-4, E12-5, E12-6, E12-7, E12-8, and 12-2.Do it!

The Navigator✓
Action Plan

• Presume that the investor has
relatively little influence over
the investee when an investor
owns less than 20% of the
common stock of another
corporation. In this case, net
income earned by the investee
is not considered a proper basis
for recognizing income from the
investment by the investor.

• Presume significant influence
for investments of 20%–50%.
Therefore, record the investor’s
share of the net income of the
investee.

Do it!

The value of debt and stock investments may fluctuate greatly during the
time they are held. For example, in one 12-month period, the stock price of
Dell Computer Corp. hit a high of $30.77 and a low of $18.87. In light of
such price fluctuations, how should companies value investments at the
balance sheet date? Valuation could be at cost, at fair value (market

value), or at the lower-of-cost-or-market value.
Many people argue that fair value offers the best approach because it repre-

sents the expected cash realizable value of securities. Fair value is the amount for
which a security could be sold in a normal market. Others counter that, unless a

VALUING AND REPORTING INVESTMENTS

Indicate how debt and stock
investments are reported in
financial statements.

S T U D Y O B J E C T I V E 5

JWCL165_c12_568-611.qxd 8/11/09 9:44 PM Page 578

security is going to be sold soon, the fair value is not relevant because the
price of the security will likely change again.

Categories of Securities
For purposes of valuation and reporting at a financial statement date,
companies classify debt and stock investments into three categories:

1. Trading securities are bought and held primarily for sale in the near
term to generate income on short-term price differences.

2. Available-for-sale securities are held with the intent of selling them sometime
in the future.

3. Held-to-maturity securities are debt securities that the investor has the intent
and ability to hold to maturity.3

Illustration 12-6 shows the valuation guidelines for these securities. These
guidelines apply to all debt securities and all stock investments in which the hold-
ings are less than 20%.

Valuing and Reporting Investments 579

INTERNATIONAL NOTE
A recent U.S. accounting

standard gives companies the
“option” of applying fair value
accounting, rather than historical
cost, to certain types of assets
and liabilities. This makes U.S.
accounting more similar to
international standards.

3
This category is provided for completeness. The accounting and valuation issues related to held-

to-maturity securities are discussed in more advanced accounting courses.

At fair value with changes
reported in net income

Trading

At fair value with changes reported
in the stockholders’ equity section

Available-for-sale

At amortized cost

Held-to-maturity

“We’ll sell
within ten

days.”

“We’ll hold the
stock for a while

to see how it
performs.”

“We intend
to hold until
maturity.”

Illustration 12-6
Valuation guidelines

TRADING SECURITIES
Companies hold trading securities with the intention of selling them in a short
period (generally less than a month). Trading means frequent buying and selling.
Companies report trading securities at fair value, and report changes from cost as
part of net income. The changes are reported as unrealized gains or losses because
the securities have not been sold. The unrealized gain or loss is the difference
between the total cost of trading securities and their total fair value. Companies clas-
sify trading securities as current assets.

Illustration 12-7 shows the cost and fair values for investments Pace
Corporation classified as trading securities on December 31, 2011. Pace has an
unrealized gain of $7,000 because total fair value of $147,000 is $7,000 greater than
total cost of $140,000.

H E L P F U L H I N T
The fact that trading
securities are short-term
investments increases
the likelihood that they
will be sold at fair value
(the company may not
be able to time their
sale) and the likelihood
that there will be
realized gains or losses.

Trading Securities,

December 31,

2011

Investments

Cost Fair Value Unrealized Gain (Loss)

Yorkville Company bonds $ 50,000 $ 48,000 $ (2,000)
Kodak Company stock 90,000 99,000 9,000

Total $140,000 $147,000 $ 7,000

Illustration 12-7
Valuation of trading
securities

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 579

Pace records fair value and unrealized gain or loss through an adjusting entry
at the time it prepares financial statements. In this entry, the company uses a valu-
ation allowance account, Market Adjustment—Trading, to record the difference
between the total cost and the total fair value of the securities. The adjusting entry
for Pace Corporation is:

580 Chapter 12 Investments

Dec. 31 Market Adjustment—Trading 7,000
Unrealized Gain—Income 7,000

(To record unrealized gain on trading
securities)

Use of a Market Adjustment—Trading account enables Pace to maintain a record
of the investment cost. It needs actual cost to determine the gain or loss realized
when it sells the securities. Pace adds the Market Adjustment—Trading balance to
the cost of the investments to arrive at a fair value for the trading securities.

The fair value of the securities is the amount Pace reports on its balance sheet.
It reports the unrealized gain in the income statement in the “Other revenues and
gains” section. The term “Income” in the account title indicates that the gain affects
net income.

If the total cost of the trading securities is greater than total fair value, an unre-
alized loss has occurred. In such a case, the adjusting entry is a debit to Unrealized
Loss—Income and a credit to Market Adjustment—Trading. Companies report the
unrealized loss under “Other expenses and losses” in the income statement.

The market adjustment account is carried forward into future accounting peri-
ods. The company does not make any entry to the account until the end of each
reporting period. At that time, the company adjusts the balance in the account to the
difference between cost and fair value. For trading securities, it closes the
Unrealized Gain (Loss)—Income account at the end of the reporting period.

And the Correct Way to Report Investments Is…?

The accompanying graph presents an estimate of the percentage of companies
on the major exchanges that have investments in the equity of other entities.

As the graph indicates, many companies have equity investments
of some type. These investments can be substantial. For example, the
total amount of equity-method investments appearing on company
balance sheets is approximately $403 billion, and the amount shown
in the income statements in any one year for all companies is approx-
imately $38 billion.

Source: “Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley
Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose
Entities, and Transparency of Filings by Issuers,” United States Securities and Exchange
Commission—Office of Chief Accountant, Office of Economic Analyses, Division of
Corporation Finance (June 2005), pp. 36–39.

Why might the use of the equity method not lead to full disclo-
sure in the financial statements?

ACCOUNTING ACROSS THE ORGANIZATION
Cash Flows
no effect
A SEL� �

�7,000
�7,000 Rev

91.1%

23.5%

6.2%

100

37.4%

Pe
rc

en
t

o
f
C

o
m

pa
ni

Categorized by Accounting Treatment

Investments in the Equity of Other Companies

Presenting consolidated
financial statements
Reporting equity method
investments
Reporting available-for-sale
investments
Reporting trading investments

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 580

before you go on…

AVAILABLE-FOR-SALE SECURITIES
As indicated earlier, companies hold available-for-sale securities with the
intent of selling these investments sometime in the future. If the intent is to
sell the securities within the next year or operating cycle, the investor classi-
fies the securities as current assets in the balance sheet. Otherwise, it classi-
fies them as long-term assets in the investments section of the balance sheet.

Companies report available-for-sale securities at fair value. The proce-
dure for determining fair value and the unrealized gain or loss for these secu-
rities is the same as for trading securities. To illustrate, assume that Ingrao
Corporation has two securities that it classifies as available-for-sale.
Illustration 12-8 provides information on their valuation.There is an unrealized loss of
$9,537 because total cost of $293,537 is $9,537 more than total fair value of $284,000.

Valuing and Reporting Investments 581

E T H I C S N O T E

Some managers seem to
hold their available-for-sale
securities that have experienced
losses, while selling those that
have gains, thus increasing
income. Do you think this is
ethical?

Available-for-Sale Securities, December 31, 2011

Investments Cost Fair Value Unrealized Gain (Loss)

Campbell Soup Corporation
8% bonds $ 93,537 $103,600 $10,063

Hershey Corporation stock 200,000 180,400 (19,600)

Total $293,537 $284,000 $(9,537)

Both the adjusting entry and the reporting of the unrealized gain or loss for
Ingrao’s available-for-sale securities differ from those illustrated for trading secu-
rities. The differences result because Ingrao does not expect to sell these securities
in the near term. Thus, prior to actual sale it is more likely that changes in fair value
may change either unrealized gains or losses. Therefore, Ingrao does not report an
unrealized gain or loss in the income statement. Instead, it reports it as a separate
component of stockholders’ equity.

In the adjusting entry, Ingrao identifies the market adjustment account with
available-for-sale securities, and it identifies the unrealized gain or loss account
with stockholders’ equity. Ingrao records the unrealized loss of $9,537 as follows:

Dec. 31 Unrealized Gain or Loss—Equity 9,537
Market Adjustment—Available-for-Sale 9,537

(To record unrealized loss on available-
for-sale securities)

If total fair value exceeds total cost, Ingrao debits Market Adjustment—
Available-for-Sale and credits Unrealized Gain or Loss—Equity.

For available-for-sale securities, the company carries forward the
Unrealized Gain or Loss—Equity account to future periods. At each fu-
ture balance sheet date, Ingrao adjusts the market adjustment account to
show the difference between cost and fair value at that time.

E T H I C S N O T E

Recently the SEC accused
investment bank Morgan Stanley
of overstating the value of certain
bond investments by $75 million.
The SEC stated that, in applying
market value accounting, Morgan
Stanley used its own more-
optimistic assumptions rather than
relying on external pricing sources.

Cash Flows
no effect
A SEL� �

�9,537 Exp
�9,537

Illustration 12-8
Valuation of available-
for-sale securities

Some of Powderhorn Corporation’s investment securities are classified as
trading securities and some are classified as available-for-sale. The cost and market value of each
category at December 31, 2011, are shown on the next page.

Trading and Available-for-

Sale Securities

Do it!

JWCL165_c12_568-611.qxd 8/11/09 9:28 PM Page 581

Balance Sheet Presentation
In the balance sheet, companies classify investments as either short-term or long-term.

SHORT-TERM INVESTMENTS
Short-term investments (also called marketable securities) are securities
held by a company that are (1) readily marketable and (2) intended to be
converted into cash within the next year or operating cycle, whichever is
longer. Investments that do not meet both criteria are classified as long-

term investments.

Readily Marketable. An investment is readily marketable when it can be sold
easily whenever the need for cash arises. Short-term paper4 meets this criterion. It
can be readily sold to other investors. Stocks and bonds traded on organized secu-
rities exchanges, such as the New York Stock Exchange, are readily marketable.
They can be bought and sold daily. In contrast, there may be only a limited market
for the securities issued by small corporations, and no market for the securities of a
privately held company.

Intent to Convert. Intent to convert means that management intends to sell the
investment within the next year or operating cycle, whichever is longer. Generally,
this criterion is satisfied when the investment is considered a resource that the in-
vestor will use whenever the need for cash arises. For example, a ski resort may
invest idle cash during the summer months with the intent to sell the securities to
buy supplies and equipment shortly before the winter season. This investment is
considered short-term even if lack of snow cancels the next ski season and elimi-
nates the need to convert the securities into cash as intended.

582 Chapter 12 Investments

Cost Fair Value Unrealized Gain (Loss)

Trading securities $93,600 $94,900 $1,300
Available-for-sale securities $48,800 $51,400 $2,600

At December 31, 2010, the Market Adjustment—Trading account had a debit balance of $9,200,
and the Market Adjustment—Available-for-Sale account had a credit balance of $5,750. Prepare
the required journal entries for each group of securities for December 31, 2011.

Solution

Trading securities:

Unrealized Loss—Income 7,900*
Market Adjustment—Trading 7,900

(To record unrealized loss on trading securities)
*$9,200 � $1,300

Available-for-sale securities:

Market Adjustment—Available-for-Sale 8,350**
Unrealized Gain or Loss—Equity 8,350

(To record unrealized gain on available-for-sale securities)
**$5,750 � $2,600

Related exercise material: BE12-4, BE12-5, BE12-6, BE12-7, E12-10, E12-11, E12-12, and 12-3.Do it!

Action Plan

• Mark trading securities to fair
value and report the adjustment
in current-period income.

• Mark available-for-sale
securities to fair value and
report the adjustment as a
separate component of
stockholders’ equity.

The Navigator✓

Distinguish between short-term
and long-term investments.

S T U D Y O B J E C T I V E 6

H E L P F U L H I N T
Trading securities are
always classified as short-
term. Available-for-sale
securities can be either
short-term or long-term.

4
Short-term paper includes (1) certificates of deposit (CDs) issued by banks, (2) money market

certificates issued by banks and savings and loan associations, (3) Treasury bills issued by the U.S.
government, and (4) commercial paper (notes) issued by corporations with good credit ratings.

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 582

Because of their high liquidity, short-term investments appear immediately
below Cash in the “Current assets” section of the balance sheet. They are reported
at fair value. For example, Pace Corporation would report its trading securities as
shown in Illustration 12-9.

Valuing and Reporting Investments 583

PACE CORPORATION
Balance Sheet (partial)

Current assets
Cash $ 21,000
Short-term investments, at fair value 147,000

LONG-TERM INVESTMENTS
Companies generally report long-term investments in a separate section of the bal-
ance sheet immediately below “Current assets,” as shown later in Illustration 12-12
(page 585). Long-term investments in available-for-sale securities are reported at
fair value. Investments in common stock accounted for under the equity method
are reported at their equity value.

Presentation of Realized and Unrealized
Gain or Loss
Companies must present in the financial statements gains and losses on invest-
ments, whether realized or unrealized. In the income statement, companies report
gains and losses in the nonoperating activities section under the categories listed in
Illustration 12-10. Interest and dividend revenue are also reported in that section.

H E L P F U L H I N T
In a recent survey of 600
large U.S. companies,
242 reported short-term
investments.

Illustration 12-9
Presentation of short-term
investments

Other Revenue and Gains Other Expenses and Losses

Interest Revenue Loss on Sale of Investments
Dividend Revenue Unrealized Loss—Income
Gain on Sale of Investments
Unrealized Gain—Income

As indicated earlier, companies report an unrealized gain or loss on available-
for-sale securities as a separate component of stockholders’ equity. To illustrate,
assume that Dawson Inc. has common stock of $3,000,000, retained earnings of
$1,500,000, and an unrealized loss on available-for-sale securities of $100,000.
Illustration 12-11 shows the balance sheet presentation of the unrealized loss.

DAWSON INC.
Balance Sheet (partial)

Stockholders’ equity
Common stock $3,000,000
Retained earnings 1,500,000

Total paid-in capital and retained earnings 4,500,000
Less: Unrealized loss on available-for-sale

securities

100,000

Total stockholders’ equity $4,400,000

Illustration 12-10
Nonoperating items related
to investments

Illustration 12-11
Unrealized loss in stockhold-
ers’ equity section

Note that the loss decreases stockholders’ equity. An unrealized gain is added
to stockholders’ equity. Reporting the unrealized gain or loss in the stockholders’
equity section serves two purposes: (1) It reduces the volatility of net income due

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 583

before you go on…

to fluctuations in fair value. (2) It informs the financial statement user of the gain
or loss that would occur if the securities were sold at fair value.

Companies must report items such as this, which affect stockholders’ equity but
are not included in the calculation of net income, as part of a more inclusive measure
called comprehensive income.We discuss comprehensive income briefly in Chapter 14.

Classified Balance Sheet
We have presented many sections of classified balance sheets in this and preceding
chapters. The classified balance sheet in Illustration 12-12 (page 585) includes, in
one place, key topics from previous chapters: the issuance of par value common
stock, restrictions of retained earnings, and issuance of long-term bonds. From this
chapter, the statement includes (highlighted in red) short-term and long-term in-
vestments. The investments in short-term securities are considered trading securi-
ties. The long-term investments in stock of less than 20% owned companies are
considered available-for-sale securities. Illustration 12-12 also includes a long-term
investment reported at equity and descriptive notations within the statement, such
as the basis for valuing merchandise inventory and one note to the statement.

584 Chapter 12 Investments

Identify where each of the following items would be reported in the financial
statements.

1. Interest earned on investments in bonds.

2. Market adjustment—available-for-sale.

3. Unrealized loss on available-for-sale securities.

4. Gain on sale of investments in stock.

5. Unrealized gain on trading securities.

Use the following possible categories:

Balance sheet:

Current assets Current liabilities
Investments Long-term liabilities
Property, plant, and equipment Stockholders’ equity
Intangible assets

Income statement:

Other revenues and gains Other expenses and losses

Solution

Financial Statement

Presentation of Investments

Item Financial Statement Category

1. Interest earned on investments in bonds. Income statement Other revenues and gains
2. Market adjustment—available-for-sale Balance sheet Investments
3. Unrealized loss on available-for-sale Balance sheet Stockholders’ equity

securities
4. Gain on sale of investments in stock Income statement Other revenues and gains
5. Unrealized gain on trading securities Income statement Other revenues and gains

Related exercise material: BE12-6, BE12-7, BE12-8, E12-10, E12-11, E12-12, and 12-4.Do it!

The Navigator✓
Action Plan

• Classify investments as current
assets if they will be held for
less than one year.

• Report unrealized gains or
losses on trading securities in
income.

• Report unrealized gains or
losses on available-for-sale
securities in equity.

• Report realized earnings on
investments in the income
statement as “Other revenues
and gains” or as “Other
expenses and losses.”

Do it!

JWCL165_c12_568-611.qxd 8/11/09 9:45 PM Page 584

Valuing and Reporting Investments 585

PACE CORPORATION
Balance Sheet

December 31, 2011

Assets

Current assets

Cash $ 21,000
Short-term investments, at fair value 147,000
Accounts receivable $ 84,000
Less: Allowance for doubtful accounts 4,000

80,000

Merchandise inventory, at FIFO cost 43,000
Prepaid insurance 23,000

Total current assets $ 314,000
Investments

Investments in stock of less than 20%
owned companies, at fair value

50,000

Investment in stock of 20–50% owned
company, at equity

150,000

Total investments 200,000
Property, plant, and equipment

Land 200,000
Buildings 800,000
Less: Accumulated depreciation 200,000

600,000

Equipment 180,000
Less: Accumulated depreciation 54,000 126,000

Total property, plant, and equipment 926,000
Intangible assets

Goodwill 270,000

Total assets $1,710,000

Liabilities and Stockholders’ Equity

Current liabilities

Accounts payable $ 185,000
Federal income taxes payable 60,000
Bond interest payable 10,000

Total current liabilities $ 255,000
Long-term liabilities

Bonds payable, 10%, due 2022

300,000

Less: Discount on bonds 10,000

Total long-term liabilities 290,000

Total liabilities 545,000
Stockholders’ equity

Paid-in capital
Common stock, $10 par value, 200,000 shares

authorized, 80,000 shares issued and outstanding 800,000
Paid-in capital in excess of par value 100,000

Total paid-in capital 900,000
Retained earnings (Note 1) 255,000

Total paid-in capital and retained earnings 1,155,000
Add: Unrealized gain on available-for-sale

securities 10,000

Total stockholders’ equity 1,

165,000

Total liabilities and stockholders’ equity $1,710,000

Note 1. Retained earnings of $100,000 is restricted for plant expansion.

Illustration 12-12
Classified balance sheet

A Good Day to
Start Saving

on page 586 for informa-
tion on how topics in this

chapter apply to you.

all about Y U*
Be sure to read

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 585

Some Facts*
* Only about 48% of people in their twenties whose

employers have a 401(k) plan participate in that
plan. [401(k) plans allow you to put part of your pre-
tax salary into investments. The investment and its
earnings are not taxed until you withdraw them in
retirement.] Many employers automatically enroll
employees in 401(k) plans when they hire them.

* Only 40% of working couples currently are covered
by pension plans, but 61% of workers expect to get
income from a company pension plan.

* More than half of workers age 55 and older have
less than $50,000 in retirement savings.

* 80% of individuals between the ages of 18 to 26
said that, if given $10,000, they would deposit the
money into a traditional bank savings account
rather than invest in the stock market. Many stated
that they are intimidated by the stock market, and
choose to give up the added returns the stock
market offers over the long run, rather than face the
market.

*all about Y U*

CCompared to citizens in many other nations,Americans are very poor savers. It isn’t that we don’t
know that we should save. It is just that we would
rather spend. When is a good time to get serious
about saving? Maybe you should start saving when
you’ve graduated and have a good job, but then
there will be those student loans to pay off, and your
car loans as well. Maybe you should start after you’ve
purchased your first home—and furnished it. Oh,
and you might have kids, so you might wait until
after they’ve gone off to college. You get the picture:
There’s always a reason not to start saving. Given that,
today is as good a day as any to start saving.

What Do You Think?*
You’ve got $3,000 in credit card bills at an 18% interest rate. Your employer
has a 401(k) plan in which it will match your contributions, up to 10% of
your annual salary. Should you pay off your credit card bills before you start
putting money into the 401(k)?

YES: Paying off an 18% debt, and thus avoiding 18% interest payments, is
essentially equivalent to earning 18% on investments. Reducing your debts
reduces your financial vulnerability.

NO: You need to get in the savings habit as soon as possible. You should
take part of the money you would have used to pay off your debt each month
and instead put it into the 401(k).

*
The authors’ comments on this situation appear on page 610.

Sources: Kelly Greene, “Workers’ Views on Retirement May Be Too Rosy,” Wall Street Journal, April 4,
2006, p. D2; Ron Lieber, “Getting Younger Folk to Save,” Wall Street Journal, June 17, 2006, p. B1;
Eric A. Henon, “Why and How Generation Y Saves and Spends,” Benefits & Compensation Digest,
February 2006, pp. 30–32.

A Good Day to Start Saving

586

About the Numbers*

Accumulated Value at Age 65 of
$300 Monthly Investment Started at

Different Ages

Age 25

$1,200,000

$1,000,000

$800,000

$600,000

$400,000

$200,000

$0
Age 35 Age 45 Age 55

The message to start saving early has been presented in many different ways. The
chart below presents the facts in very blunt terms. When you are 25 years old, if you
start putting $300 per month into an investment earning 8%, by the age of 65 you
will have accumulated more than $1 million. But if you wait until age 55, you will
accumulate only about $55,000. Notice the sharp drop-off between ages 25 and 35.

JWCL165_c12_568-611.qxd 8/8/09 8:46 PM Page 586

Comprehensive Do it! 587

Comprehensive

In its first year of operations, DeMarco Company had the following selected transactions in stock
investments that are considered trading securities.

June 1 Purchased for cash 600 shares of Sanburg common stock at $24 per share, plus $300
brokerage fees.

July 1 Purchased for cash 800 shares of Cey common stock at $33 per share, plus $600 bro-
kerage fees.

Sept. 1 Received a $1 per share cash dividend from Cey Corporation.
Nov. 1 Sold 200 shares of Sanburg common stock for cash at $27 per share, less $150 bro-

kerage fees.
Dec. 15 Received a $0.50 per share cash dividend on Sanburg common stock.

At December 31, the fair values per share were: Sanburg $25 and Cey $30.

Instructions

(a) Journalize the transactions.
(b) Prepare the adjusting entry at December 31 to report the securities at fair value.

Solution to Comprehensive Do it!

Do it!
Action Plan

• Include the price paid plus
brokerage fees in the cost of
the investment.

• Compute the gain or loss on
sales as the difference between
net selling price and the cost of
the securities.

• Base the adjustment to fair
value on the total difference
between the cost and the fair
value of the securities.

The Navigator✓

(a) June 1 Stock Investments 14,700
Cash (600 � $24) � $300 14,700

(To record purchase of 600 shares of
Sanburg common stock)

July 1 Stock Investments 27,000
Cash (800 � $33) � $600 27,000

(To record purchase of 800 shares of Cey
common stock)

Sept. 1 Cash (800 � $1.00) 800
Dividend Revenue 800

(To record receipt of $1 per share cash
dividend from Cey Corporation)

Nov. 1 Cash (200 � $27) � $150 5,250
Stock Investments ($14,700 � 200/600) 4,900
Gain on Sale of Stock Investments 350

(To record sale of 200 shares of Sanburg
common stock)

Dec. 15 Cash (600 � 200) � $0.50 200
Dividend Revenue 200

(To record receipt of $0.50 per share
dividend from Sanburg Corporation)

(b) Dec. 31 Unrealized Loss—Income 2,800
Market Adjustment—Trading 2,800

(To record unrealized loss on trading
securities)

Investment Cost Fair Value Unrealized Gain (Loss)
Sanburg common stock $ 9,800 $10,000 $ 200
Cey common stock 27,000 24,000 (3,000)

Totals $36,800 $34,000 $(2,800)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 587

588 Chapter 12 Investments

1 Discuss why corporations invest in debt and stock
securities. Corporations invest for three primary reasons:
(a) They have excess cash. (b) They view investments as a
significant revenue source. (c) They have strategic goals
such as gaining control of a competitor or moving into a
new line of business.

2 Explain the accounting for debt investments.
Companies record investments in debt securities when
they purchase bonds, receive or accrue interest, and sell the
bonds. They report gains or losses on the sale of bonds in
the “Other revenues and gains” or “Other expenses and
losses” sections of the income statement.

3 Explain the accounting for stock investments.
Companies record investments in common stock when
they purchase the stock, receive dividends, and sell the
stock. When ownership is less than 20%, the cost method is
used. When ownership is between 20% and 50%, the equity
method should be used. When ownership is more than
50%, companies prepare consolidated financial statements.

4 Describe the use of consolidated financial statements.
When a company owns more than 50% of the common

stock of another company, it usually prepares consolidated
financial statements. These statements indicate the magni-
tude and scope of operations of the companies under com-
mon control.

5 Indicate how debt and stock investments are reported
in financial statements. Investments in debt and stock
securities are classified as trading, available-for-sale, or
held-to-maturity securities for valuation and reporting pur-
poses. Trading securities are reported as current assets at fair
value, with changes from cost reported in net income.
Available-for-sale securities are also reported at fair value,
with the changes from cost reported in stockholders’ equity.
Available-for-sale securities are classified as short-term or
long-term depending on their expected future sale date.

6 Distinguish between short-term and long-term invest-
ments. Short-term investments are securities that are
(a) readily marketable and (b) intended to be converted to
cash within the next year or operating cycle, whichever is
longer. Investments that do not meet both criteria are clas-
sified as long-term investments.

SUMMARY OF STUDY OBJECTIVES

The Navigator✓

Available-for-sale securities Securities that are held with
the intent of selling them sometime in the future. (p. 579).

Consolidated financial statements Financial statements
that present the assets and liabilities controlled by the par-
ent company and the total revenues and expenses of the
subsidiary companies. (p. 576).

Controlling interest Ownership of more than 50% of the
common stock of another entity. (p. 576).

Cost method An accounting method in which the invest-
ment in common stock is recorded at cost, and revenue is
recognized only when cash dividends are received.
(p. 574).

Debt investments Investments in government and corpo-
ration bonds. (p. 572).

Equity method An accounting method in which the invest-
ment in common stock is initially recorded at cost, and the
investment account is then adjusted annually to show the
investor’s equity in the investee. (p. 575).

Fair value Amount for which a security could be sold in a
normal market. (p. 578).

Held-to-maturity securities Debt securities that the investor
has the intent and ability to hold to their maturity date. (p. 579).

Investment portfolio A group of stocks and/or debt securities
in different corporations held for investment purposes. (p. 573).

Long-term investments Investments that are not readily
marketable or that management does not intend to convert
into cash within the next year or operating cycle, whichever
is longer. (p. 582).

Parent company A company that owns more than 50% of
the common stock of another entity. (p. 576).

Short-term investments Investments that are readily mar-
ketable and intended to be converted into cash within the
next year or operating cycle, whichever is longer. (p. 582).

Stock investments Investments in the capital stock of
other corporations. (p. 573).

Subsidiary (affiliated) company A company in which more
than 50% of its stock is owned by another company. (p. 576).

Trading securities Securities bought and held primarily for
sale in the near term to generate income on short-term
price differences. (p. 579).

GLOSSARY

APPENDIX Preparing Consolidated
Financial Statements

Most of the large U.S. corporations are holding companies that own other corpora-
tions. They therefore prepare consolidated financial statements that combine the
separate companies.

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 588

Consolidated Balance Sheet
Companies prepare consolidated balance sheets from the individual balance sheets
of their affiliated companies. They do not prepare consolidated statements from
ledger accounts kept by the consolidated entity because only the separate legal en-
tities maintain accounting records.

All items in the individual balance sheets are included in the consolidated bal-
ance sheet except amounts that pertain to transactions between the affiliated com-
panies. Transactions between the affiliated companies are identified as intercompany
transactions. The process of excluding these transactions in preparing consolidated
statements is referred to as intercompany eliminations. These eliminations are nec-
essary to avoid overstating assets, liabilities, and stockholders’ equity in the consol-
idated balance sheet. For example, amounts owed by a subsidiary to a parent com-
pany and the related receivable reported by the parent company would be
eliminated. The objective in a consolidated balance sheet is to show only obliga-
tions to and receivables from parties who are not part of the affiliated group of
companies.

To illustrate, assume that on January 1, 2011, Powers Construction Company
pays $150,000 in cash for 100% of Serto Brick Company’s common stock. Powers
Company records the investment at cost, as required by the cost principle.
Illustration 12A-1 presents the separate balance sheets of the two companies
immediately after the purchase, together with combined and consolidated data.5

Powers obtains the balances in the “combined” column are obtained by adding the
items in the separate balance sheets of the affiliated companies. The combined
totals do not represent a consolidated balance sheet, because there has been a dou-
ble counting of assets and owners’ equity in the amount of $150,000.

Appendix Preparing Consolidated Financial Statements 589

H E L P F U L H I N T
Eliminations are aptly
named because they
eliminate duplicate data.
They are not adjustments.

5
We use condensed data throughout this material to keep details at a minimum.

POWERS COMPANY AND SERTO COMPANY
Balance Sheet

January 1, 2011

Powers Serto Combined Consolidated
Assets Company Company Data Data

Current assets $ 50,000 $ 80,000 $130,000 $

130,000

Investment in Serto Company

common stock 150,000 150,000

–0–

Plant and equipment (net) 325,000 145,000 470,000 470,000

Total assets $525,000 $225,000 $750,000 $600,000

Liabilities and Stockholders’ Equity

Current liabilities $ 50,000 $ 75,000 $125,000 $

125,000

Common stock 300,000 100,000 400,000 300,000
Retained earnings 175,000 50,000 225,000

75,000

Total liabilities and
stockholders’ equity $525,000 $225,000 $750,000 $600,000

Illustration 12A-1
Combined and
consolidated data

The Investment in Serto Company common stock that appears on the balance
sheet of Powers Company represents an interest in the net assets of Serto. As a re-
sult, there has been a double counting of assets. Similarly, there has been a double
counting in stockholders’ equity, because the common stock of Serto Company is
completely owned by the stockholders of Powers Company.

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 589

The balances in the consolidated data column are the amounts that should
appear in the consolidated balance sheet. The double counting has been eliminated
by showing Investment in Serto Company at zero and by reporting only the com-
mon stock and retained earnings of Powers Company as stockholders’ equity.

USE OF A WORKSHEET—COST EQUAL TO BOOK VALUE
The preparation of consolidated balance sheets is usually facilitated by
the use of a worksheet. As shown in Illustration 12A-2, the worksheet for
a consolidated balance sheet contains columns for (1) the balance sheet
data for the separate legal entities, (2) intercompany eliminations, and
(3) consolidated data. All data in the worksheet relate to the preceding ex-

ample in which Powers Company acquires 100% ownership of Serto Company for
$150,000. In this case, the cost of the investment, $150,000, is equal to the book
value $150,000 ($225,000 � $75,000) of the subsidiary’s net assets. The intercom-
pany elimination results in a credit to the Investment account maintained by
Powers Company for its balance, $150,000, and debits to the Common Stock and
Retained Earnings accounts of Serto Company for their respective balances,
$100,000 and $50,000.

590 Chapter 12 Investments

Describe the content of a
worksheet for a consolidated
balance sheet.

S T U D Y O B J E C T I V E 7

Powers Company.xls

Eliminations
Assets

Liabilities and Stockholders’ Equity

A B C D E F

Serto
Company

Powers
Company

Consolidated
DataDr. Cr.

8
7
6
5

3
4

2
1

9
10
11

12
13
14
15
16
17

19
18

20
21

150,000
50,000

150,000
325,000

525,000

50,000
300,000

175,000

525,000
100,000

50,000
150,000 150,000

130,000
300,000
175,000
125,000
600,000
–0–
–0–

–0–
470,000

600,000

75,000
100,000

50,000
225,000

80,000

145,000
225,000

Current assets
Investment in Serto Company common
stock

Totals

Current liabilities
Common stock—Powers Company
Common stock—Serto Company
Retained earnings—Powers Company
Retained earnings—Serto Company

Totals

Plant and equipment (net)

File Edit View Insert Format Tools Data Window Help

POWERS COMPANY AND SUBSIDIARY
Worksheet—Consolidated Balance Sheet

January 1, 2011 (Acquisition Date)

Illustration 12A-2
Worksheet—Cost equal
to book value

It is important to recognize that companies make intercompany eliminations
solely on the worksheet to present correct consolidated data. Neither of the affiliated
companies journalizes or posts the eliminations. Therefore, eliminations do not affect
the ledger accounts. Powers Company’s investment account and Serto Company’s
common stock and retained earnings accounts are reported by the separate entities
in preparing their own financial statements.

USE OF A WORKSHEET—COST ABOVE BOOK VALUE
The cost of acquiring the common stock of another company may be above or
below its book value. The management of the parent company may pay more than

H E L P F U L H I N T
As in the case of the
worksheets explained
earlier in this textbook,
consolidated worksheets
are also optional.

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 590

book value for the stock. Why? Because it believes the fair market values of iden-
tifiable assets such as land, buildings, and equipment are higher than their recorded
book values. Or it may believe the subsidiary’s future earnings prospects warrant a
payment for goodwill.

To illustrate, assume the same data used above, except that Powers Company
pays $165,000 in cash for 100% of Serto’s common stock. The excess of cost over
book value is $15,000 ($165,000 � $150,000). Powers recognizes this amount sepa-
rately in eliminating the parent company’s investment account, as shown in
Illustration 12A-3. Total assets and total liabilities and stockholders’ equity are the
same as in the preceding example ($600,000). However, in this case, total assets in-
clude $15,000 of Excess of Cost Over Book Value of Subsidiary. The disposition of
the excess is explained in the next section.

Appendix Preparing Consolidated Financial Statements 591

H E L P F U L H I N T
The consolidated
worksheet is another
good spreadsheet
application. This is a
good worksheet to
attempt since the
required instructions are
very straightforward.

Powers Company.xls
File Edit View Insert Format Tools Data Window Help
Liabilities and Stockholders’ Equity
A B C D E F
8
7
6
5
3
4
2
1
9
10
11

12
13
14
15
16
17
18

20
19

21
22
23

165,000

35,000

165,000
325,000 145,000

75,000

225,000525,000
15,000 15,000

50,000
300,000
175,000

525,000 225,000

100,000100,000

50,000 50,000
165,000 165,000

115,000

300,000
175,000
125,000
600,000
–0–
–0–
–0–
470,000
600,000

80,000Current assets
Investment in Serto Company common
stock

Totals

Current liabilities
Common stock —Powers Company
Common stock—Serto Company
Retained earnings—Powers Company
Retained earnings—Serto Company

Totals

Plant and equipment (net)
Excess of cost over book value of

subsidiary

Note that a separate line is added to the worksheet for the excess of cost over book value of subsidiary.

Eliminations
Assets
Powers
Company

Serto
Company Dr. Cr.

Consolidated
Data

POWERS COMPANY AND SUBSIDIARY
Worksheet—Consolidated Balance Sheet
January 1, 2011 (Acquisition Date)

Illustration 12A-3
Worksheet—Cost above
book value

CONTENT OF A CONSOLIDATED BALANCE SHEET
To illustrate a consolidated balance sheet, we will use the worksheet
shown in Illustration 12A-3. This worksheet shows an excess of cost
over book value of $15,000. In the consolidated balance sheet, Powers
first allocates this amount to specific assets, such as inventory and plant
equipment, if their fair market values on the acquisition date exceed
their book values. Any remainder is considered to be goodwill. For Serto
Company, assume that the fair market value of property and equipment is
$155,000. Thus, Powers allocates $10,000 of the excess of cost over book value to
property and equipment, and the remainder, $5,000, to goodwill. Illustration
12A-4 (next page) shows the condensed consolidated balance sheet of Powers
Company.

Explain the form and content
of consolidated financial
statements.

S T U D Y O B J E C T I V E 8

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 591

Through innovative financial restructuring, The Coca-Cola Company at one
time eliminated a substantial amount of non-intercompany debt. It sold to the
public 51% of two bottling companies. The “49% solution,” as insiders call the
strategy, enabled Coca-Cola to keep effective control over the businesses, and it
swept $3 billion of debt from its consolidated balance sheet. (It no longer consol-
idated the two bottling companies.) At the same time the new companies obtained
independent access to equity markets to satisfy their own voracious appetites
for capital.

Consolidated Income Statement
Affiliated companies also prepare a consolidated income statement. This state-
ment shows the results of operations of affiliated companies as though they are one
economic unit. This means that the statement shows only revenue and expense
transactions between the consolidated entity and companies and individuals who
are outside the affiliated group.

Consequently, all intercompany revenue and expense transactions must be
eliminated. Intercompany transactions such as sales between affiliates and interest
on loans charged by one affiliate to another must be eliminated. A worksheet facil-
itates the preparation of consolidated income statements in the same manner as it
does for the balance sheet.

592 Chapter 12 Investments

POWERS COMPANY
Consolidated Balance Sheet

January 1, 2011
Assets

Current assets $115,000
Plant and equipment (net) 480,000
Goodwill 5,000

Total assets $600,000

Liabilities and Stockholders’ Equity

Current liabilities $125,000
Stockholders’ equity

Common stock $300,000
Retained earnings 175,000 475,000

Total liabilities and stockholders’ equity $600,000

7 Describe the content of a worksheet for a consoli-
dated balance sheet. The worksheet for a consolidated
balance sheet contains columns for (a) the balance sheet
data for the separate entities, (b) intercompany elimina-
tions, and (c) consolidated data.

8 Explain the form and content of consolidated financial
statements. Consolidated financial statements are simi-

lar in form and content to the financial statements of an in-
dividual corporation. A consolidated balance sheet shows
the assets and liabilities controlled by the parent company.
A consolidated income statement shows the results of op-
erations of affiliated companies as though they are one
economic unit.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX

Illustration 12A-4
Consolidated balance sheet

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 592

Self-Study Questions 593

Intercompany eliminations Eliminations made to exclude
the effects of intercompany transactions in preparing con-
solidated statements. (p. 589).

Intercompany transactions Transactions between affiliated
companies. (p. 589).

GLOSSARY FOR APPENDIX

*Note: All Questions, Exercises, and Problems marked with an asterisk relate to material in the appendix to the chapter.

SELF-STUDY

QUESTIONS

Answers are at the end of the chapter.

1. Which of the following is not a primary reason why corpo-
rations invest in debt and equity securities?
a. They wish to gain control of a competitor.
b. They have excess cash.
c. They wish to move into a new line of business.
d. They are required to by law.

2. Debt investments are initially recorded at:
a. cost.
b. cost plus accrued interest.
c. fair value.
d. None of the above.

3. Hanes Company sells debt investments costing $26,000
for $28,000, plus accrued interest that has been recorded.
In journalizing the sale, credits are to:
a. Debt Investments and Loss on Sale of Debt Investments.
b. Debt Investments, Gain on Sale of Debt Investments,

and Bond Interest Receivable.
c. Stock Investments and Bond Interest Receivable.
d. No correct answer given.

4. Pryor Company receives net proceeds of $42,000 on the
sale of stock investments that cost $39,500. This transac-
tion will result in reporting in the income statement a:
a. loss of $2,500 under “Other expenses and losses.”
b. loss of $2,500 under “Operating expenses.”
c. gain of $2,500 under “Other revenues and gains.”
d. gain of $2,500 under “Operating revenues.”

5. The equity method of accounting for long-term invest-
ments in stock should be used when the investor has sig-
nificant influence over an investee and owns:
a. between 20% and 50% of the investee’s common stock.
b. 20% or more of the investee’s common stock.
c. more than 50% of the investee’s common stock.
d. less than 20% of the investee’s common stock.

6. Assume that Horicon Corp acquired 25% of the common
stock of Sheboygan Corp. on January 1, 2011, for $300,000.
During 2011 Sheboygan Corp. reported net income of
$160,000 and paid total dividends of $60,000. If Horicon uses
the equity method to account for its investment, the balance
in the investment account on December 31, 2011, will be:
a. $300,000.
b. $325,000.
c. $400,000.
d. $340,000.

7. Using the information in question 6, what entry would
Horicon make to record the receipt of the dividend from
Sheboygan?

a. Debit Cash and credit Revenue from Investment in
Sheboygan Corp.

b. Debit Dividends and credit Revenue from Investment
in Sheboygan Corp.

c. Debit Cash and credit Stock Investments.
d. Debit Cash and credit Dividend Revenue.

8. You have a controlling interest if:
a. you own more than 20% of a company’s stock.
b. you are the president of the company.
c. you use the equity method.
d. you own more than 50% of a company’s stock.

9. Which of the following statements is not true? Consolidated
financial statements are useful to:
a. determine the profitability of specific subsidiaries.
b. determine the total profitability of enterprises under

common control.
c. determine the breadth of a parent company’s operations.
d. determine the full extent of total obligations of enter-

prises under common control.

10. At the end of the first year of operations, the total cost of
the trading securities portfolio is $120,000. Total fair
value is $115,000. The financial statements should show:
a. a reduction of an asset of $5,000 and a realized loss of

$5,000.
b. a reduction of an asset of $5,000 and an unrealized loss

of $5,000 in the stockholders’ equity section.
c. a reduction of an asset of $5,000 in the current assets

section and an unrealized loss of $5,000 in “Other
expenses and losses.”

d. a reduction of an asset of $5,000 in the current assets
section and a realized loss of $5,000 in “Other expenses
and losses.”

11. At December 31, 2011, the fair value of available-for-sale
securities is $41,300 and the cost is $39,800. At January 1,
2011, there was a credit balance of $900 in the Market
Adjustment—Available-for-Sale account. The required
adjusting entry would be:
a. Debit Market Adjustment—Available-for-Sale for

$1,500 and credit Unrealized Gain or Loss—Equity for
$1,500.

b. Debit Market Adjustment—Available-for-Sale for $600
and credit Unrealized Gain or Loss—Equity for $600.

c. Debit Market Adjustment—Available-for-Sale for $2,400
and credit Unrealized Gain or Loss—Equity for $2,400.

d. Debit Unrealized Gain or Loss—Equity for $2,400 and
credit Market Adjustment—Available-for-Sale for
$2,400.

(SO 1)

(SO 2)

(SO 3)

(SO 3)
(SO 3)
(SO 3)

(SO 4)

(SO 5)

(SO 3)
(SO 5)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 593

594 Chapter 12 Investments

12. In the balance sheet, a debit balance in Unrealized Gain
or Loss—Equity is reported as a(n):
a. increase to stockholders’ equity.
b. decrease to stockholders’ equity.
c. loss in the income statement.
d. loss in the retained earnings statement.

13. Short-term debt investments must be readily marketable
and expected to be sold within:
a. 3 months from the date of purchase.
b. the next year or operating cycle, whichever is shorter.
c. the next year or operating cycle, whichever is longer.
d. the operating cycle.

*14. Pate Company pays $175,000 for 100% of Sinko’s com-
mon stock when Sinko’s stockholders’ equity consists of
Common Stock $100,000 and Retained Earnings $60,000.
In the worksheet for the consolidated balance sheet, the
eliminations will include a:
a. credit to Investment in Sinko Common Stock $160,000.
b. credit to Excess of Book Value over Cost of Subsidiary

$15,000.

c. debit to Retained Earnings $75,000.
d. debit to Excess of Cost over Book Value of Subsidiary

$15,000.

*15. Which of the following statements about intercompany
eliminations is true?
a. They are not journalized or posted by any of the sub-

sidiaries.
b. They do not affect the ledger accounts of any of the

subsidiaries.
c. Intercompany eliminations are made solely on the

worksheet to arrive at correct consolidated data.
d. All of these statements are true.

*16. Which one of the following statements about consolidated
income statements is false?
a. A worksheet facilitates the preparation of the statement.
b. The consolidated income statement shows the results

of operations of affiliated companies as a single eco-
nomic unit.

c. All revenue and expense transactions between parent
and subsidiary companies are eliminated.

d. When a subsidiary is wholly owned, the form and content
of the statement will differ from the income statement of
an individual corporation.

Go to the book’s companion website,
www.wiley.com/college/weygandt,
for Additional Self-Study Questions.

(SO 5)

(SO 6)

(SO 7)

(SO 8)

(SO 7)
The Navigator✓
QUESTIONS

1. What are the reasons that corporations invest in securities?
2. (a) What is the cost of an investment in bonds?

(b) When is interest on bonds recorded?
3. Tino Martinez is confused about losses and gains on the

sale of debt investments. Explain to Tino (a) how the gain
or loss is computed, and (b) the statement presentation of
the gains and losses.

4. Olindo Company sells Gish’s bonds costing $40,000 for
$45,000, including $500 of accrued interest. In recording
the sale, Olindo books a $5,000 gain. Is this correct? Explain.

5. What is the cost of an investment in stock?
6. To acquire Kinston Corporation stock, R. Neal pays

$62,000 in cash, plus $1,200 broker’s fees. What entry
should be made for this investment?

7. (a) When should a long-term investment in common stock
be accounted for by the equity method? (b) When is rev-
enue recognized under this method?

8. Rijo Corporation uses the equity method to account for its
ownership of 30% of the common stock of Pippen Packing.
During 2011 Pippen reported a net income of $80,000 and
declares and pays cash dividends of $10,000. What recogni-
tion should Rijo Corporation give to these events?

9. What constitutes “significant influence” when an in-
vestor’s financial interest is below the 50% level?

10. Distinguish between the cost and equity methods of ac-
counting for investments in stocks.

11. What are consolidated financial statements?

12. What are the valuation guidelines for investments at a
balance sheet date?

13. Tina Eddings is the controller of Mendez Inc. At
December 31, the company’s investments in trading secu-

rities cost $74,000. They have a fair value of $70,000.
Indicate how Tina would report these data in the financial
statements prepared on December 31.

14. Using the data in question 13, how would Tina report the
data if the investment were long-term and the securities
were classified as available-for-sale?

15. Hashmi Company’s investments in available-for-sale se-
curities at December 31 show total cost of $195,000 and
total fair value of $205,000. Prepare the adjusting entry.

16. Using the data in question 15, prepare the adjusting entry
assuming the securities are classified as trading securities.

17. What is the proper statement presentation of the account
Unrealized Loss—Equity?

18. What purposes are served by reporting Unrealized Gains
(Losses)—Equity in the stockholders’ equity section?

19. Altoona Wholesale Supply owns stock in Key Corporation.
Altoona intends to hold the stock indefinitely because of
some negative tax consequences if sold. Should the invest-
ment in Key be classified as a short-term investment? Why
or why not?

*20. (a) What asset and stockholders’ equity balances are
eliminated in preparing a consolidated balance sheet for a
parent and a wholly owned subsidiary? (b) Why are they
eliminated?

*21. Bohanon Company pays $318,000 to purchase all the out-
standing common stock of Erin Corporation. At the date
of purchase the net assets of Erin have a book value of
$290,000. Bohanon’s management allocates $20,000 of the
excess cost to undervalued land on the books of Erin.
What should be done with the rest of the excess?

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 594

Do it! Review 595

BE12-1 Coffey Corporation purchased debt investments for $52,000 on January 1, 2011. On
July 1, 2011, Coffey received cash interest of $2,340. Journalize the purchase and the receipt of
interest. Assume that no interest has been accrued.

BE12-2 On August 1, Wade Company buys 1,000 shares of Morgan common stock for $35,000
cash, plus brokerage fees of $700. On December 1, Wade sells the stock investments for $40,000
in cash. Journalize the purchase and sale of the common stock.

BE12-3 Kayser Company owns 25% of Fort Company. For the current year Fort reports net in-
come of $180,000 and declares and pays a $50,000 cash dividend. Record Kayser’s equity in Fort’s
net income and the receipt of dividends from Fort.

BE12-4 The cost of the trading securities of Cepeda Company at December 31, 2011, is
$62,000. At December 31, 2011, the fair value of the securities is $59,000. Prepare the adjusting
entry to record the securities at fair value.

BE12-5 For the data presented in BE12-4, show the financial statement presentation of the
trading securities and related accounts.

BE12-6 Garrett Corporation holds as a long-term investment available-for-sale stock securi-
ties costing $72,000. At December 31, 2011, the fair value of the securities is $66,000. Prepare the
adjusting entry to record the securities at fair value.

BE12-7 For the data presented in BE12-6, show the financial statement presentation of the
available-for-sale securities and related accounts. Assume the available-for-sale securities are
noncurrent.

BE12-8 Gowdy Corporation has the following long-term investments: (1) Common stock of
Dixen Co. (10% ownership) held as available-for-sale securities, cost $108,000, fair value
$115,000. (2) Common stock of Ely Inc. (30% ownership), cost $210,000, equity $270,000.
Prepare the investments section of the balance sheet.

*BE12-9 Paula Company acquires 100% of the common stock of Shannon Company for
$190,000 cash. On the acquisition date, Shannon’s ledger shows Common Stock $120,000 and
Retained Earnings $70,000. Complete the worksheet for the following accounts: Paula—
Investment in Shannon Common Stock, Shannon—Common Stock, and Shannon—Retained
Earnings.

*BE12-10 Data for the Paula and Shannon companies are given in BE12-9. Instead of paying
$190,000, assume that Paula pays $200,000 to acquire the 100% interest in Shannon Company.
Complete the worksheet for the accounts identified in BE12-9 and for the excess of cost over
book value.

BRIEF

EXERCISES

12-1 Odlaw Corporation had the following transactions relating to debt investments:

Jan. 1 Purchased 50, $1,000, 12% Clinton Company bonds for $50,000 plus broker’s fees
of $1,500. Interest is payable semiannually on January 1 and July 1.

July 1 Received semiannual interest from Clinton Company bonds.
July 1 Sold 30 Clinton Company bonds for $30,000, less $800 broker’s fees.

(a) Journalize the transactions, and (b) prepare the adjusting entry for the accrual of interest on
December 31.

12-2 Presented below and on page 596 are two independent situations:

1. Potomac Inc. acquired 10% of the 500,000 shares of common stock of Maryland Corporation
at a total cost of $11 per share on June 17, 2011. On September 3, Maryland declared and paid
a $160,000 dividend. On December 31, Maryland reported net income of $550,000 for the year.

Do it!
Do it!

ReviewDo it!

Journalize entries for debt
investments.

(SO 2)

Journalize entries for stock
investments.

(SO 3)

Record transactions under the
equity method of accounting.

(SO 3)

Prepare adjusting entry using
fair value.

(SO 5)

Indicate statement presentation
using fair value.

(SO 5, 6)

Prepare adjusting entry using
fair value.
(SO 5)

Indicate statements
presentation using fair value.

(SO 5, 6)

Prepare investments section
of balance sheet.

(SO 5, 6)

Prepare partial consolidated
worksheet when cost equals
book value.

(SO 7)

Prepare partial consolidated
worksheet when cost exceeds
book value.

(SO 7)

Make journal entry for bond
purchase and adjusting entry
for interest accrual.

(SO 2)

Make journal entries for stock
investments.

(SO 3)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 595

596 Chapter 12 Investments

2. Andy Fisher Corporation obtained significant influence over Bandit Company by buying
30% of Bandit’s 100,000 outstanding shares of common stock at a cost of $18 per share on
January 1, 2011. On May 15, Bandit declared and paid a cash dividend of $150,000. On
December 31, Bandit reported net income of $270,000 for the year.

Prepare all necessary journal entries for 2011 for (1) Potomac and (2) Andy Fisher.

12-3 Some of Grand Junction Corporation’s investment securities are classified as
trading securities and some are classified as available-for-sale. The cost and market value of
each category at December 31, 2011, was as follows.

Cost Fair Value Unrealized Gain (Loss)

Trading securities $96,300 $84,900 $(11,400)
Available-for-sale securities $59,000 $63,200 $ 4,200

At December 31, 2010, the Market Adjustment—Trading account had a debit balance of $2,200,
and the Market Adjustment—Available-for-Sale account had a credit balance of $7,750. Prepare
the required journal entries for each group of securities for December 31, 2011.

12-4 Identify where each of the following items would be reported in the financial
statements.

1. Loss on sale of investments in stock.
2. Unrealized gain on available-for-sale securities.
3. Market adjustment—trading.
4. Interest earned on investments in bonds.
5. Unrealized loss on trading securities.

Use the following possible categories:
Balance sheet:

Current assets Current liabilities
Investments Long-term liabilities
Property, plant, and equipment Stockholders’ equity
Intangible assets

Income statement:
Other revenues and gains Other expenses and losses

Do it!
Do it!

Indicate financial statement
presentation of investments

(SO 6)

Make journal entries for
trading and available-for-sale
securities.

(SO 5)

E12-1 Max Weinberg is studying for an accounting test and has developed the following ques-
tions about investments.

1. What are three reasons why companies purchase investments in debt or stock securities?
2. Why would a corporation have excess cash that it does not need for operations?
3. What is the typical investment when investing cash for short periods of time?
4. What are the typical investments when investing cash to generate earnings?
5. Why would a company invest in securities that provide no current cash flows?
6. What is the typical stock investment when investing cash for strategic reasons?

Instructions
Provide answers for Max.

E12-2 Foren Corporation had the following transactions pertaining to debt investments.

Jan. 1 Purchased 50 8%, $1,000 Choate Co. bonds for $50,000 cash plus brokerage fees of
$900. Interest is payable semiannually on July 1 and January 1.

July 1 Received semiannual interest on Choate Co. bonds.
July 1 Sold 30 Choate Co. bonds for $34,000 less $500 brokerage fees.

Instructions
(a) Journalize the transactions.
(b) Prepare the adjusting entry for the accrual of interest at December 31.

EXERCISES

Understand debt and stock
investments.

(SO 1)

Journalize debt investment
transactions and accrue
interest.

(SO 2)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 596

Exercises 597

E12-3 EmmyLou Company purchased 70 Harris Company 12%, 10-year, $1,000 bonds on
January 1, 2011, for $73,000. EmmyLou Company also had to pay $500 of broker’s fees. The
bonds pay interest semiannually on July 1 and January 1. On January 1, 2012, after receipt of
interest, EmmyLou Company sold 40 of the bonds for $40,100.

Instructions
Prepare the journal entries to record the transactions described above.

E12-4 Dossett Company had the following transactions pertaining to stock investments.

Feb. 1 Purchased 600 shares of Goetz common stock (2%) for $6,000 cash, plus brokerage
fees of $200.

July 1 Received cash dividends of $1 per share on Goetz common stock.
Sept. 1 Sold 300 shares of Goetz common stock for $4,400, less brokerage fees of $100.
Dec. 1 Received cash dividends of $1 per share on Goetz common stock.

Instructions
(a) Journalize the transactions.
(b) Explain how dividend revenue and the gain (loss) on sale should be reported in the income

statement.

E12-5 Wyrick Inc. had the following transactions pertaining to investments in common stock.

Jan. 1 Purchased 2,500 shares of Murphy Corporation common stock (5%) for $140,000 cash
plus $2,100 broker’s commission.

July 1 Received a cash dividend of $3 per share.
Dec. 1 Sold 500 shares of Murphy Corporation common stock for $32,000 cash, less $800

broker’s commission.
Dec. 31 Received a cash dividend of $3 per share.

Instructions
Journalize the transactions.

E12-6 On February 1, Neil Company purchased 500 shares (2% ownership) of Young
Company common stock for $30 per share plus brokerage fees of $400. On March 20, Neil
Company sold 100 shares of Young stock for $2,900, less a $50 brokerage fee. Neil received a
dividend of $1.00 per share on April 25. On June 15, Neil sold 200 shares of Young stock for
$7,400, less a $90 brokerage fee. On July 28, Neil received a dividend of $1.25 per share.

Instructions
Prepare the journal entries to record the transactions described above.

E12-7 On January 1 Kwun Corporation purchased a 25% equity in Connors Corporation for
$180,000. At December 31 Connors declared and paid a $60,000 cash dividend and reported net
income of $200,000.

Instructions
(a) Journalize the transactions.
(b) Determine the amount to be reported as an investment in Connors stock at December 31.

E12-8 Presented below are two independent situations.

1. Heath Cosmetics acquired 15% of the 200,000 shares of common stock of Van Fashion at a
total cost of $13 per share on March 18, 2011. On June 30, Van declared and paid a $60,000
dividend. On December 31, Van reported net income of $122,000 for the year. At December 31,
the market price of Van Fashion was $15 per share. The stock is classified as available-
for-sale.

2. Yoder, Inc., obtained significant influence over Parks Corporation by buying 30% of Parks
30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2011.
On June 15, Parks declared and paid a cash dividend of $30,000. On December 31, Parks
reported a net income of $80,000 for the year.

Instructions
Prepare all the necessary journal entries for 2011 for (1) Heath Cosmetics and (2) Yoder, Inc.

Journalize debt investment
transactions, accrue interest,
and record sale.

(SO 2)

Journalize stock investment
transactions.

(SO 3)

Journalize transactions for
investments in stocks.

(SO 3)
Journalize transactions for
investments in stocks.
(SO 3)

Journalize and post
transactions, and contrast cost
and equity method results.

(SO 3)

Journalize entries under cost
and equity methods.

(SO 3, 5)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 597

E12-9 Ryan Company purchased 70% of the outstanding common stock of Wayne
Corporation.

Instructions
(a) Explain the relationship between Ryan Company and Wayne Corporation.
(b) How should Ryan account for its investment in Wayne?
(c) Why is the accounting treatment described in (b) useful?

E12-10 At December 31, 2011, the trading securities for Natoli, Inc. are as follows.

Security Cost Fair Value

A $17,500 $16,000
B 12,500 14,000
C 23,000 19,000

$53,000 $49,000

Instructions
(a) Prepare the adjusting entry at December 31, 2011, to report the securities at fair value.
(b) Show the balance sheet and income statement presentation at December 31, 2011, after

adjustment to fair value.

E12-11 Data for investments in stock classified as trading securities are presented in E12-10.
Assume instead that the investments are classified as available-for-sale securities. They have the
same cost and fair value. The securities are considered to be a long-term investment.

Instructions
(a) Prepare the adjusting entry at December 31, 2011, to report the securities at fair value.
(b) Show the statement presentation at December 31, 2011, after adjustment to fair value.
(c) M. Linquist, a member of the board of directors, does not understand the re-

porting of the unrealized gains or losses. Write a letter to Mr. Linquist explaining the report-
ing and the purposes that it serves.

E12-12 McGee Company has the following data at December 31, 2011.

Securities Cost Fair Value

Trading $120,000 $124,000
Available-for-sale 100,000 94,000

The available-for-sale securities are held as a long-term investment.

Instructions
(a) Prepare the adjusting entries to report each class of securities at fair value.
(b) Indicate the statement presentation of each class of securities and the related unrealized gain

(loss) accounts.

*E12-13 On January 1, 2011, Lennon Corporation acquires 100% of Ono Inc. for $220,000 in
cash. The condensed balance sheets of the two corporations immediately following the acquisition
are as follows.

Lennon Ono
Corporation Inc.

Current assets $ 60,000 $ 50,000
Investment in Ono Inc. common stock 220,000
Plant and equipment (net) 300,000 220,000

$580,000 $270,000

Current liabilities $180,000 $ 50,000
Common stock 230,000 80,000
Retained earnings 170,000 140,000

$580,000 $270,000

Instructions
Prepare a worksheet for a consolidated balance sheet.

598 Chapter 12 Investments

Understand the usefulness of
consolidated statements.

(SO 4)

Prepare adjusting entry to
record fair value, and indicate
statement presentation.

(SO 5, 6)
Prepare adjusting entry to
record fair value, and indicate
statement presentation.
(SO 5, 6)

Prepare adjusting entries
for fair value, and indicate
statement presentation for
two classes of securities.

(SO 5, 6)

Prepare consolidated
worksheet when cost equals
book value.

(SO 7, 8)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 598

*E12-14 Data for the Lennon and Ono corporations are presented in E12-13. Assume that
instead of paying $220,000 in cash for Ono Inc., Lennon Corporation pays $225,000 in cash. Thus,
at the acquisition date, the assets of Lennon Corporation are: Current assets $55,000, Investment
in Ono Inc. common stock $225,000, and Plant and equipment (net) $300,000.

Instructions
Prepare a worksheet for a consolidated balance sheet.

Problems: Set A 599

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Exercise Set B and a set of Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

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.wiley.com

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PROBLEMS: SET A

P12-1A Davison Carecenters Inc. provides financing and capital to the healthcare industry,
with a particular focus on nursing homes for the elderly. The following selected transactions re-
late to bonds acquired as an investment by Davison, whose fiscal year ends on December 31.

2011

Jan. 1 Purchased at face value $2,000,000 of Hannon Nursing Centers, Inc., 10-year, 8%
bonds dated January 1, 2011, directly from Hannon.

July 1 Received the semiannual interest on the Hannon bonds.
Dec. 31 Accrual of interest at year-end on the Hannon bonds.

(Assume that all intervening transactions and adjustments have been properly recorded and that
the number of bonds owned has not changed from December 31, 2011, to December 31, 2013.)

2014

Jan. 1 Received the semiannual interest on the Hannon bonds.
Jan. 1 Sold $1,000,000 Hannon bonds at 106. The broker deducted $6,000 for commissions

and fees on the sale.
July 1 Received the semiannual interest on the Hannon bonds.
Dec. 31 Accrual of interest at year-end on the Hannon bonds.

Instructions
(a) Journalize the listed transactions for the years 2011 and 2014.
(b) Assume that the fair value of the bonds at December 31, 2011, was $2,200,000. These bonds

are classified as available-for-sale securities. Prepare the adjusting entry to record these
bonds at fair value.

(c) Based on your analysis in part (b), show the balance sheet presentation of the bonds and
interest receivable at December 31, 2011. Assume the investments are considered long-term.
Indicate where any unrealized gain or loss is reported in the financial statements.

P12-2A In January 2011, the management of Noble Company concludes that it has sufficient
cash to permit some short-term investments in debt and stock securities. During the year, the
following transactions occurred.

Feb. 1 Purchased 600 shares of Hiens common stock for $31,800, plus brokerage fees of $600.
Mar. 1 Purchased 800 shares of Pryce common stock for $20,000, plus brokerage fees of $400.
Apr. 1 Purchased 50 $1,000, 7% Roy bonds for $50,000, plus $1,000 brokerage fees. Interest is

payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the Hiens common stock.
Aug. 1 Sold 200 shares of Hiens common stock at $58 per share less brokerage fees of $200.
Sept. 1 Received a $1 per share cash dividend on the Pryce common stock.
Oct. 1 Received the semiannual interest on the Roy bonds.
Oct. 1 Sold the Roy bonds for $50,000 less $1,000 brokerage fees.

At December 31, the fair value of the Hiens common stock was $55 per share. The fair value of
the Pryce common stock was $24 per share.

Prepare consolidated
worksheet when cost exceeds
book value.

(SO 7, 8)

(a) Gain on sale of debt
investment $54,000

Journalize debt investment
transactions and show financial
statement presentation.

(SO 2, 5, 6)

Journalize investment
transactions, prepare adjusting
entry, and show statement
presentation.

(SO 2, 3, 5, 6)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 599

Instructions
(a) Journalize the transactions shown on page 599 and post to the accounts Debt Investments

and Stock Investments. (Use the T-account form.)
(b) Prepare the adjusting entry at December 31, 2011, to report the investment securities at fair

value. All

securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2011.
(d) Identify the income statement accounts and give the statement classification of each account.

P12-3A On December 31, 2011, Ramey Associates owned the following securities, held as a
long-term investment. The securities are not held for influence or control of the investee.

Common Stock Shares Cost

Hurst Co. 2,000 $60,000
Pine Co. 5,000 45,000
Scott Co. 1,500 30,000

On December 31, 2011, the total fair value of the securities was equal to its cost. In 2012, the fol-
lowing transactions occurred.

July 1 Received $1 per share semiannual cash dividend on Pine Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Hurst Co. common stock.
Sept. 1 Sold 1,500 shares of Pine Co. common stock for cash at $8 per share, less brokerage

fees of $300.
Oct. 1 Sold 800 shares of Hurst Co. common stock for cash at $33 per share, less brokerage

fees of $500.
Nov. 1 Received $1 per share cash dividend on Scott Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Hurst Co. common stock.

31 Received $1 per share semiannual cash dividend on Pine Co. common stock.

At December 31, the fair values per share of the common stocks were: Hurst Co. $32, Pine Co.
$8, and Scott Co. $18.

Instructions
(a) Journalize the 2012 transactions and post to the account Stock Investments. (Use the

T-account form.)
(b) Prepare the adjusting entry at December 31, 2012, to show the securities at fair value. The

stock should be classified as available-for-sale securities.
(c) Show the balance sheet presentation of the investments at December 31, 2012. At this date,

Ramey Associates has common stock $1,500,000 and retained earnings $1,000,000.

P12-4A Glaser Services acquired 30% of the outstanding common stock of Nickels Company
on January 1, 2011, by paying $800,000 for the 45,000 shares. Nickels declared and paid $0.30 per
share cash dividends on March 15, June 15, September 15, and December 15, 2011. Nickels
reported net income of $320,000 for the year. At December 31, 2011, the market price of Nickels
common stock was $24 per share.

Instructions
(a) Prepare the journal entries for Glaser Services for 2011 assuming Glaser cannot exercise sig-

nificant influence over Nickels. (Use the cost method and assume that Nickels common stock
should be classified as a trading security.)

(b) Prepare the journal entries for Glaser Services for 2011, assuming Glaser can exercise signif-
icant influence over Nickels. Use the equity method.

(c) Indicate the balance sheet and income statement account balances at December 31, 2011,
under each method of accounting.

P12-5A The following securities are in Pascual Company’s portfolio of long-term available-
for-sale securities at December 31, 2011.

Cost
1,000 shares of Abel Corporation common stock $52,000
1,400 shares of Frey Corporation common stock 84,000
1,200 shares of Weiss Corporation preferred stock 33,600

600 Chapter 12 Investments

(a) Gain on stock sale $600

(b) Unrealized loss $4,100

(b) Revenue from investments
$96,000

Journalize transactions and
adjusting entry for stock
investments.

(SO 3, 5, 6)

(a) Total dividend revenue
$54,000

Prepare entries under the cost
and equity methods, and
tabulate differences.

(SO 3)

Journalize stock investment
transactions and show
statement presentation.

(SO 3, 5, 6)

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 600

Problems: Set A 601

On December 31, 2011, the total cost of the portfolio equaled total fair value. Pascual had the
following transactions related to the securities during 2012.

Jan. 20 Sold 1,000 shares of Abel Corporation common stock at $55 per share less brokerage
fees of $600.

28 Purchased 400 shares of $70 par value common stock of Rosen Corporation at $78 per
share, plus brokerage fees of $480.

30 Received a cash dividend of $1.15 per share on Frey Corp. common stock.
Feb. 8 Received cash dividends of $0.40 per share on Weiss Corp. preferred stock.

18 Sold all 1,200 shares of Weiss Corp. preferred stock at $27 per share less brokerage fees
of $360.

July 30 Received a cash dividend of $1.00 per share on Frey Corp. common stock.
Sept. 6 Purchased an additional 900 shares of $10 par value common stock of Rosen

Corporation at $82 per share, plus brokerage fees of $1,200.
Dec. 1 Received a cash dividend of $1.50 per share on Rosen Corporation common stock.

At December 31, 2012, the fair values of the securities were:

Frey Corporation common stock $64 per share
Rosen Corporation common stock $72 per share

Pascual Company uses separate account titles for each investment, such as “Investment in Frey
Corporation Common Stock.”

Instructions
(a) Prepare journal entries to record the transactions.
(b) Post to the investment accounts. (Use T accounts.)
(c) Prepare the adjusting entry at December 31, 2012 to report the portfolio at fair value.
(d) Show the balance sheet presentation at December 31, 2012, for the investment-related accounts.

P12-6A The following data, presented in alphabetical order, are taken from the records of
Urbina Corporation.

Accounts payable $ 240,000
Accounts receivable 140,000
Accumulated depreciation—building 180,000
Accumulated depreciation—equipment 52,000
Allowance for doubtful accounts 6,000
Bonds payable (10%, due 2019) 500,000
Buildings 950,000
Cash 42,000
Common stock ($10 par value; 500,000 shares authorized,

150,000 shares issued) 1,500,000
Dividends payable 80,000
Equipment 275,000
Goodwill 200,000
Income taxes payable 120,000
Investment in Flott common stock (10% ownership), at cost 278,000
Investment in Portico common stock (30% ownership), at equity 380,000
Land 390,000
Market adjustment—available-for-sale securities (Dr) 8,000
Merchandise inventory 170,000
Notes payable (due 2012) 70,000
Paid-in capital in excess of par value 130,000
Premium on bonds payable 40,000
Prepaid insurance 16,000
Retained earnings 103,000
Short-term stock investment, at fair value (and cost) 180,000
Unrealized gain—available-for-sale securities 8,000

The investment in Flott common stock is considered to be a long-term available-for-sale security.

Instructions
Prepare a classified balance sheet at December 31, 2011.

(a) Loss on sale of preferred
stock $1,560

Total assets $2,791,000

Prepare a balance sheet.

(SO 5, 6)

JWCL165_c12_568-611.qxd 8/11/09 9:51 PM Page 601

602 Chapter 12 Investments

Prepare consolidated
worksheet and balance sheet
when cost exceeds book value.

(SO 7, 8)

*P12-7A Robinson Corporation purchased all the outstanding common stock of Hoffman
Plastics, Inc. on December 31, 2011. Just before the purchase, the condensed balance sheets of the
two companies appeared as follows.

Robinson Corporation Hoffman Plastics, Inc.

Current assets $1,480,000 $ 435,500
Plant and equipment (net) 2,100,000 676,000

$3,580,000 $1,111,500

Current liabilities $ 578,000 $ 92,500
Common stock 1,950,000 525,000
Retained earnings 1,052,000 494,000

$3,580,000 $1,111,500

Robinson used current assets of $1,225,000 to acquire the stock of Hoffman Plastics. The excess
of this purchase price over the book value of Hoffman Plastics’ net assets is determined to be
attributable $86,000 to Hoffman Plastics’ plant and equipment and the remainder to goodwill.

Instructions
(a) Prepare the entry for Robinson’s acquisition of Hoffman Plastics, Inc. stock.
(b) Prepare a consolidated worksheet at December 31, 2011.
(c) Prepare a consolidated balance sheet at December 31, 2011.

Excess of cost over book
value $120,000

P12-1B Groneman Farms is a grower of hybrid seed corn for Ogleby Genetics Corporation. It
has had two exceptionally good years and has elected to invest its excess funds in bonds. The
following selected transactions relate to bonds acquired as an investment by Groneman Farms,
whose fiscal year ends on December 31.

2011

Jan. 1 Purchased at face value $400,000 of Ziemer Corporation 10-year, 9% bonds dated
January 1, 2011, directly from the issuing corporation.

July 1 Received the semiannual interest on the Ziemer bonds.
Dec. 31 Accrual of interest at year-end on the Ziemer bonds.

(Assume that all intervening transactions and adjustments have been properly recorded and the
number of bonds owned has not changed from December 31, 2011, to December 31, 2013.)

2014

Jan. 1 Received the semiannual interest on the Ziemer bonds.
Jan. 1 Sold $200,000 of Ziemer bonds at 114. The broker deducted $7,000 for commissions

and fees on the sale.
July 1 Received the semiannual interest on the Ziemer bonds.
Dec. 31 Accrual of interest at year-end on the Ziemer bonds.

Instructions
(a) Journalize the listed transactions for the years 2011 and 2014.
(b) Assume that the fair value of the bonds at December 31, 2011, was $385,000. These bonds are

classified as available-for-sale securities. Prepare the adjusting entry to record these bonds at
fair value.

(c) Based on your analysis in part (b) show the balance sheet presentation of the bonds and in-
terest receivable at December 31, 2011. Assume the investments are considered long-term.
Indicate where any unrealized gain or loss is reported in the financial statements.

P12-2B In January 2011, the management of Prasad Company concludes that it has sufficient
cash to purchase some short-term investments in debt and stock securities. During the year, the
following transactions occurred.

Feb. 1 Purchased 500 shares of DET common stock for $30,000, plus brokerage fees of $800.
Mar. 1 Purchased 600 shares of STL common stock for $20,000, plus brokerage fees of $300.

PROBLEMS: SET B

(a) Gain on sale of debt
investments $21,000

Journalize debt investment
transactions and show financial
statement presentation.
(SO 2, 5, 6)
Journalize investment
transactions, prepare adjusting
entry, and show statement
presentation.
(SO 2, 3, 5, 6)

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Apr. 1 Purchased 40 $1,000, 9% CIN bonds for $40,000, plus $1,200 brokerage fees. Interest is
payable semiannually on April 1 and October 1.

July 1 Received a cash dividend of $0.60 per share on the DET common stock.
Aug. 1 Sold 300 shares of DET common stock at $69 per share, less brokerage fees of $350.
Sept. 1 Received a $1 per share cash dividend on the STL common stock.
Oct. 1 Received the semiannual interest on the CIN bonds.
Oct. 1 Sold the CIN bonds for $45,000, less $1,000 brokerage fees.

At December 31, the fair value of the DET common stock was $66 per share. The fair value of
the STL common stock was $29 per share.

Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock

Investments. (Use the T-account form.)
(b) Prepare the adjusting entry at December 31, 2011, to report the investments at fair value. All

P12-3B On December 31, 2011, Sauder Associates owned the following securities, held as
long-term investments.

Common Stock Shares Cost

Adel Co. 4,000 $100,000
Beran Co. 5,000 30,000
Caren Co. 3,000 60,000

On this date, the total fair value of the securities was equal to its cost. The securities are not held
for influence or control over the investees. In 2012, the following transactions occurred.

July 1 Received $1 per share semiannual cash dividend on Beran Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Adel Co. common stock.
Sept. 1 Sold 1,500 shares of Beran Co. common stock for cash at $8 per share, less brokerage

fees of $300.
Oct. 1 Sold 600 shares of Adel Co. common stock for cash at $30 per share, less brokerage

fees of $600.
Nov. 1 Received $1 per share cash dividend on Caren Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Adel Co. common stock.

31 Received $1 per share semiannual cash dividend on Beran Co. common stock.

At December 31, the fair values per share of the common stocks were: Adel Co. $23, Beran Co.
$7, and Caren Co. $19.

Instructions
(a) Journalize the 2012 transactions and post to the account Stock Investments. (Use the
T-account form.)
(b) Prepare the adjusting entry at December 31, 2012, to show the securities at fair value. The

stock should be classified as available-for-sale securities.
(c) Show the balance sheet presentation of the investment-related accounts at December 31,

2012. At this date, Sauder Associates has common stock $2,000,000 and retained earnings
$1,200,000.

P12-4B Terry’s Concrete acquired 20% of the outstanding common stock of Blakeley, Inc. on
January 1, 2011, by paying $1,100,000 for 40,000 shares. Blakeley declared and paid a $0.50 per share
cash dividend on June 30 and again on December 31, 2011. Blakeley reported net income of $600,000
for the year. At December 31, 2011, the market price of Blakeley’s common stock was $30 per share.

Instructions
(a) Prepare the journal entries for Terry’s Concrete for 2011 assuming Terry’s cannot exercise

significant influence over Blakeley. (Use the cost method and assume Blakeley common
stock should be classified as available-for-sale.)

(b) Prepare the journal entries for Terry’s Concrete for 2011, assuming Terry’s can exercise
significant influence over Blakeley. (Use the equity method.)

(c) Indicate the balance sheet and income statement account balances at December 31, 2011,
under each method of accounting.

Problems: Set B 603

(a) Gain on sale, $2,700 and
$2,400

(b) Unrealized loss $2,020

Journalize transactions and
adjusting entry for stock
investments.

(SO 3, 5, 6)
Prepare entries under the cost
and equity methods, and
tabulate differences.
(SO 3)

(a) Total dividend revenue
$40,000

(b) Revenue from investment
$120,000

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604 Chapter 12 Investments

P12-5B The following are in Jamison Company’s portfolio of long-term available-for-sale se-
curities at December 31, 2011.

Cost
700 shares of Adler Corporation common stock $35,000
900 shares of Lynn Corporation common stock 42,000
800 shares of Swanson Corporation preferred stock 22,400

On December 31, the total cost of the portfolio equaled total fair value. Jamison Company had
the following transactions related to the securities during 2012.

Jan. 7 Sold 700 shares of Adler Corporation common stock at $56 per share, less brokerage
fees of $700.

10 Purchased 300 shares, $70 par value common stock of Pesavento Corporation at $78
per share, plus brokerage fees of $240.

26 Received a cash dividend of $1.15 per share on Lynn Corporation common stock.
Feb. 2 Received cash dividends of $0.40 per share on Swanson Corporation preferred stock.

10 Sold all 800 shares of Swanson Corporation preferred stock at $26 per share less bro-
kerage fees of $180.

July 1 Received a cash dividend of $1.00 per share on Lynn Corporation common stock.
Sept. 1 Purchased an additional 800 shares of the $70 par value common stock of Pesavento

Corporation at $75 per share, plus brokerage fees of $900.
Dec. 15 Received a cash dividend of $1.50 per share on Pesavento Corporation common stock.

At December 31, 2012, the fair values of the securities were:

Lynn Corporation common stock $48 per share
Pesavento Corporation common stock $72 per share

Jamison uses separate account titles for each investment, such as Investment in Lynn
Corporation Common Stock.

Instructions
(a) Prepare journal entries to record the transactions.
(b) Post to the investment accounts. (Use T accounts.)
(c) Prepare the adjusting entry at December 31, 2012, to report the portfolio at fair value.
(d) Show the balance sheet presentation at December 31, 2012, for the investment-related accounts.

P12-6B The following data, presented in alphabetical order, are taken from the records of
Nichols Corporation.

Accounts payable $ 375,000
Accounts receivable 135,000
Accumulated depreciation—building 270,000
Accumulated depreciation—equipment 80,000
Allowance for doubtful accounts 10,000
Bonds payable (10%, due 2021) 600,000
Buildings 1,350,000
Cash 210,000
Common stock ($5 par value; 500,000 shares authorized,

440,000 shares issued) 2,200,000
Discount on bonds payable 30,000
Dividends payable 75,000
Equipment 415,000
Goodwill 300,000
Income taxes payable 180,000
Investment in Givens Inc. stock (30% ownership), at equity 900,000
Land 780,000
Merchandise inventory 255,000
Notes payable (due 2012) 110,000
Paid-in capital in excess of par value 300,000
Prepaid insurance 25,000
Retained earnings 480,000
Short-term stock investment, at fair value (and cost) 280,000

Instructions
Prepare a classified balance sheet at December 31, 2011.

(a) Loss on sale of preferred
stock $1,780

Journalize stock investment
transactions and show
statement presentation.
(SO 3, 5, 6)
Prepare a balance sheet.
(SO 5, 6)

Total assets $4,290,000

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*P12-7B Patel Company purchased all the outstanding common stock of Singh Company on
December 31, 2011. Just before the purchase, the condensed balance sheets of the two companies
were as follows.

Patel Company Singh Company

Current assets $1,478,000 $379,000
Plant and equipment (net) 1,882,000 351,000

$3,360,000 $730,000

Current liabilities $ 870,000 $ 90,000
Common stock 1,947,000 360,000
Retained earnings 543,000 280,000

$3,360,000 $730,000

Patel used current assets of $710,000 to acquire the stock of Singh. The excess of this purchase
price over the book value of Patel’s net assets is determined to be attributable $20,000 to Singh’s
plant and equipment and the remainder to goodwill.

Instructions
(a) Prepare the entry for Patel Company’s acquisition of Singh Company stock.
(b) Prepare a consolidated worksheet at December 31, 2011.
(c) Prepare a consolidated balance sheet at December 31, 2011.

Comprehensive Problem 605

Excess of cost over book
value $50,000

Prepare consolidated
worksheet and balance sheet
when cost exceeds book value.
(SO 7, 8)

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set C.

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CP12-1 Part I Mindy Feldkamp and her two colleagues, Oscar Lopez and Lori Melton, are
personal trainers at an upscale health spa/resort in Tampa, Florida. They want to start a health
club that specializes in health plans for people in the 50� age range. The growing population in
this age range and strong consumer interest in the health benefits of physical activity have con-
vinced them they can profitably operate their own club. In addition to many other decisions, they
need to determine what type of business organization they want. Oscar believes there are more
advantages to the corporate form than a partnership, but he hasn’t yet convinced Mindy and
Lori. They have come to you, a small business consulting specialist, seeking information and ad-
vice regarding the choice of starting a partnership versus a corporation.

Instructions
(a) Prepare a memo (dated May 26, 2010) that describes the advantages and disad-

vantages of both partnerships and corporations. Advise Mindy, Oscar, and Lori regarding
which organizational form you believe would better serve their purposes. Make sure to in-
clude reasons supporting your advice.

Part II After deciding to incorporate, each of the three investors receives 20,000 shares of $2
par common stock on June 12, 2010, in exchange for their co-owned building ($200,000 market
value) and $100,000 total cash they contributed to the business. The next decision that Mindy,
Oscar, and Lori need to make is how to obtain financing for renovation and equipment. They un-
derstand the difference between equity securities and debt securities, but do not understand the
tax, net income, and earnings per share consequences of equity versus debt financing on the future
of their business.

COMPREHENSIVE PROBLEM

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606 Chapter 12 Investments

Instructions
(b) Prepare notes for a discussion with the three entrepreneurs in which you will compare the

consequences of using equity versus debt financing. As part of your notes, show the differ-
ences in interest and tax expense assuming $1,400,000 is financed with common stock, and
then alternatively with debt. Assume that when common stock is used, 140,000 shares will
be issued. When debt is used, assume the interest rate on debt is 9%, the tax rate is 32%, and
income before interest and taxes is $300,000. (You may want to use an electronic spreadsheet.)

Part III During the discussion about financing, Lori mentions that one of her clients, Roberto
Marino, has approached her about buying a significant interest in the new club. Having an inter-
ested investor sways the three to issue equity securities to provide the financing they need. On
July 21, 2010, Mr. Marino buys 90,000 shares at a price of $10 per share.

The club, LifePath Fitness, opens on January 12, 2011, and after a slow start, begins to pro-
duce the revenue desired by the owners. The owners decide to pay themselves a stock dividend,
since cash has been less than abundant since they opened their doors. The 10% stock dividend is
declared by the owners on July 27, 2011. The market value of the stock is $3 on the declaration
date. The date of record is July 31, 2011 (there have been no changes in stock ownership since the
initial issuance), and the issue date is August 15, 2011. By the middle of the fourth quarter of
2011, the cash flow of LifePath Fitness has improved to the point that the owners feel ready to
pay themselves a cash dividend. They declare a $0.05 cash dividend on December 4, 2011. The
record date is December 14, 2011, and the payment date is December 24, 2011.

Instructions
(c) (1) Record all of the transactions related to the common stock of LifePath Fitness during the

years 2010 and 2011. (2) Indicate how many shares are issued and outstanding after the stock
dividend is issued.

Part IV Since the club opened, a major concern has been the pool facilities. Although the
existing pool is adequate, Mindy, Oscar, and Lori all desire to make LifePath a cutting-edge facility.
Until the end of 2011, financing concerns prevented this improvement. However, because there
has been steady growth in clientele, revenue, and income since the fourth quarter of 2011, the
owners have explored possible financing options. They are hesitant to issue stock and change the
ownership mix because they have been able to work together as a team with great effectiveness.
They have formulated a plan to issue secured term bonds to raise the needed $600,000 for the
pool facilities. By the end of April 2012 everything was in place for the bond issue to go ahead.
On June 1, 2012, the bonds were issued for $548,000. The bonds pay semiannual interest of 3%
(6% annual) on December 1 and June 1 of each year. The bonds mature in 10 years, and amorti-
zation is computed using the straight-line method.

Instructions
(d) Record (1) the issuance of the secured bonds, (2) the interest payment made on December 1,

2012, (3) the adjusting entry required at December 31, 2012, and (4) the interest payment
made on June 1, 2013.

Part V Mr. Marino’s purchase of LifePath Fitness was done through his business. The invest-
ment has always been accounted for using the cost method on his firm’s books. However, early in
2013 he decided to take his company public. He is preparing an IPO (initial public offering), and
he needs to have the firm’s financial statements audited. One of the issues to be resolved is to re-
state the investment in LifePath Fitness using the equity method, since Mr. Marino’s ownership
percentage is greater than 20%.

Instructions
(e) (1) Give the entries that would have been made on Marino’s books if the equity method of

accounting for investments had been used since the initial investment. Assume the following
data for LifePath.

2010 2011 2012

Net income $30,000 $70,000 $105,000
Total cash dividends $ 2,100 $20,000 $ 50,000

(2) Compute the balance in the LifePath Investment account at the end of 2012.

JWCL165_c12_568-611.qxd 8/11/09 9:53 PM Page 606

Broadening Your Perspective 607

Go to the book’s companion website,
www.wiley.com/college/weygandt,
to see the completion of this problem.

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Financial Reporting Problem: PepsiCo, Inc.
BYP12-1 The annual report of PepsiCo is presented in Appendix A.

Instructions
(a) See Note 1 to the financial statements and indicate what the consolidated financial state-

ments include.
(b) Using PepsiCo’s consolidated statement of cash flows, determine how much was spent for

capital acquisitions during the current year.

Comparative Analysis Problem: PepsiCo, Inc.
vs. The Coca-Cola Company
BYP12-2 PepsiCo’s financial statements are presented in Appendix A. Financial statements
of The Coca-Cola Company are presented in Appendix B.

Instructions
(a) Based on the information contained in these financial statements, determine each of the fol-

lowing for each company.
(1) Net cash used for investing (investment) activities for the current year (from the state-

ment of cash flows).
(2) Cash used for capital expenditures during the current year.

(b) Each of PepsiCo’s financial statements is labeled “consolidated.” What has been consolidated?
That is, from the contents of PepsiCo’s annual report, identify by name the corporations that
have been consolidated (parent and subsidiaries).

Exploring the Web
BYP12-3 Most publicly traded companies are analyzed by numerous analysts. These analysts
often don’t agree about a company’s future prospects. In this exercise you will find analysts’

FINANCIAL REPORTING AND ANALYSIS

B R O A D E N I N G Y O U R P E R S P E C T I V E

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(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 11.)

CCC12 Natalie has been approached by Ken Thornton, a shareholder of The Beanery Coffee
Inc. Ken wants to retire and would like to sell his 1,000 shares in The Beanery Coffee, which
represents 20% of all shares issued. The Beanery is currently operated by Ken’s twin daughters,
who each own 40% of the common shares. The Beanery not only operates a coffee shop but also
roasts and sells beans to retailers, under the name “Rocky Mountain Beanery.”

Ken has met with Curtis and Natalie to discuss the business operation. All have concluded
that there would be many advantages for Cookie & Coffee Creations Inc. to acquire an interest
in The Beanery Coffee. Despite the apparent advantages, Natalie and Curtis are still not con-
vinced that they should participate in this business venture.

CONTINUING COOKIE CHRONICLE

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 607

ratings about companies and make comparisons over time and across companies in the same
industry. You will also see to what extent the analysts experienced “earnings surprises.” Earn-
ings surprises can cause changes in stock prices.

Address: biz.yahoo.com/i, or go to www.wiley.com/college/weygandt

Steps
1. Choose a company.
2. Use the index to find the company’s name.
3. Choose Research.

Instructions
(a) How many analysts rated the company?
(b) What percentage rated it a strong buy?
(c) What was the average rating for the week?
(d) Did the average rating improve or decline relative to the previous week?
(e) How do the analysts rank this company among all the companies in its industry?
(f) What was the amount of the earnings surprise percentage during the last quarter?

608 Chapter 12 Investments

Decision Making Across the Organization
BYP12-4 At the beginning of the question and answer portion of the annual stockholders’
meeting of Kemper Corporation, stockholder Mike Kerwin asks, “Why did management sell the
holdings in UMW Company at a loss when this company has been very profitable during the
period its stock was held by Kemper?”

Since president Tony Chavez has just concluded his speech on the recent success and bright
future of Kemper, he is taken aback by this question and responds, “I remember we paid
$1,300,000 for that stock some years ago, and I am sure we sold that stock at a much higher
price. You must be mistaken.”

Kerwin retorts, “Well, right here in footnote number 7 to the annual report it shows that
240,000 shares, a 30% interest in UMW, were sold on the last day of the year. Also, it states that
UMW earned $520,000 this year and paid out $160,000 in cash dividends. Further, a summary
statement indicates that in past years, while Kemper held UMW stock, UMW earned $1,240,000
and paid out $440,000 in dividends. Finally, the income statement for this year shows a loss on
the sale of UMW stock of $180,000. So, I doubt that I am mistaken.”

Red-faced, president Chavez turns to you.

Instructions
With the class divided into groups, answer the following.

(a) What dollar amount did Kemper receive upon the sale of the UMW stock?
(b) Explain why both stockholder Kerwin and president Chavez are correct.

Communication Activity
BYP12-5 Bunge Corporation has purchased two securities for its portfolio. The first is a stock
investment in Longley Corporation, one of its suppliers. Bunge purchased 10% of Longley with
the intention of holding it for a number of years, but has no intention of purchasing more shares.
The second investment was a purchase of debt securities. Bunge purchased the debt securities
because its analysts believe that changes in market interest rates will cause these securities to
increase in value in a short period of time. Bunge intends to sell the securities as soon as they
have increased in value.

Instructions
Write a memo to Max Scholes, the chief financial officer, explaining how to account for each of these
investments. Explain what the implications for reported income are from this accounting treatment.

CRITICAL THINKING

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 608

Ethics Case
BYP12-6 Bartlet Financial Services Company holds a large portfolio of debt and stock secu-
rities as an investment. The total fair value of the portfolio at December 31, 2011, is greater than
total cost. Some securities have increased in value and others have decreased. Deb Faust, the
financial vice president, and Jan McCabe, the controller, are in the process of classifying for the
first time the securities in the portfolio.

Faust suggests classifying the securities that have increased in value as trading securities in
order to increase net income for the year. She wants to classify the securities that have decreased
in value as long-term available-for-sale securities, so that the decreases in value will not affect
2011 net income.

McCabe disagrees. She recommends classifying the securities that have decreased in value
as trading securities and those that have increased in value as long-term available-for-sale
securities. McCabe argues that the company is having a good earnings year and that recogniz-
ing the losses now will help to smooth income for this year. Moreover, for future years, when
the company may not be as profitable, the company will have built-in gains.

Instructions

(a) Will classifying the securities as Faust and McCabe suggest actually affect earnings as each
says it will?

(b) Is there anything unethical in what Faust and McCabe propose? Who are the stakeholders
affected by their proposals?

(c) Assume that Faust and McCabe properly classify the portfolio. Assume, at year-end, that
Faust proposes to sell the securities that will increase 2011 net income, and that McCabe
proposes to sell the securities that will decrease 2011 net income. Is this unethical?

“All About You” Activity
BYP12-7 The Securities and Exchange Commission (SEC) is the primary regulatory agency
of U.S. financial markets. Its job is to ensure that the markets remain fair for all investors. The
following SEC sites provide useful information for investors.

Address: www.sec.gov/answers.shtml and http://www.sec.gov/investor/tools/quiz.htm, or go to
www.wiley.com/college/weygandt.

Instructions
(a) Go to the first SEC site and find the definition of the following terms.

(i) Ask price.
(ii) Margin account.
(iii) Prospectus.
(iv) Index fund.

(b) Go to the second SEC site and take the short quiz.

FASB Codification Activity
BYP12-8 Access the FASB Codification at http://asc.fasb.org to prepare responses to the fol-
lowing. Use the Master Glossary for determining the proper definitions.

(a) What is the definition of a trading security?
(b) What is the definition of an available-for-sale security?
(c) What is the definition of a holding gain or loss?

Answers to Insight and Accounting Across
the Organization Questions
p. 577 How Procter & Gamble Accounts for Gillette
Q: Where on Procter & Gamble’s balance sheet will you find its investment in Gillette Company?
A: Because Procter & Gamble owns 9% of Gillette, Procter & Gamble does not report Gillette in

the investment section of its balance sheet. Instead, Gillette’s assets and liabilities are
included and commingled with the assets and liabilities of Procter & Gamble.

Broadening Your Perspective 609

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p. 580 And the Correct Way to Report Investments Is . . . ?
Q: Why might the use of the equity method not lead to full disclosure in the financial statements?
A: Under the equity method, the investment in common stock of another company is initially

recorded at cost. After that, the investment account is adjusted at each reporting date to show the
investor’s equity in the investee. However, on the investor’s balance sheet, only the investment
account is shown. The pro-rata share of the investee’s assets and liabilities are not reported.
Because the pro-rata share of the investee’s assets and liabilities are not shown, some argue that
the full disclosure principle is violated.

Author’s Comments on All About You:
A Good Day to Start Saving, p. 586
We believe that the correct answer to this situation is both yes and no. Here is what we propose:
You need to cut up your credit cards, and then pay down your credit card debt. You should pre-
pare a budget and figure out an affordable monthly payment that will pay off your debt as fast as
possible. After you have paid off the credit card, you should continue to make this same payment
into some form of savings account. If your employer has a 401(k) plan, then you should put the
payment into that, since it has significant tax advantages. Otherwise, set up an Individual
Retirement Account (IRA). Most local banks or brokerage houses would be happy to help you
set up an account.

A final note: All of us want to have financial security when we retire. We don’t want to be a
burden to anyone. That means that we should, whenever possible, participate in any tax-
advantaged savings programs available to us, such as the 401(k) and IRAs. This is especially true
given the concerns that many people have about the long-term viability of Social Security.

Answers to Self-Study Questions
1. d 2. a 3. b 4. c 5. a 6. b 7. c 8. d 9. a 10. c 11. c 12. b
13. c *14. d *15. d *16. d

610 Chapter 12 Investments

Remember to go back to the Navigator box on the chapter-opening page and check off your completed work.✓

JWCL165_c12_568-611.qxd 8/8/09 8:47 PM Page 610

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