Chapter Thirteen Questions
 

 1. In a corporation, who is responsible for declaring dividends?

The board of directors. [See text page 429.]
 

2. In terms of resources, what does the balance in a corporation's retained earnings represent?

Retained earnings is the source of resources generated by management and kept in the company.  It results from net income (resources generated by management) less dividends (resources generated by management and distributed to owners). [See text page 497.]
 

3. Define the term discontinued operations.

The activities of a company's major segment that has been disposed of are referred to as a discontinued operation. [See text page 484.]
 

4. On which financial statement and in which section of the statement are discontinued operations reported?

Discontinued operations are reported on the income statement in a separate section titled discontinued operations. [See text page 484.]
 

5. Define the term extraordinary items.

An extraordinary item is an unusual and infrequent event that affects a company’s income. In addition, gains or losses on the retirement of long-term debt are classified as extraordinary items. [See text page 485.]
 

6. On which financial statement and in which section of the statement are extraordinary items reported?

Extraordinary items are reported on the income statement in a separate section titled extraordinary items. [See text page 485.]
 

7. Define the term cumulative effects of changes in accounting principles.

The cumulative effect of a change in an accounting principle is the change in income that would have occurred if the company had used a new accounting principle, instead of a previous one, for all the years the previous one had been used. Examples of changes in accounting principles would be FIFO to LIFO inventory costing and straight-line to double-declining-balance depreciation. [See text page 485.]
 

8. On which financial statement and in which section of the statement are cumulative effects of changes in accounting principles reported?

The cumulative effects of changes in accounting principles are reported on the income statement in a separate section titled cumulative effects of changes in accounting principles. [See text page 486.]
 

9. What is a stock dividend?

A stock dividend is the distribution of additional shares of a company’s own stock to its stockholders.  Stock dividends are declared and distributed by companies who do not want to distributed cash dividends. [See text page 487.]
 

10. What effect does a stock dividend have on total stockholders’ equity?

A stock dividend does not change total stockholders' equity.  It reduces retained earnings for the market value of the shares distributed as the dividend, increases common stock for the par value of the shares, and increases additional paid-in capital for the difference between the market value of the shares and their par value. [See text page 488.]
 

11. State the formula for earnings per share.

Earnings per share = net income available to common stockholders / average number of common shares outstanding during the period. [See text page 490.]
 

12. State the formula for dividend payout.

Dividend payout = common stock cash dividends / net income available to common stockholders. [See text page 494.]
 
 

Chapter Thirteen Exercises
 

Exercise 13.1: Retained Earnings Available for Dividends

The board of directors of the Plourde Corporation is meeting to discuss declaring the corporation’s cash dividends. The corporation has 25,000,000 shares of common stock outstanding and has never issued any preferred stock. On January 1, the corporation’s retained earnings balance was $87,000,000. For the year ended December 31, the corporation reported net income of $48,000,000.

1. Calculate the maximum dollar amount of total dividends the board of directors could declare.
 
Retained earnings, January 1
$87,000,000
Plus: net income
$48,000,000
Retained earnings available for dividends
$135,000,000
 
 
2. Calculate the corporation’s maximum dividends per share on common stock.

Retained earnings available for dividends / # of common shares = maximum common stock dividends
$135,000,000 / 25,000,000 shares = $5.40 per share
 
 
3. Calculate the corporation’s dividends per share if the directors want to distribute "only" the current year's net income to common stockholders.

income / # of common shares

$48,000,000 / 25,000,000 shares = $1.92 per share
 
 
4. Determing the dollar amount of resources generated by management during the year ended December. 31.

Net income represents the dollar amount of resources generated by management.  Since the company's net income for the year ended December 31 was $48,000,000, management generated $48,000,000 of resources during the year.
 
 
5. Assuming the board of directors did not declare dividends this year ended December 31, determine the dollar amount of the corporation’s December 31 resources generated by management since the corporation was founded and kept in the business.

The source of management generated resources kept in the business is retained earnings, which was $135,000,000 on December 31, as calculated in part 1.
 
 
Exercise 13.2: Statement of Retained Earnings Preparation

For its fiscal year ended June 30, the Cheung Corporation reported net income of $5,700,000. The corporation declared dividends of $1,400,000 during the year. At the beginning of its fiscal year, the company’s retained earning balance was $21,000,000.

1. Prepare the Cheung Corporation’s statement of retained earnings for the year ended June 30.
 
Retained earnings, July 1
$21,000,000
Plus: net income
$5,700,000
Subtotal
$26,700,000
Less: Dividends
$1,400,000
Retained earnings, June 30
$25,300,000
 
 
2. Determine the dollar amount of resources generated by management during the year ended June 30.

The source of management generated resources is net income, which was $5,700,000.
 
 
3. Determine the dollar amount of resources generated by management during the year ended June 30 and kept in be business as of June 30.

The source of management generated resources is net income. Management generated resources kept in the business is net income less dividends.
 
Net income, year ended June 30
$5,700,000
Dividends, year ended June 30
$1,400,000
Resources (net income) kept in the business
$4,300,000
 
 
4. Determine the dollar amount of the corporation’s June 30 resources generated by management since the corporation was founded and kept in the business.

The source of management generated resources kept in the business is retained earnings, which was $25,300,000 on June 30, as calculated in part 1.
 
 
Exercise 13.3: Effects of Discontinued Operations

In order to concentrate its efforts on merchandising, the MacKinnon Corporation sold the insurance segment of its business in March. The company’s accountants determined that this sale qualified for treatment as a discontinued operation. When the MacKinnon Corporation sold the insurance segment’s assets, the result was a $250,000 gain before taxes.  During the year ended December 31, the operations of the insurance segment resulted in a $600,000 loss before taxes. During the year, the continuing operations of the MacKinnon Corporation resulted in income of $3,800,000 before taxes. The corporation’s effective tax rate was 35%.

1. Determine the dollar amount of the corporation’s income from continuing operations (after taxes) for the year ended December 31.
 
Income from continuing operations before income taxes
$3,800,000
Income taxes expense (35%)
$1,330,000
Income from continuing operations after income taxes
$2,470,000
 
 
2. Determine the dollar amount of the corporation’s income (loss) from discontinued operations (after taxes).
 
Income from discontinued operations before income taxes
($600,000)
Income taxes expense (35%)
($210,000)
Income (Loss) from discontinued operations after income taxes
($390,000)
 
 
3. Determine the dollar amount of the corporation’s gain on disposal of discontinued operations (after taxes).
 
Gain on disposal of discontinued operations before income taxes
$250,000
Income taxes expense (35%)
$87,500
Gain on disposal of discontinued operations after income taxes
$162,500
 
 
4. Prepare the section of the MacKinnon Corporation’s income statement for the year ended December 31, beginning with income before taxes.
 
Income before taxes
$3,800,000
Income taxes expense (35%)
$1,330,000
Income from continuing operations
$2,470,000
Discontinued operations    
Income (Loss)  from insurance operations, less income taxes of $210,000
($390,000)
 
Gain on disposal of insurance operations, less income taxes of $87,500
$162,500
 ($227,500)
Net income  
$2,242,500
 
 
Exercise 13.4: Extraordinary Item: Early Retirement of Debt

The Hersom Corporation paid $10,300,000 to retire one of its bond issues on May 1. The bonds were $10,000,000, 9%, 20-year bonds, issued 10 years ago at their principal amount. The company’s effective income tax rate is 35%. The corporation reported $8,450,000 income before extraordinary items (after taxes) for the year ended December 31.

1. Calculate the gain or loss before taxes the company recognized when it retired the bonds. Assume that all appropriate interest payments were made before they were retired.
 
Cash paid on bond retirement
$10,300,000
Bonds payable
$10,000,000
Loss on retirement of bonds before taxes
$300,000
 
 
2. Calculate the gain or loss after taxes the company recognized when it retired the bonds. Assume that all appropriate interest payments were made before they were retired.
 
Loss on retirement of bonds before taxes
$300,000
Income taxes expense (35%)
$105,000
Loss on retirement of bonds after taxes
$195,000
 
 
3. Prepare the section of the Hersom Corporation’s income statement beginning with income before extraordinary items.
 
Income before extraordinary items
$8,450,000
Extraordinary item: loss of early retirement of debt, less income taxes of $105,000
 ($195,000)
Net income  
$8,255,000
 
 
4. In addition to the above, assume the Hersom Corporation reported the following results from discontinuing its real estate segment: income from real estate operations $110,000 less income taxes of $38,500; loss on sale of real estate segment $330,000 less income taxes of $115,500. Prepare the section of the Hersom Corporation’s income statement for the year ended December 31, beginning with $13,220,000 income before taxes. Hint: the company’s net income should be the same as in part 3.
 
Income before taxes
$13,220,000
Income taxes expense (35%)
$4,627,000
Income from continuing operations
$8,593,000
Discontinued operations    
Income from real estate operations, less income taxes of $38,500
$71,500
 
Loss on disposal of real estate segment, less income taxes of $115,500
 ($214,500)
 ($143,000)
Income before extraordinary items
$8,450,000
Extraordinary item: loss of early retirement of debt, less income taxes of $105,000
 ($195,000)
Net income  
$8,255,000
 
 
Exercise 13.5: Accounting Changes

The Santos Corporation changed its display equipment depreciation method. The change resulted in $20,000 additional depreciation expense in the year ended December 31. If the new method had been used in previous years, depreciation expense would have totaled $800,000 instead of the $720,000 recorded in those years. The company’s effective income tax rate has remained at 35%. The corporation reported $7,075,250 income after extraordinary items (after taxes) for the year ended December 31.

1. Calculate the Santos Corporation’s before taxes cumulative effect of changing its depreciation method.
 
Depreciation using the new method
$800,000
Depreciation using the previous method
$720,000
Cumulative effect of the change (before taxes)
$80,000
 
 
2. Calculate the Santos Corporation’s after taxes cumulative effect of changing its depreciation method.
 
Cumulative effect of the change (before taxes)
$80,000
Income taxes (35%)
$28,000
Cumulative effect of the change (after taxes)
$52,000
 
 
3. Prepare the section of the Santos Corporation’s income statement for the year ended December 31, beginning with income before accounting changes.
 
Income before accounting changes
$7,075,250
Cumulative effect of change in depreciation method, less income taxes of $28,000
 ($52,000)
Net income  
$7,023,250
 
 
4. In addition to the above, assume the Santos Corporation also reported the following results from discontinuing its financing segment: income from financing operations $220,000 less income taxes of $77,000; gain on sale of financing segment $450,000 less income taxes of $157,500. The company also reported a loss of $85,000 before taxes ($55,250 after taxes) from early retirement of debt. Prepare the section of the Santos Corporation’s income statement for the year ended December 31, beginning with $10,300,000 income before taxes. Hint: the company’s net income should be the same as in part 3.
 
Income before taxes
$10,300,000
Income taxes expense (35%)
$3,605,000
Income from continuing operations
$6,695,000
Discontinued operations    
Income from financing operations, less income taxes of $77,000
$143,000
 
Gain on disposal of financing segment, less income taxes of $157,500
 $292,500
 $435,500
Income before extraordinary items and accounting changes
$7,130,500
Extraordinary item: loss of early retirement of debt, less income taxes of $24,750
 ($55,250)
Income before accounting changes
$7,075,250
Cumulative effect of change in depreciation method, less income taxes of $28,000
 ($52,000)
Net income  
$7,023,250
 
 
Exercise 13.6 Classified Income Statement

The following information for the fiscal year ended January 31 was gathered from the Veronelli Corporation’s accounting system. The company’s effective income tax rate for 1997 is 35%.
 
Cost of goods sold
$8,400,000
Cumulative effect of changing depreciation methods, less income taxes $12,600
($23,400)
Gain on disposal of newspaper segment, less income taxes of $43,750
$81,250
Income (loss) from operations of newspaper segment, less income taxes of $26,250
($48,750)
Income taxes expense
$910,000
Loss on early retirement of debt, less income taxes of $21,000
($39,000)
Operating expenses
$3,000,000
Sales
$14,000,000

Prepare a classified income statement for the Veronelli Corporation for the year ended January 31, beginning with sales and ending with net income.
 
 
Sales
$14,000,000
Cost of goods sold
$8,400,000
Gross profit
$5,600,000
Operating expenses
$3,000,000
Income before taxes
$2,600,000
Income taxes expense (35%)
$910,000
Income from continuing operations after income taxes
$1,690,000
Discontinued operations    
Income (loss) from newspaper operations, less income taxes of $26,250
($48,750)
 
Gain on disposal of newspaper segment, less income taxes of $43,750
 $81,250
 $32,500
Income before extraordinary items and accounting changes
$1,722,500
Extraordinary item: loss of early retirement of debt, less income taxes of $21,000
 ($39,000)
Income before accounting changes
$1,683,500
Cumulative effect of changing depreciation methods, less income taxes of $12,600
 ($23,400)
Net income  
$1,660,100
 
 
Exercise 13.7 Earnings Per Share: No Preferred Stock: No Additional Shares Issued

The stockholders’ equity section of the Holloway Corporation’s May 31 balance sheet is as follows.
 
Stockholders’ Equity
 
Contributed Capital  
Common Stock, $1 par, 500,000 shares authorized, 400,000 shares issued
$400,000
Additional Paid-in Capital, Common Stock
$2,400,000
Total Contributed Capital
$2,800,000
Retained Earnings
$7,300,000
Total Stockholders’ Equity
$10,100,000

The Holloway Corporation reported $340,000 net income for the fiscal year ended May 31. During the year, the company did not issue any common stock. Calculate the corporation’s earnings per share for the year ended May 31.

Earnings per share = net income available to common stockholders / average number of common shares outstanding

Earnings per share  = $340,000 / 400,000 common shares = $.85 per share
 
 
Exercise 13.8 Earnings Per Share: No Preferred Stock: Additional Shares Issued

The stockholders’ equity section of the Mathews Corporation’s December 31 balance sheet is as follows.
 
Stockholders’ Equity
 
Contributed Capital  
Common Stock, $.25 par, 800,000 shares authorized, 600,000 shares issued
$150,000
Additional Paid-in Capital, Common Stock
$3,450,000
Total Contributed Capital
$3,600,000
Retained Earnings
$9,100,000
Total Stockholders’ Equity
$12,700,000

The Mathews Corporation began the rear with 400,000 shares of common stock outstanding and issued another 200,000 shares on October 1. The corporation reported $945,000 net income for the fiscal year ended December 31.

1. Calculate the average number of common shares outstanding during the year.
 
400,000 shares x 9 months (January through September)
3,600,000
600,000 shares x 3 months (October through December)
1,800,000
Total common shares
5,400,000
   
Average common shares outstanding: (5,400,000 / 12 months)
 450,000
 
 
2. Calculate the corporation’s earnings per share for the year ended December 31.

Earnings per share = net income available to common stockholders / average number of common shares outstanding

Earnings per share = $945,000 / 450,000 shares = $2.10
 
 
Exercise 13.9 Earnings Per Share: Preferred Stock: Additional Shares Issued

The stockholders’ equity section of the Weza Corporation’s December 31 balance sheet is as follows
 
Stockholders’ Equity
 
Contributed Capital  
8% Preferred Stock, $100 par, 300,000 shares authorized, 200,000 shares issued
$20,000,000
Common Stock, $1 par, 15,000,000 shares authorized, 8,000,000 shares issued
$8,000,000
Additional Paid-in Capital, Common Stock
$40,000,000
Total Contributed Capital
$68,000,000
Retained Earnings
$19,600,000
Total Stockholders’ Equity
$87,600,000

The Weza Corporation began the year with 7,000,000 shares of common stock outstanding and issued another 1,000,000 shares on July 1. The corporation reported $2,500,000 net income for the fiscal year ended December 31.

1. Calculate the average number of common shares outstanding during the year.
 
7,000,000 shares x 6 months (January through June)
42,000,000
8,000,000 shares x 6 months (July through December)
48,000,000
Total common shares
90,000,000
   
Average common shares outstanding (90,000,000 / 12 months)
 7,500,000
 
 
2. Calculate the dollar amount of the Weza Corporation’s net income available to common stockholders.
 
Total net income
$2,500,000
Dividends on preferred stock ($20,000,000 x .08)
$1,600,000
Net income available to common stockholders
$900,000
 
 
3. Calculate the corporation’s earnings per share for the year ended December 31.

Earnings per share = net income available to common stockholders / average number of common shares outstanding

Earnings per share = $900,000 / 7,500,000 shares = $.12
 
 
Exercise 13.10 Dividends Payout Ratio

The stockholders’ equity section of the Bartlett Corporation’s December 31 balance sheet is as follows
 
Stockholders’ Equity
 
Contributed Capital  
6% Preferred Stock, $100 par, 500,000 shares authorized, 50,000 shares issued
$5,000,000
Common Stock, $1 par, 40,000,000 shares authorized, 6,000,000 shares issued
$6,000,000
Additional Paid-in Capital, Common Stock
$25,000,000
Total Contributed Capital
$36,000,000
Retained Earnings
$8,100,000
Total Stockholders’ Equity
$44,100,000

The Bartlett Corporation began the year with 5,600,000 shares of common stock outstanding and issued another 400,000 shares on July 1. The corporation reported $4,300,000 net income for the fiscal year ended December 31 and paid total cash dividends of $900,000.

1. Calculate the corporation's preferred stock dividends for the year ended December 31.

Preferred stock dividends = $5,000,000 preferred stock x .06 = $300,000.
 
 
2. Calculate the corporation's common stock dividends for the year ended December 31.
 
Total dividends
$900,000
Dividends on preferred stock
$300,000
Common stock dividends
$600,000
 
 
3. Calculate the net income available to common stockholders for the year ended December 31.
 
Total net income
$4,300,000
Dividends on preferred stock
$300,000
Net income available to common stockholders
$4,000,000
 
 
4. Calculate the dividends payout ratio for the year ended December 31.

Dividends payout ratio = common stock cash dividends / net income available to common stockholders.

Dividends payout ratio = $600,000 / $4,000,000 = .15.
 
 
5. Calculate the total cash dividends the company would have had to distribute in the year ended December 31 in order for it to have had a dividend payout ratio of .20.

Dividends payout ratio = common stock cash dividends / net income available to common stockholders.

Dividend payout ratio = (total cash dividends - preferred stock dividends) / net income available to common stockholders.

.20 = (total cash dividends - $300,000)/$4,000,000

total cash dividends - $300,000 = .20 x $4,000,000

total cash dividends - $300,000 = $800,000

total cash dividends = $800,000 + $300,000 = $1,100,000
 

 
 
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