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At the end of 2005, Mom’s Cookie Company had retained earnings of $42,990.
During 2005, the company earned net income of $52,990 and paid dividends of $10,000.
Therefore, its retained earnings increased by $42,990 ($52,990 $10,000). Each year,
net income is added to retained earnings, and dividends are subtracted. A net loss would
be subtracted from retained earnings.
There is an important difference between contributed capital and retained earn-
ings. Retained earnings results from profits that could be used to pay dividends to stock-
holders. Dividends paid from retained earnings are a return to stockholders from a
company’s earnings. If dividends in excess of retained earnings are paid, this is a return
F334 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
336 Activities

of contributed capital. The company is repaying investors a portion of the amount they
contributed to the company when they purchased the company’s stock. Therefore, it is
important to distinguish between contributed capital and retained earnings.




2 SELF-STUDY PROBLEM Bovine Company, a dairy, began operations in January 2004. It
issued 100,000 shares of $1 par value common stock. The stock
sold for $5 per share. The company’s charter permits it to issue 250,000 shares of stock.
In 2005, the company repurchased 8,000 shares of stock at a cost of $7 per share. Bovine’s
net income and cash dividend payments have been as follows:

Year Net Income Dividends
2004 $ (60,000) $ 0
2005 140,000 50,000
2006 220,000 100,000

Required Draft the stockholders’ equity section of Bovine’s balance sheet for the years
ended December 31, 2006 and 2005.
The solution to Self-Study Problem 2 appears at the end of the chapter.



CHANGES STOCKHOLDERS’ EQUITY
IN
The statement of stockholders’ (or shareholders’) equity describes events that changed
OBJECTIVE 4
the amount of stockholders’ equity during a fiscal period. Exhibit 9 provides the state-
Explain transactions ment of stockholders’ equity for Mom’s Cookie Company. Beginning and ending bal-
affecting stockholders’ ances are the same as those reported in the company’s balance sheet (Exhibit 8).
equity and describe how The format of the statement of stockholders’ equity varies from corporation to cor-
these transactions are poration, but all statements list the events that changed stockholders’ equity during the
reported in a company’s
past fiscal year. Most corporations report this information for the most recent three fis-
financial statements.
cal years. Some companies report this information as a schedule in the notes section of
their financial reports, rather than as a separate statement.
Exhibit 10 illustrates transactions that affect stockholders’ equity for most companies.


Exhibit 9 Statement of Stockholders’ Equity for Mom’s Cookie Company

Common Paid-In Retained Treasury
Stock Capital Earnings Stock Total

December 31, 2005 $10,000 $ 90,000 $ 42,990 $ 0 $142,990
Net income 107,427 107,427
Dividends (20,000) (20,000)
Stock purchased (12,000) (12,000)
Stock issued 10,000 100,000 110,000
December 31, 2006 $20,000 $190,000 $130,417 $(12,000) $328,417




Equity Transactions
The statement of stockholders’ equity summarizes equity transactions for a fiscal pe-
riod. From the information in Exhibit 9, we can reconstruct the transactions for 2005
for Mom’s Cookie Company.
F335
CHAPTER F9: Financing Activities
337
Financing Activities

Exhibit 10 Examples of Transactions That Affect Common Stockholders’ Equity

Transaction Common Stock Paid–In Capital Retained Earnings Treasury Stock



Increase Increase
Issue New Shares


Increase or
Earn Net Income
Incur Net Loss Decrease


Decrease
Pay Dividends


Decrease*
Repurchase Stock



*An increase in treasury stock decreases stockholders' equity.




ASSETS LIABILITIES OWNERS’ EQUITY
Other Contributed Retained
Date Accounts Cash Assets Capital Earnings
Dec. 31, 2005 Net Income* 87,427
Retained Earnings 87,427
Dec. 31, 2005 Retained Earnings 20,000
Cash 20,000
Dec. 31, 2005 Treasury Stock 12,000
Cash 12,000
Dec. 31, 2005 Cash 110,000
Common Stock 10,000
Paid-In Capital 100,000



*Individual revenue and expense accounts would be closed and the balances transferred to retained earnings. In total, these amounts
are equal to net income. Transactions are assumed to have occurred on December 31.



The first transaction transfers net income earned during 2005 to retained earnings.
The second transaction deducts the amount of dividends paid during 2005 from re-
tained earnings. The third transaction records the purchase of treasury stock, and the
final transaction records the amount received from the sale of common stock. Note
that, other than closing revenue and expense accounts to retained earnings, equity trans-
actions normally do not involve revenues or expenses. A company cannot earn profit
from equity transactions. When treasury stock is sold at a price higher than its cost,
the incremental amount is added to Paid-In Capital. When treasury stock is sold at a
price less than its cost, the amount is deducted from Paid-In Capital.
Equity transactions affect a company’s balance sheet, statement of stockholders’ eq-
uity, and statement of cash flows. Exhibits 8 and 9 contain the balance sheet and state-
ment of stockholders’ equity effects. Exhibit 11 shows the statement of cash flow effects
for Mom’s Cookie Company for 2005.
The cash flow effects result from transactions affecting cash during the fiscal pe-
riod. All of these effects result from financing activities and either increase (stock issued)
F336 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
338 Activities

Exhibit 11
Equity Transaction
Cash flow from financing activities:
Effects on Statement of
Cash dividends $ (20,000)
Cash Flows for Mom’s
Common stock repurchased (12,000)
Cookie Company
Common stock issued 110,000
Net cash flow $ 78,000




or decrease (payment of dividends and repurchase of stock) cash. Cash flows associ-
ated with net income, which increases Retained Earnings, are reported as part of oper-
ating activities on the statement of cash flows.


Cash Dividends
Several issues are important in recording cash dividend transactions. Cash dividends
are paid only on shares outstanding. They are not paid on shares held in treasury; a
company does not pay dividends to itself.
Three dates are important for dividend transactions. The date of declaration for
dividends is the date on which a corporation’s board of directors announces that a
http://ingram.swlearning. dividend will be paid. The date of record for a dividend is the date used to determine
com those owners who will receive the dividend. All registered owners on the date of record
receive the dividend. The date of payment for a dividend is the date on which the div-
Find out what compa-
idends are mailed to those receiving dividends.
nies have declared div-
idends recently. Dividends declared during a fiscal period are reported on the statement of stock-
holders’ equity as a reduction in retained earnings. Dividends paid are reported on the
corporation’s statement of cash flows for that period. Those amounts are not always
the same. For example, a company may declare a dividend near the end of its fiscal year
but not pay the dividend until the following fiscal year. Dividends declared but not paid
are reported as a current liability, Dividends Payable.


Issuing New Stock
When a company issues new shares of stock, each current stockholder normally has a
right to purchase a portion of the new shares equal to the percentage of shares he or
she owned prior to the sale. The right to maintain the same percentage of ownership
when new shares are issued is known as the preemptive right of stockholders. This
right prevents management from diluting the control (and wealth) of current owners
by selling new shares to someone other than the current owners. Of course, current
owners may choose not to purchase those shares.
When a company prepares to issue new shares, it normally issues stock rights to
existing owners. Stock rights authorize the recipient to purchase new shares. The num-
ber of rights a stockholder receives depends on the number of shares the stockholder
owns. Stock rights may be sold to others if the original recipient does not want to pur-
chase the new shares.


Stock Dividends
Corporations sometimes issue stock dividends. Stock dividends are shares of stock dis-
tributed by a company to its current stockholders without charge to the stockhold-
ers. The effect of a stock dividend is to increase the number of shares of stock a company
has outstanding and the number held by each stockholder. The increase in the num-
ber of shares held by each stockholder is in proportion to the number that stockholder
owned before the distribution.
F337
CHAPTER F9: Financing Activities
339
Financing Activities

For example, assume that you owned 1,000 shares of Druid Company’s stock on
June 1, 2004, the date the company distributed a 5% stock dividend. You would receive
50 additional shares (1,000 shares 5%). The total number of shares of common stock
outstanding increased by 5% as a result of this distribution.
Unlike cash dividends, stock dividends do not decrease a company’s cash. No cash is
paid out. The amount of the stock dividend is subtracted from retained earnings and added
to contributed capital. Therefore, the total amount of stockholders’ equity does not change.
The amount transferred is the market price of the stock at the time the dividend is declared.


Total Shares Stock New Shares Market Value
Outstanding Dividend Issued per Share Effect on Balance Sheet

100,000 5% 5,000 $10 Contributed Capital* $50,000
Retained Earnings $50,000

*This amount would be allocated to Common Stock for 5,000 shares par value and to Paid-In Capital In Excess of Par for the
remainder of the $50,000. If the stock is no-par, all $50,000 is applied to Common Stock.



Sometimes corporations issue large stock dividends known as stock splits. When a
corporation declares a stock split, it issues a multiple of the number of shares of stock
outstanding before the split. For example, a company might issue two new shares for
every one of its old shares.
A split does not change a company’s total stockholders’ equity. Usually, a company
will reduce the par value of its common stock in proportion to the size of a stock split.
Thus, if the par value is $1 per share before a 2-for-1 split, the par value will be $0.50
per share after the split. By changing the par value, the company keeps the same amount
of contributed capital on its books after the split, and no account balances are altered.


2-for-1 Total Shares Par Value Total
Split Outstanding per Share Par Value

Before split 100,000 $1.00 $100,000
After split 200,000 $0.50 $100,000




If a company does not reduce its par value, an amount equal to the par value of the
additional stock is transferred from retained earnings to contributed capital. The mar-
ket value of a company’s stock also adjusts to a stock split. For example, if stock was sell-
ing at $10 per share before a 2-for-1 split, it should sell at about $5 per share after the
split. Companies often use stock splits to reduce the price of their stock to make it more
attractive to investors who have to pay less to purchase the stock than prior to the split.


PREFERRED STOCK
Some corporations issue more than one class of stock. The classes usually have differ-
OBJECTIVE 5
ent voting and dividend rights. A corporation’s annual report describes the different
Distinguish between classes of stock issued by the company. In addition to common stock, many compa-
preferred stock and nies issue preferred stock.
common stock, and Preferred stock is stock with a higher claim on dividends and assets than com-
discuss why corporations mon stock. Cash dividends must be paid to preferred stockholders before they can be
may issue more than one
paid to common stockholders. Also, preferred stockholders generally have a liquidation
type of stock.
preference over common stockholders. That is, if a corporation has to liquidate its assets,
F338 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
340 Activities

preferred stockholders are repaid for their investments before common stockholders
but after creditors. Preferred stock, therefore, is less risky as an investment than com-
mon stock but is more risky than bonds or other debt investments.
Preferred stockholders normally do not have voting rights in a corporation. They
share in the profits of a corporation but not in decisions about the company’s operations.
Preferred stock attracts investors who want to take less risk
than that taken by common stockholders. If a company does well,
Percentage of Major Corporations
holders of preferred stock receive a reasonable return on their in-
Reporting Preferred Stock
vestments and may be able to exchange their preferred shares for
shares of common stock. If a company does poorly, preferred
stockholders are likely to receive higher returns than common
stockholders. Again, they have more protection against loss in case
of liquidation.
85.3%
Usually, a paid-in capital in excess of par value account is not
reported for preferred stock. The stock often is issued at par value
14.7 %
or has no par value. In some cases, a liquidation value or divi-
dend rate is reported for preferred stock. A liquidation value is the
No Preferred amount stockholders would receive for each share if the company
were to liquidate, assuming that sufficient cash were available af-
Preferred
ter creditors had been paid to pay the full liquidation value. The
(Data source: Accounting Trends & Techniques, 2001)
dividend rate identifies the annual dividend paid on the stock as
a percentage of the par value or liquidation value of the stock. For
example, if preferred stock has a stated or par value of $10 per share and a dividend
rate of 5%, the company would pay a cash dividend of $0.50 per share ($10 5%)
each year to preferred stockholders.
Preferred stockholders receive cash dividends in the same way that common stock-
holders do. However, the amount of the dividend payment for the two types of stock
often differs. Usually, preferred stockholders receive the stated dividend rate, while div-
idends to common stockholders depend on a company’s profitability. When a company
is highly profitable, it normally pays larger dividends to common stockholders than it
does when it is less profitable. If it is unprofitable, it may skip dividends for the year.
Preferred stock often is cumulative. This means that any dividends not paid to pre-
ferred stockholders in prior years must be paid in the current year before any dividends
can be paid to common stockholders. Most often, cash dividends are paid quarterly on
both common and preferred stock, resulting in a cash outflow and reduction of re-
tained earnings.
Dividends, whether on common or on preferred stock, are not an expense. They
are a distribution of profits. Because preferred dividends are paid before common div-
idends, they reduce the amount of net income available for common stock dividends.
Net income available for common stockholders is net income minus dividends on pre-
ferred stock.
Some companies issue redeemable preferred stock. This stock is repurchased by
the issuing company at a particular time, usually within a few years after it is issued.
Because it has a fixed life and does not have voting rights, redeemable preferred stock
is not included as part of stockholders’ equity. It is reported as a separate item between
liabilities and equity on the balance sheet.
Companies may issue bonds or preferred stock that can be converted into shares
of common stock. These securities are referred to as convertible securities. The num-
ber of shares of stock received in exchange for each bond or share of preferred stock is
set at the time the convertible securities are sold.
Convertible bonds and preferred stock attract investors who want the greater pro-
tection of bonds or preferred stock but who also want the chance to share in a com-
pany’s earnings if it is successful. Investors can convert their bonds or preferred stock
into common stock if a company performs well. Because of this conversion feature,
convertible bonds often pay a lower rate of interest and convertible preferred stock pays
a lower dividend than do similar nonconvertible securities.
F339
CHAPTER F9: Financing Activities
341
Financing Activities


Case In Point
Disclosure of Preferred Stock Information
PepsiCo, Inc., reported stockholders’ equity in its 2001 annual report as follows:

(In millions)
http://ingram.swlearning.
com Preferred Stock, no par value $ 26
Common Shareholders’ Equity
Learn more about
Common stock, par value 12/3¢ per share (issued 1,782 and 2,029
PepsiCo.
shares, respectively) $ 30
Capital in excess of par value 13
Retained earnings 11,519
Accumulated other comprehensive loss (1,646)
Less: repurchased common stock, at cost (26 and 280 shares,
respectively) (1,268)
Total Common Shareholders’ Equity $ 8,648

A note provides the following information about PepsiCo’s stock:

As of December 29, 2001, there were 3.6 billion shares of common stock and 3
million shares of convertible preferred stock authorized, which are designated as
$5.46 cumulative preferred convertible stock. Of the authorized convertible pre-
ferred shares, 803,953 shares were issued and 736,153 shares were outstanding.
Each share is convertible at the option of the holder into 4.9625 shares of com-
mon stock. The convertible preferred shares may be called for redemption at $78
per share plus accrued and unpaid dividends upon written notice.




INTERNATIONAL REPORTING FINANCING ACTIVITIES
OF
Foreign corporations report debt and stockholders’ equity much as U.S. corporations
do. Most industrialized nations use similar reporting rules, though some big differences
exist. Each nation sets its own accounting and reporting rules. Therefore, it is not al-
ways safe to assume that the amounts in a foreign company’s statements mean the same
as those in a U.S. company’s statements.
INTERNATIONAL
Financial terms vary from country to country.
For example, common stock may be known as share
LEARNING NOTE capital. Share premium may refer to paid-in capital
in excess of par value. Earned surplus or profit and
If a foreign corporation has stock listed on U.S. stock exchanges, it
normally issues annual financial reports that conform with U.S. loss may be used instead of retained earnings. Reserve
GAAP. These companies may issue different annual reports to stock- accounts also are common in many foreign countries.
holders in their own countries, using different accounting rules. Such accounts identify portions of stockholders’ eq-
uity that are restricted for a particular purpose and
cannot be used to pay dividends.



OTHER RELATED TOPICS
This section describes other related topics that may be observed for some companies.


Stock Options
Stock options are rights to purchase shares of a company’s stock at a specified price.
Options often are granted to employees and managers of a company as part of com-
pensation. For example, assume that employees receive options to purchase 10,000
F340 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
342 Activities

shares of their company’s stock on January 2, 2004. The options permit employees to
purchase shares at $50 per share on January 2, 2005. If the company does well in 2004
and the stock price rises above $50, employees will profit from using (exercising) their
options. Options provide an incentive for employees to be productive and help a com-
pany’s stock price to increase.
A company sometimes may sponsor an employee stock ownership plan (ESOP).
The company makes shares of its stock available to the plan. The shares are distributed
when employees earn them through service to the company. These shares are like trea-
sury stock until they are earned by employees. A company’s stockholders’ equity, there-
fore, may include an item for employee compensation related to an ESOP that reduces
its stockholders’ equity.
Stock option plans can be complex. Many types of plans exist, and accounting for
them varies according to plan type and terms. Stock option plans often bring tax ben-
efits to corporations. The terms of stock option plans, therefore, often are determined
by tax regulations.


Noncontrolling Interest
Noncontrolling interest, sometimes called minority interest, is the portion of a sub-
sidiary company’s equity owned by shareholders other than the parent corporation. For
example, assume that Parent Company owns 80% of Subsidiary Company’s stock. Sub-
sidiary Company reports total stockholders’ equity of $2 million for fiscal 2004. There-
fore, the noncontrolling interest (20% $2,000,000) is $400,000. Parent Company
reports this amount as noncontrolling interest on its balance sheet.
Corporations report noncontrolling interest in different ways. Some report it as
part of stockholders’ equity, a portion of the corporation’s total equity held by outside
interests. Others report noncontrolling interest as a liability, a claim by outside inter-
ests against a portion of the corporation’s resources. Most companies include noncon-
trolling interest as a separate category between liabilities and equity.


Appropriation of Retained Earnings
An appropriation of retained earnings transfers part of the retained earnings balance to
a restricted retained earnings account. The restricted amount cannot be distributed as
dividends. The new account title might be Retained Earnings—Appropriation for Plant
Expansion, or something similar. Appropriations are rare among U.S. companies but
sometimes are found in the financial statements of foreign companies.


Foreign Currency Adjustments
These adjustments to stockholders’ equity are commonly made by multinational cor-
porations. Multinationals are companies that operate in both foreign and domestic
(U.S.) markets. Some of their operations are conducted in foreign currency—British
pounds or Japanese yen, for example. When preparing financial statements in the United
States, multinationals translate their foreign operations into U.S. dollars. Foreign cur-
rency translation is the process of converting the financial results of operations in a for-
eign currency into U.S. dollars for financial-reporting purposes.
A translation adjustment is the gain or loss that results when the operations of a
company’s foreign subsidiaries are translated from foreign to U.S. currency for report-
ing consolidated financial statements. These adjustments may result in gains or losses
depending on whether the dollar has gained or lost value relative to other currencies.
Translation adjustments are reported in the stockholders’ equity section of the balance
sheet as part of other comprehensive income. Gains are added in computing total stock-
holders’ equity and losses are deducted.
F341
CHAPTER F9: Financing Activities
343
Financing Activities



3 SELF-STUDY PROBLEM Required Use information from the accompanying financial
statements of Lesco, Inc. to answer the following questions:
A. What was Lesco’s total contributed capital for 2004?
B. How many shares of common stock were outstanding at the end of 2004?
C. What dollar amount of treasury stock did Lesco hold at the end of 2004?
D. What dollar amount of stock did Lesco repurchase during 2004? How much did it
issue?
E. What was the amount of dividends paid in 2004?
F. How much net cash flow came from financing activities associated with stock-
holders’ equity during 2004, excluding the effect of net income? What were the
sources of that cash flow?
G. How much net income came from financing activities associated with stockhold-
ers’ equity during the current year?



Lesco, Inc.
Balance Sheet (Excerpt)
December 31, 2004

Stockholders’ Equity
Common stock, $0.10 par value,
1,000,000 shares authorized,
700,000 shares issued $ 70,000
Paid-in capital in excess of par value 810,240
Retained earnings 356,812
Treasury stock (30,000 shares at cost) (42,296)
Total stockholders’ equity $1,194,756


Lesco, Inc.
Statement of Stockholders’ Equity
December 31, 2004

Common Paid-In Retained Treasury
Stock Capital Earnings Stock Total
December 31, 2003 $65,000 $747,196 $306,201 $(33,941) $1,084,456
Net income 92,611 92,611
Dividends (42,000) (42,000)
Stock purchased (8,355) (8,355)
Stock issued 5,000 63,044 68,044
December 31, 2004 $70,000 $810,240 $356,812 $(42,296) $1,194,756




The solution to Self-Study Problem 3 appears at the end of the chapter.




REVIEW SUMMARY of IMPORTANT CONCEPTS


1. Liabilities result from contractual relationships with lenders, suppliers, customers, em-
ployees, governments, and other parties.

2. Three attributes of a liability are (1) a present responsibility to repay (transfer resources)
at some future time, (2) the binding nature of the agreement (to return resources), and
(3) the occurrence of the original transfer of value at some time in the past.
F342 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
344 Activities

3. Debt obligations include notes and bonds payable.
a. Debt is recorded at its present value.
b. Principal repaid and interest are recorded over the life of the debt.
c. An amortization table is useful for determining amounts recorded and reported for
debt obligations.

4. Other obligations include contingencies and commitments, including leases.
a. Contingencies are possible future events that may result in obligations.
b. Commitments are agreements to use or acquire resources in the future.
c. Capital leases are financing arrangements that result in a company recording assets
and liabilities for the present value of future lease payments.

5. Stockholders’ equity includes contributed capital and retained earnings.
a. Contributed capital includes the par (or stated) value of stock plus paid-in capital in
excess of par (or stated) value. If stock has no par or stated value, the entire amount
of contributed capital is reported as common or capital stock.
b. Stock repurchased by a corporation from its stockholders is reported on the balance
sheet as treasury stock.

6. Transactions affecting stockholders’ equity include paying cash dividends, issuing stock,
repurchasing stock, and those transactions that result in net income.
a. The effects of these transactions are summarized in the statement of stockholders’
equity.
b. A company cannot create income through transactions involving its own stock.
c. The main stockholders’ equity transactions that affect cash flow are the issuance or
repurchase of stock and the payment of cash dividends.
d. Stock dividends increase the number of shares outstanding but do not change the
total equity balance and do not affect cash.

7. Corporations may issue preferred stock in addition to common stock. Preferred stock
has a higher claim to dividends and assets than common stock. Some preferred stock
and some bonds that are issued are convertible; this feature permits the purchaser to
exchange the securities for common stock.

8. Amounts reported in the financial statements of foreign corporations often are deter-
mined using rules that are different from those used in the United States. Terms used
in these reports also may differ from those used in the United States.

9. Some companies engage in special financing arrangements or activities that affect their
financial statements.
a. A company sometimes grants employees or managers stock options that permit
them to purchase the company’s stock at a specified price.
b. Noncontrolling interest is the portion of a parent company’s subsidiary that is not
owned by the parent.
c. An appropriation of retained earnings separates a portion of retained earnings so
that it cannot be used to pay dividends.
d. A foreign currency adjustment is a gain or loss that results when a company trans-
lates foreign operations into U.S. dollars for financial reporting purposes.




DEFINE TERMS and CONCEPTS DEFINED in this CHAPTER


capital stock (F332) paid-in capital in excess of par value (F333)
charter (F332) par value (F332)
commitment (F329) preemptive right (F336)
common stock (F332) preferred stock (F337)
contingency (F328) stock dividends (F336)
contributed capital (F332) stock rights (F336)
date of declaration (F336) stock split (F337)
date of payment (F336) treasury stock (F332)
date of record (F336)
F343
CHAPTER F9: Financing Activities
345
Financing Activities


SELF-STUDY PROBLEM SOLUTIONS
SSP9-1 A. Present value of bonds PV of annuity (interest) PV of maturity value

PV $1,600 4.10020 (Table 4, 5 periods, 7%) $20,000 0.71299 (Table 3, 5 periods, 7%)
PV $6,560 $14,260 $20,820

B.

A B C D E F
Amortization
Present Value Interest Incurred of Principal Value at End of
at Beginning of (Column B Real Amount (Column C Year (Column
Year Year Interest Rate) Paid Column D) B Column E)

2005 20,820 1,457 1,600 (143) 20,677
2006 20,677 1,447 1,600 (153) 20,525
2007 20,525 1,437 1,600 (163) 20,362
2008 20,362 1,425 1,600 (175) 20,187
2009 20,187 1,413 1,600 (187) 20,000
Total 7,180 8,000 (820)




C. First year:

ASSETS LIABILITIES OWNERS’ EQUITY
Other Contributed Retained
Date Accounts Cash Assets Capital Earnings
Jan. 1, 2005 Cash 20,820
Bonds Payable 20,820
Dec. 31, 2005 Interest Expense 1,457
Bonds Payable 143
Cash 1,600




ASSETS LIABILITIES OWNERS’ EQUITY
Other Contributed Retained
Date Accounts Cash Assets Capital Earnings
Dec. 31, 2009 Interest Expense 1,413
Bonds Payable 187
Cash 1,600
Dec. 31, 2009 Bonds Payable 20,000
Cash 20,000
F344 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
346 Activities

SSP9-2 Fifth year:

Bovine Company
Stockholders’ Equity
December 31, 2006 2005

Common stock, $1 par value, 250,000 shares
authorized, 100,000 shares issued $100,000 $100,000
Paid-in capital in excess of par value 400,000 400,000
Retained earnings 150,000 30,000
Treasury stock, 8,000 shares at cost (56,000) 0
Total stockholders’ equity $594,000 $530,000




SSP9-3 A. Contributed capital $880,240 $70,000 common stock $810,240 paid-in capital
in excess of par value
B. Shares outstanding 670,000 700,000 issued 30,000 treasury shares
C. Treasury stock $42,296
D. Stock repurchased $8,355; stock issued $68,044
E. Dividends paid $42,000
F. Cash flow:

Paid for dividends $(42,000)
Purchase of stock (8,355)
Sale of stock 68,044
Net cash flow $ 17,689

G. Net income from financing activities $0. Financing activities do not create net in-
come.




Thinking Beyond the Question
What are the fundamental accounting issues associated with
financing activities?

Financing activities for corporations involve issuing debt and stock. These ac-
tivities provide financial resources for the corporation to grow. Debt has to be
repaid along with interest. Stockholders expect dividends or increases in stock
prices resulting from profits earned by the corporation. How do managers de-
cide how much of their financing should come from debt and how much from
equity? What effect does the mix of debt and equity have for a corporation’s
profits and risk?




QUESTIONS
Why is it useful to report short-term liabilities separately from long-term liabilities when
Q9-1
preparing the balance sheet?
Obj. 1

What are the differences among debentures, serial bonds, and callable bonds?
Q9-2
Obj. 1

Distinguish between the stated rate and the effective rate. Under what circumstances are these
Q9-3
rates the same? Under what circumstances are these rates different?
Obj. 1
F345
CHAPTER F9: Financing Activities
347
Financing Activities

Q9-4 While studying for an accounting exam, a friend observes that a capital lease is merely a means
of financing the acquisition of assets. Do you agree? Explain the basis for your answer. If you
Obj. 2
agree, describe the ways in which a capital lease is similar to other financing activities. If you
disagree, describe the ways in which it is different.
What is a contingency, and how does it differ from a liability? Under what conditions should
Q9-5
a contingency be reported as if it were a liability?
Obj. 2

Q9-6 How is a commitment different from a contingency?
Obj. 2

You and Bob are studying for an upcoming accounting exam. Bob says, “Contributed cap-
Q9-7
ital is basically the stockholders’ equity of the company. It includes things like common
Obj. 3
stock, paid-in capital in excess of par, preferred stock, and retained earnings.” Do you agree?
Discuss.
A friend remarks that, as he understands it, most current liabilities appearing on the bal-
Q9-8
ance sheet arise from transactions involving operating activities. Do you agree? List three
Obj. 1
current liabilities that might appear on the balance sheet. For each one, explain the under-
lying transaction that must have occurred for that specific liability to arise. Indicate, for each
liability, whether it is the result of an operating activity, a financing activity, or an invest-
ing activity.
Jane has just purchased, from Beach Club Inc., 5,000 shares of Beach Club’s $10 par value
Q9-9
common stock at a price of $40 per share. Explain how this event should be accounted for by
Obj. 3
Beach Club. Indicate which accounts will be involved and the amounts.
GAAP require that a firm disclose the details of changes to all stockholders’ equity accounts.
Q9-10
What are the two primary techniques that companies use to meet this obligation?
Obj. 4
The text states that “a company cannot earn profit from equity transactions.” Why might this
Q9-11
be? If a company buys widgets at $10 and resells them at $13, there is a $3 profit. What’s the
Obj. 4
difference if a company buys back some of its own stock for $25 per share and resells it at $28
per share? Why do you think that GAAP do not allow a profit (or loss) to be recorded on eq-
uity transactions?
Clearly distinguish among the following terms: date of declaration, date of record, and date
Q9-12
of payment. Construct a realistic example in which you use these terms.
Obj. 4

Preferred stock generally does not have voting rights and its holders, therefore, do not have a
Q9-13
formal voice in company affairs. Why, then, is it said that preferred stock is a less risky in-
Obj. 5
vestment than common stock?
If preferred stock generally has a dividend preference over common stock anyway, what is
Q9-14
gained by holding preferred stock that is cumulative?
Obj. 5

Preferred stock generally pays a larger return to investors than do bonds but a lesser return
Q9-15
than earned by common stockholders. Why?
Obj. 5
Clarify the differences among the following terms: contributed capital, common stock, capi-
Q9-16
tal stock, preferred stock, and treasury stock.
Obj. 5




If your instructor is using Personal Trainer in this course, you may complete online the assign-
EXERCISES ments identified by .
Write a short definition for each of the terms listed in the Terms and Concepts Defined in this
E9-1
Chapter section.
Oxford Company issued $1 million of five-year, 8% bonds on January 1, 2004. The bonds pay
E9-2
interest semiannually. How much did the bonds sell for under each of the following situa-
Obj. 1
tions?
a. The bonds sold to yield a real rate of 10%.
b. The bonds sold to yield a real rate of 6%.
c. The bonds sold to yield a real rate of 8%.
F346 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
348 Activities

E9-3 For each of the following independent situations, determine: (a) whether the bonds sold at
face (maturity) value, at a premium (more than face value), or at a discount (less than face
Obj. 1
value), and (b) whether interest expense recognized each year for the bonds was less than,
equal to, or greater than the amount of interest paid on the bonds.
a. Bonds with a stated rate of 7% were sold to yield an effective rate of 9%.
b. Bonds with a stated rate of 10% were sold to yield an effective rate of 8%.
c. Bonds with a stated rate of 6% were sold to yield an effective rate of 6%.

Herbal Enterprises issued 10-year bonds with a face value of $10 million on October 1, 2005.
E9-4
The bonds pay interest at 7% annually. The bonds sold at 93.29% of face value to yield an ef-
Obj. 1
fective rate of 8%.
a. How much interest expense should Herbal recognize on the bonds for the fiscal year
ended September 30, 2006?
b. What amount of net liability would the company report for the bonds on its 2006 bal-
ance sheet?
c. How much total expense would the company recognize for the bonds over the 10 years
they are outstanding?

Today is the fiscal year end for the Benson Boat Company. The regular year-end interest pay-
E9-5
ment on its 9% bonds payable was made earlier today. All necessary entries were recorded.
Obj. 1
Bonds Payable now has a balance of $186,400. The chief financial officer (CFO) has proposed
buying back this debt in the open market later today for $175,000. The debt is not due for re-
payment for another seven years. Explain how this proposed action would affect this year’s
(a) income statement, (b) balance sheet, and (c) statement of cash flows. Be specific.

Linfield Company sold 20-year bonds having a face value of $200,000 at a price of $180,364.
E9-6
The bonds pay annual interest at 7% and were priced to yield an effective return of 8%. Us-
Obj. 1
ing the format presented in this chapter, record the following:
a. The issuance of the bonds.
b. The first payment of interest.
c. The repayment of principal at maturity. Assume that the last payment of interest has
already been made and recorded.

The Digital Manufacturing Company issued $600,000 of six-year bonds on January 1, 2004.
E9-7
The bonds pay interest of 7% on the face value (0.07 $600,000 $42,000). The bonds were
Obj. 1
sold to give creditors a return of 6%.
a. Calculate the present value of the bonds at the time they are issued.
b. Prepare an amortization table for the bonds.
SPREADSHEET
c. Record Digital Manufacturing’s bond transactions at January 1, 2004, December 31,
2004, and December 31, 2009.

The Calvert Corporation plans to expand its operations. To obtain the necessary cash, $5 mil-
E9-8
lion of 6%, five-year bonds were issued on January 1, 2005. The bonds pay interest annually.
Obj. 1

a. Assume Calvert Corporation issued the bonds to yield an effective rate of 7%. Calculate
the selling price of the bonds and describe the interest rate conditions under which the
bonds were sold.
b. Now, assume Calvert Corporation issued the bonds to yield an effective rate of 5%.
Calculate the selling price of the bonds and describe the conditions under which the
bonds were sold.
c. Without setting up an amortization table, calculate the total amount of interest expense
over the life of the bonds in parts a and b above. How do they compare? Why?

The Medical Lake Clinic acquired diagnostic equipment via a five-year capital lease. Medical
E9-9
Lake Clinic promised to make five end-of-year lease payments of $5,200. Each payment is to
Obj. 1
include 9% interest. Using the format presented in this chapter, record:
a. The entry necessary at the beginning of the lease.
b. The entry necessary at the date of the first lease payment.
F347
CHAPTER F9: Financing Activities
349
Financing Activities

E9-10 For each of the situations that follow, determine whether a liability should be reported on the
balance sheet. If a liability should be reported, suggest an account name and indicate whether
Obj. 2
it should be reported as a current liability or as a long-term liability. If no liability should be
reported, indicate why.
a. The last installment payment on a three-year note payable is due next month.
b. Specialized production machinery has been acquired under a capital lease.
c. A $14 million lawsuit has been filed by a customer who claims injury from one of the
company’s products.
d. The labor services of employees have been consumed but not paid for yet. Payment is
not anticipated until the next regular payday in two weeks.
e. A 20-year issue of bonds has been outstanding for 19 years and is expected to be repaid
in cash at its maturity date.
f. The company has signed a contract promising to buy $600,000 worth of merchandise
during the coming year.

Below are listed key word clues and descriptions. The key word clues relate to different fea-
E9-11
tures or aspects of debt. Match the letter of each clue to the most relevant description pro-
Objs. 1, 2
vided. Use each clue only once.
a. bond e. contingency i. liability m. secured
b. callable f. current j. maturity value n. serial
c. capital g. debenture k. nominal
d. commitment h. effective l. operating
1. Obligations expected to be discharged within one year
2. A financial instrument that promises to repay principal at maturity and to pay
interest each period until then
3. An obligation to convey resources to another entity in the future
4. Debt that is backed up by specific assets of the debtor company
5. A bond backed only by the general creditworthiness of the issuing company
6. Bonds that can be reacquired at the request of the issuing company
7. The amount repaid to bondholders at the end of the bond’s life
8. The rate of interest that determines the amount of cash sent to bondholders
each period
9. Bonds that mature a portion at a time over the life of the issue
10. The actual (or real) rate of return earned by the holder of a bond
11. A type of lease that results in a liability being reported on the balance sheet
12. An existing condition that may result in an economic effect later
13. A promise to engage in some future economic activity
14. A lease that does not result in a liability being reported on the balance sheet

Bohannan Company’s charter allows it to sell 400,000 shares of $4 par value common stock.
E9-12
So far, the firm has sold 80,000 shares for a total of $780,000. Just yesterday, the company
Obj. 3
reacquired 1,000 shares from a disgruntled shareholder at a price of $10 per share.
a. What is a charter and by whom is it issued?
b. What total amount of contributed capital should this company report in the stockhold-
ers’ equity section of its balance sheet?
c. What was the average selling price of each share of common stock?
d. How many shares of stock are outstanding?
e. What balance should be reported in stockholders’ equity for Common Stock?

The charter of Pelenova, Inc. states that it may issue up to one million shares of common
E9-13
stock. Over the life of the company, 255,000 shares have been sold to investors. Total profits
Obj. 3
over the life of the company have been $876,000, and exactly one-half of that amount has been
paid out in dividends. As of today’s balance sheet date, the company holds 13,000 shares that
have been bought back from shareholders.
a. What is the number of authorized shares?
b. What is the number of issued shares?
c. What is the number of outstanding shares?
F348 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
350 Activities

E9-14 The Quick Chips Company, a fast-food manufacturer, began operations in January 2004. It is-
sued 500,000 shares of $0.25 par value common stock. The stock sold for $20 per share. There
Obj. 3
are 600,000 shares authorized. In 2006, the company repurchased 15,000 shares of stock at a cost
of $26 per share. Quick Chips’s net income and cash dividend payments have been as follows:

Year Net Income Dividends
2004 $(100,000) $ 0
2005 250,000 75,000
2006 400,000 150,000

Draft the stockholders’ equity section of Quick Chips’s balance sheet for the years ended De-
cember 31, 2005 and 2006.
Harbor Company reported net income of $1.7 million for the year ending December 31, 2004.
E9-15
On January 27, 2005, the board of directors met and decided that each of the firm’s 400,000
Obj. 4
outstanding common shares should receive a dividend of $0.65. The board voted to distrib-
ute the dividend on March 15 to those stockholders who owned the shares as of February 10.
a. Identify the date of declaration, the date of record, and the date of payment.
b. What percentage of net income was distributed in dividends?
c. Why do you suppose the company did not distribute 100% of net income as dividends?
What else can companies do with profits?
On March 1, Tubac Company distributed a $3.00 cash dividend to each of its 54,000 out-
E9-16
standing shares of $4 par value common stock. On June 12, the company declared and issued
Obj. 4
a 5% stock dividend when the market price of the stock was $7 per share. On September 20,
the company declared a 2-for-1 stock split and changed the par value accordingly. Describe
how the company’s year-end income statement, balance sheet, statement of cash flows, and
statement of stockholders’ equity will be affected by the
a. cash dividend,
b. stock dividend, and
c. stock split.
Fast Start Corporation manufactures automobile ignitions. Selected portions of the company’s
E9-17
recent financial statements are given below.
Obj. 4


Fast Start Corporation
Balance Sheet (Excerpt)
December 31, 2004

Stockholders’ equity:
Common stock, $0.50 par value, 2,000,000 shares
authorized, 1,400,000 shares issued $ 700,000
Paid-In capital in excess of par value 8,200,000
Retained earnings 4,600,000
Treasury stock (60,000 shares at cost) (480,000)
Total stockholders’ equity $13,020,000


Fast Start Corporation
Statement of Stockholders’ Equity
December 31, 2004
(in thousands)

Common Paid-In Retained Treasury
Stock Capital Earnings Stock Total
December 31, 2003 $650 $7,450 $4,035 $(260) $11,875
Net income 900 900
Dividends (335) (335)
Stock purchased (220) (220)
Stock issued 50 750 800
December 31, 2004 $700 $8,200 $4,600 $(480) $13,020
F349
CHAPTER F9: Financing Activities
351
Financing Activities

a. What was Fast Start’s total contributed capital at year end?
b. How many shares of common stock were outstanding at year end?
c. What dollar amount of treasury stock did Fast Start hold at year end?
d. What dollar amount of treasury stock did Fast Start repurchase during the year? How
much common stock did the company issue?
e. What was the amount of dividends paid during the year?
f. How much cash flow came from financing activities associated with shareholders’ eq-
uity during the current year, excluding the effect of net income? What were the sources
of that cash flow?
g. How much net income came from financing activities associated with stockholders’ eq-
uity during the current year?
Study the partial statement of stockholders’ equity below. The left-most column, which usu-
E9-18
ally contains the explanations of events affecting stockholders’ equity, is missing. You may as-
Objs. 4, 5
sume that the first number in a column is the beginning balance and the last number is the
ending balance.

Preferred Common Paid-In Retained Treasury
Stock Stock Capital Earnings Stock Total
$55,000 $20,000 $315,000 $182,183 $(7,212) $564,971
23,488a 23,488
(8,500)b (8,500)
1,906c 1,906
d e
5,000 85,000 90,000
$55,000 $25,000 $400,000 $197,171 $(5,306) $671,865



Using your knowledge of the statement of stockholders’ equity, explain what underlying event
caused each of the five items on the statement that are marked by a letter.
San Diego Company has 4,000 shares of $100 par value, 7% cumulative preferred stock out-
E9-19
standing. In addition, the company has 10,000 shares of common stock outstanding. The com-
Obj. 5
pany began operations and issued both classes of stock on January 1, 2004. The total amount
of cash dividends declared and paid during each of the first four years of the company’s life
is shown below. Complete the table by indicating the dollars of dividends that should be paid
each year to each class of stock.

Total Dividends Dividends Unpaid
Dividends to to Dividends
Year Paid Preferred Common to Preferred

2004 $50,000

2005 10,000

2006 45,000

2007 70,000



E9-20 Below are listed key word clues and descriptions. The key word clues relate to different fea-
tures or aspects of equity. Match the letter of each key word clue to the most relevant de-
Objs. 3, 4, 5
scription provided. Use each clue only once.
a. authorized f. declaration k. preemptive p. split
b. charter g. issued l. preferred q. stock
c. common h. outstanding m. record r. treasury
d. contributed i. par n. redeemable
e. cumulative j. payment o. retained
(Continued)
F350 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
352 Activities

_____ 1. Shares of a company’s own stock that have been reacquired by the company
_____ 2. Capital resulting from direct investments made by stockholders in the company
_____ 3. Earnings that have not been distributed to owners as dividends
_____ 4. The voting stock in a corporation
_____ 5. The actual number of shares that have been sold or given to stockholders
_____ 6. The document granted by a state that gives a corporation the legal right to exist
_____ 7. An arbitrary value assigned to a share of stock (not a very meaningful value)
_____ 8. The maximum number of shares that a corporation is permitted to issue
_____ 9. Stock that receives a fixed dividend amount
_____ 10. The number of shares that are currently in the hands of stockholders
_____ 11. The date on which a corporation announces that a dividend will be paid
_____ 12. Preferred stock that will be repurchased by the issuing company at a fixed future
date
_____ 13. A type of dividend in which new shares are distributed to existing stockholders
_____ 14. The privilege of existing stockholders to buy a prorata share of any new stock
that is offered for sale
_____ 15. The date on which a dividend is distributed to stockholders
_____ 16. A very large stock dividend
_____ 17. A feature that encourages corporations to make up any previously omitted divi-
dends on preferred stock
_____ 18. The date that determines who will receive a dividend that has been declared
Sweetwater Company reports the following stockholders’ equity section of the balance sheet.
E9-21
Objs. 4, 5
Preferred stock, $50 par value, 8% cumulative $ 2,500,000
Common stock, $2 par value 800,000
Paid-in capital in excess of par value, common stock 11,000,000
Retained earnings 4,894,000
Total $19,194,000

a. How many preferred shares are outstanding?
b. How many common shares are outstanding?
c. At what average price was the common stock sold?
d. If the firm declares dividends totaling $376,000, what amount per share will be paid to
the preferred stockholders and what amount per share will be paid to common stock-
holders? (Assume that there are no unpaid prior dividends on the preferred stock.)


If your instructor is using Personal Trainer in this course, you may complete online the assign-
PROBLEMS ments identified by .

Bond Amortization Table
P9-1
Obj. 1 On January 1, 2004, Holstein Enterprises issued bonds. Its accounting department prepared
the amortization table below.

Present
Value at Amortization
Beginning Interest Amount of Value at
Year of Year Incurred Paid Principal End of Year

1 384,440 34,600 32,000 2,600 387,040

2 387,040 34,834 32,000 2,834 389,874

3 389,874 35,089 32,000 3,089 392,963

4 392,963 35,367 32,000 3,367 396,330

5 396,330 35,670 32,000 3,670 400,000

Total 175,560 160,000 15,560
F351
CHAPTER F9: Financing Activities
353
Financing Activities

Required
A. What was the total face value of the bonds issued?
B. At what price were the bonds sold?
C. What is the stated rate, or nominal rate, of interest for these bonds?
D. What is the real, or effective, rate of interest for these bonds?
E. What amount will appear on the year 3 income statement related to these bonds?
F. What amount will appear on the year 4 balance sheet related to these bonds?
G. Explain the interrelationship among the three items reported in the last row of the
table (the row labeled Total).

Bonds and the Accounting System
P9-2
Obj. 1 Pattison Associates issued 4-year bonds with a face value of $300,000 to yield an effective rate
of 6%. The bonds pay interest annually and were sold at a price of $310,394.

Required
A. What was the stated rate for these bonds?
B. Show what information would be entered into the accounting system regarding these
bonds on the date of issue. Using the format presented in this chapter, record the en-
SPREADSHEET
try necessary at issuance and at the first interest payment date, and the entry at the
final interest payment date. (Hint: It may be helpful to prepare an amortization
table.)

Issuance and Amortization of Bonds
P9-3
Obj. 1 Sky King Company sold $9 million of four-year, 8% debentures on July 1, 2004. The bonds
sold to yield a real rate of 7%. Interest is paid annually on June 30.

Required
A. Determine the price of the bonds.
B. Prepare an amortization schedule for the bonds.
C. Using the format presented in this chapter, record the entry to the accounting system
SPREADSHEET
that is necessary to recognize interest on the bonds at June 30, 2005.
D. Assume the bonds had been sold to yield a real rate of 9%. At what price would they
have sold?

Issuance and Amortization of Bonds
P9-4
Obj. 1 Plum Grove Company sold $10 million of four-year, 9% debentures on July 1, 2004. The
bonds sold to yield an effective rate of 10%. Interest is paid annually on June 30.

Required
A. Determine the price of the bonds.
B. Prepare an amortization schedule for the bonds.
C. Using the format presented in this chapter, record the entry to the accounting system
SPREADSHEET
that is necessary to recognize interest on the bonds at June 30, 2005.
D. Assume the bonds had been sold to yield 8%. At what price would they have sold?

Ethical Issues Related to Debt
P9-5
Obj. 1 Slick Tawker is an investment broker. Recently he contacted potential investors and offered
to sell them bonds that were paying a 10% annual rate of interest. He noted that the bonds
were paying a much higher return than other investments and that similar bonds were selling
at a real rate of 6% interest. The bonds had a 10-year maturity and paid interest semiannu-
ally. Several investors purchased the bonds because of the high rate of interest but later were
concerned to learn that the maturity value of $1,000 per bond was considerably less than the
$1,350 they had paid for each bond.

Required Compare the price of the bonds sold by Slick to bonds yielding a real rate of 6%.
What was the approximate real rate of return earned by the investors? Did they have a right
to be concerned about their investments? Do you see any ethical problems with Slick’s sales
pitch?
F352 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
354 Activities

Choosing between Financing Options
P9-6
Obj. 1 The management of Poliwog Financial plans to borrow $50,000 to carry out current opera-
tions. Two repayment options are available. The appropriate interest rate is 8%.

Option 1: The company may repay the amount borrowed by making four equal an-
nual payments, the first one due in one year.
Option 2: The company may pay just the interest annually, and then pay the entire
amount of $50,000 at the end of four years.

Required
A. Identify the amount of the annual payment required under Option 1 and the amount
of the required annual interest payment under Option 2.
B. Identify the total cash outflows and the total interest expense incurred for the four
years under each option.
C. Explain why there is a difference in the total cash outflow and total interest expense be-
tween the two plans.
D. Which plan would you recommend to the company?


Acquiring Assets via Capital Lease
P9-7
Obj. 2 Jessica Johnson Logging Company is considering the acquisition of a new bulldozer. Big Dig,
Inc. has offered to lease the equipment to Johnson Company for all 12 years of its useful life
at annual year-end lease payments of $24,500. Each payment will include 9% interest. At the
end of 12 years of lease payments, Big Dig, Inc. will allow Johnson to keep the bulldozer.

Required
A. At what amount should the bulldozer and lease obligation be recorded on Johnson’s
SPREADSHEET
books at the date of acquisition?
B. Prepare an amortization table covering only the first four years of the lease.
C. Explain why a $24,500 lease payment doesn’t cause the amount owed to decrease by
$24,500.
D. Explain why Johnson’s interest expense gets smaller for each successive year of the
lease.
E. Using the format presented in this chapter, record the entry to capitalize the bulldozer
and lease obligation on Johnson’s books.
F. Using the format presented in this chapter, record the entry to recognize the first year-
end lease payment.


Determining Lease Payments
P9-8
Obj. 2 Garcia Orchards & Processing Company has been taking bids for three new tractors. Gold-
baum Equipment has made an offer to sell a qualifying model for $41,000 each. In addition,
Goldbaum has offered to finance the transaction through a capital lease over the expected 15-
year life of the tractors with no money down. No mention of the size of the required year-end
lease payments has been made yet, but Garcia knows that Goldbaum will expect a 9% return
on the lease arrangement.

Required If Garcia accepts this option:
A. What will be the size of each annual year-end lease payment?
B. What amount will Garcia capitalize on its balance sheet for the tractors and for the
lease obligation? What does this amount represent?
C. Using the format presented in this chapter, record the entry to set up the lease on Gar-
cia’s books.
D. What total amount will Garcia pay over the life of the lease for financing? (Hint: You
do not need to prepare an amortization table.)
E. Using the format presented in this chapter, record the entry necessary when Garcia
makes the first lease payment.
F. When the second year’s lease payment is recorded, will the amount of interest expense
be larger or smaller than that for the first year? Explain.
F353
CHAPTER F9: Financing Activities
355
Financing Activities

P9-9 Choosing between Financing Options
Obj. 2
Careful Electric Company is planning to purchase equipment for one of its generating plants.
Dealer A has offered to sell the equipment at a total cost of $2 million, including installation.
This dealer requires a 6% return and is willing to spread the payments over a 10-year period.
Payments are to be made at the end of each year in equal installments.
Dealer B is asking $1.8 million for the same equipment and will charge an additional
$50,000 for installation, to be paid when the equipment is delivered. Payments can be spread
over 10 years, made at the end of each year. This dealer requires an 8% return.

Required
A. Calculate the amount of the annual payments required by each dealer. Round to near-
est whole dollar.
B. Determine the projected total cash outflow under each option.
C. If Careful could pay cash for the new equipment, how much money (interest) would it
save under each option?
D. Which option should be chosen?
E. Assume the equipment is acquired using the financing offered by Dealer A. How will
the financing activities section of the statement of cash flows be affected by these trans-
actions in the first year?

Using Spreadsheet Functions to Evaluate a Lease Proposal
P9-10
Obj. 2 FencePost.com needs additional equipment to expand production capacity. A vendor has sug-
gested a lease plan in which FencePost would make end-of-the-month payments for five years of
$3,250. At that point the equipment would be worthless and discarded. The vendor expects to
earn a return on this financing arrangement of 9.75% compounded annually. The chief financial
officer at FencePost recognizes this arrangement would be accounted for as a capital lease.

Required
SPREADSHEET
A. Use the PV function in an Excel spreadsheet to determine the amount at which the
lease would be recorded in the accounting system. List the arguments you inserted into
the formula.
B. Show how this transaction would be entered into the accounting system at inception of
the lease.
C. Prepare an amortization table for the lease (first four months only).
D. Show the entry that must be made on the date of the first lease payment.
E. Explain how you can tell that the vendor earns a 9.75% rate of return on this transaction.

Using Spreadsheet Functions to Evaluate a Lease Proposal
P9-11
Obj. 2 Rampaging Technology, Inc. is growing rapidly and is expanding its production capacity. An
equipment supplier has suggested a lease plan based on a selling price of $350,000. Rampag-
ing would make five equal-size end-of-the-year payments and then own the machine. The
supplier expects to earn a return on this financing arrangement of 11.35% compounded an-
nually. Such a lease would be accounted for as a capital lease.

Required
SPREADSHEET
A. Use the PMT function in an Excel spreadsheet to determine the amount of the annual
payment that would be required. List the arguments you inserted into the formula.
B. Show how this transaction would be entered into the accounting system at inception of
the lease.
C. Prepare an amortization table for the lease.
D. Explain why the annual interest expense decreases during each of the five years.
E. Show the entry that must be made on the date of the first lease payment.
F. Explain how you can tell that the vendor earns an 11.35% rate of return on this transaction.

Reporting Changes in Stockholders’ Equity
P9-12
Obj. 4 On the next page is shown the stockholders’ equity section of Tulip Company’s balance sheet
at December 31, 2004:
(Continued)
F354 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
356 Activities

Common stock, $2 par value, 5,400,000 shares
authorized, 2,200,000 shares issued and outstanding $ 4,400,000
Paid-in capital in excess of par value 30,800,000
Retained earnings 46,000,000
Total stockholders’ equity $81,200,000

All of the following occurred in year 2005 and were properly recorded.
1. The company purchased 30,000 shares of its own stock at $21 per share on January 2.
2. The company purchased 20,000 shares of the Sumo Corporation at $6 per share on
February 14.
3. The company declared and issued a 10% stock dividend on March 2. The fair market
value of the stock at that time was $25 per share.
4. The company declared and paid a cash dividend of $0.40 on its common stock on July 21.
5. The company reported a net loss of $5,200,000 on December 31.

Required
A. Prepare the stockholders’ equity section as of December 31, 2005 after all the events de-
scribed above have been properly accounted for.
B. Describe the effects on the financing section of the year 2005 statement of cash
flows.

Stock Splits and Stock Dividends
P9-13
Obj. 4 The Carpelli Corporation manufactures solar panels that provide electricity for businesses and
homes. The company has been doing well for several years and so the board of directors has
decided to declare a stock split in the amount of two shares for every share of stock held by
shareholders. The split will be effective as of February 15, 2005.
Below is the stockholders’ equity section of the Carpelli Corporation’s balance sheet at
December 31, 2004.

Common stock, $4 par, 250,000 shares authorized,
100,000 shares issued and outstanding $ 400,000
Additional paid-in capital in excess of par 1,200,000
Retained earnings 3,600,000
Total $5,200,000

Required
A. Prepare the stockholders’ equity section for the Carpelli Corporation’s balance sheet af-
ter the stock split. How many shares of stock will be issued to the shareholders? As-
sume the market value of the stock is $18 per share on February 15, 2005.
B. Assume that the Carpelli Corporation’s board of directors decided to declare a 100%
stock dividend instead of the split. Prepare the stockholders’ equity section after the
stock dividend. How many shares of stock will be issued to the shareholders? (Note
that for a large stock dividend—100% in this case—the dollar amount transferred from
retained earnings to contributed capital will be the par value of the stock, instead of the
market price.)
C. Compare the stockholders’ equity sections after the split and after the dividend. How
do they differ?
D. What should be the selling price of the stock after the split? After the dividend?

The Statement of Stockholders’ Equity and Other Financial Statements
P9-14
Objs. 3, 4 Olafson Electronics reported the following statement of stockholders’ equity at the end of its
10th year in business.

Required For each of the five lettered items in the statement on the next page, indicate where
that same information will be found on one or more other financial statements. Be specific as
to the statement(s) and the specific section of the statement(s).
F355
CHAPTER F9: Financing Activities
357
Financing Activities


Preferred Common Paid-In Retained Treasury
Stock Stock Capital Earnings Stock Total

December 31, year 9 $21,000 $10,000 $188,000 $77,831 $(10,094) $286,737
26,182a
Net income 26,182
(14,300)b
Dividends (14,300)
(1,263)c
Stock purchased (1,263)
79,000d
Stock issued 4,000 75,000
$14,000e
December 31, year 10 $21,000 $263,000 $89,713 $(11,357) $376,356




Convertible Preferred Stock
P9-15
Obj. 5 The Bedford Bicycle Company has 3,000 shares of $10 par preferred stock outstanding. The
stock originally had been issued for $16 per share. It is convertible into shares of common
stock at the rate of five shares of $1 par common for every share of preferred. No cash would
be paid by the converting shareholders. This convertible preferred stock pays a dividend of $1
per share per year.

Required
A. Assume there are 40,000 shares of common stock outstanding, originally issued at $30
per share, but having a current market value of $32 per share. The retained earnings
account balance is $3,200,000. Prepare the stockholders’ equity section of the balance
sheet before conversion of any preferred stock.
B. Now, assume that all of the preferred stock is converted to common stock. Prepare the
stockholders’ equity section of the balance sheet. Compare and explain the totals in
stockholders’ equity before and after the conversion of the preferred stock.
C. Explain how the conversion of preferred stock into common stock will be reported in
the financing section of the cash flow statement.
D. Assume that the Velasquez Corporation is similar to the Bedford Bicycle Company in
many respects including the fact that it has $10 par value preferred stock outstanding.
Velasquez pays a dividend of $1.60 per share per year on its preferred stock; the stock
is not convertible to common. What do you think is the main reason for the difference
in dividend rates between the two companies?

Understanding the Stockholders’ Equity Section of the Balance
P9-16
Sheet
Objs. 3, 4, 5
Saigon Building Supply was organized and began operations on January 1, 2004. At Decem-
ber 31, 2005, it reported the following stockholders’ equity section on its comparative balance
sheet.



December 31, 2005 2004

Stockholders’ equity
8.5% preferred stock, $10 par value,
10,000 shares authorized and issued b a
Common stock, $2 par value,
300,000 shares authorized,
110,000 and 90,000 shares issued d c
Paid-in capital in excess of par value f e
Retained earnings h g
Treasury stock (4,500 and 3,100 shares at cost) j i
Total stockholders’ equity $1,411,750 $1,037,800



(Continued)
F356 FinancingSECTION F2: Analysis and Interpretation of Financial Accounting Information
358 Activities

The company reported net income of $75,000 for calendar year 2004 and $125,000 for 2005.
The firm’s dividend policy is to pay out 10% of its profits each year in dividends. The date of
payment is always April 1 of the following year. Treasury stock was acquired at a cost of $12
per share in 2004. At December 31, 2005, the average cost of treasury stock was $13.50 per
share. The common shares sold during 2005 were sold at $14 each.

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