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Overview
Statement of Changes in Equity and the Balance Sheet
Upon completion of this lesson, candidates should be able to:
Identify the major components and classifications of [the statement of changes in equity]
(1.A.1.c).
Demonstrate an understanding of how [a statement of changes in equity] is prepared (1.A.1.g).
Identify transactions that affect paid-in capital and those that affect retained earnings (1.A.2.v).
Determine the effect on shareholders’ equity of large and small stock dividends (1.A.2.w).
Identify the major components and classifications of [the balance sheet] (1.A.1.c).
Demonstrate an understanding of how [a balance sheet] is prepared (1.A.1.g).
The previous lesson gave an introduction to the financial statements as well as discussed the
income statement in greater depth. This lesson will focus on the next two financial statements:
the statement of changes in equity and the balance sheet.
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Study Guide
Statement of Changes in Equity and the Balance Sheet
What are the elements of CoE Statements?
Compare between preferred and comm
stock
I. The statement of changes in equity presents the organization's detailed changes in each
equity account over the course of the period presented. The accounts typically presented in
the statement of changes in equity include the following:
A. Preferred Stock: Contributed capital for non-voting stock which generally carries a
stated dividend rate that will be paid first in the event the organization declares a
dividend.
1. Generally non-voting stock ownership.
2. Generally carries a specified dividend rate stated as a percentage of par value.
For example, a $100 par 8% preferred share would be entitled to an $8 dividend
annually if the organization declared dividends. Preferred Stock dividends must
be paid before any common shareholders receive dividends from the
organization.
3. May be convertible into common stock at a specified conversion ratio.
4. May be callable at a specified price at the option of the organization.
5. Behind company creditors, but ahead of common shareholders for preference
in the case of bankruptcy or other liquidation of the organization.
B. Common Stock
1. Usually carried at par value unless the stock is “no par” stock, in which case the
entire amount paid for the stock is classified as common stock.
2. Dividends are not predetermined like preferred stock and are only paid when
declared and only then, after the preferred shareholders receive their stated
dividend.
3. Last in line for preference in the case of bankruptcy or other liquidation.
C. Additional Paid-In Capital
1. Amount received by the organization for stock over the par value of the shares.
2. Can be affected by various equity transactions, including stock dividends,
resales of treasury stock, and issuance of options and warrants.
D. Treasury Stock
1. Amount paid by the organization to repurchase its own stock
2. Shown as contra equity, or a reduction to the equity section
E. Retained Earnings
1. Net income or loss for the organization is ultimately recorded in retained
earnings.
2. Dividends declared are a reduction to retained earnings.
F. Accumulated Other Comprehensive Income
1. Other comprehensive income or loss for the organization is ultimately recorded
in Accumulated
Other Comprehensive
Income.
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2. Items accumulated here are not part of the calculation of net income.
G. Non-Controlling Interest
1. When an organization has a controlling interest in another entity, but not
complete ownership, 100% of the assets and liabilities of the subsidiary are
included in the balance sheet of the organization and the portion of the
subsidiary that is owned by third parties is segregated as a separate component
of equity.
How to account for issuance of options?
II. Several common transactions affect the equity accounts.
A. Sale of new shares: Generally sold for an amount above par value. Cash received is
recorded and the common stock/preferred stock account is increased for the par
value and the additional paid-in capital account is increased for the balance.
B. Issuance of options: Usually issued as a form of compensation and recorded as part of
additional paid-in capital as compensation expense is recognized.
1. Total compensation expense is valued at the fair value of the options on the
date they are granted.
2. Compensation expense is recognized over the service period required for the
employee to become vested in the options.
C. Dividends: Retained earnings is reduced when a cash dividend is declared. If payment
of the dividend is delayed, a payable is also recorded and then reduced when the
payment is later made.
D. Net Income/Loss: Increases/Decreases retained earnings each year.
E. Other Comprehensive Income Items: Increase/Decrease accumulated other
comprehensive income each year.
F. Repurchase of treasury stock: Treasury stock is increased (which is a reduction to
equity) for the cost of the treasury shares.
G. Resale of treasury stock.
1. When sold for an amount in excess of the repurchase price, the cost is taken out
of treasury stock and the excess is added to additional paid-in capital.
2. When sold for an amount below the repurchase price, the cost is taken out of
treasury stock and the difference is taken from additional paid-in capital to the
extent it was previously increased for treasury stock transactions. If no
additional paid-in capital from treasury stock transactions exists, the difference
is taken from retained earnings.
H. Stock split: Generally has no impact on any of the equity accounts as long as the par
value is also changed to reflect the new share size. For example, if 100 shares of $1
par common stock undergo a 2-for-1 stock split, the result would be 200 shares of
$0.50 par common stock. Common stock is $100 before the split (100 × $1) and is still
$100 after the split (200 × $0.50) so no journal entry is needed.
I. Stock dividends: A stock dividend occurs when an organization distributes additional
shares of stock to existing stockholders as a dividend rather than paying them cash.
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1. Small stock dividend: Less than 20–25% of the number of shares outstanding.
Retained earnings is reduced for the fair value of the stock being issued,
common stock is increased for the par value of the stock issued, and the
difference is included in additional paid-in capital.
2. Large stock dividend: Greater than 20–25% of the number of shares
outstanding. Retained earnings is reduced for the par value of the stock being
issued and common stock is increased for the same amount. No impact on
additional paid-in capital, similar to a stock split.
Practice Question
Jolley, Inc. has 100,000 common shares outstanding with a $1 par value and
a market value of $8. Jolley declares a 22% stock dividend.
What is the impact on the various equity accounts if the transaction is
considered a small stock dividend?
What is the impact on the various equity accounts if the transaction is
considered a large stock dividend?
Answer
1. A small stock dividend is recorded at fair value. 22,000 new shares are
issued (100,000 × 22%) and the fair value of $176,000 is taken from
retained earnings (22,000 × $8), common stock is increased by $22,000
(22,000 × $1) to reflect the par value of the new shares and the balance
of $154,000 ($176,000 − $22,000) is recorded as an increase to
additional paid-in capital.
2. A large stock dividend is recorded at par value. 22,000 new shares are
issued (100,000 × 22%) and the par value of $22,000 is taken from
retained earnings (22,000 × $1) and common stock is increased for the
same amount.
III. Illustration: The basic format for the statement of changes in equity is illustrated using ABC
Co. information for 20X2.
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What are the element of BS?
IV. The balance sheet shows the organization's assets, liabilities, and owners’ equity as of the
end of the period presented. The balance sheet is the only one of the four main financials
statements that presents information as of a point in time, rather than over a period of
time. The classic accounting equation “assets = liabilities + equity” is illustrated through the
balance sheet.
A. Assets represent the resources available to the organization for carrying out its
purpose. Assets are presented in order of liquidity within two general categories,
current or non-current, based upon the period of time the assets are expected to
convert to cash.
1. Cash, accounts receivable, inventory, prepaid assets, and other items expected
to be realized within one year (or the operating cycle if longer) are classified as
current.
2. Property and equipment, intangible assets, and other assets expected to
benefit the company for longer than one year (or the operating cycle if longer)
are classified as non-current.
B. Liabilities represent third party claims to the assets of the organization. Liabilities are
the amounts owed by the organization to third parties, such as debt, accounts
payable, or wages payable. Liabilities are presented in the order they come due
within two general categories, current or non-current, based upon the period of time
before assets or other resources of the company will be utilized to satisfy the liability.
1. Accounts payable, accrued expenses (wages, utilities, rent, etc.), deferred
revenue, principal portions of long-term debt due in the coming year, and other
liabilities expected to be settled with cash or other current assets within one
year (or the operating cycle if longer) are classified as current.
2. Liabilities due after one year (or the operating cycle if longer), such as bonds or
bank debt, are classified as long-term. In addition, deferred tax liabilities are
considered long-term liabilities by definition.
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were explained in part I of this lesson.
1. Equity accounts are generally presented in order of liquidation preference with
preferred stock first, followed by common stock and additional paid-in capital.
Retained earnings and accumulated other comprehensive income are generally
presented last in the equity section.
D. The balance sheet is incomplete without the additional disclosures in the notes to the
financial statements. These disclosures help investors understand the key
assumptions and methods of accounting used so they can more effectively compare
prior periods and assist with comparisons with other companies. Key disclosures
include the following items.
1. Significant accounting policies, including the following:
a. Any securities classified as cash equivalents
b. Inventory valuation method and cost flow assumptions
c. Method of depreciation
2. Significant estimates made within the accounts
3. Amounts within major classes of inventory (i.e., raw materials, work in process,
finished goods)
4. Gross amounts within major classes of property and equipment (i.e. furniture,
equipment, buildings, land) and accumulated depreciation for each
5. Components of deferred tax assets and liabilities
6. Expected annual principal payments on debt for the next five years and all
amounts due thereafter
7. Sinking fund provisions for bonds
8. Par values and contractual provisions for preferred stock and common stock
9. Details about employee stock compensation programs
10. Significant commitments or contingencies not recorded in the balance sheet
11. Other information as may be needed for a full understanding of the items
reported in the balance sheet
V. Illustration: The basic format for the balance sheet is illustrated using ABC Co. information
for 20X2.
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Practice Question
Jolley, Inc. is preparing its 20X1 balance sheet and needs some assistance with properly
classifying some of its liabilities. Jolley's operating cycle is approximately 90 to 120 days.
Identify whether the following items should be current or non-current on the balance sheet.
1. Debt of $10,000 payable over 5 years at a rate of $2,000 per year plus interest.
2. Bonds of $100,000 due in full in 15 years. Interest of $6,000 is payable on the bonds each
year and the full amount of the interest was already recorded and paid for 20X1.
Accordingly, no interest payable was recorded at the end of the year.
3. Deferred Tax Liability of $3,000 expected to reverse entirely within the next year.
4. Accrued Warranty of $12,000 expected to be paid out evenly over the next three years.
5. Accounts Payable of $38,000 generally due between 30 and 90 days.
Answer
1. Because $2,000 is due in the coming year and the remainder is due thereafter, this debt
should be classified as current for $2,000 and non-current for $8,000.
2. Because the principal portion of the bonds is not due for 15 years, the entire amount
should be classified as non-current. Jolley has fully paid its interest for the year, so they
have no need for a payable associated with the interest. Classification of the interest is
not relevant.
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3. By definition, Deferred Tax Liabilities are non-current liabilities.
4. The accrued warranty should be split as current and non-current based on the expected
payments related to the warranty. $4,000 would be current and $8,000 would be noncurrent.
5. Because the amount is expected to be paid within the next year, the entire amount is
current.
Summary
The statement of changes in equity presents the organization's detailed changes in each equity
account over the course of the period presented. The accounts typically presented in this
financial statement include: preferred stock, common stock, additional paid-in capital,
treasury stock, retained earnings, accumulated other comprehensive income, and noncontrolling interest. You should be familiar with the common transactions that affect equity
accounts. The balance sheet shows the organization's assets, liabilities, and owner's equity as
of the end of the period presented. Assets represent the resources available for carrying out
the organization's purpose and can be current or non-current. Liabilities represent third-party
claims to the organization's assets and are also represented as current or non-current. Equities
represent owner claims to the organization's assets. It is also important to know the key
disclosures related to the balance sheet.
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Slides
Statement of Changes in Equity and the Balance Sheet
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Flashcards
!
Statement of Changes in Equity and the Balance Sheet
1
FC.soc.FC001_1802
Which accounts are typically presented in
the statement of changes in equity?
Preferred Stock
Common Stock
Additional Paid-in Capital
Treasury Stock
Retained Earnings
Accumulated Other Comprehensive
Income
Non-Controlling Interest
2
FC.soc.FC002_1802
Explain the effect on the financial
statements of the repurchase of treasury
stock and the resale of treasury stock.
Purchase of Treasury Stock:
Treasury stock (a contra equity
account) increases for the cost of
the shares, which reduces equity.
R e s a l e o f T r e a s u r y S t o c k : When
stock is resold for greater than the
repurchase price of the stock, the
cost is taken from treasury stock
and the excess is added to
additional paid-in capital. When
stock is resold for an amount lower
than the repurchase price, the
difference is taken from additional
paid-in capital and retained
earnings if there is not sufficient
additional paid-in capital from
previous resales of treasury stock.
3
FC.soc.FC003_1802
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S t o c k S p l i t : Does not impact the
equity accounts as long as the par
value is changed to reflect the new
share size.
S t o c k D i v i d e n d s : A small stock
dividend is less than 20–25% of the
number of outstanding shares.
Retained earnings is reduced for
the fair value of stock, common
stock is increased for the par value,
and the difference is included in
additional paid-in capital. For large
stock dividends (greater than
20–25%), retained earnings is
reduced and common stock is
increased for the par value of the
stock issued in the dividend.
Explain the events of stock splits and
stock dividends.
4
FC.soc.FC004_1802
Explain:
Three major sections included on a
balance sheet
Footnote disclosures
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A s s e t s : The resources available to
the organization for carrying out its
purpose. Divided into a current and
non-current portion.
L i a b i l i t i e s : Represent third-party
claims to the assets of an
organization. Divided into a current
and non-current portion.
E q u i t i e s : Represent the owner
claims to the assets of the
organization.
F o o t n o t e D i s c l o s u r e s : The
disclosures help investors
understand key assumptions and
methods used to better compare
financial statements between
organizations.
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Test Bank Questions
Statement of Changes in Equity and the Balance Sheet
Question 1 (1A1-W018)
1A1-W018
McCarthy Corp. is issuing its first financial statements. The CFO of the company is of the view that
all assets shall be recorded at historical cost throughout the life of the organization. Which of the
following is the b e s t critique of such a disclosure?
Historical value assumes that the value of an asset is the amount that would have to be
paid to replace the asset on the balance sheet date.
Historical value takes into account the effects of inflation on the asset; therefore, the value
fluctuates in each period.
Historical value does not take into account the effect of depreciation; therefore, the true
value of the asset cannot be determined.
Historical value is less relevant for assessing a company's current financial position.
Most asset accounts of a nonfinancial nature are reported at historical cost. While historical
cost measures are considered reliable because the amounts can be verified, they are also
considered less relevant than fair value or current market value measures would be for
assessing a firm's current financial position.
Question 2 (1A2-W022)
1A2-W022
Brendan Bishop Scientific is considering acquiring a new plant and paying for it with common
stock at par value. However, the CFO is not in favor of the acquisition. Which of the following is
the m o s t l i k e l y reason for the CFO's disagreement?
The company has fewer amounts of long-term assets.
The company's stock is most likely overpriced.
It is difficult to estimate the net realizable value of the asset and, hence, difficult to estimate
the annual depreciation expenses.
The true cost of the asset cannot be determined as the stock's trading activity should also
be considered.
When property, plant, and equipment assets are acquired through the issuance of stock or
other securities, the par value of the stock will be inadequate to measure the true cost of the
property. Instead, if the stock is being actively traded, its current market value is used. If the
stock value cannot be determined because the stock is not actively traded, an estimate of
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the market value of the property should be made and used as the basis for recording the
value of both the asset and the issuance of the stock.
Question 3 (MQ2915)
MQ2915
Mirr, Inc. was incorporated on January 1, year 1, with proceeds from the issuance of $750,000 in
stock and borrowed funds of $110,000. During the first year of operations, revenues from sales
and consulting amounted to $82,000, and operating costs and expenses totaled $64,000. On
December 15, Mirr declared a $3,000 cash dividend, payable to stockholders on January 15, year
2. No additional activities affected owners' equity in year 1. Mirr's liabilities increased to $120,000
by December 31, year 1. On Mirr's December 31, year 1 balance sheet, total assets should be
reported at:
Use Balance sheet Formula then oe formula ( beg +- Changes)
$885,000
$882,000
$878,000
$875,000
Mirr began operations on 1/1/Y1 with the following balance sheet elements:
Assets = Liabilities + Owners' equity
$860,000 = $110,000 + $750,000
During year 1, liabilities increased to $120,000, and owners' equity increased to $765,000
[$750,000 beginning balance + $18,000 net income ($82,000 revenues − 64,000 expenses) −
$3,000 dividends declared]. Therefore, 12/31/Y1 assets must be $885,000.
Assets = Liabilities + Owners' equity
$885,000 = $120,000 + $765,000
Question 4 (MQ2916)
MQ2916
Which of the following should be disclosed in the summary of significant accounting policies?
Composition of plant assets.
Not alternative - not peculiar
Pro forma effect of retroactive application of an accounting change.
Not alternative - not peculiar
Basis of consolidation.
Maturity dates
of long-term
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This answer is correct because ASC Topic 235 states that the summary of significant
accounting policies should encompass those accounting principles and methods that
involve a selection from existing acceptable alternatives (or are peculiar to the industry in
which the entity operates). Of the answers listed, only basis of consolidation involves a
choice among acceptable methods.
Question 5 (MQ2933)
MQ2933
How would the declaration of a 10% stock dividend by a corporation affect each of the following
on its books?
Retained earnings (RE) Total stockholders' equity (SE)
Decrease
No effect
Decrease
Decrease
No effect
Decrease
No effect
No effect
Entries for small stock and large stock dividend
Regardless of the size of a stock dividend, RE is decreased and other SE accounts are
increased. Since the dividend described in this question is small (< 20%–25% of the
outstanding shares), the journal entry would be:
Retained earnings
(FV)
Common stock dividend distributable
(par value)
Additional paid-in capital
(plug)
Accordingly, RE will decrease and, since all affected accounts are elements of SE, total SE
will not change. Note that the entry for a large stock dividend would be:
Retained earnings
(par)
Common stock dividend distributable
Question 6 (MQ2934)
(par)
1. Is the stock dividend large or small? LARGE
2. RE - PAR - Common Stock PAR since it is
not determined
MQ2934
Mike's Ice Cream Shop has 500 shares of stock outstanding at $1 par value per share. As a reward
for a great year, Mike (the majority owner and CEO) is issuing a stock dividend of 300 shares to all
shareholders. Current market value of the stock is $20/share. What are the appropriate
accounting entries to record this stock dividend?
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Dr. Retained earnings $6,000, Cr. Par value distributable $300 Cr. Paid-in Capital $5,700
Dr. Retained earnings $6,000, Cr. Paid-in capital $6,000
Dr. Retained earnings $6,000, Cr. Par value distributable $6,000
Dr. Retained earnings $300, Cr. Par value distributable $300
This is a large stock dividend because the dividend of 300 shares is 60% of the current shares
outstanding of 500. Large stock dividends are recorded at par value because the fair value of
each share of stock is diluted because of the magnitude of the dividend. Therefore, Mike's
will debit Retained earnings at par value and credit the par value distributable for par value.
Question 7 (STK-0005)
STK-0005
On February 1, Year 1, Kew Corp., a newly formed company, had the following stock issued and
outstanding:
Common stock, no par, $1 stated value, 10,000 shares originally issued for $15 per share.
Preferred stock, $10 par value, 3,000 shares originally issued for $25 per share.
Kew’s February 1, Year 1, statement of stockholders’ equity should report
Common stock Preferred stock Additionalpaid-in capital
$ 150,000
$30,000
$ 45,000
$ 150,000
$75,000
$0
$ 10,000
$75,000
$ 140,000
$ 10,000
$30,000
$ 185,000
This answer is correct. Common stock and preferred stock are reported at par or stated
value, and any excess invested above par or stated value is recorded as additional paid-in
capital. In this case, common stock is recorded at stated value (10,000 × $1 = $10,000), and
preferred stock is recorded at par value (3,000 × $10 = $30,000). Additional paid-in capital
from common stock is $140,000 [10,000 × ($15 − $1)], and additional paid-in capital from
preferred stock is $45,000 [3,000 × ($25 − $10)], so additional paid-in capital is $185,000
($140,000 + $45,000).
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Criteria for classifying lt liabilities and current liabilities
tb.soc.001_1805
Jimenez Transportation purchased five new transportation vehicles in 20x6. They plan to pay
these vehicles off in even installments over the next 8 years. On the 20x7 year-end financial
statements, how would the amount Jimenez plans to pay off in 20x8 differ from the amount they
plan to pay off in 20x9?
The amount they plan to pay off in 20x8 would be classified as a current liability, and the
amount they plan to pay off in 20x9 would be classified as a long-term liability.
The amount they plan to pay off in 20x8 would be classified as depreciation, and the
amount they plan to pay off in 20x9 would be classified as a long-term liability.
The amount they plan to pay off in 20x8 would be classified as a current liability, and the
amount they plan to pay off in 20x9 would be classified as a long-term investment.
The amount they plan to pay off in 20x8 would be classified as property, plant, and
equipment, and the amount they plan to pay off in 20x9 would be classified as a long-term
investment.
Liabilities are classified on the balance sheet as either current or long-term depending on
when they are expected to be satisfied. Liabilities expected to be satisfied within 12 months 1
or one operating cycle (whichever is longer) and2 satisfied using current assets are classified
as current liabilities. All other liabilities are classified as long-term liabilities. The amount to
be paid in 20x8 is a current liability since it is to be paid within one year of 12/31/X7 and the
amount to be paid in 20x9 is a long-term liability since it is to be paid more than one year
after 12/31/X7. Therefore, this is the correct answer.
Question 9 (tb.soc.002_1805)
tb.soc.002_1805
Wilson Industries holds a number of government securities. $10,000 of these securities have a
one-year maturity date, while $4,000 have an 18-month maturity date. Wilson prepares a
classified balance sheet using a 2-year operating cycle. How should these securities be classified?
All $14,000 in government securities should be classified as long-term investments.
$10,000 should be classified as current assets and $4,000 should be classified as long-term
assets.
$4,000 should be classified as current assets and $10,000 should be classified as long-term
assets.
All $14,000 in government securities should be classified as current assets.
Assets are classified on the balance sheet as either current or long-term depending on when
they are expected to be used or converted into cash. Assets expected to be used or
converted into cash within 12 months or one operating cycle (whichever is longer) are
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classified as current assets. All other assets are classified as long-term assets. Since the
operating cycle is 2 years, that is the “dividing line” between current and long-term. All
$14,000 of the securities are classified as current assets since they mature within the 2-year
operating cycle. Therefore, this is the correct answer.
Question 10 (tb.soc.003_1805)
tb.soc.003_1805
JT Engineering currently holds two debts: a $9,000 debt due in 9 months and a $7,000 debt due in
14 months. JT prepares a classified balance sheet using a 1-year operating cycle. How should
these debts be classified?
All $16,000 in debt should be classified as current liabilities.
All $16,000 in debt should be classified as long-term liabilities.
The $7,000 should be classified as a current liability, and the $9,000 should be classified as a
long-term liability.
The $9,000 should be classified as a current liability, and the $7,000 should be classified as a
long-term liability.
Liabilities are classified on the balance sheet as either current or long-term depending on
when they are expected to be satisfied. Liabilities expected to be satisfied within 12 months
or one operating cycle (whichever is longer) and satisfied using current assets are classified
as current liabilities. All other liabilities are classified as long-term liabilities. Since the
operating cycle is 1 year, that is the “dividing line” between current and long-term. The
$9,000 is a current liability since it is to be paid in 9 months and the $7,000 is a long-term
liability since it is to be paid in 14 months. Therefore, this is the correct answer.
Question 11 (tb.soc.004_1805)
tb.soc.004_1805
Anders Industries currently holds two debts: an $11,000 debt due in 12 months and a $16,000 debt
due in 18 months. Anders prepares a classified balance sheet using an 18-month operating cycle.
How should these debts be classified?
$11,000 should be classified as a current liability, and $16,000 should be classified as a longterm liability.
$16,000 should be classified as a current liability, and $11,000 should be classified as a longterm debt.
All $27,000 in debt should be classified as long-term liabilities.
All $27,000 in debt should be classified as current liabilities.
Liabilities
classified on
the
sheet
as either
current
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when they are expected to be satisfied. Liabilities expected to be satisfied within 12 months
or one operating cycle (whichever is longer) and satisfied using current assets are classified
as current liabilities. All other liabilities are classified as long-term liabilities. Since the
operating cycle is 18 months, that is the “dividing line” between current and long-term. Both
liabilities are current liabilities because they will be satisfied within 18 months. Therefore,
this is the correct answer.
Question 12 (tb.soc.005_1805)
tb.soc.005_1805
Griffin Industries holds a debt that is due 16 months from now. Griffin prepares a classified
balance sheet using an 18-month operating cycle. How would classification of this debt be
different if Griffin used a one-year operating cycle?
With the 18-month cycle it is classified as a long-term liability, while with a one-year cycle it
is classified as a current liability.
With the 18-month cycle it is classified as a current liability, while with a one-year cycle it is
classified as a long-term liability.
With the 18-month cycle it is classified as stockholders’ equity, while with a one-year cycle it
is classified as a current liability.
With the 18-month cycle it is classified as a current liability, while with a one-year cycle it is
classified as stockholders’ equity.
Liabilities are classified on the balance sheet as either current or long-term depending on
when they are expected to be satisfied. Liabilities expected to be satisfied within 12 months
or one operating cycle (whichever is longer) and satisfied using current assets are classified
as current liabilities. All other liabilities are classified as long-term liabilities. If the operating
cycle is 18 months, the liability is classified as a current liability since it is due in less than 18
months. If the operating cycle is 1 year, the liability is classified as a long-term liability since
it is due in more than 1 year. Therefore, this is the correct answer.
Question 13 (tb.soc.006_1805)
tb.soc.006_1805
Wells Enterprises holds a debt that is due 20 months from now. Wells prepares a classified
balance sheet using a one-year operating cycle. How would classification of this debt be different
if Wells used a two-year operating cycle?
With a one-year cycle it is classified as a current liability and with a two-year cycle it is
classified as a long-term liability.
With a one-year cycle it is classified as stockholders’ equity and with a two-year cycle it is
classified as a current liability.
With the one-year cycle it is classified as a long-term liability, while with a two-year cycle it
is classified as a current liability.
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With a one-year cycle it is classified as a current liability and with a two-year cycle it is
classified as stockholders’ equity.
Liabilities are classified on the balance sheet as either current or long-term depending on
when they are expected to be satisfied. Liabilities expected to be satisfied within 12 months
or one operating cycle (whichever is longer) and satisfied using current assets are classified
as current liabilities. All other liabilities are classified as long-term liabilities. If the operating
cycle is one year, the liability is classified as a long-term liability since it is due in more than
1 year. If the operating cycle is 2 years, the liability is classified as a current liability since it is
due in less than 2 years. Therefore, this is the correct answer.
Question 14 (tb.soc.007_1805)
tb.soc.007_1805
How does the classification of a cash equivalent differ from the classification of a current asset?
A cash equivalent is an investment that will be turned into cash within one month or less,
whereas a current asset will be turned into cash within six months or less or within the
length of the operating cycle, whichever is longer.
A cash equivalent is a trading security, whereas a current asset is all other assets except
trading securities.
A cash equivalent is an investment that will be turned into cash within three months or less,
whereas a current asset will be turned into cash within one year or within one operating
cycle, whichever is longer.
There is no difference between the two classifications.
Cash equivalents are investments with original maturities of 3 months or less that are highly
liquid and easy to sell. They will be turned into cash within three months or less. They are a
type of current asset. Current assets are assets that are expected to be used or converted
into cash within one year or one operating cycle, whichever is longer. Therefore, this is the
correct answer.
Question 15 (tb.soc.009_1805)
tb.soc.009_1805
How does a corporation recognize a deficit in retained earnings?
As a reduction in paid-in capital
As a reduction in stockholders’ equity on the balance sheet
As a net loss on the income statement
As a decrease in treasury stock
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A deficit in retained earnings means there is a negative balance in retained earnings. This
happens when net losses and dividend payments over a company's life exceed net income
over the company's life. Since it is negative equity, it is shown on the balance sheet as a
reduction in stockholders’ equity on the balance sheet. Therefore, this is the correct answer.
Question 16 (tb.soc.010_1805)
tb.soc.010_1805
Treasury stock and a retained earnings deficit will have what effect on stockholders’ equity?
They will increase stockholders’ equity.
They will have no effect on stockholders’ equity.
They will reduce stockholders’ equity.
They will double stockholders’ equity.
Treasury stock is when a company repurchases its own stock. Since issuing stock increases
equity, buying it back decreases equity. A deficit in retained earnings means there is a
negative balance in retained earnings. This happens when net losses and dividend
payments over a company's life exceed net income over the company's life. Since retained
earnings increases equity, a deficit decreases equity. Therefore, this is the correct answer.
Question 17 (tb.soc.011_1805)
tb.soc.011_1805
Which of the following would cause a reduction in stockholders’ equity on the balance sheet?
A stock split
A stock dividend
No difference
No difference
Positive net income
increase
A deficit in retained earnings
A deficit in retained earnings means dividends paid exceeds income earned over the
company's life. It is a form of negative equity, meaning it is a reduction in stockholders’
equity. Therefore, this is the correct answer.
Question 18 (tb.soc.013_1805)
tb.soc.013_1805
Candela Company has retained earnings of $500,000, common stock of $400,000, and total
common
stockholders’
equity of $1,200,000.
It has 200,000 shares of $2 par value common
stock
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outstanding, which is currently selling for $5 per share. If Candela Company declares a 2-for-1
stock split on its common stock, which of the following will occur?
Net income will increase by $1,000,000.
Retained earnings will decrease by $1,000,000.
Total paid-in capital will increase by $1,000,000.
There will be no effect on total common stockholders’ equity.
A stock split increases the number of shares of stock authorized, issued, and outstanding.
However, it has no impact on total paid-in capital, retained earnings, or total common
shareholders’ equity. Therefore, this is the correct answer. The $1,000,000 is calculated as
200,000 shares × $5 (price per share).
Question 19 (tb.soc.014_1805)
tb.soc.014_1805
Which of the following is a likely reason for a stock split?
A company wishes to increase paid-in capital to have resources for more growth.
A company wishes to increase par value of its stock to increase its capital assets.
A company wishes to lower the stockholders’ equity.
A company wishes to lower the market price of its stock to increase marketability.
A stock split increases the number of shares of stock that are authorized, issued, and
outstanding. Because the number of shares of stock increases, each share is worth less
money. The lower price can improve the stock's marketability as more people are able to
afford it. Therefore, this is the correct answer.
Question 20 (tb.soc.015_1805)
tb.soc.015_1805
Both stock splits and stock dividends ________ total stockholders’ equity, while only ________
result in a decrease in the par value of common stock.
increase; stock splits
increase; stock dividends
decrease; stock dividends
maintain; stock splits
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Stock splits and stock dividends both increase the number of shares of stock a firm has
outstanding. Neither results in any change in total equity. Under a stock dividend, retained
earnings decrease and paid-in capital increases by the same amount. Neither component
changes with a stock split. Stock splits do result in a decrease in the par value of the stock,
while there is no change in par value with stock dividends. Therefore, this is the correct
answer.
Question 21 (tb.soc.016_1805)
tb.soc.016_1805
Stock dividends ________ retained earnings and ________ total paid-in capital.
increase, decrease
increase, increase
decrease, increase
decrease, decrease
Under a stock dividend, retained earnings decrease because dividends of any kind result in
a decrease in retained earnings. This is because a dividend returns capital to owners. At the
same time, more shares of stock are issued with a stock dividend. This results in an increase
in total paid-in capital. The decrease in retained earnings is equal to the increase in paid-in
capital. Therefore, this is the correct answer.
Question 22 (tb.soc.017_1805)
tb.soc.017_1805
What is the result of stock dividends?
Retained earnings increase while total paid-in capital decreases.
Both retained earnings and total paid-in capital increase.
Both retained earnings and total paid-in capital decrease.
Retained earnings decrease while total paid-in capital increases.
Under a stock dividend, retained earnings decrease because dividends of any kind result in
a decrease in retained earnings. This is because a dividend returns capital to owners. At the
same time, more shares of stock are issued with a stock dividend. This results in an increase
in total paid-in capital. The decrease in retained earnings is equal to the increase in paid-in
capital. Therefore, this is the correct answer.
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Question 23 (tb.soc.018_1805)
tb.soc.018_1805
Which accounts are affected by a small stock dividend?
Common stock, retained earnings, and cash
Common stock, paid-in capital in excess of par—common stock, retained earnings, and
cash
Retained earnings and cash
Common stock, paid-in capital in excess of par—common stock, and retained earnings
A stock dividend occurs when an organization distributes additional shares of stock to
existing stockholders as a dividend rather than paying them cash. For "small" stock
dividends (less than 20–25% of the number of shares outstanding) retained earnings is
reduced for the fair value of the stock being issued, common stock is increased for the par
value of the stock issued, and the difference is included in additional paid-in capital. For
"large" stock dividends (greater than 20–25% of the number of shares outstanding) retained
earnings is reduced for the par value of the stock being issued and common stock is
increased for the same amount. There is no impact on additional paid-in capital, similar to a
stock split.
Question 24 (tb.soc.019_1805)
tb.soc.019_1805
What is one major difference between a stock split and a stock dividend?
The total paid-in capital increases with a stock split but has no change with a stock
dividend.
The par value per share decreases with a stock split but has no change with a stock
dividend.
The total retained earnings has no change with a stock split but increases with a stock
dividend.
The total par value of the stock increases with a stock split but has no change with a stock
dividend.
Stock splits and stock dividends both increase the number of shares of stock a firm has
outstanding. Neither results in any change in total equity. One difference is that par value
per share decreases with stock splits while remaining unchanged with stock dividends.
Therefore, this is the correct answer.
Question 25 (tb.soc.020_1805)
tb.soc.020_1805
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Claire and David hold stock in two different companies, but both recently received additional
shares of common stock rather than a cash dividend. After receiving the additional stock, the par
value of Claire's stock decreased by 67%, but the par value of David's stock remained the same.
What is the difference between the stock that Claire and David received?
Claire received a stock split, and David received a stock dividend.
Claire received a stock dividend, and David received a stock split.
Claire received newly issued stock, and David received a stock split.
Claire received a stock dividend, and David received newly issued stock.
Stock splits and stock dividends both increase the number of shares of stock a firm has
outstanding. Neither results in any change in total equity. One difference is that par value
per share decreases with stock splits while remaining unchanged with stock dividends.
Since the par value per share of Claire's stock decreased, she must have received a stock
split. Since the par value per share of David's stock remained the same, he must have
received a stock dividend. Therefore, this is the correct answer.
Question 26 (tb.soc.021_1805)
tb.soc.021_1805
Based on the stock's par value, a large stock dividend is most similar to a ________; but based on
the stock's market value, a large stock dividend is most similar to a ________.
small stock dividend; stock split
stock split; small stock dividend
cash dividend; small stock dividend
stock split; cash dividend
Stock dividends are classified based on the amount of new shares issued. Small stock
dividends are those in which the new shares issued are no more than 20–25% of the current
shares outstanding, while large stock dividends are stock dividends larger than that. The
reason for the difference in accounting treatment is that a large stock dividend will likely
have a much larger impact on share price than a small stock dividend. This means share
price is not an appropriate way to measure the value of a large stock dividend.
Consequently, par value is used to value large stock dividends. Since the par value per share
does not change with either a large stock dividend or a small stock dividend, a large stock
dividend is most similar to a small stock dividend with respect to par value. Stock price is
likely to fall after any stock dividend since there are a greater number of shares outstanding
as a result of stock dividends. The decrease is larger with large stock dividends. Stock price
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also drops fairly significantly from stock splits as the number of shares increases
significantly as a result of stock splits. Since the market value per share drops significantly
with either a large stock dividend or a stock split, a large stock dividend is most similar to a
stock split with respect to market value. Therefore, this is the correct answer.
Question 27 (tb.soc.022_1805)
tb.soc.022_1805
Palmer Beauty Products wants to increase their number of shares to decrease the stock's market
value, but they do not want to change the par value of the shares. What would you recommend
they do?
Issue a small stock dividend.
Issue a stock split.
Issue a reverse stock split.
Issue a large stock dividend.
Stock dividends are classified based on the amount of new shares issued. Small stock
dividends are those in which the new shares issued are no more than 20–25% of the current
shares outstanding, while large stock dividends are stock dividends larger than that. This
means that the stock price will decrease more with a large stock dividend than with a small
stock dividend because shares increase by a larger amount with a large stock dividend. Par
value per share does not change for any size stock dividend. This means that a large stock
dividend will likely give a large decrease in market value without changing the par value per
share. Therefore, this is the correct answer.
Question 28 (tb.soc.023_1805)
tb.soc.023_1805
Hayes Incorporated reported the following stockholders’ equity on December 31, 20x6:
Common stock, 85,000 shares at $50 par value $4,250,000
Paid-in capital in excess of par
$583,000
Retained earnings
$716,000
Total stockholders' equity
$5,549,000
On June 30, 20x7, Hayes declared a 5-for-1 stock split. At the time of declaration, shares were
selling for $300 per share. Through the first two quarters of the fiscal year, Hayes recorded a net
income of $103,000. How will Hayes’ stockholders’ equity section change as a result of this
information?
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Number of shares will increase to 340,000, par value will remain at $50 per share, and
stockholders’ equity will increase to $17,000,000.
Number of shares will increase to 425,000, par value will decrease to $10 per share, and
stockholders’ equity will increase to $5,652,000.
Number of shares will increase to 340,000, par value will decrease to $12.50, and
stockholders’ equity will increase to $5,652,000.
Number of shares will increase to 425,000, par value will remain at $50 per share, and
stockholders’ equity will increase to $21,250,000.
When a company declares a stock split, the number of shares authorized, issued, and
outstanding increases by the factor of the stock split. In addition, the par value per share
decreases by the inverse of the factor of the stock split. The total common stock, paid-in
capital, and retained earnings stay the same as a result of the stock split. Retained earnings
increases from net income. In this example, Hayes's number of shares will increase to
425,000 (85,000 × 5), par value will decrease to $10 per share ($50 ÷ 5), retained earnings will
increase to $819,000 ($716,000 + $103,000), and total stockholders’ equity will increase to
$5,652,000 ($4,250,000 + 583,000 + 819,000). Therefore, this is the correct answer.
Question 29 (tb.soc.024_1805)
tb.soc.024_1805
Washington Rare Coins reported the following stockholders’ equity on December 31, 20x6:
Common stock, 15,000 shares at $25 par value $375,000
Paid-in capital in excess of par
$92,000
Retained earnings
$68,000
Total stockholders' equity
$535,000
On August 14, 20x7, Washington declared a 2-for-1 stock split. At the time of declaration, shares
were selling for $114 per share. Through the first two quarters of the fiscal year, Washington
recorded a net loss of $6,500. How will Washington's stockholders’ equity section change as a
result of this information?
Number of shares will increase to 30,000, par value will remain at $25 per share, and
stockholders’ equity will increase to $750,000.
Number of shares will remain at 15,000, par value will increase to $50, and stockholders’
equity will increase to $750,000.
Number of shares will remain at 15,000, par value will decrease to $12.50/share, and
stockholders’ equity will decrease to $341,000.
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Number of shares will increase to 30,000, par value will decrease to $12.50 per share, and
stockholders’ equity will decrease to $528,500.
When a company declares a stock split, the number of shares authorized, issued, and
outstanding increases by the factor of the stock split. In addition, the par value per share
decreases by the inverse of the factor of the stock split. The total common stock, paid-in
capital, and retained earnings stay the same as a result of the stock split. Retained earnings
increases from net income and decreases from net losses. In this example, Washington's
number of shares will increase to 30,000 (15,000 × 2), par value will decrease to $12.50 per
share ($25 ÷ 2), retained earnings will decrease to $61,500 ($68,000 − $6,500), and total
stockholders’ equity will decrease to $528,500 ($375,000 + 92,000 + 61,500). Therefore, this is
the correct answer.
Question 30 (tb.soc.027_1805)
tb.soc.027_1805
In the financial statements, the presentation of an accumulated other comprehensive loss is
similar to the presentation of what other financial item?
The excess paid-in capital from common stock
A net loss rather than net income in a single accounting period
Retained earnings
The cost of treasury stock
Accumulated other comprehensive loss is subtracted from total paid-in capital and retained
earnings in the stockholders’ equity section of the balance sheet. Treasury stock is also
subtracted from total paid-in capital and retained earnings in the stockholders’ equity
section of the balance sheet. Therefore, this is the correct answer.
Question 31 (tb.soc.028_1805)
tb.soc.028_1805
Delgado Corp. purchased some common stock from Keller Enterprises. Delgado plans to hold this
stock for a minimum of five years, although they could sell it sooner if they need to. How do you
expect Delgado to classify the stock on their balance sheet?
As a short-term investment
As a long-term liability
As a long-term investment
As owners’ equity
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A long-term investment is a type of asset. Assets arise when a company owns or controls
something that is expected to provide future economic benefit. Purchasing stock results in
an asset since the stock could be sold for cash in the future. Assets are considered long-term
when the benefits are expected beyond one year. Since Delgado is not expecting to sell the
stock anytime soon, it is classified as “available for sale,” not “trading.” Because the
expected sale date is beyond one year, it is a long-term investment. Therefore, this is the
correct answer.
Question 32 (tb.soc.029_1805)
tb.soc.029_1805
Holden Company purchased 150 acres of land on the outer edge of a growing city. Holden expects
the value of this land to appreciate by 500% over the next three years. How would you expect
Holden to report the value of this land on their balance sheet?
At market value
At the expected future value at the time of sale
At historical cost
At a depreciated value
In general, assets are reported on the balance sheet at historical cost. One exception is
when the asset's value has permanently been reduced (impaired). A second is for trading
securities and available-for-sale securities, which are recorded at market value. A third
exception is for fixed assets, which are recorded at depreciated cost. The land in this
question does not fit any of these exceptions. Therefore, this is the correct answer.
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