Stockholders' Equity(Quick Test #2 with Coaching)

Liabilities and stockholders' equity are often described as claims to a corporation's assets. However, the liabilities have a higher claim than the stockholders' claims. Hence, the stockholders' claims are said to be secondary or residual claims to the corporation's assets.

Paid-in capital reports the amounts that the corporation received at the time the corporation had issued its shares of stock.

Treasury stock represents the amount the corporation had paid to buy back some of its own shares of stock (which have not been retired). As a result, the balance in the account Treasury Stock is a debit balance. This debit balance will be a subtraction within the stockholders section of the balance sheet since the normal balances in stockholders' equity are credit balances.

Every business corporation will have issued common stock. However, relatively few corporations will also issue preferred stock.

Generally, shares of preferred stock are purchased by investors who desire a known, stable, and consistent dividend. For example, if a corporation issues 6% $100 Preferred Stock, the stock will pay a constant dividend of $6 per share. The amount is determined by multiplying the stated rate of 6% times the par value of $100.

Since the dividend is the key feature for these investors, as long as the dividend rate is similar to the rate that the market desires, the market price of the preferred stock will be close to its par value.

The owners of the common stock elect the board of directors and vote on the most significant issues affecting the corporation.

Capital stock includes both common stock and preferred stock.

Generally the preferred shares of stock have their dividends fixed at the stated rate. (A rare exception is preferred stock with a participating feature.) Therefore the preferred stock is not likely to see an increase in dividends.

On the other hand, the dividends on the common shares of stock will be determined and declared by the board of directors. Hence, in the early years of a corporation the cash dividends of the common stock will likely be very small. However, in later years when the corporation has large amounts of earnings and a large cash balance, the common stockholders may receive very large dividends.

The term dividends in arrears refers to past omitted dividends that should have been paid to holders of the corporation's cumulative preferred stock.

The cumulative feature requires that the preferred dividends in arrears must be paid before any dividends can be paid to the other stockholders. Any dividends in arrears should be disclosed in the notes to the financial statements.

A positive amount of net income will cause retained earnings to increase.

A positive amount of other comprehensive income will cause accumulated other comprehensive income to increase. Accumulated other comprehensive income is a separate item within stockholders' equity.

A corporation may have a large amount of retained earnings but may have very little cash. For instance, the corporation may have used its cash to acquire new facilities, add more efficient equipment, expand its sales territory, etc.

Also, a new venture may have recently raised a large amount of cash from investors, but it has negative retained earnings.

The board of directors declares the dividends that will be paid by the corporation.

The members of the board of directors are elected by the stockholders of the corporation's common stock.

Cash dividends are based on the outstanding shares of stock on a specified date (the record date).

The shares of treasury stock are deducted from the number of issued shares in arriving at the number of outstanding shares of stock.

The repurchased (but not retired) shares of common stock are known as treasury stock. When the shares are repurchased, the cost is recorded with a debit in the account Treasury Stock and a credit to the account Cash.

Rather than listing the cost of the treasury stock as an asset, the debit balance in Treasury Stock will be listed as a deduction near the end of the stockholders' equity section of the balance sheet.

Using the accounting equation, we can determine that the stockholders' equity has increased by $45,000 during the year: Asset increase of $70,000 = Liability increase of $25,000 + Stockholders' equity increase of $45,000.

The $45,000 increase in stockholders' equity is the net change in the following items:

+ Net income (which causes stockholders' equity to increase)
+ Issuing new shares of stock (which causes stockholders' equity to increase)
- Purchase of outstanding shares of stock (which causes stockholders' equity to decrease)
- Dividends declared (which causes stockholders' equity to decrease)
+/- Other comprehensive income

From the information given in the question, we know that during the accounting year there were dividends of $10,000, no new shares of stock issued or purchased, and no comprehensive income during the accounting year. Therefore, the $45,000 increase in stockholders' equity is the net change in these items:

For the math to work, the net income must have been $55,000.

A stock dividend is a distribution of additional shares of a corporation's stock (as opposed to a distribution of cash). In the question, the corporation declared and distributed 10,000 shares of common stock (100,000 shares X 10%) during July. Therefore, when the corporation declared the $0.05 cash dividend per share, there were 110,000 shares outstanding on the record date. The result is a total cash dividend of $5,500 computed as 110,000 shares X $0.05.

When a stock dividend occurs, the market value of the new shares will be transferred from retained earnings to paid-in capital. Since both are components of stockholders' equity, there is no change in the total amount of stockholders' equity.

When a stock split occurs, there is no change to retained earnings, paid-in capital, or any part of stockholders' equity. Hence, there is no change in total amount of stockholders' equity.

However, in a 2-for-1 stock split the number of shares of stock will double and the par value per share will become half of the previous par value per share. (Total par value is unchanged.)

Assume that a corporation has 200,000 shares of common stock outstanding. A 50% stock dividend will result in issuing 100,000 additional shares of common stock to the existing stockholders (in proportion to their holdings). After the stock dividend there will be 300,000 shares of common stock outstanding.

If a 3-for-2 stock split occurs, the stockholders will also end up with 300,000 shares of common stock instead of their 200,000 shares.

Both the 50% stock dividend and the 3-for-2 stock split will result in the same 300,000 shares of common stock outstanding.

When a corporation borrows $100,000 from its bank, the corporation's asset account Cash is increased by $100,000 and its liability account Notes Payable or Loans Payable is increased by $100,000. There is no change to stockholders' equity when the corporation borrows money from its bank.

When a corporation collects $100,000 of its accounts receivable, the asset Cash is increased by $100,000 and the asset Accounts Receivable is decreased by $100,000. There is no change to stockholders' equity. (There is no change to the liabilities, and no change to the total amount of assets.)

The comprehensive income of a corporation consists of two components: 1) net income, and 2) other comprehensive income.

Retained earnings will increase by the amount of net income, and accumulated other comprehensive income will increase by the amount of other comprehensive income.

Accumulated other comprehensive income will be increased by items considered to be other comprehensive income.

Two examples of other comprehensive income are: foreign currency translation adjustments and unrealized gains/losses on postretirement benefit plans.

Beginning in 2018, the unrealized holding gains (and losses) on equity securities with readily determinable market values are to be included in net income and retained earnings.

Prior to 2018, these unrealized holding gains and losses were included in other comprehensive income and accumulated other comprehensive income.